**UNITED STATESSECURITIES AND EXCHANGE  COMMISSION**Washington,DC 20549

**FORM10-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 June 29, 2007** |
| ** **                                        |
| **or**                                            |
|                                              |
| **o**                                             | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15  (d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                              |
| ** **                                        | **For the transition period from                      to                ** |
| ** **                                        |
| ** **                                        | **Commission file number:    000-51928** |
|                                                   |  |  |

 

**CPI INTERNATIONAL, INC.**

(ExactName of Registrant as Specified in Its Charter)

**Delaware**

(State or OtherJurisdiction of Incorporation or Organization)

** **

**75-3142681**

(I.R.S. EmployerIdentification No.)

** **

**811Hansen WayPalo Alto, California 94303-1110(650) 846-2900**

(Addressof Principal Executive Offices and Telephone Number,Including Area Code)

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrant wasrequired to file such reports) and (2) has been subject to such filingrequirements for the past 90 days. Yes x     No o 

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer andlarge accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one): 

Large acceleratedfiler  o                   Acceleratedfiler  o                   Non-acceleratedfiler  x

Indicateby check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act). Yes o    No x

**APPLICABLEONLY TO CORPORATE ISSUERS:**

Indicate the number of shares outstanding for each of the registrant’sclasses of Common Stock, as of the latest practicable date: 16,355,696 sharesof Common Stock, $0.01 par value, at August 6, 2007.

 

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**CPI INTERNATIONAL, INC.**

andSubsidiaries

**10-Q REPORT**

**INDEX**
| Part I: FINANCIAL  INFORMATION | 4         |
|--------------------------------|-----------|
|                           | Item 1.   | Unaudited  Condensed Consolidated Financial Statements | 4 |
|                           |      |   | Condensed  Consolidated Balance Sheets | 4 |
|                           |      |   | Condensed  Consolidated Statements of Operations and Comprehensive Income | 5 |
|                           |      |   | Condensed  Consolidated Statements of Cash Flows | 6 |
|                           |      |   | Notes to  Unaudited Condensed Consolidated Financial Statements | 7 |
|                           | Item 2.   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 33 |
|                           | Item 3.   | Quantitative  and Qualitative Disclosures About Market Risk | 52 |
|                           | Item 4.   | Controls and  Procedures | 53 |
|                           |      |
| Part II: OTHER  INFORMATION    | 54        |
|                           |      |   | 54 |
|                           | Item 1.   | Legal Proceedings | 54 |
|                           | Item  1A. | Risk  Factors | 54 |
|                           | Item 2.   | Unregistered  Sales of Equity Securities and Use of Proceeds | 54 |
|                           | Item 3.   | Defaults Upon  Senior Securities | 54 |
|                           | Item 4.   | Submission of  Matters to a Vote of Security Holders | 54 |
|                           | Item 5.   | Other Information | 54 |
|                           | Item  6.  | Exhibits | 55 |

 

 

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**CPI INTERNATIONAL, INC.**

andSubsidiaries

***Cautionary StatementsRegarding Forward-Looking Statements***

This document contains forward-lookingstatements within the meaning of Section 27A of the Securities Act of 1933, asamended, and Section 21E of the Securities Exchange Act of 1934, as amended,that relate to future events or our future financial performance. In somecases, 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 comparableterminology. These statements are only predictions. Actual events or resultsmay differ materially.

Although we believe that the expectationsreflected in the forward-looking statements are reasonable, we cannot guaranteefuture results, levels of activity, performance or achievements. Moreover,neither we nor any other person assumes responsibility for the accuracy andcompleteness of the forward-looking statements. Forward-looking statements aresubject to known and unknown risks and uncertainties, which could cause actualresults to differ materially from the results projected, expected or implied bythe forward-looking statements. These risk factors include, without limitation,competition in our end markets; our significant amount of debt; changes orreductions in the United States defense budget; U.S. government contracts lawsand regulations; changes in technology; the impact of unexpected costs; inabilityto obtain raw materials and components; and currency fluctuations. All writtenand oral forward-looking statements made in connection with this report thatare attributable to us or persons acting on our behalf are expressly qualifiedin their entirety by the foregoing risk factors and other cautionary statementsincluded herein and in our other filings with the Securities and ExchangeCommission (SEC). We are under no duty to update any of the forward-lookingstatements after the date of this report to conform such statements to actualresults or to changes in our expectations.

The information in this report is not acomplete description of our business or the risks and uncertainties associatedwith an investment in our securities. You should carefully consider the variousrisks and uncertainties that impact our business and the other information inthis report and in our other filings with the SEC before you decide to investin our securities or to maintain or increase your investment.

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**CPI INTERNATIONAL, INC.**

andSubsidiaries

# **Part I:  FINANCIAL INFORMATION**

## **Item 1.    Unaudited CondensedConsolidated Financial Statements**

### **CONDENSED CONSOLIDATED BALANCE SHEETS**

(In thousands, except share and per share data – unaudited)
| ** **                                                                                                            | ** ** | **June 29,** | ** ** | **September 29,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|------------------------|------------|
| ** **                                                                                                            | ** ** | **2007**          | ** ** | **2006**               | ** ** |
| **Assets**                                                                                                            | ** ** | ** **        | ** ** | ** **             | ** ** |
| Current Assets:                                                                                                       |       |              |       |                   |       |
| Cash and cash equivalents                                                                                             |       | $                 | 39,420     |                   | $          | 30,153 |   |
| Restricted cash                                                                                                       |       | 3,046             |       | 1,746                  |       |
| Accounts receivable, net                                                                                              |       | 46,591            |       | 43,628                 |       |
| Inventories                                                                                                           |       | 60,350            |       | 54,031                 |       |
| Deferred tax assets                                                                                                   |       | 11,190            |       | 11,520                 |       |
| Prepaid and other current assets                                                                                      |       | 5,907             |       | 3,080                  |       |
| Total current assets                                                                                                  |       | 166,504           |       | 144,158                |       |
| Property, plant,  and equipment, net                                                                                  |       | 65,362            |       | 63,851                 |       |
| Deferred debt  issue costs, net                                                                                       |       | 8,543             |       | 9,644                  |       |
| Intangible  assets, net                                                                                               |       | 73,689            |       | 75,489                 |       |
| Goodwill                                                                                                              |       | 147,270           |       | 147,489                |       |
| Other long-term  assets                                                                                               |       | 844               |       | 1,128                  |       |
| Total assets                                                                                                          |       | $                 | 462,212    |                   | $          | 441,759 |   |
|                                                                                                                  |       |              |       |                   |       |
| **Liabilities  and stockholders’ equity**                                                                        | ** ** | ** **        | ** ** | ** **             | ** ** |
| Current  Liabilities:                                                                                                 |       |              |       |                   |       |
| Current portion of long-term debt                                                                                     |       | $                 | 1,000      |                   | $          | 1,714 |   |
| Accounts payable                                                                                                      |       | 20,580            |       | 19,101                 |       |
| Accrued expenses                                                                                                      |       | 26,037            |       | 23,269                 |       |
| Product warranty                                                                                                      |       | 5,527             |       | 5,958                  |       |
| Income taxes payable                                                                                                  |       | 6,820             |       | 10,693                 |       |
| Advance payments from customers                                                                                       |       | 8,970             |       | 6,310                  |       |
| Total current liabilities                                                                                             |       | 67,934            |       | 67,045                 |       |
| Deferred income  taxes                                                                                                |       | 29,865            |       | 29,933                 |       |
| Long-term debt,  less current portion                                                                                 |       | 240,822           |       | 245,067                |       |
| Other long-term  liabilities                                                                                          |       | 79                |       | 41                     |       |
| Total liabilities                                                                                                     |       | 339,700           |       | 342,086                |       |
| Commitments and  contingencies                                                                                        |       |              |       |                   |       |
| Stockholders’  equity                                                                                            |       |              |       |                   |       |
| Common stock ($0.01 par value, 90,000,000 shares authorized;16,333,794  and 16,049,577 shares issued and outstanding) |       | 163               |       | 160                    |       |
| Additional paid-in capital                                                                                            |       | 67,991            |       | 65,295                 |       |
| Accumulated other comprehensive income                                                                                |       | 1,093             |       | 679                    |       |
| Retained earnings                                                                                                     |       | 53,265            |       | 33,539                 |       |
| Total stockholders’ equity                                                                                       |       | 122,512           |       | 99,673                 |       |
| Total liabilities and stockholders’ equity                                                                       |       | $                 | 462,212    |                   | $          | 441,759 |   |

 

**The accompanying notes are an integral part of theseunaudited condensed consolidated financial statements.**

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### **CONDENSED CONSOLIDATEDSTATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME**

(In thousands, except shareand per share data – unaudited)
| ** **                                             | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                             | ** ** | **June 29,  2007**          | ** ** | **June 30,  2006**         | ** ** | **June 29,  2007** | ** ** | **June 30,  2006** | ** ** |
| Sales                                                  |       | $                                | 87,318     |                            | $          | 87,761 |   | $ | 259,485 |   | $ | 257,069 |   |
| Cost of sales                                          |       | 58,667                           |       | 60,867                          |       | 176,548 |   | 179,223 |   |
| Gross profit                                           |       | 28,651                           |       | 26,894                          |       | 82,937 |   | 77,846 |   |
| Operating costs  and expenses:                         |       |                             |       |                            |       |   |   |   |   |
| Research and development                               |       | 2,232                            |       | 2,515                           |       | 6,475 |   | 6,366 |   |
| Selling and marketing                                  |       | 4,911                            |       | 5,248                           |       | 14,539 |   | 14,952 |   |
| General and administrative                             |       | 5,835                            |       | 5,441                           |       | 16,085 |   | 17,419 |   |
| Amortization of acquisition-related intangible  assets |       | 548                              |       | 548                             |       | 1,642 |   | 1,642 |   |
| Net loss on disposition of fixed assets                |       | 16                               |       | 212                             |       | 74 |   | 420 |   |
| Total operating  costs and expenses                    |       | 13,542                           |       | 13,964                          |       | 38,815 |   | 40,799 |   |
| Operating income                                       |       | 15,109                           |       | 12,930                          |       | 44,122 |   | 37,047 |   |
| Interest  expense, net                                 |       | 5,143                            |       | 5,945                           |       | 15,757 |   | 18,409 |   |
| Income before  income taxes                            |       | 9,966                            |       | 6,985                           |       | 28,365 |   | 18,638 |   |
| Income tax  expense                                    |       | 1,835                            |       | 2,517                           |       | 8,639 |   | 7,610 |   |
| Net income                                             |       | $                                | 8,131      |                            | $          | 4,468 |   | $ | 19,726 |   | $ | 11,028 |   |
|                                                   |       |                             |       |                            |       |   |   |   |   |
| Other  comprehensive income, net of tax                |       |                             |       |                            |       |   |   |   |   |
| Net unrealized gain (loss) on cash flow hedges         |       | 820                              |       | (196                            | )          | 414 |   | (685 | ) |
| Comprehensive  income                                  |       | $                                | 8,951      |                            | $          | 4,272 |   | $ | 20,140 |   | $ | 10,343 |   |
|                                                   |       |                             |       |                            |       |   |   |   |   |
| Earnings per  share - Basic                            |       | $                                | 0.50       |                            | $          | 0.30 |   | $ | 1.22 |   | $ | 0.80 |   |
| Earnings per  share - Diluted                          |       | $                                | 0.46       |                            | $          | 0.27 |   | $ | 1.11 |   | $ | 0.71 |   |
|                                                   |       |                             |       |                            |       |   |   |   |   |
| Shares used to compute  earnings per share - Basic     |       | 16,306,256                       |       | 15,039,754                      |       | 16,206,873 |   | 13,736,031 |   |
| Shares used to compute  earnings per share - Diluted   |       | 17,796,425                       |       | 16,766,822                      |       | 17,696,217 |   | 15,443,427 |   |

**Theaccompanying notes are an integral part of these unaudited condensedconsolidated financial statements.**

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### **CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

 (In thousands – unaudited)
| ** **                                                       | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                       | ** ** | **June 29,**               | ** ** | **June 30,** | ** ** |
| ** **                                                       | ** ** | **2007**                        | ** ** | **2006** | ** ** |
| ** **                                                       | ** ** | ** **                      | ** ** | ** ** | ** ** |
| **Cash  flows from operating activities**                        | ** ** | ** **                      | ** ** | ** ** | ** ** |
| Net cash provided by operating activities                        |       | $                               | 19,259     |   | $ | 1,918 |   |
|                                                             |       |                            |       |   |   |
| **Cash  flows from investing activities**                        |       |                            |       |   |   |
| Deferred expenses relating to sale of San Carlos  property       |       | —                          |       | (212 | ) |
| Capital expenditures                                             |       | (6,392                          | )          | (8,419 | ) |
| Capitalized expenses relating to potential business  acquisition |       | (395                            | )          | — |   |
| Net cash used in investing activities                            |       | (6,787                          | )          | (8,631 | ) |
|                                                             |       |                            |       |   |   |
| **Cash  flows from financing activities**                        |       |                            |       |   |   |
| Proceeds from issuance of debt                                   |       | —                          |       | 10,000 |   |
| Repayments of debt                                               |       | (5,000                          | )          | (47,500 | ) |
| Proceeds from issuance of common stock                           |       | —                          |       | 52,942 |   |
| Proceeds upon exercise of stock options                          |       | 604                             |       | — |   |
| Proceeds from ESPP shares issued                                 |       | 520                             |       | — |   |
| Payment of IPO financing costs                                   |       | —                          |       | (5,634 | ) |
| Stockholder distribution payments                                |       | —                          |       | (17,000 | ) |
| Excess tax benefit on stock option exercises                     |       | 671                             |       | — |   |
| Net cash used in financing activities                            |       | (3,205                          | )          | (7,192 | ) |
|                                                             |       |                            |       |   |   |
| **Net  increase (decrease) in cash and cash equivalents**        |       | 9,267                           |       | (13,905 | ) |
| Cash and cash equivalents at beginning of period                 |       | 30,153                          |       | 26,511 |   |
| Cash and cash equivalents at end of period                       |       | $                               | 39,420     |   | $ | 12,606 |   |
|                                                             |       |                            |       |   |   |
| **Supplemental  disclosure of cash flow information**            |       |                            |       |   |   |
| Interest paid                                                    |       | $                               | 11,562     |   | $ | 13,714 |   |
| Income taxes paid, net of refunds                                |       | $                               | 12,799     |   | $ | 5,205 |   |

 

**Theaccompanying notes are an integral part of these unaudited condensedconsolidated financial statements.**

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**NOTES TOUNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

(All tabular dollar amounts in thousands except share and per shareamounts)

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

*The Company*

Unless the context otherwise requires, “CPIInternational” means CPI International, Inc., and “CPI” means Communications& Power Industries, Inc. CPI is a direct subsidiary of CPI International.CPI International is a holding company with no operations of its own. The termthe “Company” refers to CPI International and its subsidiaries on aconsolidated basis.

The accompanying unaudited condensedconsolidated financial statements represent the consolidated results andfinancial position of CPI International, which is controlled by affiliates ofThe Cypress Group (“Cypress”). CPI International, through its wholly ownedsubsidiary, CPI, develops, manufactures, and distributes microwave and powergrid Vacuum Electron Devices (“VED”), microwave amplifiers, modulators andvarious other power supply equipment and devices. The Company has tworeportable segments, VED and satcom equipment.

*Basis of Presentation and Consolidation*

The Company’s fiscal year is the 52- or 53-week period that ends on theFriday nearest September 30. Fiscal year 2007 comprises the 52-week periodending September 28, 2007 and fiscal year 2006 comprised the 52-week periodended September 29, 2006. All period references are to the Company’s fiscalperiods unless otherwise indicated.

The accompanying unaudited condensed consolidated financial statementsof the Company as of June 29, 2007 and for the three and nine months ended June29, 2007 are unaudited and reflect all normal recurring adjustments which are,in the opinion of management, necessary for the fair statement of suchfinancial statements. These unaudited condensed consolidated financialstatements should be read in conjunction with the Company’s consolidatedfinancial statements and notes thereto included in the Company’s Annual Reporton Form 10-K for the fiscal year ended September 29, 2006.  Thecondensed consolidated balance sheet as of September 29, 2006 has been derivedfrom the audited financial statements at that date. The results ofoperations for the interim period ended June 29, 2007 are not necessarilyindicative of results to be expected for the full year.

The accompanying unaudited condensed consolidatedfinancial statements include the accounts of the Company and its wholly ownedsubsidiaries.  All significant intercompany balances, transactions, andstockholdings have been eliminated in consolidation.

*Use of Estimates and Assumptions*

The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States of America requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities, disclosure of contingent assets and liabilities atthe date of the condensed consolidated financial statements and the reportedamounts of sales and costs and expenses during the reporting period. On anongoing basis, the Company evaluates its estimates, including those related toprovision for revenue recognition, market values for inventories reported atlower of cost or market, product warranty, and recoverability and valuation ofrecorded amounts of long-lived assets and identifiable intangible assets,including goodwill. The Company bases its estimates on various factors andinformation, which may include, but are not limited to, history and priorexperience, experience of other enterprises in the same industry, new relatedevents, current economic conditions and 

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informationfrom third party professionals that are believed to be reasonable under thecircumstances, the results of which form the basis for making judgments about thecarrying values of assets and liabilities that are not readily apparent fromother sources.  Actual results may differ from these estimates underdifferent assumptions or conditions.

*Revenue Recognition*

Sales are recognized when persuasive evidenceof an arrangement exists, delivery has occurred, the price is fixed ordeterminable, and collectibility is reasonably assured. The Company’s productsare generally subject to warranties, and the Company provides for the estimatedfuture costs of repair, replacement or customer accommodation in cost of sales.

The Company has commercial and U.S.Government fixed-price contracts that are accounted for under AmericanInstitute of Certified Public Accountants Statement of Position No. 81-1, “Accountingfor Performance of Construction-Type and Certain Production-Type Contracts.”These contracts are generally longer than one year in duration and include amaterial amount of product development. The Company uses thepercentage-of-completion method when reasonably dependable estimates of theextent of progress toward completion, contract revenues and contract costs canbe made. The portion of revenue earned or the amount of gross profit earned fora period is determined by measuring the extent of progress toward completionusing total cost incurred to date and estimated costs at contract completion.

Sales under cost-reimbursement contracts,which are primarily for research and development, are recorded as costs areincurred and include estimated earned fees in the proportion that costsincurred to date bear to total estimated costs. The fees under certaincommercial and U.S. Government contracts may be increased or decreased inaccordance with cost or performance incentive provisions that measure actualperformance against established targets or other criteria. Such incentive feeawards or penalties are included in revenue at the time the amounts can bereasonably determined.

**2.****                                     ****Supplemental Balance Sheet Information**

**Accounts Receivable:** Accountsreceivable are stated net of allowances for doubtful accounts of approximately$0.1 million and $0.5 million at June 29, 2007 and September 29, 2006,respectively.

**Inventories:** The followingtable provides details of inventories, net of reserves:
|                         | ** ** | **June 29,** | ** ** | **September 29,** | ** ** |
|-------------------------|------------|-------------------|------------|------------------------|------------|
| ** **              | ** ** | **2007**          | ** ** | **2006**               | ** ** |
| Raw material and  parts |       | $                 | 38,475     |                   | $          | 35,160 |   |
| Work in process         |       | 12,982            |       | 10,481                 |       |
| Finished goods          |       | 8,893             |       | 8,390                  |       |
|                    |       | $                 | 60,350     |                   | $          | 54,031 |   |

 

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**Reservefor excess, slow moving and obsolete inventory:** The following tablesummarizes the activity related to reserves for excess, slow moving andobsolete inventory:

|                                                | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------|------------|---------------------------------|------------|
| ** **                                     | ** ** | **June 29, 2007**     | ** ** | **June 30, 2006** | ** ** |
| Balance at  beginning of period                |       | $                               | 8,822      |   | $ | 8,655 |   |
| Inventory  provision, charged to cost of sales |       | 803                             |       | 898 |   |
| Inventory  write-offs                          |       | (710                            | )          | (259 | ) |
| Balance at end of  period                      |       | $                               | 8,915      |   | $ | 9,294 |   |

 

**Reserve for loss contracts andcost in excess of market inventory:** The following tablesummarizes the activity related to reserves for loss contracts and cost inexcess of market inventory:
|                                                                                                 | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                      | ** ** | **June 29, 2007**     | ** ** | **June 30, 2006** | ** ** |
| Balance at  beginning of period                                                                 |       | $                               | 1,702      |   | $ | 1,430 |   |
| Provision for  loss contracts and cost in excess of market inventory, charged to cost of  sales |       | 970                             |       | 1,350 |   |
| Credit to cost  of sales upon revenue recognition                                               |       | (1,202                          | )          | (1,145 | ) |
| Balance at end  of period                                                                       |       | $                               | 1,470      |   | $ | 1,635 |   |

 

**IntangibleAssets:** The following tables present the details of the Company’s totalacquisition-related intangible assets:
| ** **                  | ** ** | **June 29, 2007** | ** ** | **September 29, 2006** | ** ** |
|-----------------------------|------------|-----------------------------|------------|----------------------------------|------------|
| ** **                  | ** ** | **Cost**                    | ** ** | **Accumulated  Amortization**    | ** ** | **Net** | ** ** | **Cost** | ** ** | **Accumulated  Amortization** | ** ** | **Net** | ** ** |
| ** **                  | ** ** | ** **                  | ** ** | ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| VED Core  Technology        |       | $                           | 30,700     |                             | $          | (2,120 | ) | $ | 28,580 |   | $ | 30,700 |   | $ | (1,659 | ) | $ | 29,041 |   |
| VED Application  Technology |       | 19,800                      |       | (2,723                           | )          | 17,077 |   | 19,800 |   | (2,130 | ) | 17,670 |   |
| X-ray Generator  and Satcom |       |                        |       |                             |       |   |   |   |   |   |   |   |   |
| ApplicationTechnology       |       | 8,000                       |       | (1,840                           | )          | 6,160 |   | 8,000 |   | (1,441 | ) | 6,559 |   |
| Customer backlog            |       | 17,450                      |       | (17,450                          | )          | — |   | 17,450 |   | (17,450 | ) | — |   |
| Land lease                  |       | 11,810                      |       | (865                             | )          | 10,945 |   | 11,810 |   | (706 | ) | 11,104 |   |
| Tradename                   |       | 5,800                       |       | —                           |       | 5,800 |   | 5,800 |   | — |   | 5,800 |   |
| Customer list  and programs |       | 5,700                       |       | (622                             | )          | 5,078 |   | 5,700 |   | (451 | ) | 5,249 |   |
| Noncompete  agreement       |       | 110                         |       | (61                              | )          | 49 |   | 110 |   | (44 | ) | 66 |   |
|                        |       | $                           | 99,370     |                             | $          | (25,681 | ) | $ | 73,689 |   | $ | 99,370 |   | $ | (23,881 | ) | $ | 75,489 |   |

 

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Theestimated future amortization expense of purchased intangibles as of June 29,2007, excluding the Company’s unamortized tradename, was as follows:
| Fiscal Year               | ** ** | ** ** | ** ** |
|--------------------------------|------------|------------|------------|
| 2007 (remaining  three months) |       | $          | 611        |   |
| 2008                           |       | 2,442      |       |
| 2009                           |       | 2,441      |       |
| 2010                           |       | 2,420      |       |
| 2011                           |       | 2,420      |       |
| Thereafter                     |       | 57,555     |       |
|                           |       | $          | 67,889     |   |

 

**3.****                                     ****Long-TermDebt**

Long-termdebt comprises the following:
|                                                                               | ** ** | **June 29,** | ** ** | **September 29,** | ** ** |
|-------------------------------------------------------------------------------|------------|-------------------|------------|------------------------|------------|
| ** **                                                                    | ** ** | **2007**          | ** ** | **2006**               | ** ** |
|                                                                          |       |              |       |                   |       |
| Term loan,  expiring 2010                                                     |       | $                 | 37,500     |                   | $          | 42,500 |   |
| 8% Senior  subordinated notes, due 2012                                       |       | 125,000           |       | 125,000                |       |
| Floating rate  senior notes, due 2015, net of issue discount of $678 and $719 |       | 79,322            |       | 79,281                 |       |
|                                                                          |       | 241,822           |       | 246,781                |       |
| Less: Current  portion                                                        |       | 1,000             |       | 1,714                  |       |
| Long-term portion                                                             |       | $                 | 240,822    |                   | $          | 245,067 |   |

 

**Senior Credit Facility and TermLoan of CPI:**In fiscal year 2004, CPI entered into a $130.0million credit agreement, which was amended and restated on November 29, 2004,and further amended on February 16, 2005, April 13, 2005, and December 15, 2005(the “Senior Credit Facility”). The Senior Credit Facility consists of a $40.0million revolving commitment, with a sub-facility of $15.0 million for lettersof credit and $5.0 million for swingline loans (“Revolver”), which expires onJanuary 23, 2010, and a $90.0 million term loan (“Term Loan”), which expires onJuly 23, 2010. As of June 29, 2007, the Company had no outstanding borrowingsunder the Revolver and $37.5 million outstanding under the Term Loan, aftertaking into account a $5.0 million Term Loan repayment in December 2006 usingavailable operating cash. The $5.0 million Term Loan repayment included a $1.7million ECF (as defined below) payment, and an optional prepayment of $3.3million. Upon certain specified conditions, including compliance on a pro formabasis with the covenants in the Senior Credit Facility, CPI may seekcommitments for a new class of term loans, not to exceed $65.0 million. TheSenior Credit Facility is guaranteed by CPI International and all of CPI’sdomestic subsidiaries and is secured by substantially all of their and CPI’sassets.

Borrowings under the Revolver would bearinterest at a rate equal to, at CPI’s option, London Interbank Offered Rate(LIBOR) plus 2.75% per annum, or the Alternate Base Rate (ABR) plus 1.75% perannum. Available borrowings under the Revolver are reduced by any amountssecured through letters of credit; at June 29, 2007, the Company had letters ofcredit commitments for $3.7 million. The Term Loan borrowings bear interest ata rate equal to, at CPI’s option, LIBOR plus 2.25% per annum or the

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ABR plus 1.25% per annum,payable quarterly. The ABR is the greater of the (a) Prime Rate and (b) FederalFunds Rate plus 0.50%. In addition to customary fronting and administrativefees under the Senior Credit Facility, CPI pays letter of credit participationfees equal to the applicable Revolver LIBOR margin per annum on the averagedaily amount of the letter of credit exposure, and a commitment fee of 0.50%per annum on the average daily unused amount of revolving commitment. As ofJune 29, 2007 (1) the Term Loan borrowings consisted of one tranche of $5.5million and one tranche of $32.0 million with interest payable on July 16, 2007and July 25, 2007, each at 7.6% per annum, and (2) a Revolving commitment of$3.7 million for letter of credit exposure, with letter of credit participationfees and fronting fees payable quarterly at a combined interest rate of 3.0%per annum.

CPI is required to make an annual prepaymentwithin 90 days after the end of each fiscal year based on a calculation ofExcess Cash Flow (“ECF”), as defined in the Senior Credit Facility, multipliedby a factor of 25%, 50% or 75% depending on the leverage ratio at the end ofthe fiscal year, less optional prepayments made during the fiscal year. TheCompany made an ECF payment of $1.7 million for the fiscal year ended September29, 2006 in December 2006 and there is no expected ECF payment due for fiscalyear 2007, primarily because of the $3.3 million optional prepayment that wasmade in December 2006.

CPI can make optional prepayments on theoutstanding loans at any time without premium or penalty, except for customary “breakage”costs with respect to LIBOR loans. In March 2005, CPI made an optionalprepayment of $5.7 million; in May 2006, CPI made additional optionalprepayments of $47.5 million in the aggregate using proceeds from the initialpublic offering of CPI International’s common stock; and in December 2006, CPImade an additional prepayment of $3.3 million.

See Note 12 for information regarding therecent refinancing of the Senior Credit Facility.

**8% Seniorsubordinated notes of CPI:**In connection with a business combination on January 23, 2004, CPIissued $125.0 million in aggregate principal amount of its 8% SeniorSubordinated Notes (the “8% Notes”). The 8% Notes have no sinking fundrequirements.

The 8% Notes bear interest at the rate of8.0% per year, payable on February 1 and August 1 of each year. The8% Notes will mature on February 1, 2012. The 8% Notes are unsecuredobligations, jointly and severally guaranteed by CPI International and each ofCPI’s domestic subsidiaries. The payment of all obligations relating to the 8%Notes are subordinated in right of payment to the prior payment in full in cashor cash equivalents of all senior debt (as defined in the indenture governingthe 8% Notes) of CPI, including debt under the Senior Credit Facility. Eachguarantee of the 8% Notes is and will be subordinated to guarantor senior debt(as defined in the indenture governing the 8% Notes) on the same basis as the8% Notes are subordinated to CPI’s senior debt.

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At any time or from time to time on or afterFebruary 1, 2008, CPI, at its option, may redeem the 8% Notes, in whole orin part, at the redemption prices (expressed as percentages of principalamount) set forth below, together with accrued and unpaid interest thereon, ifany, to the redemption date, if redeemed during the 12-month period beginningon February 1 of the years indicated below:

| Year                 | ** ** | **Optional  Redemption  Price** | ** ** |
|----------------------|------------|---------------------------------|------------|
| 2008                 |       | 104                             | %          |
| 2009                 |       | 102                             | %          |
| 2010 and  thereafter |       | 100                             | %          |

 

At any time on or prior to February 1, 2008,the 8% Notes may also be redeemed or purchased (by CPI or any other person) inwhole but not in part, at CPI’s option, upon the occurrence of a change ofcontrol (as defined in the indenture governing the 8% Notes) at a price equalto 100% of the principal amount of the 8% Notes, plus a “make-whole” premium(as defined in the indenture governing the 8% Notes) to the redemption price onFebruary 1, 2008, and accrued and unpaid interest, if any, to, the date ofredemption or purchase. Upon a change of control, CPI may be required topurchase all or any part of the 8% Notes for a cash price equal to 101% of theprincipal amount, plus accrued and unpaid interest thereon, if any, to the dateof purchase.

The indenture governing the 8% Notes containsa number of covenants that, among other things, restrict, subject to certainexceptions, the ability of CPI and its restricted subsidiaries (as defined inthe indenture governing the 8% Notes) to incur additional indebtedness, sellassets, consolidate or merge with or into other companies, pay dividends orrepurchase or redeem capital stock or subordinated indebtedness, make certaininvestments, issue capital stock of their subsidiaries, incur liens and enterinto certain types of transactions with their affiliates.

Events of default under the indenturegoverning the 8% Notes include: failure to make payments on the 8% Notes whendue; failure to comply with covenants in the indenture governing the 8% Notes;a default under certain other indebtedness of CPI or any of its restrictedsubsidiaries that is caused by a failure to make payments on such indebtednessor that results in the acceleration of the maturity of such indebtedness; theexistence of certain final judgments or orders against CPI or any of therestricted subsidiaries; and the occurrence of certain insolvency or bankruptcyevents.

**Floatingrate senior notes of CPI International:**On February 22, 2005, CPIInternational issued $80.0 million in principal amount of its Floating RateSenior Notes (the “FR Notes”). The FR Notes were issued at a 1% discount. Theproceeds from the issuance of FR Notes were used to make a distribution tostockholders of CPI International of approximately $75.8 million and to payfees and expenses of approximately $3.5 million associated with the issuance ofFR Notes. The FR Notes have no sinking fund requirements.

The FR Notes require interest payments at anannual interest rate, reset at the beginning of each semi-annual period, equalto the then six-month LIBOR plus 5.75%, payable semiannually on February 1 andAugust 1 of each year. The interest rate on the semi-annual interest paymentdue August 1, 2007 is approximately 11.15% per annum. CPI International may, atits option, elect to pay interest through the issuance of additional FR Notesfor any interest payment date on or before February 1, 2010. If CPIInternational elects to pay interest through the issuance of additional FRNotes, the annual interest rate on the FR Notes will increase by an additional1% step-up, with the step-up increasing by an additional 1% for each interestpayment made through the issuance of additional FR Notes (up to a maximum of4%). The FR Notes will mature on February 1, 2015.

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The FR Notes are general unsecuredobligations of CPI International. The FR Notes are not guaranteed by any of CPIInternational’s subsidiaries but are structurally subordinated to all existingand future indebtedness and other liabilities of CPI International’ssubsidiaries. The FR Notes are senior in right of payment to CPI International’sexisting and future indebtedness that is expressly subordinated to the FRNotes.

Because CPI International is a holdingcompany with no operations of its own, CPI International relies ondistributions from CPI to satisfy its obligations under the FR Notes. TheSenior Credit Facility and the indenture governing the 8% Notes restrict CPI’sability to make distributions to CPI International. The Senior Credit Facility prohibitsCPI from making distributions to CPI International unless there is no defaultunder the Senior Credit Facility and CPI International and CPI satisfy certainleverage ratios. The indenture governing the 8% Notes prohibits CPI from makingdistributions to CPI International unless, among other things, there is nodefault under the indenture and the amount of the proposed dividend plus allprevious Restricted Payments (as defined in the indenture governing the 8%Notes) does not exceed a specified amount.

At any time or from time to time CPIInternational, at its option, may redeem the Notes in whole or in part at theredemption prices (expressed as percentages of principal amount) set forthbelow, together with accrued and unpaid interest thereon, if any, to theredemption date, if redeemed during the 12-month period beginning on February 1of the years indicated below:
| Year                 | ** ** | **Optional  Redemption  Price** | ** ** |
|----------------------|------------|---------------------------------|------------|
| 2007                 |       | 103                             | %          |
| 2008                 |       | 102                             | %          |
| 2009                 |       | 101                             | %          |
| 2010 and  thereafter |       | 100                             | %          |

 

Upon a change of control, as defined in theindenture governing the FR Notes, CPI International may be required to purchaseall or any part of the outstanding FR Notes for a cash price equal to 101% ofthe principal amount, plus accrued and unpaid interest thereon, if any, to thedate of purchase.

The indenture governing the FR Notes containscertain covenants that, among other things, limit the ability of CPIInternational and its restricted subsidiaries (as defined in the indenturegoverning the FR Notes) to incur additional indebtedness, sell assets,consolidate or merge with or into other companies, pay dividends or repurchaseor redeem capital stock or subordinated indebtedness, make certain investments,issue capital stock of their subsidiaries, incur liens and enter into certaintypes of transactions with their affiliates.

Events of default under the indenturegoverning the FR Notes include: failure to make payments on the FR Notes whendue; failure to comply with covenants in the indenture governing the FR Notes;a default under certain other indebtedness of CPI International or any of itsrestricted subsidiaries that is caused by a failure to make payments on suchindebtedness or that results in the acceleration of the maturity of suchindebtedness; the existence of certain final judgments or orders against CPIInternational or any of the restricted subsidiaries; and the occurrence ofcertain insolvency or bankruptcy events.

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See Note 4 for information on the interest rate swap agreement entered into by the Company to hedge the interest rate exposure associated with the FR Notes.  See also Note 12 for information on the recent repurchase of a portion of the FR Notes and the issuance of a notice of redemption for a portion of the FR Notes.

 **Debt Maturities:** As of June 29, 2007, maturities onlong-term debt were as follows:
| Fiscal Year | ** ** | **Term  Loan** | ** ** | **8% Senior  Subordinated  Notes** | ** ** | **Floating Rate  Senior Notes** | ** ** | **Total** | ** ** |
|------------------|------------|----------------|------------|-----------------------------------------|------------|-------------------------------------------|------------|-----------|------------|
| 2007             |       | $              | —     |                                    | $          | —                                    |       | $         | —     |   | $ | — |   |
| 2008             |       | —         |       | —                                  |       | —                                    |       | —    |       |
| 2009             |       | —         |       | —                                  |       | —                                    |       | —    |       |
| 2010             |       | 37,500         |       | —                                  |       | —                                    |       | 37,500    |       |
| 2011             |       | —         |       | —                                  |       | —                                    |       | —    |       |
| Thereafter       |       | —         |       | 125,000                                 |       | 80,000                                    |       | 205,000   |       |
|             |       | $              | 37,500     |                                    | $          | 125,000                                   |       | $         | 80,000     |   | $ | 242,500 |   |

 

The preceding table doesnot reflect recent refinancing and redemptions described in Note 12.

**4.****                                     ****Derivative Financial Instruments**

The Company uses forward exchange contractsto hedge the foreign currency exposure associated with forecasted manufacturingcosts in Canada. As of June 29, 2007, CPI had outstanding forward contractcommitments to purchase Canadian dollars for an aggregate U.S. notional amountof $17.9 million; the last forward contract expires on December 17, 2007. AtJune 29, 2007 and September 29, 2006, the fair value of foreign currencyforward contracts was an asset of $1.0 million and $0.1 million, respectively,and the unrealized gain, net of related tax expense, was $0.8 million and$8,000, respectively.

The Company’s foreign currency forwardcontracts are designated as a cash flow hedge and are considered highlyeffective, as defined by Statement of Financial Accounting Standards (“SFAS”)No. 133, “Accounting for Derivative Instruments and Hedging Activities.” Theunrealized gains and losses from foreign exchange forward contracts areincluded in “accumulated other comprehensive income” in the condensed consolidatedbalance sheets, and the Company anticipates recognizing the entire unrealizedgain in operating earnings within the next twelve months. Changes in the fairvalue of foreign currency forward contracts due to changes in time value areexcluded from the assessment of effectiveness, and are immediately recognizedin general and administrative in the condensed consolidated statements ofoperations. The time value was not material for the three and nine months endedJune 29, 2007 and June 30, 2006. If the transaction being hedged fails tooccur, or if a portion of any derivative is ineffective, then the Companypromptly recognizes the gain or loss on the associated financial instrument inthe condensed consolidated statements of operations. No ineffective amountswere recognized due to anticipated transactions failing to occur in the threeand nine months ended June 29, 2007 and June 30, 2006. Realized gains andlosses from foreign currency forward contracts are recognized in cost of salesand general and administrative in the condensed consolidated statements ofoperations. Net income in the three and nine months ended June 29, 2007includes a recognized loss from foreign currency forward contracts of $0.2million. Net income in the three and nine months ended June 30, 2006 includes arecognized gain from foreign currency forward contracts of $0.3 million and$1.3 million, respectively.

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The Company also uses derivatives to hedgethe interest rate exposure associated with the FR Notes. On April 15, 2005, theCompany entered into an $80.0 million interest rate swap contract (the “Swap”)to receive variable rate 6-month LIBOR interest and pay 4.15% fixed rateinterest, which when combined with the 5.75% margin, results in a fixed rate of9.9% on the FR Notes through January 31, 2008. The Swap interest payments aremade semi-annually, beginning with the first payment on February 1, 2006. TheSwap matures on January 31, 2008. In fiscal year 2005, the Company deposited$1.0 million as collateral for the Swap; the amount of collateral fluctuatesbased on the fair value of the Swap. In fiscal year 2006, the Company receiveda $0.5 million refund of the Swap collateral. The Swap collateral remaining isreported as “prepaid and other current assets” in the accompanying condensedconsolidated balance sheets as of June 29, 2007, and as “other long-term assets”as of September 29, 2006. The unrealized gains and losses from the Swap areincluded in “accumulated other comprehensive income” in the condensedconsolidated balance sheets. The interest rate swap gain or loss is included inthe assessment of hedge effectiveness. During the three and nine months endedJune 29, 2007, a gain of approximately $0.1 million was recognized on theineffective portion of the Swap due to an anticipated repurchase and redemptionof an aggregate of $58.0 million of the FR Notes. (See Note 12 for adescription of those transactions.) The ineffective portion of the Swapassociated with the remaining $22.0 million of the FR Notes was notsignificant. At June 29, 2007 and September 29, 2006, the fair value of theSwap was an asset of $0.5 million and $1.1 million, respectively, and theunrealized gain, net of related tax expense, was $0.3 million and $0.7 million,respectively.

**5.****                                     ****Commitments and Contingencies**

**Leases:**At June 29, 2007, the Company was committedto minimum rentals under non-cancelable operating lease agreements, primarilyfor land and facility space, that expire on various dates through 2050. Rentexpense is recognized on a straight line basis over the lease term.

A summary of future minimum lease payments as of June 29, 2007 was asfollows:
|                                      | ** ** | **Operating** | ** ** |
|--------------------------------------|------------|---------------|------------|
| **Fiscal Year**                 | ** ** | **Leases**    | ** ** |
| 2007 (remaining  three months)       |       | $             | 379        |   |
| 2008                                 |       | 1,350         |       |
| 2009                                 |       | 1,139         |       |
| 2010                                 |       | 953           |       |
| 2011                                 |       | 349           |       |
| Thereafter                           |       | 3,449         |       |
| Total future minimum  lease payments |       | $             | 7,619      |   |

 

**Product Warranty:** The Companyoffers warranties on most of its products. The specific terms and conditions ofthe warranties offered by the company vary depending upon the product sold. TheCompany estimates the costs that may be incurred under its warranty plans andrecords a liability in the amount of such estimated costs at the time revenueis recognized. The Company periodically assesses the adequacy of its recordedwarranty liabilities and adjusts the balance based on actual experience andchanges in future expectations. The determination of product warranty reservesrequires the Company to make estimates of product return rates and expectedcost to repair or replace the products under warranty.

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                Changes inthe Company’s warranty reserve during the nine months ended June 29, 2007 andJune 30, 2006 were as follows:
|                                                          | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                               | ** ** | **June 29, 2007**     | ** ** | **June 30, 2006** | ** ** |
| Beginning  product warranty                              |       | $                               | 5,958      |   | $ | 6,359 |   |
| Cost of warranty  claims                                 |       | (4,232                          | )          | (4,262 | ) |
| Accruals for  product warranty, charged to cost of sales |       | 3,801                           |       | 4,198 |   |
| Ending product warranty                                  |       | $                               | 5,527      |   | $ | 6,295 |   |

 

**Guarantees:**The Company hasrestricted cash of $3.0 million and $1.7 million as of June 29, 2007 andSeptember 29, 2006, consisting primarily of bank guarantees from customeradvance payments to the Company’s international subsidiaries and collateral fora construction contract. The bank guarantees become unrestricted cash whenperformance under the sales or supply contract is complete.

Under the terms of the Swap,the Company must provide collateral to match any unfavorable mark-to-marketexposure (fair value) on the Swap. The collateral required totals a certainminimum amount plus an amount equal to the unfavorable mark-to-market exposureon the Swap. Generally, the required collateral will rise as interest ratesdecline. The Company has posted $0.5 million of collateral under the Swap,which is included in the condensed consolidated balance sheet in “prepaid andother current assets” as of June 29, 2007 and in “other long-term assets” as ofSeptember 29, 2006.

****Indemnification:****As permitted under Delaware law, the Company has agreements whereby theCompany indemnifies its officers, directors and certain employees for certainevents or occurrences while the employee, officer or director is, or wasserving, at the Company’s request in such capacity. The term of theindemnification period is for the officer’s or director’s lifetime. The maximumpotential amount of future payments the Company could be required to make underthese indemnification agreements is unlimited; however, the Company hasDirector and Officer insurance policies that limit its exposure and may enableit to recover a portion of any future amounts paid.

The Company has entered into other standard indemnification agreementsin its ordinary course of business. Pursuant to these agreements, the Companyagrees to indemnify, defend, hold harmless, and to reimburse the indemnifiedparty for losses suffered or incurred by the indemnified party, generally theCompany’s business partners or customers, in connection with any patent,copyright or other intellectual property infringement claim by any third partywith respect to its products. The term of these indemnification agreements isgenerally perpetual after execution of the agreement. The maximum potentialamount of future payments the Company could be required to make under theseindemnification agreements is unlimited. The Company has not incurredsignificant costs to defend lawsuits or settle claims related to theseindemnification agreements. The Company believes the estimated fair value ofthese agreements is minimal. Accordingly, the Company has no liabilitiesrecorded for these agreements as of June 29, 2007.

From time to time, the Company may be subjectto claims that arise in the ordinary course of business. In the opinion ofmanagement, all such matters involve amounts that would not have a materialadverse effect on the Company’s consolidated financial position if unfavorablyresolved.

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**6.****                                     ****Stock-based Compensation Plans**

Asof June 29, 2007, the Company had an aggregate of 1.5 million shares of itscommon stock available for future grant and approximately 3.2 million optionsthat were outstanding under its various equity plans. Awards are subject toterms and conditions as determined by the Company’s Board of Directors.

****StockOption Activity****

The following table summarizes stock option activity under the Company’sstock option plans: 
|                                | ** ** | **Number of  Shares** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Weighted-Average  Remaining  Contractual Term  (Years)** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|--------------------------------|------------|----------------------------|------------|-----------------------------------------|------------|-----------------------------------------------------------------|------------|---------------------------------|------------|
| Balance at  September 29, 2006 |       | 3,163,057                  |       | $                                       | 4.51       | ** **                                                      | ** ** | ** **                      | ** ** | ** ** |
| Granted                        |       | 297,000                    |       | 14.39                                   | ** ** | ** **                                                      | ** ** | ** **                      | ** ** |
| Exercised                      |       | (237,681                   | )          | 2.54                                    | ** ** | ** **                                                      | ** ** | ** **                      | ** ** |
| Forfeited or  cancelled        |       | (36,547                    | )          | 10.50                                   |       |                                                            |       |                            |       |
| Balance at June  29, 2007      |       | 3,185,829                  |       | $                                       | 5.51       |                                                            | 6.81       |                            | $          | 45,610 |   |
| Exercisable at  June 29, 2007  |       | 2,283,970                  |       | $                                       | 3.02       |                                                            | 6.24       |                            | $          | 38,402 |   |

 

The aggregate intrinsic value in the preceding table represents thetotal intrinsic value, based on the Company’s closing stock price of $19.83 asof June 29, 2007, which would have been received by the option holders had alloption holders exercised their options as of that date. All exercisable optionsas of June 29, 2007 are in-the-money.

During the three and nine months ended June 29, 2007, cash receivedfrom option exercises was approximately $0.1 million and $0.6 million,respectively, and the total intrinsic value of options exercised was $0.5million and $3.2 million, respectively. There were no options granted orexercised during the three and nine months ended June 30, 2006.

**Restricted Stock Awards:**There were 11,466 and 9,999 sharesoutstanding of nonvested restricted stock granted to directors as of June 29,2007 and September 29, 2006, respectively. The restricted stock awards vestover periods of one to three years. A summary of the status of the Company’snonvested restricted stock awards as of June 29, 2007, and changes during thenine months then ended is presented below:
|                                  | ** ** | **Number  of Shares** | ** ** | **Weighted-  Average Grant-  Date Fair Value** | ** ** |
|----------------------------------|------------|----------------------------|------------|---------------------------------------------------------------|------------|
| Nonvested at  September 29, 2006 |       | 9,999                      |       | $                                                             | 18.00      |   |
| Granted                          |       | 7,022                      |       | 17.09                                                         |       |
| Vested                           |       | (5,555                     | )          | 18.00                                                         |       |
| Forfeited                        |       | —                     |       | —                                                        |       |
| Nonvested at June 29,  2007      |       | 11,466                     |       | $                                                             | 17.44      |   |

 

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Aggregate intrinsic value of the nonvested restricted stock awards atJune 29, 2007 was $0.2 million.

The Company settles stock option exercises and restricted stock awardswith newly issued common shares.

*Valuationand Expense Information under SFAS No. 123(R)*

On October 1, 2005, the Company adopted SFAS No. 123 (revised2004) or 123(R), “Share-Based Payment,” which requires the measurement andrecognition of compensation expense for all share-based payment awards made tothe Company’s employees and directors including employee stock options,restricted stock awards and employee stock purchases related to the ESPP basedon estimated fair values. The following table summarizes stock-basedcompensation expense for the three and nine months ended June 29, 2007 and June30, 2006, which was allocated as follows:

 
| ** **                                                                    | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                    | ** ** | **June 29, 2007**      | ** ** | **June 30, 2006**     | ** ** | **June 29, 2007** | ** ** | **June 30, 2006** | ** ** |
| Share-based  compensation cost recognized in the income statement by caption: | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cost of sales                                                                 |       | $                                | 75         |                            | $          | — |   | $ | 196 |   | $ | — |   |
| Research and development                                                      |       | 25                               |       | 7                               |       | 68 |   | 7 |   |
| Selling and marketing                                                         |       | 28                               |       | 12                              |       | 87 |   | 12 |   |
| General and administrative                                                    |       | 209                              |       | 89                              |       | 538 |   | 90 |   |
|                                                                          |       | $                                | 337        |                            | $          | 108 |   | $ | 889 |   | $ | 109 |   |
| Share-based compensation  cost capitalized in inventory                       |       | $                                | 78         |                            | $          | 27 |   | $ | 206 |   | $ | 27 |   |
| Share-based  compensation cost remaining in inventory at end of period        |       | $                                | 39         |                            | $          | 27 |   | $ | 39 |   | $ | 27 |   |
| Share-based  compensation expense by type of award:                           | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Stock options                                                                 |       | $                                | 277        |                            | $          | 89 |   | $ | 712 |   | $ | 90 |   |
| Restricted stock                                                              |       | 27                               |       | 19                              |       | 85 |   | 19 |   |
| Stock purchase plan                                                           |       | 33                               |       | —                          |       | 92 |   | — |   |
|                                                                          |       | $                                | 337        |                            | $          | 108 |   | $ | 889 |   | $ | 109 |   |

 

The tax benefit realized from option exercises and restricted stockvesting totaled approximately $0.1 million and $1.1 million during thethree and nine months ended June 29, 2007, respectively. There were no optionsexercised or restricted stock vested and hence no tax benefit realized duringthe three and nine months ended June 30, 2006.

The weighted-average estimated fair value of stock options andrestricted stock granted during the three and nine months ended June 29, 2007was $10.71 and $7.97 per share, respectively, using the Black-Scholes modelwith the following weighted-average assumptions:

| Expected term (in years) |   | 6.00 - 6.25        |   |
|--------------------------|--------|--------------------|--------|
| Expected  volatility     |   | 49.33%             |   |
| Risk-free rate           |   | 4.56% – 4.71% |   |
| Dividend yield           |   | 0%                 |   |

 

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Since the Company’s common stock has not been publicly traded for asufficient time period, the expected volatility is based on expectedvolatilities of similar companies that have a longer history of being publiclytraded. The expected term of options granted is based on the simplified methodfor plain vanilla options in accordance with Securities and Exchange Commission(“SEC”) Staff Accounting Bulletin (“SAB”) No. 107. The risk-free rates arebased on the U.S. Treasury yield in effect at the time of the grant.

As stock-based compensation expense recognized in the condensedconsolidated statement of operations for the three and nine months ended June29, 2007 is based on awards ultimately expected to vest, it has been reducedfor estimated forfeitures. SFAS No. 123(R) requires forfeitures to be estimatedat the time of grant and revised, if necessary, in subsequent periods if actualforfeitures differ from those estimates.

As of June 29, 2007, there was approximately$4.0 million of total unrecognized compensation costs related to nonvestedstock options, which is expected to be recognized over a weighted-averagevesting period of 2.3 years. As of June 29, 2007, there was $0.2 million oftotal unrecognized compensation costs related to nonvested restricted stockawards, which is expected to be recognized over a weighted average vestingperiod of 1.5 years.

**7.****                                     ****Income Taxes**

The Company’s effective tax rate was approximately 18.4% and 30.5% forthe three and nine months ended June 29, 2007, respectively, as compared to36.0% and 40.8% for the three and nine months ended June 30, 2006,respectively.  The effective tax rate for the three and nine months endedJune 29, 2007 includes a discrete tax benefit of $1.8 million related to thefiling of amended income tax returns for prior years to reflect a change inestimate with regard to reporting Canadian income earned in the U.S.  TheCompany’s estimated fiscal year 2007 effective income tax rate, excludingdiscrete tax items, is approximately 38%.

Income tax expense for the three months ended June 30, 2006 includes adiscrete tax benefit of $0.2 million for true-up adjustments to fiscal year2005 tax expense related to changes in estimates made as a result of filing the2005 income tax returns. Income tax expense for the nine months ended June 30,2006 included $0.3 million of charges attributable to the fourth quarter offiscal year 2005, consisting of $0.5 million to correct the overstatement oftax benefits recorded in the fourth quarter of fiscal year 2005 for stock-basedcompensation expense that is not deductible for income tax purposes in aforeign tax jurisdiction, offset by reversal of a $0.2 million tax contingencyreserve that was no longer required. Without the correction to theoverstatement of tax benefits, the Company’s effective tax rate for the ninemonths ended June 30, 2006 would have been approximately 39%.

**8.****                                     ****Earnings Per Share**

Basic earnings per share are computed usingthe weighted-average number of common shares outstanding during the periodexcluding outstanding nonvested restricted shares subject to repurchase.Diluted earnings per share are computed using the weighted-average number ofcommon and dilutive potential common equivalent shares outstanding during theperiod. Potential common equivalent shares consist of common stock issuableupon exercise of stock options and nonvested restricted shares using thetreasury stock method.

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The following table is a reconciliation of theshares used to calculate basic and diluted earnings per share:

|                                                                         | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                              | ** ** | **June 29,**                | ** ** | **June 30,**               | ** ** | **June 29,** | ** ** | **June 30,** | ** ** |
| ** **                                                              | ** ** | **2007**                         | ** ** | **2006**                        | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                                                    |       |                             |       |                            |       |   |   |   |   |
| Weighted average  shares outstanding - Basic                            |       | 16,306,256                       |       | 15,039,754                      |       | 16,206,873 |   | 13,736,031 |   |
| Effect of  dilutive stock options and nonvested restricted stock awards |       | 1,490,169                        |       | 1,727,068                       |       | 1,489,344 |   | 1,707,396 |   |
| Weighted average shares  outstanding - Diluted                          |       | 17,796,425                       |       | 16,766,822                      |       | 17,696,217 |   | 15,443,427 |   |

 

The calculation of diluted net income per shareexcludes all anti-dilutive shares. For the three and nine months endedJune 29, 2007, the number of anti-dilutive shares, as calculated based onthe weighted average closing price of our common stock for the periods, wasapproximately 0.5 million shares. For the three and nine months ended June30, 2006, the number of anti-dilutive shares, as calculated based on theweighted average closing price of our common stock for the periods, wasapproximately 0.3 million shares.

**9.****                                     ****Segments, Geographic and CustomerInformation**

The Company’s reportable segments are VED andsatcom equipment. The VED segment develops, manufactures and distributes highpower/high frequency microwave and radio frequency signal components. Thesatcom equipment segment manufactures and supplies high power amplifiers andnetworks for satellite communication uplink and industrial applications.Segment information reported below is consistent with the manner in which it isreviewed and evaluated by the Company’s chief operating decision maker (“CODM”),its chief executive officer, and is based on the nature of the Company’soperations and products offered to customers.

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Summarized financial information concerning theCompany’s reportable segments is shown in the following tables:
|                                 | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                      | ** ** | **June 29,  2007**          | ** ** | **June 30,  2006**         | ** ** | **June 29,  2007** | ** ** | **June 30,  2006** | ** ** |
| Sales to external  customers    |       |                             |       |                            |       |   |   |   |   |
| VED                             |       | $                                | 70,651     |                            | $          | 73,050 |   | $ | 209,842 |   | $ | 205,843 |   |
| Satcom equipment                |       | 16,667                           |       | 14,711                          |       | 49,643 |   | 51,226 |   |
|                            |       | $                                | 87,318     |                            | $          | 87,761 |   | $ | 259,485 |   | $ | 257,069 |   |
| Intersegment  product transfers |       |                             |       |                            |       |   |   |   |   |
| VED                             |       | $                                | 6,903      |                            | $          | 5,924 |   | $ | 16,608 |   | $ | 18,608 |   |
| Satcom equipment                |       | 1                                |       | —                          |       | 10 |   | 1 |   |
|                            |       | $                                | 6,904      |                            | $          | 5,924 |   | $ | 16,618 |   | $ | 18,609 |   |
| EBITDA                          |       |                             |       |                            |       |   |   |   |   |
| VED                             |       | $                                | 19,231     |                            | $          | 19,001 |   | $ | 54,747 |   | $ | 52,462 |   |
| Satcom equipment                |       | 1,842                            |       | (79                             | )          | 4,460 |   | 4,773 |   |
| Other                           |       | (3,739                           | )          | (3,657                          | )          | (8,478 | ) | (13,402 | ) |
|                            |       | $                                | 17,334     |                            | $          | 15,265 |   | $ | 50,729 |   | $ | 43,833 |   |

 

Amounts not reported as VED or satcomequipment are reported as other. Other consists primarily of corporateoperating expenses and certain other expenses that are managed by the corporateorganization, such as business combination-related expenses, share-basedcompensation expense, and certain non-recurring or unusual expenses. The ninemonths ended June 30, 2006 included non-recurring expenses for a special bonusof $3.25 million and expenses of $3.8 million related to the relocation of theCompany’s Eimac operations from its former San Carlos, California facility toits nearby Palo Alto, California and Mountain View, California facilities. Thespecial bonus was paid to employees and directors (other than directors who areemployees or affiliates of Cypress) to reward them for the increase in Companyvalue.

EBITDA represents earnings before provisionfor income taxes, net interest expense and depreciation and amortization. Forthe reasons listed below, the Company believes that GAAP-based financialinformation for leveraged businesses such as the Company’s business should besupplemented by EBITDA so that investors better understand the Company’sfinancial performance in connection with their analysis of the Company’sbusiness:

·                    EBITDA is a component of the measures used by the Company’sboard of directors and management team to evaluate the Company’s operatingperformance;

·                    the Senior Credit Facility contains covenants that requirethe Company to maintain certain interest expense coverage and leverage ratiosthat contain EBITDA as a component, and the Company’s management team usesEBITDA to monitor compliance with such covenants;

·                    EBITDA is a component of the measures used by the Company’smanagement team to make day-to-day operating decisions;

·                    EBITDA facilitates comparisons between the Company’soperating results and those of competitors with different capital structuresand therefore is a component of the measures used by the Company’s managementto facilitate internal comparisons to competitors’ results and the Company’sindustry in general; and

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·                    the payment of management bonuses is contingent upon, amongother things, the satisfaction by the Company of certain targets that containEBITDA as a component.

Other companies may defineEBITDA differently and, as a result, the Company’s measure of EBITDA may not bedirectly comparable to EBITDA of other companies. Although the Company usesEBITDA as a financial measure to assess the performance of its business, theuse of EBITDA is limited because it does not include certain material costs,such as interest and taxes, necessary to operate the Company’s business. Whenanalyzing the Company’s performance, EBITDA should be considered in additionto, and not as a substitute for, net income, cash flows from operatingactivities or other statements of operations or statements of cash flows dataprepared in accordance with GAAP.

The following table reconciles net income toEBITDA:
|                               | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                    | ** ** | **June 29,**                | ** ** | **June 30,**               | ** ** | **June 29,** | ** ** | **June 30,** | ** ** |
| ** **                    | ** ** | **2007**                         | ** ** | **2006**                        | ** ** | **2007** | ** ** | **2006** | ** ** |
| Net income                    |       | $                                | 8,131      |                            | $          | 4,468 |   | $ | 19,726 |   | $ | 11,028 |   |
| Depreciation and amortization |       | 2,225                            |       | 2,335                           |       | 6,607 |   | 6,786 |   |
| Interest expense, net         |       | 5,143                            |       | 5,945                           |       | 15,757 |   | 18,409 |   |
| Income tax expense            |       | 1,835                            |       | 2,517                           |       | 8,639 |   | 7,610 |   |
| EBITDA                        |       | $                                | 17,334     |                            | $          | 15,265 |   | $ | 50,729 |   | $ | 43,833 |   |

 

With the exception ofgoodwill, the Company does not identify or allocate assets by operatingsegment, nor does its CODM evaluate operating segments using discrete assetinformation.

Goodwill by reportable segment and geographic areawas as follows:
|                           | ** ** | **June 29,** | ** ** | **September 29,** | ** ** | ** ** |
|---------------------------|------------|-------------------|------------|------------------------|------------|------------|
| ** **                | ** ** | **2007**          | ** ** | **2006**               | ** ** | ** ** |
| **Reportable  segments:** | ** ** | ** **        | ** ** | ** **             | ** ** | ** ** |
| VED                       |       | $                 | 133,439    |                   | $          | 133,637    |   |   |
| Satcom Equipment          |       | 13,831            |       | 13,852                 |       |       |
|                      |       | $                 | 147,270    |                   | $          | 147,489    |   |   |
|                      |       |              |       |                   |       |       |
| **Geographic  areas:**    |       |              |       |                   |       |       |
| United States             |       | $                 | 99,007     |                   | $          | 99,226     |   |   |
| Canada                    |       | 48,263            |       | 48,263                 |       |       |
|                      |       | $                 | 147,270    |                   | $          | 147,489    |   |   |

 

The decrease in goodwill from September 29,2006 to June 29, 2007 was due to an adjustment for tax benefits realized fromthe exercise of fully vested stock options that were acquired in a businesscombination.

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Geographic sales by customer location were asfollows for external customers:
|                        | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **             | ** ** | **June 29,**                | ** ** | **June 30,**               | ** ** | **June 29,** | ** ** | **June 30,** | ** ** |
| ** **             | ** ** | **2007**                         | ** ** | **2006**                        | ** ** | **2007** | ** ** | **2006** | ** ** |
| United States          |       | $                                | 50,896     |                            | $          | 54,502 |   | $ | 152,977 |   | $ | 162,709 |   |
| All foreign  countires |       | 36,422                           |       | 33,259                          |       | 106,508 |   | 94,360 |   |
| Total sales            |       | $                                | 87,318     |                            | $          | 87,761 |   | $ | 259,485 |   | $ | 257,069 |   |

 

Therewere no individual foreign countries with sales greater than 10% of total salesfor the periods presented.

Net property, plant and equipment by geographic areawas as follows:
|               | ** ** | **June 29, 2007** | ** ** | **September 29, 2006**                 | ** ** |
|---------------|------------|-----------------------------|------------|--------------------------------------------------|------------|
| ** **    | ** ** | **Cost**                    | ** ** | **Accumulated  Depreciation  and  Amortization** | ** ** | **Net Property,  Plant and  Equipment** | ** ** | **Cost** | ** ** | **Accumulated  Depreciation  and  Amortization** | ** ** | **Net Property,  Plant and  Equipment** | ** ** |
| United States |       | $                           | 66,937     |                                             | $          | (15,396 | ) | $ | 51,541 |   | $ | 64,527 |   | $ | (11,221 | ) | $ | 53,306 |   |
| Canada        |       | 15,761                      |       | (1,977                                           | )          | 13,784 |   | 11,915 |   | (1,440 | ) | 10,475 |   |
| Other         |       | 178                         |       | (141                                             | )          | 37 |   | 177 |   | (107 | ) | 70 |   |
| Total         |       | $                           | 82,876     |                                             | $          | (17,514 | ) | $ | 65,362 |   | $ | 76,619 |   | $ | (12,768 | ) | $ | 63,851 |   |

 

The U.S. Government is theonly customer that accounted for 10% or more of the Company’s consolidatedsales in the three and nine months ended June 29, 2007 and June 30, 2006.Direct sales to the U.S. Government were $14.6 million and $43.6 million forthe three and nine months ended June 29, 2007, respectively, and $16.5 millionand $44.3 million for the three and nine months ended June 30, 2006, respectively.Accounts receivable from this customer represented 12% and 14% of consolidatedaccounts receivable as of June 29, 2007 and September 29, 2006, respectively.

**10.****                              ****Sale of San Carlos Assets**

In February 2003, the Company entered into anagreement to sell the land and close its facilities located in San Carlos,California to consolidate the Company’s Eimac operations into the Company’sexisting facility in nearby Palo Alto, California. In September 2006, the salewas completed. The aggregate sales proceeds were $24.8 million, of which $11.3million was received in September 2006 and $13.5 million was received asadvance payments in fiscal year 2004. The Company had total selling costs of$1.3 million related to the sale of the San Carlos property. The aggregatesales proceeds of $24.8 million less the related selling costs of $1.3 million,offset by the land and building’s net book value of approximately $23.5million, resulted in no gain or loss on the sale.

**11.****                              ****Recently Released AccountingPronouncements**

In June 2006, the Financial AccountingStandards Board (“FASB”) issued FASB Interpretation (“FIN”) No. 48, “Accountingfor Income Tax Uncertainties.” FIN No. 48 defines the threshold for recognizingthe benefits of tax return positions in the financial statements as “more-likely-than-not”to be sustained by the taxing authority. The recently issued literature alsoprovides guidance on the derecognition, measurement and classification ofincome tax uncertainties, along with any related interest and penalties. FINNo. 48 also includes guidance concerning accounting for income taxuncertainties in interim periods and increases the level of disclosuresassociated with any recorded income tax 

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uncertainties. FIN No. 48 iseffective for fiscal years beginning after December 15, 2006. Anydifferences between the amounts recognized in the statements of financialposition prior to the adoption of FIN No. 48 and the amounts reported afteradoption will be accounted for as a cumulative-effect adjustment recorded tothe beginning balance of retained earnings. The Company will be required toadopt FIN No. 48 in its fiscal year 2008 commencing September 29, 2007 and iscurrently in the process of determining the impact, if any, of adopting theprovisions of this new standard on its financial position, results ofoperations and liquidity.

In September 2006, the FASB issued SFAS No.157, “Fair Value Measurements,” which defines fair value, establishes aframework for measuring fair value under other accounting pronouncements thatpermit or require fair value measurements, changes the methods used to measurefair value and expands disclosures about fair value measurements. Inparticular, disclosures are required to provide information on: the extent towhich fair value is used to measure assets and liabilities; the inputs used todevelop measurements; and the effect of certain of the measurements on earnings(or changes in net assets). SFAS No. 157 is effective for fiscal yearsbeginning after November 15, 2007 and interim periods within those fiscalyears. Early adoption, as of the beginning of an entity’s fiscal year, is alsopermitted, provided interim financial statements have not yet been issued. TheCompany will be required to adopt SFAS No. 157 in its fiscal year 2009 commencingOctober 4, 2008 and is currently evaluating the potential impact, if any, thatthe adoption of this new standard will have on its consolidated financialstatements.

In September 2006, the FASB issued SFAS No.158, “Employers’ Accounting for Defined Benefit Pension and OtherPostretirement Plans – an amendment of FASB Statements No. 87, 88, 106, and132(R),” which requires an employer to recognize the overfunded or underfundedstatus of a defined benefit plan as an asset or liability in its condensed consolidatedbalance sheet. Under SFAS No. 158, actuarial gains and losses and prior servicecosts or credits that have not yet been recognized through earnings as netperiodic benefit cost will be recognized in other comprehensive income, net oftax, until they are amortized as a component of net periodic benefit cost. SFASNo. 158 is effective as of the end of the fiscal year ending after December 15,2006 and shall not be applied retrospectively. The Company will be required toadopt SFAS No. 158 in the fourth quarter of fiscal year 2007 and is currentlyevaluating the impact, if any, that the adoption of this new standard will haveon its consolidated financial statements.

In September 2006, the SEC issued SAB No. 108, “Considering the Effectsof Prior Year Misstatements when Quantifying Misstatements in Current YearFinancial Statements.” SAB No. 108 provides guidance on how prior yearmisstatements should be considered when quantifying misstatements in thecurrent year financial statements. SAB No. 108 requires registrants to quantifymisstatements using both a balance sheet and an income statement approach andevaluate whether either approach results in quantifying a misstatement that,when all relevant quantitative and qualitative factors are considered, ismaterial. SAB No. 108 does not change the guidance in SAB No. 99, “Materiality,”when evaluating the materiality of misstatements. SAB No. 108 is applicable forfiscal years ending after November 15, 2006. Upon initial application, SAB No.108 permits a one-time cumulative effect adjustment to beginning retainedearnings. The Company will adopt SAB No. 108 in the fourth quarter of fiscalyear 2007 and is currently evaluating what effect adopting the new guidancewill have on its consolidated results of operations and financial condition.

In February 2007, the FASB issued SFAS No.159, “The Fair Value Option for Financial Assets and Financial Liabilities –Including an amendment of FASB Statement No. 115.” SFAS No. 159 permitscompanies to choose to measure many financial instruments and certain otheritems at fair value that are 

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not currently required to bemeasured at fair value. The objective of SFAS No. 159 is to provideopportunities to mitigate volatility in reported earnings caused by measuring relatedassets and liabilities differently without having to apply hedge accountingprovisions. SFAS No. 159 also establishes presentation and disclosurerequirements designed to facilitate comparisons between companies that choosedifferent measurement attributes for similar types of assets and liabilities.SFAS No. 159 is effective for fiscal years beginning after November 15, 2007.The Company will be required to adopt SFAS No. 159 in its fiscal year 2009commencing October 4, 2008 and is currently evaluating the impact, if any, thatthe adoption of this new standard will have on its consolidated financialstatements.

**12.****                              ****Subsequent Events**

*Refinancing Transactions*

**Amended Credit Facility:**On August 1, 2007, CPI entered into an Amended and Restated Credit Agreement(Credit Agreement), dated as of August 1, 2007 (Closing Date), which provides for an amended credit facility (AmendedCredit Facility) in the aggregate principal amount of $160 million, consistingof a $100 million term loan facility (Term Loan) and a $60 million revolvingcredit facility (Revolver), with a sub-facility of $15 million for letters ofcredit and $5 million for swing line loans. Upon certain specified conditions, including maintaining a seniorsecured leverage ratio of 3.75:1 or less on a pro forma basis, CPI may seekcommitments for a new class of term loans, not to exceed $125 million in theaggregate.  The Amended Credit Facilityis guaranteed by CPI International and all of the CPI’s domestic subsidiariesand is secured by substantially all of the assets of CPI International, CPI andCPI’s domestic subsidiaries.

Exceptas noted below, the Term Loan will mature on August 1, 2014 and the Revolverwill mature on August 1, 2013.  However,if, prior to August 1, 2011, CPI has not repaid or refinanced its $125 million8% Senior Subordinated Notes due 2012, both the Term Loan and the Revolver willmature on August 1, 2011.

The Amended Credit Facility replaces CPI’s existing $130 million creditfacility. On the Closing Date, CPI borrowed $100 million under the Term Loan,the proceeds of which were principally used to satisfy outstanding term loanamounts of $37.5 million under the existing Senior Credit Facility and to pay adividend to CPI International to permit CPI International to repurchase andredeem $58 million aggregate principal amount of its FR Notes as describedbelow. Future borrowings under the Amended Credit Facility may be used forgeneral corporate purposes.

Borrowingsunder the Amended Credit Facility will bear interest at a rate equal to, at CPI’soption, LIBOR) or the ABR plus the applicable margin.  The ABR is the greater of the (a) the PrimeRate and (b) the Federal Funds Rate plus 0.50%. For Term Loans, the applicable margin will be 2.00% for LIBOR borrowingsand 1.00% for ABR borrowings.  Theapplicable margins under the Revolver vary depending on CPI’s leverage ratio,as defined in the Credit Agreement, and range from 1.25% to 2.00% forEurodollar loans and from 0.25% to 1.00% for ABR borrowings.

Inaddition to customary fronting and administrative fees under the Amended CreditFacility, CPI will pay letter of credit participation fees equal to theapplicable LIBOR margin per annum on the average daily amount of the letter ofcredit exposure, and a commitment fee on the average daily unused commitmentsunder the Revolver.  The commitment feewill vary depending on CPI’s leverage ratio, as defined in the CreditAgreement, and will range from 0.25% to 0.50%.

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TheAmended Credit Facility requires that CPI repay $250,000 of the Term Loan atthe end of each fiscal quarter prior to the maturity date of the Term Loan,with the remainder due on the maturity date. CPI is required to prepay its outstanding loans under the Amended CreditFacility, subject to certain exceptions and limitations, with net cash proceedsreceived from certain events, including, without limitation (1) all suchproceeds received from certain asset sales by CPI International, CPI or any ofCPI’s subsidiaries, (2) all such proceeds received from issuances of debt(other than certain specified permitted debt) or preferred stock by CPIInternational, CPI or any of CPI’s subsidiaries, and (3) all such proceeds paidto CPI International, CPI or any of CPI’s subsidiaries from casualty andcondemnation events in excess of amounts applied to replace, restore orreinvest in any properties for which proceeds were paid within a specifiedperiod.

IfCPI’s leverage ratio, as defined in the Credit Agreement, exceeds 3.5:1 at theend of any fiscal year, CPI will also be required to make an annual prepaymentwithin 90 days after the end of such fiscal year based on a calculation ofexcess cash flow, as defined in the Credit Agreement, less optional prepaymentsmade during the fiscal year.  CPI canmake optional prepayments on the outstanding loans at any time without premiumor penalty, except for customary “breakage” costs with respect to LIBOR loans.

TheAmended Credit Facility contains a number of covenants that, among otherthings, restrict, subject to certain exceptions, the ability of CPIInternational, CPI and CPI’s subsidiaries to: sell assets; engage in mergersand acquisitions; pay dividends and distributions or repurchase their capitalstock; incur additional indebtedness or issue equity interests; make investmentsand loans; create liens or further negative pledges on assets; engage incertain transactions with affiliates; enter into sale and leasebacktransactions; amend agreements or make prepayments relating to subordinatedindebtedness; and amend or waive provisions of charter documents in a mannermaterially adverse to the lenders. CPI International, CPI and all of CPI’ssubsidiaries must comply with a maximum capital expenditure limitation and amaximum total secured leverage ratio, each calculated on a consolidated basisfor the Company (including its subsidiaries).

**FR Notes repurchase:**On August 2, 2007, CPI International closed its tender offer of aportion of the FR Notes (which expired on August 1, 2007), with $38,175,000 inaggregate principal amount of the FR Notes tendered and accepted for purchase.Tendering holders were paid on August 2, 2007 an aggregate of approximately$39.4 million, representing $1,032.50 per $1,000.00 principal amount of the FRNotes tendered, plus accrued interest up to, but not including, the date ofpurchase.

**FR Notes redemption:** On August 6, 2007, the trustee for the FR Notes, upon instruction ofCPI International, notified the holders of the FR Notes that $19,825,000aggregate principal amount of the FR Notes will be redeemed on September 5,2007. The aggregate redemption price will be approximately $20.4 million or$1,030 per $1,000 principal amount of the FR Notes, plus accrued and unpaidinterest to, but not including, the date of redemption.

After giving effect to the purchase and redemption of the FR Notesdescribed above, CPI International will have $22.0 million aggregate principalamount of the FR Notes outstanding.

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*MalibuResearch Acquisition*

On August 10, 2007, the Company completed its acquisition of all outstandingcommon stock of the privately held Malibu Research Associates, Inc. for apurchase price of approximately $22.0 million in cash and a potential earnoutof up to $15.0 million, which is primarily contingent upon the achievement ofcertain financial objectives over the three years following the acquisition.Malibu Research, headquartered in Camarillo, California, is a designer,manufacturer and integrator of advanced antenna systems for radar, radarsimulators and telemetry systems, as well as for strategically vital data linksused in ground, airborne, unmanned aerial vehicles (UAV) and shipboard systems.

**13.****                              ****Supplemental Guarantors CondensedConsolidating Financial Information (Unaudited)**

On January 23, 2004, CPI issued $125.0million of 8% Notes that are guaranteed by CPI International and all of CPI’sdomestic subsidiaries. Separate financial statements of the guarantors are notpresented because (i) the guarantors are wholly-owned and have fully andunconditionally guaranteed the 8% Notes on a joint and several basis and (ii)the Company’s management has determined that such separate financial statementsare not material to investors. Instead, presented below are the consolidatingfinancial statements of: (a) the parent or CPI International, (b) the issuer,CPI, (c) the guarantor subsidiaries (all of the domestic subsidiaries), (d) thenon-guarantor subsidiaries, (e) the consolidating elimination entries, and (f)the consolidated totals. The accompanying consolidating financial informationshould be read in connection with the condensed consolidated financialstatements of CPI International.

Investments in subsidiaries are accounted forbased on the equity method. The principal elimination entries eliminateinvestments in subsidiaries, intercompany balances, intercompany transactionsand intercompany sales.

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**CONDENSED CONSOLIDATING BALANCE SHEETAs of June 29, 2007**
| ** **                                      | ** ** | **Parent**                | ** ** | **Issuer** | ** ** | **Guarantor**    | ** ** | **Non-Guarantor** | ** ** | **Consolidating** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------|------------|---------------------------|------------|------------|------------|------------------|------------|-------------------|------------|-------------------|------------|------------------|------------|
| ** **                                      | ** ** | **(CPI Int’l)** | ** ** | **(CPI)**  | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**  | ** ** | **Eliminations**  | ** ** | **Total**        | ** ** |
|                                            |       |                      |       |       |       |             |       |              |       |              |       |             |       |
| **Assets**                                      |       |                      |       |       |       |             |       |              |       |              |       |             |       |
| Cash and cash  equivalents                      |       | $                         | 644        |       | $          | 36,050           |       | $                 | 1,138      |              | $          | 1,588            |       | $ | — |   | $ | 39,420 |   |
| Restricted cash                                 |       | —                    |       | —     |       | 2,211            |       | 835               |       | —            |       | 3,046            |       |
| Accounts  receivable, net                       |       | —                    |       | 21,151     |       | 7,527            |       | 17,913            |       | —            |       | 46,591           |       |
| Inventories                                     |       | —                    |       | 40,456     |       | 2,403            |       | 18,151            |       | (660              | )          | 60,350           |       |
| Deferred tax  assets                            |       | —                    |       | 10,579     |       | 3                |       | 788               |       | (180              | )          | 11,190           |       |
| Intercompany  receivable                        |       | —                    |       | 26,052     |       | 2,747            |       | —            |       | (28,799           | )          | —           |       |
| Prepaid and  other current assets               |       | 1,049                     |       | 3,845      |       | 261              |       | 873               |       | (121              | )          | 5,907            |       |
| Total current assets                            |       | 1,693                     |       | 138,133    |       | 16,290           |       | 40,148            |       | (29,760           | )          | 166,504          |       |
| Property, plant  and equipment, net             |       | —                    |       | 48,781     |       | 2,769            |       | 13,812            |       | —            |       | 65,362           |       |
| Deferred debt  issue costs, net                 |       | 2,951                     |       | 5,592      |       | —           |       | —            |       | —            |       | 8,543            |       |
| Intangible  assets, net                         |       | —                    |       | 58,741     |       | 6,527            |       | 8,421             |       | —            |       | 73,689           |       |
| Goodwill                                        |       | —                    |       | 93,159     |       | 5,848            |       | 48,263            |       | —            |       | 147,270          |       |
| Other long-term  assets                         |       | —                    |       | 844        |       | —           |       | —            |       | —            |       | 844              |       |
| Intercompany  notes receivable                  |       | —                    |       | 1,035      |       | —           |       | —            |       | (1,035            | )          | —           |       |
| Investment in  subsidiaries                     |       | 230,415                   |       | 65,295     |       | —           |       | —            |       | (295,710          | )          | —           |       |
| Total assets                                    |       | $                         | 235,059    |       | $          | 411,580          |       | $                 | 31,434     |              | $          | 110,644          |       | $ | (326,505 | ) | $ | 462,212 |   |
|                                            |       |                      |       |       |       |             |       |              |       |              |       |             |       |
| **Liabilities  and stockholders’ equity**  |       |                      |       |       |       |             |       |              |       |              |       |             |       |
| Current portion  of long-term debt              |       | $                         | —     |       | $          | 1,000            |       | $                 | —     |              | $          | —           |       | $ | — |   | $ | 1,000 |   |
| Accounts payable                                |       | 227                       |       | 12,010     |       | 439              |       | 7,904             |       | —            |       | 20,580           |       |
| Accrued expenses                                |       | 3,278                     |       | 16,180     |       | 1,021            |       | 5,558             |       | —            |       | 26,037           |       |
| Product warranty                                |       | —                    |       | 3,181      |       | 225              |       | 2,121             |       | —            |       | 5,527            |       |
| Deferred income  taxes                          |       | 180                       |       | —     |       | —           |       | —            |       | (180              | )          | —           |       |
| Income taxes  payable                           |       | —                    |       | —     |       | 327              |       | 6,614             |       | (121              | )          | 6,820            |       |
| Advance payments  from customers                |       | —                    |       | 4,145      |       | 2,099            |       | 2,726             |       | —            |       | 8,970            |       |
| Intercompany  payable                           |       | 28,157                    |       | —     |       | —           |       | 642               |       | (28,799           | )          | —           |       |
| Total current liabilities                       |       | 31,842                    |       | 36,516     |       | 4,111            |       | 25,565            |       | (29,100           | )          | 68,934           |       |
| Deferred income  taxes                          |       | —                    |       | 24,147     |       | —           |       | 5,718             |       | —            |       | 29,865           |       |
| Intercompany  notes payable                     |       | —                    |       | —     |       | —           |       | 1,035             |       | (1,035            | )          | —           |       |
| Long-term debt,  less current portion           |       | 79,322                    |       | 161,500    |       | —           |       | —            |       | —            |       | 240,822          |       |
| Other long-term  liabilities                    |       | —                    |       | 79         |       | —           |       | —            |       | —            |       | 79               |       |
| Total liabilities                               |       | 111,164                   |       | 222,242    |       | 4,111            |       | 32,318            |       | (30,135           | )          | 339,700          |       |
| Common stock                                    |       | 163                       |       | —     |       | —           |       | —            |       | —            |       | 163              |       |
| Parent  investment                              |       | —                    |       | 121,719    |       | 22,228           |       | 57,683            |       | (201,630          | )          | —           |       |
| Additional  paid-in capital                     |       | 67,991                    |       | —     |       | —           |       | —            |       | —            |       | 67,991           |       |
| Accumulated  other comprehensive income         |       | 1,093                     |       | 799        |       | —           |       | 118               |       | (917              | )          | 1,093            |       |
| Retained  earnings                              |       | 54,648                    |       | 66,820     |       | 5,095            |       | 20,525            |       | (93,823           | )          | 53,265           |       |
| Net stockholders’ equity                   |       | 123,895                   |       | 189,338    |       | 27,323           |       | 78,326            |       | (296,370          | )          | 122,512          |       |
| Total liabilities and stockholders’ equity |       | $                         | 235,059    |       | $          | 411,580          |       | $                 | 31,434     |              | $          | 110,644          |       | $ | (326,505 | ) | $ | 462,212 |   |

 

28

----

**CONDENSED CONSOLIDATING BALANCE SHEETAs of September 29, 2006**
| ** **                                       | ** ** | **Parent**                | ** ** | **Issuer** | ** ** | **Guarantor**    | ** ** | **Non-Guarantor** | ** ** | **Consolidating** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------|------------|---------------------------|------------|------------|------------|------------------|------------|-------------------|------------|-------------------|------------|------------------|------------|
| ** **                                       | ** ** | **(CPI Int’l)** | ** ** | **(CPI)**  | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**  | ** ** | **Eliminations**  | ** ** | **Total**        | ** ** |
|                                             |       |                      |       |       |       |             |       |              |       |              |       |             |       |
| **Assets**                                       |       |                      |       |       |       |             |       |              |       |              |       |             |       |
| Cash and cash  equivalents                       |       | $                         | 139        |       | $          | 28,299           |       | $                 | 290        |              | $          | 1,425            |       | $ | — |   | $ | 30,153 |   |
| Restricted cash                                  |       | —                    |       | —     |       | 941              |       | 805               |       | —            |       | 1,746            |       |
| Accounts  receivable, net                        |       | —                    |       | 22,642     |       | 7,132            |       | 13,854            |       | —            |       | 43,628           |       |
| Inventories                                      |       | —                    |       | 34,659     |       | 2,215            |       | 18,540            |       | (1,383            | )          | 54,031           |       |
| Deferred tax  assets                             |       | —                    |       | 10,703     |       | 3                |       | 814               |       | —            |       | 11,520           |       |
| Intercompany  receivable                         |       | —                    |       | 27,988     |       | 2,748            |       | —            |       | (30,736           | )          | —           |       |
| Prepaid and  other current assets                |       | 887                       |       | 1,238      |       | 165              |       | 790               |       | —            |       | 3,080            |       |
| Total current assets                             |       | 1,026                     |       | 125,529    |       | 13,494           |       | 36,228            |       | (32,119           | )          | 144,158          |       |
| Property, plant  and equipment, net              |       | —                    |       | 50,344     |       | 2,982            |       | 10,525            |       | —            |       | 63,851           |       |
| Deferred debt  issue costs, net                  |       | 3,123                     |       | 6,521      |       | —           |       | —            |       | —            |       | 9,644            |       |
| Intangible  assets, net                          |       | —                    |       | 59,901     |       | 6,715            |       | 8,873             |       | —            |       | 75,489           |       |
| Goodwill                                         |       | —                    |       | 93,378     |       | 5,848            |       | 48,263            |       | —            |       | 147,489          |       |
| Other long-term  assets                          |       | 731                       |       | 397        |       | —           |       | —            |       | —            |       | 1,128            |       |
| Intercompany  notes receivable                   |       | —                    |       | 1,035      |       | —           |       | —            |       | (1,035            | )          | —           |       |
| Investment in  subsidiaries                      |       | 204,778                   |       | 55,247     |       | —           |       | —            |       | (260,025          | )          | —           |       |
| Total assets                                     |       | $                         | 209,658    |       | $          | 392,352          |       | $                 | 29,039     |              | $          | 103,889          |       | $ | (293,179 | ) | $ | 441,759 |   |
|                                             |       |                      |       |       |       |             |       |              |       |              |       |             |       |
| **Liabilities  and stockholders’ equity**   |       |                      |       |       |       |             |       |              |       |              |       |             |       |
| Current portion  of long-term debt               |       | $                         | —     |       | $          | 1,714            |       | $                 | —     |              | $          | —           |       | $ | — |   | $ | 1,714 |   |
| Accounts payable                                 |       | 199                       |       | 9,667      |       | 490              |       | 8,745             |       | —            |       | 19,101           |       |
| Accrued expenses                                 |       | 1,298                     |       | 16,130     |       | 921              |       | 4,920             |       | —            |       | 23,269           |       |
| Product warranty                                 |       | —                    |       | 3,506      |       | 204              |       | 2,248             |       | —            |       | 5,958            |       |
| Income taxes  payable                            |       | —                    |       | 4,778      |       | 204              |       | 5,711             |       | —            |       | 10,693           |       |
| Advance payments  from customers                 |       | —                    |       | 3,451      |       | 909              |       | 1,950             |       | —            |       | 6,310            |       |
| Intercompany  payable                            |       | 27,744                    |       | —     |       | —           |       | 2,992             |       | (30,736           | )          | —           |       |
| Total current liabilities                        |       | 29,241                    |       | 39,246     |       | 2,728            |       | 26,566            |       | (30,736           | )          | 67,045           |       |
| Deferred income  taxes                           |       | 447                       |       | 23,578     |       | —           |       | 5,908             |       | —            |       | 29,933           |       |
| Intercompany  notes payable                      |       | —                    |       | —     |       | —           |       | 1,035             |       | (1,035            | )          | —           |       |
| Long-term debt,  less current portion            |       | 79,281                    |       | 165,786    |       | —           |       | —            |       | —            |       | 245,067          |       |
| Other long-term  liabilities                     |       | —                    |       | 41         |       | —           |       | —            |       | —            |       | 41               |       |
| Total liabilities                                |       | 108,969                   |       | 228,651    |       | 2,728            |       | 33,509            |       | (31,771           | )          | 342,086          |       |
| Common stock                                     |       | 160                       |       | —     |       | —           |       | —            |       | —            |       | 160              |       |
| Parent  investment                               |       | —                    |       | 120,705    |       | 22,228           |       | 57,536            |       | (200,469          | )          | —           |       |
| Additional  paid-in capital                      |       | 65,295                    |       | —     |       | —           |       | —            |       | —            |       | 65,295           |       |
| Accumulated  other comprehensive income          |       | 679                       |       | 8          |       | —           |       | (23               | )          | 15                |       | 679              |       |
| Retained  earnings                               |       | 34,555                    |       | 42,988     |       | 4,083            |       | 12,867            |       | (60,954           | )          | 33,539           |       |
| Net stockholders’ equity                    |       | 100,689                   |       | 163,701    |       | 26,311           |       | 70,380            |       | (261,408          | )          | 99,673           |       |
| Total  liabilities and stockholders’ equity |       | $                         | 209,658    |       | $          | 392,352          |       | $                 | 29,039     |              | $          | 103,889          |       | $ | (293,179 | ) | $ | 441,759 |   |

 

29

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**CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS  For the Three Months Ended June 29, 2007**
| ** **                                                                    | ** ** | **Parent**                | ** ** | **Issuer** | ** ** | **Guarantor**    | ** ** | **Non-Guarantor** | ** ** | **Consolidating** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------------------------|------------|---------------------------|------------|------------|------------|------------------|------------|-------------------|------------|-------------------|------------|------------------|------------|
| ** **                                                                    | ** ** | **(CPI Int’l)** | ** ** | **(CPI)**  | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**  | ** ** | **Eliminations**  | ** ** | **Total**        | ** ** |
| Sales                                                                         |       | $                         | —     |       | $          | 55,453           |       | $                 | 15,073     |              | $          | 37,186           |       | $ | (20,394 | ) | $ | 87,318 |   |
| Cost of sales                                                                 |       | —                    |       | 38,210     |       | 12,660           |       | 28,182            |       | (20,385           | )          | 58,667           |       |
| Gross profit                                                                  |       | —                    |       | 17,243     |       | 2,413            |       | 9,004             |       | (9                | )          | 28,651           |       |
| Operating costs  and expenses:                                                |       |                      |       |       |       |             |       |              |       |              |       |             |       |
| Research and development                                                      |       | —                    |       | 716        |       | —           |       | 1,516             |       | —            |       | 2,232            |       |
| Selling and marketing                                                         |       | —                    |       | 2,019      |       | 924              |       | 1,968             |       | —            |       | 4,911            |       |
| General and administrative                                                    |       | —                    |       | 3,453      |       | 246              |       | 2,136             |       | —            |       | 5,835            |       |
| Amortization of acquisition-related intangible  assets                        |       | —                    |       | 334        |       | 62               |       | 152               |       | —            |       | 548              |       |
| Net loss on disposition of assets                                             |       | —                    |       | 1          |       | —           |       | 15                |       | —            |       | 16               |       |
| Total operating  costs and expenses                                           |       | —                    |       | 6,523      |       | 1,232            |       | 5,787             |       | —            |       | 13,542           |       |
| Operating income                                                              |       | —                    |       | 10,720     |       | 1,181            |       | 3,217             |       | (9                | )          | 15,109           |       |
| Interest expense (income), net                                                |       | 1,950                     |       | 3,198      |       | (15              | )          | 10                |       | —            |       | 5,143            |       |
| (Loss) income  before income tax expense and equity in income of subsidiaries |       | (1,950                    | )          | 7,522      |       | 1,196            |       | 3,207             |       | (9                | )          | 9,966            |       |
| Income tax (benefit) expense                                                  |       | (765                      | )          | 1,448      |       | 321              |       | 831               |       | —            |       | 1,835            |       |
| Equity in income of subsidiaries                                              |       | 9,316                     |       | 3,242      |       | —           |       | —            |       | (12,558           | )          | —           |       |
| Net income                                                                    |       | $                         | 8,131      |       | $          | 9,316            |       | $                 | 875        |              | $          | 2,376            |       | $ | (12,567 | ) | $ | 8,131 |   |

 

**CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS  For the Three Months Ended June 30, 2006**
| ** **                                                                    | ** ** | **Parent**                | ** ** | **Issuer** | ** ** | **Guarantor**    | ** ** | **Non-Guarantor** | ** ** | **Consolidating** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------------------------|------------|---------------------------|------------|------------|------------|------------------|------------|-------------------|------------|-------------------|------------|------------------|------------|
| ** **                                                                    | ** ** | **(CPI Int’l)** | ** ** | **(CPI)**  | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**  | ** ** | **Eliminations**  | ** ** | **Total**        | ** ** |
| Sales                                                                         |       | $                         | —     |       | $          | 59,103           |       | $                 | 15,958     |              | $          | 31,036           |       | $ | (18,336 | ) | $ | 87,761 |   |
| Cost of sales                                                                 |       | —                    |       | 42,091     |       | 12,994           |       | 23,925            |       | (18,143           | )          | 60,867           |       |
| Gross profit                                                                  |       | —                    |       | 17,012     |       | 2,964            |       | 7,111             |       | (193              | )          | 26,894           |       |
| Operating costs  and expenses:                                                |       |                      |       |       |       |             |       |              |       |              |       |             |       |
| Research and development                                                      |       | —                    |       | 927        |       | —           |       | 1,588             |       | —            |       | 2,515            |       |
| Selling and marketing                                                         |       | —                    |       | 2,206      |       | 921              |       | 2,121             |       | —            |       | 5,248            |       |
| General and administrative                                                    |       | —                    |       | 3,841      |       | 225              |       | 1,375             |       | —            |       | 5,441            |       |
| Amortization of acquisition-related intangible  assets                        |       | —                    |       | 334        |       | 63               |       | 151               |       | —            |       | 548              |       |
| Net loss on disposition of assets                                             |       | —                    |       | 206        |       | 2                |       | 4                 |       | —            |       | 212              |       |
| Total operating  costs and expenses                                           |       | —                    |       | 7,514      |       | 1,211            |       | 5,239             |       | —            |       | 13,964           |       |
| Operating income                                                              |       | —                    |       | 9,498      |       | 1,753            |       | 1,872             |       | (193              | )          | 12,930           |       |
| Interest expense (income), net                                                |       | 2,026                     |       | 3,912      |       | (2               | )          | 9                 |       | —            |       | 5,945            |       |
| (Loss) income  before income tax expense and equity in income of subsidiaries |       | (2,026                    | )          | 5,586      |       | 1,755            |       | 1,863             |       | (193              | )          | 6,985            |       |
| Income tax (benefit) expense                                                  |       | (811                      | )          | 2,318      |       | 504              |       | 506               |       | —            |       | 2,517            |       |
| Equity in income of subsidiaries                                              |       | 5,683                     |       | 2,608      |       | —           |       | —            |       | (8,291            | )          | —           |       |
| Net income                                                                    |       | $                         | 4,468      |       | $          | 5,876            |       | $                 | 1,251      |              | $          | 1,357            |       | $ | (8,484 | ) | $ | 4,468 |   |

 

30

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**CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS  For the Nine Months Ended June 29, 2007**
| ** **                                                                    | ** ** | **Parent**                | ** ** | **Issuer** | ** ** | **Guarantor**    | ** ** | **Non-Guarantor** | ** ** | **Consolidating** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------------------------|------------|---------------------------|------------|------------|------------|------------------|------------|-------------------|------------|-------------------|------------|------------------|------------|
| ** **                                                                    | ** ** | **(CPI Int’l)** | ** ** | **(CPI)**  | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**  | ** ** | **Eliminations**  | ** ** | **Total**        | ** ** |
| Sales                                                                         |       |                      | $          | —     |       | $                | 163,484    |              |       | $                 | 46,004     |             |       | $ | 105,872 |   |   | $ | (55,875 | ) |   | $ | 259,485 |   |
| Cost of sales                                                                 |       |                      | —     |       | 113,916    |             |       | 38,367            |       |              | 80,863     |             |       | (56,598 | ) |   | 176,548 |   |
| Gross profit                                                                  |       |                      | —     |       | 49,568     |             |       | 7,637             |       |              | 25,009     |             |       | 723 |   |   | 82,937 |   |
| Operating costs and  expenses:                                                |       |                      |       |       |       |             |       |              |       |              |       |             |       |   |   |   |   |   |
| Research and  development                                                     |       |                      | —     |       | 2,261      |             |       | —            |       |              | 4,214      |             |       | — |   |   | 6,475 |   |
| Selling and  marketing                                                        |       |                      | —     |       | 6,003      |             |       | 2,622             |       |              | 5,914      |             |       | — |   |   | 14,539 |   |
| General and  administrative                                                   |       |                      | —     |       | 11,546     |             |       | 968               |       |              | 3,571      |             |       | — |   |   | 16,085 |   |
| Amortization of  acquisition-related intangible assets                        |       |                      | —     |       | 1,002      |             |       | 187               |       |              | 453        |             |       | — |   |   | 1,642 |   |
| Net loss on  disposition of assets                                            |       |                      | —     |       | 18         |             |       | —            |       |              | 56         |             |       | — |   |   | 74 |   |
| Total operating costs  and expenses                                           |       |                      | —     |       | 20,830     |             |       | 3,777             |       |              | 14,208     |             |       | — |   |   | 38,815 |   |
| Operating income                                                              |       |                      | —     |       | 28,738     |             |       | 3,860             |       |              | 10,801     |             |       | 723 |   |   | 44,122 |   |
| Interest expense  (income), net                                               |       |                      | 6,070      |       | 9,817      |             |       | (30               | )          |              | (100       | )                |       | — |   |   | 15,757 |   |
| (Loss) income before  income tax expense and equity in income of subsidiaries |       |                      | (6,070     | )          | 18,921     |             |       | 3,890             |       |              | 10,901     |             |       | 723 |   |   | 28,365 |   |
| Income tax  (benefit) expense                                                 |       |                      | (2,331     | )          | 6,669      |             |       | 1,058             |       |              | 3,243      |             |       | — |   |   | 8,639 |   |
| Equity in income  of subsidiaries                                             |       |                      | 23,465     |       | 11,213     |             |       | —            |       |              | —     |             |       | (34,678 | ) |   | — |   |
| Net income                                                                    |       |                      | $          | 19,726     |       | $                | 23,465     |              |       | $                 | 2,832      |             |       | $ | 7,658 |   |   | $ | (33,955 | ) |   | $ | 19,726 |   |

 

**CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS  For the Nine Months Ended June 30, 2006**
| ** **                                                                    | ** ** | **Parent**                | ** ** | **Issuer** | ** ** | **Guarantor**    | ** ** | **Non-Guarantor** | ** ** | **Consolidating** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------------------------|------------|---------------------------|------------|------------|------------|------------------|------------|-------------------|------------|-------------------|------------|------------------|------------|
| ** **                                                                    | ** ** | **(CPI Int’l)** | ** ** | **(CPI)**  | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**  | ** ** | **Eliminations**  | ** ** | **Total**        | ** ** |
| Sales                                                                         |       |                      | $          | —     |       | $                | 167,686    |              |       | $                 | 45,000     |             |       | $ | 99,992 |   |   | $ | (55,609 | ) |   | $ | 257,069 |   |
| Cost of sales                                                                 |       |                      | —     |       | 122,617    |             |       | 36,936            |       |              | 75,191     |             |       | (55,521 | ) |   | 179,223 |   |
| Gross profit                                                                  |       |                      | —     |       | 45,069     |             |       | 8,064             |       |              | 24,801     |             |       | (88 | ) |   | 77,846 |   |
| Operating costs and  expenses:                                                |       |                      |       |       |       |             |       |              |       |              |       |             |       |   |   |   |   |   |
| Research and  development                                                     |       |                      | —     |       | 2,613      |             |       | —            |       |              | 3,753      |             |       | — |   |   | 6,366 |   |
| Selling and  marketing                                                        |       |                      | —     |       | 6,304      |             |       | 2,764             |       |              | 5,884      |             |       | — |   |   | 14,952 |   |
| General and  administrative                                                   |       |                      | —     |       | 10,411     |             |       | 959               |       |              | 6,049      |             |       | — |   |   | 17,419 |   |
| Amortization of  acquisition-related intangible assets                        |       |                      | —     |       | 1,002      |             |       | 188               |       |              | 452        |             |       | — |   |   | 1,642 |   |
| Net loss on  disposition of assets                                            |       |                      | —     |       | 378        |             |       | 2                 |       |              | 40         |             |       | — |   |   | 420 |   |
| Total operating costs  and expenses                                           |       |                      | —     |       | 20,708     |             |       | 3,913             |       |              | 16,178     |             |       | — |   |   | 40,799 |   |
| Operating income                                                              |       |                      | —     |       | 24,361     |             |       | 4,151             |       |              | 8,623      |             |       | (88 | ) |   | 37,047 |   |
| Interest expense  (income), net                                               |       |                      | 6,126      |       | 12,258     |             |       | (11               | )          |              | 36         |             |       | — |   |   | 18,409 |   |
| (Loss) income before  income tax expense and equity in income of subsidiaries |       |                      | (6,126     | )          | 12,103     |             |       | 4,162             |       |              | 8,587      |             |       | (88 | ) |   | 18,638 |   |
| Income tax  (benefit) expense                                                 |       |                      | (2,451     | )          | 6,097      |             |       | 1,200             |       |              | 2,764      |             |       | — |   |   | 7,610 |   |
| Equity in income  of subsidiaries                                             |       |                      | 14,703     |       | 8,785      |             |       | —            |       |              | —     |             |       | (23,488 | ) |   | — |   |
| Net income                                                                    |       |                      | $          | 11,028     |       | $                | 14,791     |              |       | $                 | 2,962      |             |       | $ | 5,823 |   |   | $ | (23,576 | ) |   | $ | 11,028 |   |

 

31

----

**CONDENSED CONSOLIDATING STATEMENTOF CASH FLOWSFor the Nine Months Ended June 29, 2007**

 
| ** **                                                       | ** ** | **Parent**                | ** ** | **Issuer** | ** ** | **Guarantor**    | ** ** | **Non-Guarantor** | ** ** | **Consolidating** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------------------|------------|---------------------------|------------|------------|------------|------------------|------------|-------------------|------------|-------------------|------------|------------------|------------|
| ** **                                                       | ** ** | **(CPI Int’l)** | ** ** | **(CPI)**  | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**  | ** ** | **Eliminations**  | ** ** | **Total**        | ** ** |
| **Cash  flows from operating activities**                        |       |                      |       |       |       |             |       |              |       |              |       |             |       |
| Net cash (used in) provided by operating activities              |       | $                         | (619       | )          | $          | 14,898           |       | $                 | 872        |              | $          | 4,108            |       | $ | — |   | $ | 19,259 |   |
| **Cash  flows from investing activities**                        | ** ** |                      | ** ** | ** ** | ** ** |             | ** ** |              | ** ** |              | ** ** |             | ** ** |
| Capital expenditures                                             |       | —                    |       | (2,423     | )          | (24              | )          | (3,945            | )          | —            |       | (6,392           | )          |
| Capitalized expenses relating to potential business  acquisition |       | —                    |       | (395       | )          | —           |       | —            |       | —            |       | (395             | )          |
| Net cash used in investing activities                            |       | —                    |       | (2,818     | )          | (24              | )          | (3,945            | )          | —            |       | (6,787           | )          |
| **Cash  flows from financing activities**                        |       |                      |       |       |       |             |       |              |       |              |       |             |       |
| Repayments of debt                                               |       | —                    |       | (5,000     | )          | —           |       | —            |       | —            |       | (5,000           | )          |
| Proceeds from exercise of stock options                          |       | 604                       |       | —     |       | —           |       | —            |       | —            |       | 604              |       |
| Proceeds from ESPP shares issued                                 |       | 520                       |       | —     |       | —           |       | —            |       | —            |       | 520              |       |
| Excess tax benefit on stock option exercises                     |       | —                    |       | 671        |       | —           |       | —            |       | —            |       | 671              |       |
| Net cash provided by (used in) financing activities              |       | 1,124                     |       | (4,329     | )          | —           |       | —            |       | —            |       | (3,205           | )          |
| **Net  increase in cash and cash equivalents**                   |       | 505                       |       | 7,751      |       | 848              |       | 163               |       | —            |       | 9,267            |       |
| Cash and cash equivalents at beginning of period                 |       | 139                       |       | 28,299     |       | 290              |       | 1,425             |       | —            |       | 30,153           |       |
| Cash and cash equivalents at end of period                       |       | $                         | 644        |       | $          | 36,050           |       | $                 | 1,138      |              | $          | 1,588            |       | $ | — |   | $ | 39,420 |   |

 

**CONDENSED CONSOLIDATING STATEMENTOF CASH FLOWSFor the Nine Months Ended June 30, 2006**
| ** **                                                 | ** ** | **Parent**                | ** ** | **Issuer** | ** ** | **Guarantor**    | ** ** | **Non-Guarantor** | ** ** | **Consolidating** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------------|------------|---------------------------|------------|------------|------------|------------------|------------|-------------------|------------|-------------------|------------|------------------|------------|
| ** **                                                 | ** ** | **(CPI Int’l)** | ** ** | **(CPI)**  | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**  | ** ** | **Eliminations**  | ** ** | **Total**        | ** ** |
| **Cash  flows from operating activities**                  |       |                      |       |       |       |             |       |              |       |              |       |             |       |
| Net cash (used in) provided by operating activities        |       | $                         | (3,409     | )          | $          | 1,285            |       | $                 | 451        |              | $          | 3,591            |       | $ | — |   | $ | 1,918 |   |
| **Cash  flows from investing activities**                  | ** ** | ** **                | ** ** | ** ** | ** ** |             | ** ** |              | ** ** |              | ** ** |             | ** ** |
| Deferred expenses relating to sale of San Carlos  property |       | —                    |       | (212       | )          | —           |       | —            |       | —            |       | (212             | )          |
| Capital expenditures                                       |       | —                    |       | (6,456     | )          | (106             | )          | (1,857            | )          | —            |       | (8,419           | )          |
| Investment in subsidiary                                   |       | (47,500                   | )          | 47,500     |       | —           |       | —            |       | —            |       | —           |       |
| Net cash (used in) provided by investing activities        |       | (47,500                   | )          | 40,832     |       | (106             | )          | (1,857            | )          | —            |       | (8,631           | )          |
| **Cash  flows from financing activities**                  |       |                      |       |       |       |             |       |              |       |              |       |             |       |
| Proceeds from issuance of debt                             |       | —                    |       | 10,000     |       | —           |       | —            |       | —            |       | 10,000           |       |
| Repayments of debt                                         |       | —                    |       | (47,500    | )          | —           |       | —            |       | —            |       | (47,500          | )          |
| Proceeds from issuance of common stock                     |       | 52,942                    |       | —     |       | —           |       | —            |       | —            |       | 52,942           |       |
| Payment of IPO financing costs                             |       | (5,634                    | )          | —     |       | —           |       | —            |       | —            |       | (5,634           | )          |
| Stockholder distribution payments                          |       | (17,000                   | )          | —     |       | —           |       | —            |       | —            |       | (17,000          | )          |
| Intercompany dividends                                     |       | 20,959                    |       | (20,959    | )          | —           |       | —            |       | —            |       | —           |       |
| Net cash provided by (used in) financing activities        |       | 51,267                    |       | (58,459    | )          | —           |       | —            |       | —            |       | (7,192           | )          |
| **Net  increase (decrease) in cash and cash equivalents**  |       | 358                       |       | (16,342    | )          | 345              |       | 1,734             |       | —            |       | (13,905          | )          |
| Cash and cash equivalents at beginning of period           |       | 33                        |       | 25,528     |       | 323              |       | 627               |       | —            |       | 26,511           |       |
| Cash and cash equivalents at end of period                 |       | $                         | 391        |       | $          | 9,186            |       | $                 | 668        |              | $          | 2,361            |       | $ | — |   | $ | 12,606 |   |

 

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## **Item 2.    Management’s Discussion and Analysis of Financial Condition andResults of Operations**

*Our fiscal years are the 52- or 53-weekperiods that end on the Friday nearest September 30. Fiscal year 2007 comprisesthe 52-week period ending September 28, 2007 and fiscal year 2006 comprised the52-week period ended September 29, 2006. The following discussion should beread in conjunction with the accompanying unaudited condensed consolidatedfinancial statements, and the notes thereto, of CPI International, Inc.*

**Overview**

CPI International, Inc., headquartered inPalo Alto, California, is the parent company of Communications & PowerIndustries, Inc., a leading provider of microwave, radio frequency, power andcontrol solutions for critical defense, communications, medical, scientific andother applications. Communications & Power Industries, Inc. develops,manufactures and distributes products used to generate, amplify and transmithigh-power/high-frequency microwave and radio frequency signals and/or providepower and control for various applications. End-use applications of thesesystems include the transmission of radar signals for navigation and location;transmission of deception signals for electronic countermeasures; transmissionand amplification of voice, data and video signals for broadcasting, Internetand other types of communications; providing power and control for medicaldiagnostic imaging; and generating microwave energy for radiation therapy inthe treatment of cancer and for various industrial and scientific applications.

Unless the context otherwise requires, “CPIInternational” means CPI International, Inc., and “CPI” means Communications& Power Industries, Inc. CPI is a direct subsidiary of CPI International.CPI International is a holding company with no operations of its own. The terms“we,” “us,” “our” and the “Company” refer to CPI International and its directand indirect subsidiaries on a consolidated basis.

**MalibuResearch Acquisition**

On August 10, 2007, we completed our acquisition of all outstandingcommon stock of the privately held Malibu Research Associates, Inc. for apurchase price of approximately $22.0 million in cash and a potential earnoutof up to $15.0 million, which is primarily contingent upon the achievement ofcertain financial objectives over the three years following the acquisition.Malibu Research, headquartered in Camarillo, California, is a designer,manufacturer and integrator of advanced antenna systems for radar, radarsimulators and telemetry systems, as well as for strategically vital data linksused in ground, airborne, unmanned aerial vehicles (UAV) and shipboard systems.

**EimacRelocation**

After relocating our Eimac operations (“Eimac”)from our former facility in San Carlos, California, we made organizationalchanges and consolidated Eimac into our Microwave Power Products division,located in Palo Alto, California, in June 2006. The Eimac integration wascompleted in January 2007. As part of this relocation and integration, Eimac experiencedplanned manufacturing disruptions stemming from the decommissioning of ourproduction equipment in San Carlos and the required reconfiguration,installation and testing of that equipment prior to production readiness inPalo Alto. During fiscal year 2005, in anticipation of these planneddisruptions, customers accelerated the placement of orders with Eimac. Thisorder acceleration in fiscal year 2005, and the subsequent acceleration ofproduct shipments, caused a reduction of customers’ demand requirements fromEimac during fiscal year 2006, particularly in our medical, communications andindustrial markets.

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Eimac orders and sales for the nine months endedJune 30, 2006 reflected the negative impact of the Eimac relocation andintegration. In addition, during the nine months ended June 30, 2006, weincurred move-related expenses and Eimac experienced unfavorable overheadabsorption and manufacturing variances due to the reduction in sales volume andrelocation disruptions. By the first quarter of fiscal year 2007, orders andsales rates for Eimac had recovered to near their historical levels.

**Orders**

We sell our products into six end markets:radar, electronic warfare, medical, communications, industrial andscientific.  We frequently refer to ourradar and electronic warfare markets as our “defense markets.”

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

Our orders by market for the nine monthsended June 29, 2007 and June 30, 2006 are summarized as follows (dollars inmillions):
|                     | ** ** | **Nine Months Ended** | ** ** | ** **              | ** ** | ** **                   | ** ** |
|---------------------|------------|---------------------------------|------------|-------------------------|------------|------------------------------|------------|
| ** **          | ** ** | **June 29,  2007**         | ** ** | **June 30,  2006** | ** ** | **Increase (Decrease)** | ** ** |
| ** **          | ** ** | ** **                      | ** ** | **% of**           | ** ** | ** **                   | ** ** | **% of** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **          | ** ** | **Amount**                      | ** ** | **Orders**              | ** ** | **Amount**                   | ** ** | **Orders** | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| Radar               |       | $                               | 92.4       |                    | 34         | %                            | $          | 88.6 |   | 36 | % | $ | 3.8 |   | 4 | % |
| Electronic  Warfare |       | 17.0                            |       | 6                       |       | 18.4                         |       | 7 |   | (1.4 | ) | (8 | ) |
| Medical             |       | 53.9                            |       | 20                      |       | 46.9                         |       | 19 |   | 7.0 |   | 15 |   |
| Communications      |       | 81.7                            |       | 31                      |       | 71.7                         |       | 29 |   | 10.0 |   | 14 |   |
| Industrial          |       | 16.1                            |       | 6                       |       | 16.7                         |       | 7 |   | (0.6 | ) | (4 | ) |
| Scientific          |       | 8.3                             |       | 3                       |       | 3.9                          |       | 2 |   | 4.4 |   | 113 |   |
| Total               |       | $                               | 269.4      |                    | 100        | %                            | $          | 246.2 |   | 100 | % | $ | 23.2 |   | 9 | % |

 

Explanations for the order increase ordecrease by market for the nine months ended June 29, 2007 compared to the ninemonths ended June 30, 2006 are as follows:

·      **Radar and Electronic Warfare:** Themajority of our sales in the radar and electronic warfare markets are forproducts for domestic and international defense and government end uses. Ordersin these markets are characterized by many smaller orders in the $0.5 millionto $3.0 million range by product or program, and the timing of these orders mayvary from year to year. On a combined basis, orders for the radar andelectronic warfare markets increased from an aggregate of $107.0 million in thenine months ended June 30, 2006 to an aggregate of $109.4 million in the ninemonths ended June 29, 2007. This approximate 2% overall increase in orders forthese markets on a combined basis is consistent with our expectations ofoverall low single digit percentage average long-term annual growth in thesemarkets taken on a combined basis.

·      **Medical: **The increase inmedical orders from the nine months ended June 30, 2006 to the nine monthsended June 29, 2007 resulted from continued increases in orders for ourmagnetic resonance imaging (“MRI”) products due to growth in the number of MRIsystems

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        on which we have products;increases in orders for our x-ray generators due to growth in the overall x-raygenerator market and our share of this market, as well as increases in ordersfor our x-ray generators for a Russian tender program, now in its second yearof supporting theexpansion of the Russian medical infrastructure.

·      **Communications: **The increase incommunications orders was primarily attributable to increases in orders toforeign customers for satellite communications amplifiers used for newsgathering and mobile applications, broadcast applications and direct-to-homeapplications. These increases were partially offset by a decrease in orders forour newer types of satellite communications amplifiers for certain programs forNorth American direct-to-home broadcast and military satellite communicationsapplications, due to the timing of orders for these programs.

·      **Industrial:**Ordersin the industrial market, one of our smallest markets, are cyclical. The decrease inindustrial orders was primarily attributable to the timing of orders forproducts used in electromagnetic susceptibility test programs and otherindustrial applications.

·      **Scientific:** Orders in thescientific market, our smallest market, are historically one-time projects andcan fluctuate significantly from period to period. The increase in scientificorders was primarily the result of orders for products for the SpallationNeutron Source at Oakridge National Laboratory.

Incoming order levels fluctuate significantlyon a quarterly or annual basis, and a particular quarter’s or year’s order ratemay not be indicative of future order levels. In addition, our sales are highlydependent upon manufacturing scheduling and performance and, accordingly, it isnot possible to accurately predict when orders will be recognized as sales.

**Backlog**

As of June 29, 2007, we had an order backlog of $198.4 million comparedto an order backlog of $184.8 million as of June 30, 2006. Backlog representsthe cumulative balance, at a given point in time, of recorded customer salesorders that have not yet been shipped or recognized as sales. Backlog isincreased when an order is received, and backlog is decreased when we recognizesales. We believe backlog and orders information is helpful to investors becausethis information may be indicative of future sales results. Although backlogconsists 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 materialcompared to total contract volume.

**Results ofOperations**

We derive our revenue primarily from the sale ofmicrowave and radio frequency products, including high-power microwaveamplifiers, satellite communications amplifiers, medical x-ray imagingsubsystems, and other related products. Our products generally have sellingprices ranging from $2,000 to $100,000, with certain limited products priced upto $1,000,000.

Cost of goods sold generally includes costsfor raw materials, manufacturing costs, including allocation of overhead andother indirect costs, charges for reserves for excess and obsolete inventory,warranty claims and losses on fixed price contracts. Operating expensesgenerally consist of research and development, selling and marketing andgeneral and administrative expenses.

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*Three Months Ended June 29, 2007 Compared to Three Months Ended June30, 2006*

Thefollowing table sets forth our historical results of operations for each of theperiods indicated (dollars in millions):
|                                                   | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------------|------------|----------------------------------|------------|
| ** **                                        | ** ** | **June 29, 2007**      | ** ** | **June 30, 2006** | ** ** |
| ** **                                        | ** ** | ** **                       | ** ** | **% of** | ** ** | ** ** | ** ** | **% of** | ** ** |
| ** **                                        | ** ** | **Amount**                       | ** ** | **Sales** | ** ** | **Amount** | ** ** | **Sales** | ** ** |
| Sales                                             |       | $                                | 87.3       |   | 100.0 | % | $ | 87.8 |   | 100.0 | % |
| Cost of sales                                     |       | 58.7                             |       | 67.2 |   | 60.9 |   | 69.4 |   |
| Gross profit                                      |       | 28.7                             |       | 32.9 |   | 26.9 |   | 30.6 |   |
| Operating costs  and expenses:                    |       |                             |       |   |   |   |   |   |   |
| Research and  development                         |       | 2.2                              |       | 2.5 |   | 2.5 |   | 2.8 |   |
| Selling and  marketing                            |       | 4.9                              |       | 5.6 |   | 5.2 |   | 5.9 |   |
| General and  administrative                       |       | 5.8                              |       | 6.6 |   | 5.4 |   | 6.2 |   |
| Amortization of  acquisition- related intangibles |       | 0.5                              |       | 0.6 |   | 0.5 |   | 0.6 |   |
| Net loss on  disposition of fixed assets          |       | —                           |       | 0.0 |   | 0.2 |   | 0.2 |   |
| Total operating costs and expenses                |       | 13.5                             |       | 15.5 |   | 14.0 |   | 15.9 |   |
| Operating income                                  |       | 15.1                             |       | 17.3 |   | 12.9 |   | 14.7 |   |
| Interest  expense, net                            |       | 5.1                              |       | 5.8 |   | 5.9 |   | 6.7 |   |
| Income before taxes                               |       | 10.0                             |       | 11.5 |   | 7.0 |   | 8.0 |   |
| Income tax  expense                               |       | 1.8                              |       | 2.1 |   | 2.5 |   | 2.8 |   |
| Net income                                        |       | $                                | 8.1        |   | 9.3 | % | $ | 4.5 |   | 5.1 | % |
| Other Data:                                       |       |                             |       |   |   |   |   |   |   |
| EBITDA (a)                                        |       | $                                | 17.3       |   | 19.8 | % | $ | 15.3 |   | 17.4 | % |

 

Note: Totals maynot equal the sum of the component line items due to independent rounding.Percentages are calculated based on rounded dollar amounts presented.

(a)               EBITDArepresents earnings before provision for income taxes, net interest expense anddepreciation and amortization. For the reasons listed below, we believe thatGAAP-based financial information for leveraged businesses such as ours shouldbe supplemented by EBITDA so that investors better understand our financialperformance in connection with their analysis of our business:

·     EBITDA is acomponent of the measures used by our board of directors and management team toevaluate our operating performance;

·     our seniorcredit facilities contain covenants that require us to maintain certaininterest expense coverage and leverage ratios that contain EBITDA as acomponent, and our management team uses EBITDA to monitor compliance with suchcovenants;

·     EBITDA is acomponent of the measures used by our management team to make day-to-dayoperating decisions;

·     EBITDAfacilitates comparisons between our operating results and those of competitorswith different capital structures and therefore is a component of the measuresused by the management to facilitate internal comparisons to competitors’results and our industry in general; and

·     the paymentof management bonuses is contingent upon, among other things, the satisfactionby us of certain targets that contain EBITDA as a component.

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Other companies may define EBITDAdifferently and, as a result, our measure of EBITDA may not be directlycomparable to EBITDA of other companies.  Although we useEBITDA as a financial measure to assess the performance of our business, theuse of EBITDA is limited because it does not include certain material costs,such as interest and taxes, necessary to operate our business. When analyzingour performance, EBITDA should be considered in addition to, and not as asubstitute for, net income, cash flows from operating activities or otherstatements of operations or statements of cash flows data prepared inaccordance with GAAP.

For areconciliation of Net Income to EBITDA, see Note 9 of the accompanyingunaudited condensed consolidated financial statements.

**Sales:** Our sales by market for the three months ended June29, 2007, and June 30, 2006, are summarized as follows (dollars in millions):
|                     | ** ** | **Three Months Ended** | ** ** | ** **              | ** ** | ** **                   | ** ** |
|---------------------|------------|----------------------------------|------------|-------------------------|------------|------------------------------|------------|
| ** **          | ** ** | **June 29,  2007**          | ** ** | **June 30,  2006** | ** ** | **Increase (Decrease)** | ** ** |
| ** **          | ** ** | ** **                       | ** ** | **% of**           | ** ** | ** **                   | ** ** | **% of** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **          | ** ** | **Amount**                       | ** ** | **Sales**               | ** ** | **Amount**                   | ** ** | **Sales** | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| Radar               |       | $                                | 31.5       |                    | 36         | %                            | $          | 32.1 |   | 37 | % | $ | (0.6 | ) | (2 | )% |
| Electronic  Warfare |       | 5.0                              |       | 6                       |       | 7.0                          |       | 8 |   | (2.0 | ) | (29 | ) |
| Medical             |       | 18.0                             |       | 21                      |       | 15.6                         |       | 18 |   | 2.4 |   | 15 |   |
| Communications      |       | 27.3                             |       | 31                      |       | 24.9                         |       | 28 |   | 2.4 |   | 10 |   |
| Industrial          |       | 4.7                              |       | 5                       |       | 6.5                          |       | 7 |   | (1.8 | ) | (28 | ) |
| Scientific          |       | 0.8                              |       | 1                       |       | 1.7                          |       | 2 |   | (0.9 | ) | (53 | ) |
| Total               |       | $                                | 87.3       |                    | 100        | %                            | $          | 87.8 |   | 100 | % | $ | (0.5 | ) | (1 | )% |

 

Sales for the three months ended June 29, 2007 of$87.3 million were $0.5 million, or approximately 1%, less than sales of $87.8million for the three months ended June 30, 2006. Explanations for the salesincrease or decrease by market are as follows:

·      **Radar and Electronic Warfare: **The majority of our sales in the radar and electronicwarfare markets are for products for domestic and international defense andgovernment end uses.   The timing oforders receipts and subsequent shipments in these markets may vary from year toyear.  On a combined basis, sales forthese two markets decreased approximately 7% in the three months ended June 29,2007 as compared to the three months ended June 30, 2006, primarily due toshipments made in the three months ended June 30, 2006 for certain electronicwarfare programs that were not expected to, and did not, repeat in the threemonths ended June 29, 2007, as well as the timing of orders and sales forcertain radar programs. Management believes that, on a combined basis, thesemarkets will experience low single digit percentage average long-term annualgrowth.

·      **Medical:** The 15% increase in sales of our medicalimaging and radiation therapy products was primarily due to increased sales ofour products used in x-ray imaging. In the three months ended June 29, 2007,sales of x-ray generators to United States and foreign customers increased $2.1million due to growth in our market share and an increase in shipments for aRussian tender program, now in its second year of supporting the expansion ofthe Russian medical infrastructure. Shipments of our products used in MRI alsoincreased due to an increase in sales of replacement products, or spares,resulting from growth in the number of MRI systems on which we have products. 

·      **Communications: **The increase in sales in thecommunications market was primarily the result of increased sales of both newerand traditional satellite communications products for foreign 

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                       broadcast network and direct-to-homeapplications, as well as increased sales of newer products for foreign newsgathering and mobile applications and U.S. military communicationsapplications. These increases were partially offset by a decrease in shipmentsof our newer satellite communications products for North Americandirect-to-home broadcast applications due to the timing of these programs.

·      **Industrial:**Sales in theindustrial market, one of our smallest markets, are cyclical. The decrease in industrial sales wasprimarily due to timing of orders and shipments of products used forelectromagnetic susceptibility test programs and other industrial applications.

·      **Scientific: **Sales in the scientific market, oursmallest market, are historically one-time projects and can fluctuatesignificantly from period to period. The decrease in scientific sales wasprimarily the result of shipments we made to various laboratories in the threemonths ended June 30, 2006 that did not repeat in the three months ended June29, 2007.

**Gross Profit**. Gross profit was $28.7 million, or 32.9% of sales,for the three months ended June 29, 2007 as compared to $26.9 million, or 30.6%of sales, in the three months ended June 30, 2006. The three months ended June30, 2006 included non-recurring expenses of approximately $1.8 million formove-related expenses, including unfavorable overhead absorption andmanufacturing variances, for Eimac. The three months ended June 29, 2007, ascompared to the three months ended June 30, 2006, were favorably impacted bythe shipment of products with higher gross margins and were unfavorablyimpacted by approximately $0.5 million due to increases in our Canadian dollardenominated manufacturing expenses due to the weakening of the U.S. dollar.

**Research and Development**. Research and development expenses were$2.2 million, or 2.5% of sales, for the three months ended June 29, 2007, a$0.3 million decrease from $2.5 million, or 2.8% of sales, for the three monthsended June 30, 2006.  The decrease inresearch and development in fiscal year 2007 was due primarily to moredevelopment engineering costs being charged to customer-sponsored research anddevelopment, which is reported as cost of sales. Total spending on research anddevelopment, including customer-sponsored research and development, was $3.9million for the three months ended June 29, 2007 and $3.7 million in the threemonths ended June 30, 2006.

**Selling and Marketing**. Selling and marketing expenses were$4.9 million, or 5.6% of sales, for the three months ended June 29, 2007, a$0.3 million decrease from the $5.2 million, or 5.9% of sales, for the threemonths ended June 30, 2006. The reduction in selling and marketing expenses forthe three months ended June 29, 2007 compared to the three months ended June30, 2006 was primarily due to higher spending in three months ended June 30,2006 for new product introductions.

**Generaland Administrative**. General and administrative expenses were$5.8 million, or 6.6% of sales, for the three months ended June 29, 2007, a$0.4 million increase from the $5.4 million, or 6.2% of sales, for the threemonths ended June 30, 2006. The increase in general and administrative expensesin the three months ended June 29, 2007 was primarily due to increases inforeign currency translation losses, incremental expenses associated withmeeting the compliance requirements of Section 404 of the Sarbanes-Oxley Act of2002, and higher stock-based compensation expenses. The increase in foreigncurrency translation losses is primarily due to the weakening of the U.S.dollar and its corresponding impact to the translation of our net Canadianliability position.  

**Amortization of Acquisition-Related Intangibles**. Amortization of acquisition-relatedintangibles consists of purchase accounting charges for technology and otherintangible assets. Amortization of acquisition-related intangibles was $0.5million for both the three months ended June 29, 2007 and the three monthsended June 30, 2006.

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**Interest Expense, net (“Interest Expense”)**. Interest Expense of $5.1 million forthe three months ended June 29, 2007 was $0.8 million lower than interestexpense of $5.9 million for the three months ended June 30, 2006. The reductionin interest expense in the three months ended June 29, 2007 compared to thethree months ended June 30, 2006 was primarily due to lower debt levelsresulting from term loan prepayments of $5.0 million in December 2006, and$47.5 million in May 2006 using the proceeds from the initial public offeringof our common stock.

**Income Tax Expense**. We recorded an income tax expense of $1.8 millionand $2.5 million for the three months ended June 29, 2007 and June 30, 2006,respectively.  Our effective tax rate was approximately 18.4% for thethree months ended June 29, 2007 as compared to approximately 36.0% for thethree months ended June 30, 2006.  The effective tax rate for the three months ended June 29,2007 includes a discrete tax benefit of $1.8 million related to the filing ofamended income tax returns for prior years to reflect a change inestimate with regard to reporting Canadian income earned in the U.S.  Our estimated fiscal year 2007effective income tax rate, excluding discrete tax items, is approximately 38%.  

**Net Income**. Net income was $8.1 million, or 9.3% of sales, forthe three months ended June 29, 2007 as compared to $4.5 million, or 5.1% ofsales, in the three months ended June 30, 2006. The increase in net income inthe three months ended June 29, 2007 was due primarily to the absence ofmove-related expenses for Eimac, lower interest expense, and the income taxbenefit from filing amended U.S. income tax returns for prior years.

**EBITDA**. EBITDAwas $17.3 million, or 19.8% of sales, for the three months ended June 29, 2007as compared to $15.3 million, or 17.4% of sales, for the three months endedJune 30, 2006. The increase in EBITDA for the three months ended June 29, 2007was primarily due to the absence in the fiscal year 2007 period of move-relatedexpenses of $2.3 million, including unfavorable overhead absorption andmanufacturing variances, for the Eimac relocation, and a favorable mix ofproducts with higher gross margins in the three months ended June 29, 2007;partially offset by EBITDA decreases in fiscal year 2007 from the weakening ofthe U.S. dollar and higher expenses for Sarbanes-Oxley compliance.  The weakening of the U.S. dollar reducedEBITDA by a total of $1.1 million due to increases in Canadian dollardenominated expenses and translation losses from our net Canadian liabilityposition.

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*Nine Months Ended June 29, 2007 Compared to Nine Months Ended June 30,2006*

The followingtable sets forth our historical results of operations for each of the periodsindicated (dollars in millions):

|                                                 | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------------|------------|---------------------------------|------------|
| ** **                                      | ** ** | **June 29, 2007**     | ** ** | **June 30, 2006** | ** ** |
| ** **                                      | ** ** | ** **                      | ** ** | **% of** | ** ** | ** ** | ** ** | **% of** | ** ** |
| ** **                                      | ** ** | **Amount**                      | ** ** | **Sales** | ** ** | **Amount** | ** ** | **Sales** | ** ** |
| Sales                                           |       | $                               | 259.5      |   | 100.0 | % | $ | 257.1 |   | 100.0 | % |
| Cost of sales  (a)                              |       | 176.5                           |       | 68.0 |   | 179.2 |   | 69.7 |   |
| Gross profit                                    |       | 82.9                            |       | 31.9 |   | 77.8 |   | 30.3 |   |
| Operating costs  and expenses:                  |       |                            |       |   |   |   |   |   |   |
| Research and  development                       |       | 6.5                             |       | 2.5 |   | 6.4 |   | 2.5 |   |
| Selling and  marketing (a)                      |       | 14.5                            |       | 5.6 |   | 15.0 |   | 5.8 |   |
| General and  administrative (a)                 |       | 16.1                            |       | 6.2 |   | 17.4 |   | 6.8 |   |
| Amortization of acquisition-related intangibles |       | 1.6                             |       | 0.6 |   | 1.6 |   | 0.6 |   |
| Net loss on  disposition of assets              |       | —                          |       | 0.0 |   | 0.4 |   | 0.2 |   |
| Total operating  costs and expenses             |       | 38.8                            |       | 15.0 |   | 40.8 |   | 15.9 |   |
| Operating income                                |       | 44.1                            |       | 17.0 |   | 37.0 |   | 14.4 |   |
| Interest  expense, net                          |       | 15.8                            |       | 6.1 |   | 18.4 |   | 7.2 |   |
| Income before taxes                             |       | 28.4                            |       | 10.9 |   | 18.6 |   | 7.2 |   |
| Income tax  expense                             |       | 8.6                             |       | 3.3 |   | 7.6 |   | 3.0 |   |
| Net income                                      |       | $                               | 19.7       |   | 7.6 | % | $ | 11.0 |   | 4.3 | % |
| Other Data:                                     |       |                            |       |   |   |   |   |   |   |
| EBITDA (b)                                      |       | $                               | 50.7       |   | 19.5 | % | $ | 43.8 |   | 17.0 | % |

 

(a)    The nine months ended June 30, 2006 includes a specialbonus expense (see “Special Bonus” below) of $3.25 million, allocated asfollows: $0.3 million to cost of sales, $0.2 million to selling and marketingand $2.75 million to general and administrative.

(b)    EBITDA represents earnings before provision for incometaxes, net interest expense and depreciation and amortization. For the reasonslisted below, we believe that GAAP-based financial information for leveragedbusinesses such as ours should be supplemented by EBITDA so that investorsbetter understand our financial performance in connection with their analysisof our business:

·     EBITDAis a component of the measures used by our board of directors and managementteam to evaluate our operating performance;

·     oursenior credit facilities contain covenants that require us to maintain certaininterest expense coverage and leverage ratios that contain EBITDA as acomponent, and our management team uses EBITDA to monitor compliance with suchcovenants;

·     EBITDAis a component of the measures used by our management team to make day-to-dayoperating decisions;

·     EBITDAfacilitates comparisons between our operating results and those of competitorswith different capital structures and therefore is a component of the measuresused by the management to facilitate internal comparisons to competitors'results and our industry in general; and

·     thepayment of management bonuses is contingent upon, among other things, thesatisfaction by us of certain targets that contain EBITDA as a component.

                Other companies maydefine EBITDA differently and, as a result, our measure of EBITDA may not bedirectly comparable to EBITDA of other companies. Although we use EBITDA as afinancial measure to assess the performance of our business, the use of EBITDAis limited because it does not include certain material costs, 

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such asinterest and taxes, necessary to operate our business. When analyzing ourperformance, EBITDA should be considered in addition to, and not as asubstitute for, net income, cash flows from operating activities or otherstatements of operations or statements of cash flows data prepared inaccordance with GAAP.

For a reconciliation of Net Income to EBITDA, see Note9 of the accompanying unaudited condensed consolidated financial statements.

**Sales:** Our sales bymarket for the nine months ended June 29, 2007 and June 30, 2006 are summarizedas follows (dollars in millions):
|                     | ** ** | **Nine Months Ended** | ** ** | ** **              | ** ** | ** **                   | ** ** |
|---------------------|------------|---------------------------------|------------|-------------------------|------------|------------------------------|------------|
| ** **          | ** ** | **June 29,  2007**         | ** ** | **June 30,  2006** | ** ** | **Increase (Decrease)** | ** ** |
| ** **          | ** ** | ** **                      | ** ** | **% of**           | ** ** | ** **                   | ** ** | **% of** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **          | ** ** | **Amount**                      | ** ** | **Orders**              | ** ** | **Amount**                   | ** ** | **Orders** | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| Radar               |       | $                               | 88.8       |                    | 34         | %                            | $          | 90.1 |   | 35 | % | $ | (1.3 | ) | (1 | )% |
| Electronic  Warfare |       | 17.9                            |       | 7                       |       | 20.0                         |       | 8 |   | (2.1 | ) | (11 | ) |
| Medical             |       | 52.1                            |       | 20                      |       | 42.8                         |       | 17 |   | 9.3 |   | 22 |   |
| Communications      |       | 80.5                            |       | 31                      |       | 83.6                         |       | 33 |   | (3.1 | ) | (4 | ) |
| Industrial          |       | 16.1                            |       | 6                       |       | 16.3                         |       | 6 |   | (0.2 | ) | (1 | ) |
| Scientific          |       | 4.1                             |       | 2                       |       | 4.3                          |       | 1 |   | (0.2 | ) | (5 | ) |
| Total               |       | $                               | 259.5      |                    | 100        | %                            | $          | 257.1 |   | 100 | % | $ | 2.4 |   | 1 | % |

 

Sales for the nine months ended June 29, 2007of $259.5 million were $2.4 million, or 1%, higher than sales of $257.1 millionfor the nine months ended June 30, 2006. Explanations for the sales increase or decrease by market are asfollows:

·                  **Radarand Electronic Warfare: **The majority of our sales inthe radar and electronic warfare markets are for products for domestic andinternational defense and government end uses. The timing of orders receipts and subsequent shipments in these marketsmay vary from year to year.  On acombined basis, sales for these two markets decreased 3%, totaling an aggregateof $110.1 million in the nine months ended June 30, 2006, as compared to anaggregate of $106.7 million in the first nine months of fiscal year 2007. Theslight decline in combined sales was due primarily to shipments made in thefirst nine months of fiscal year 2006 for certain electronic warfare programsthat were not expected to, and did not, repeat in the first nine months offiscal year 2007, as well as the timing of orders and sales for certainelectronic warfare and radar programs. Management believes that, on a combinedbasis, these markets will experience low single digit percentage averagelong-term annual growth.

·                  **Medical:** The 22%increase in sales of our medical imaging and radiation therapy products wasprimarily due to increased sales of our products used in x-ray imaging, inradiation therapy for the treatment of cancer and in MRI. In the nine monthsended June 29, 2007, as compared to the nine months ended June 30, 2006, salesof replacement MRI products, or spares, increased due to growth in the numberof MRI systems on which we have products. Sales of x-ray generators to U.S. andforeign customers increased $5.8 million, including a $1.9 million increase insales of x-ray generators that are utilized in conjunction with equipment usedfor the treatment of cancer and a $1.4 million increase in sales of x-raygenerators for a Russian tender program, now in its second year of supporting the expansion of the Russian medicalinfrastructure. 

·                  **Communications: **The decrease insales in the communications market was primarily the result of the timing ofshipments for troposcatter communications programs.  In fiscal year 2006, we enjoyed unusuallystrong sales of products for troposcatter communications programs, and our

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shipments of products for these programs were $1.8 million higher inthe first nine months of fiscal year 2006 than in the first nine months offiscal year 2007, as we currently have provided these programs with sufficientstock of our products.  In addition, thefirst half of fiscal year 2006 contained higher sales of traditional satellitecommunications amplifiers for North American direct-to-home broadcastapplications than the first half of fiscal year 2007, due to the cyclicalnature of the direct-to-home broadcast market, and shipments of satellitecommunications amplifiers to an Indian government agency for a one-time applicationin the nine months ended June 30, 2006 did not recur in the nine months endedJune 29, 2007.  These decreases werepartially offset by an increase in shipments of both traditional and newersatellite communications products to U.S. and foreign customers for variousprograms, including foreign satellite news gathering or mobile applications,broadcast network applications, direct-to-home broadcast applications andmilitary satellite communications applications. These newer satellitecommunications products for the direct-to-home broadcast and military satellitecommunications applications were for the 30 gigahertz frequency band, orKa-band, which is projected to be one of the major new satellite communicationsgrowth areas for both commercial and military applications.

·                  **Industrial:**Sales in the industrial market, one of oursmallest markets, are cyclical. Industrial sales levels in the first nine months of fiscal year 2007 ascompared to the first nine months of fiscal year 2006 were essentially unchanged.

·                  **Scientific: **Sales in thescientific market, our smallest market, are historically one-time projects andcan fluctuate significantly from period to period. Scientific sales levels in the first nine months of fiscal year 2007 ascompared to the first nine months of fiscal year 2006 were essentiallyunchanged.  

**Gross Profit**. Gross profitwas $82.9 million, or 31.9% of sales, for the nine months ended June 29, 2007as compared to $77.8 million, or 30.3% of sales, in the nine months ended June30, 2006. The nine months ended June 30, 2006 included non-recurring expensesof approximately $5.6 million for move-related expenses, including unfavorableoverhead absorption and manufacturing variances, from the Eimac relocation. Thenine months ended June 29, 2007, as compared to the nine months ended June 30,2006, were favorably impacted by the shipment of products with higher grossmargins and were unfavorably impacted by approximately $2.7 million due toincreases in our Canadian dollar denominated manufacturing expenses resultingfrom the expiration of favorable foreign currency hedge contracts in March 2006and the further weakening of the U.S. dollar.

**Research and Development**. Researchand development expenses were $6.5 million, or 2.5% of sales, for the ninemonths ended June 29, 2007, a $0.1 million increase from $6.4 million, or 2.5%of sales, for the nine months ended June 30, 2006.  Total spending on research and development,including company-sponsored amounts charged to research and development, andcustomer-sponsored amounts, which is reported as cost of sales, increased to$11.5 million, or 4.4% of sales in the nine months ended June 30, 2007 ascompared to $10.7 million, or 4.2% of sales, in the nine months ended June 30, 2006.  The increase in research and developmentspending was primarily due to additional investment in the growth of medicaldiagnostic imaging products and vacuum electron devices (“VED”) products forradar, electronic warfare and certain of the satellite communication markets.

**Selling and Marketing**. Selling andmarketing expenses were $14.5 million, or 5.6% of sales, for the nine monthsended June 29, 2007, a $0.5 million decrease from the $15.0 million, or 5.8% ofsales, for the nine months ended June 30, 2006. The reduction in selling andmarketing expenses for the first nine months of fiscal year 2007 compared tothe first nine months of fiscal year 2006 was primarily due to higher spendingin the first nine months of fiscal year 2006 for new product introductions.Selling and marketing expenses for the nine months ended June 30, 2006 included$0.2 million of the special bonus discussed below.

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**General and Administrative**. General andadministrative expenses were $16.1 million, or 6.2% of sales, for the ninemonths ended June 29, 2007, a $1.3 million decrease from the $17.4 million, or6.8% of sales, for the nine months ended June 30, 2006. The nine months endedJune 30, 2006 included $2.75 million of the special bonus, discussed below, andEimac relocation expenses of $1.1 million. The nine months ended June 29, 2007 include approximately $1.1 millionfor incremental expenses associated with meeting the compliance requirements ofSection 404 of the Sarbanes-Oxley Act of 2002, $0.4 million for additionalexpenses as a result of becoming a publicly traded company in April 2006, $0.5million for expenses associated with the evaluation of certain potentialacquisition candidates, and $0.4 million higher stock-based compensationexpenses. 

**Special Bonus***.* On December15, 2005, our board of directors approved the payment of $3.25 million inspecial, one-time bonuses to our employees and directors (other than directorswho are employees or affiliates of The Cypress Group) to reward them for theincrease in company value. The special bonus was not paid pursuant to ourmanagement incentive plan, our 2006 Equity and Performance Incentive Plan orany of our other formal compensation plans. The bonus amount was not determinedbased on a formula, but was instead an amount determined by our board ofdirectors to be reasonable compensation for the increase in company value. Thespecial bonus was charged to the condensed consolidated statement of operationsin the same lines as cash compensation paid to the same employees anddirectors, as follows: $2.75 million to general and administrative, $0.3million to cost of sales, and $0.2 million to selling and marketing.

**Amortization ofAcquisition-Related Intangibles**. Amortization ofacquisition-related intangibles consists of purchase accounting charges fortechnology and other intangible assets. Amortization of acquisition-relatedintangibles was $1.6 million for both the nine months ended June 29, 2007 andthe nine months ended June 30, 2006.

**Interest Expense, net (“InterestExpense”)**. Interest expense of $15.8 million for the ninemonths ended June 29, 2007 was $2.6 million lower than interest expense of$18.4 million for the nine months ended June 30, 2006. The reduction ininterest expense for the nine months ended June 29, 2007 compared to the nine monthsended June 30, 2006 was primarily due to the lower debt levels resulting fromterm loan prepayments of $5.0 million in December 2006, and $47.5 million inMay 2006 using proceeds from the initial public offering of our common stock.

**Income Tax Expense**. We recorded an income tax expense of $8.6 million and $7.6 millionfor the nine months ended June 29, 2007 and June 30, 2006, respectively. Our effective tax rate was approximately 30.5% for the nine months endedJune 29, 2007 as compared to approximately 40.8% for the nine months ended June30, 2006.  The effective tax rate for the nine months ended June 29, 2007 includesa discrete tax benefit of $1.8 million that was recorded in the third quarterrelated to the filing of amended income tax returns for prior years to reflecta change in estimate with regard to reporting Canadian income earned in theU.S. Our estimated fiscal year 2007 effective income tax rate, excludingdiscrete tax items, is approximately 38%. 

Income tax expense for the nine months ended June 30, 2006 included$0.3 million of charges attributable to the fourth quarter of fiscal year 2005,consisting of $0.5 million to correct the overstatement of tax benefitsrecorded in the fourth quarter of fiscal year 2005 for stock-based compensationexpense that is not deductible for income tax purposes in a foreign taxjurisdiction, offset by reversal of a $0.2 million tax contingency reserve thatwas no longer required. Without the correction to the overstatement of taxbenefits, our effective tax rate for the nine months ended June 30, 2006 wouldhave been approximately 39%.

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**Net Income**.Net income was $19.7 million, or 7.6% of sales, for the nine months ended June29, 2007 as compared to $11.0 million, or 4.3% of sales, in the nine months endedJune 30, 2006. The increase in net income for the nine months ended June 29,2007 was primarily due to the absence in fiscal year 2007 of non-recurringexpenses for the Eimac relocation and the special bonus, and lower interestexpense and a favorable mix of products with higher gross margins in fiscalyear 2007; somewhat offset by increases in our Canadian dollar denominatedexpenses resulting from the expiration of favorable foreign currency hedgecontracts in March 2006 and the further weakening of the U.S. dollar in fiscalyear 2007.  The nine months ended June29, 2007 include incremental expenses associated with meeting the compliancerequirements of Section 404 of the Sarbanes-Oxley Act of 2002, additional expensesas a result of becoming a publicly traded company in April 2006, $0.5 millionfor expenses associated with the evaluation of certain potential acquisitioncandidates, and higher stock-based compensation expenses.

**EBITDA**. EBITDA was$50.7 million, or 19.5% of sales, for the nine months ended June 29, 2007 ascompared to $43.8 million, or 17.0% of sales, in the nine months ended June 30,2006. The increase in EBITDA for the first nine months of fiscal year 2007 wasprimarily due to the absence in the 2007 period of move-related expenses of $6.8million, including unfavorable overhead absorption and manufacturing variancesfor the Eimac relocation, the absence in fiscal year 2007 of non-recurringexpenses for the special bonus of $3.25 million, and higher sales and afavorable mix of products with higher gross margins in fiscal year 2007;partially offset by increases in our Canadian dollar denominated expenses of$3.2 million resulting from the weakening of the U.S. dollar and expiration offavorable foreign currency hedge contracts in March 2006, higher stock-basedcompensation expenses in fiscal year 2007 of $0.8 million, and higheracquisition-related, public company and Sarbanes-Oxley compliance expenses infiscal year 2007.

**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 othersthat are related to uncertainties in the markets in which we compete and otherglobal economic factors. We have historically financed, and intend to continue tofinance, our capital and working capital requirements, including debt serviceand internal growth, through a combination of cash flows from our operationsand borrowings under our senior credit facilities. Our primary uses of cash arecost of sales, operating expenses, debt service and capital expenditures.

Pro forma for our recent refinancingdiscussed below (including the redemption of a portion of CPI International’s floatingrate senior notes (the “FR Notes”) expected on September 5, 2007), we will have$247.0 million in total principal amount of debt outstanding, compared to $247.5million as of September 29, 2006. As of June 29, 2007, we had cash andequivalents of $39.4 million compared to $30.2 million as of September 29,2006. Cash balances in excess of operating requirements are invested daily inovernight U.S. Government securities and money market accounts.

**Recent****RefinancingTransactions**

**Amended CreditFacility:**On August 1, 2007, CPIentered into an Amended and Restated Credit Agreement (Credit Agreement), datedas of August 1, 2007  (Closing Date), whichprovides for an amended credit facility (Amended Credit Facility) in theaggregate principal amount of $160 million, consisting of a $100 million termloan facility (Term Loan) and a $60 million revolving credit facility,

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with a sub-facility of $15 million for letters of credit and$5 million for swing line loans.  Uponcertain specified conditions, including maintaining a senior secured leverageratio of 3.75:1 or less on a pro forma basis, CPI may seek commitments for anew class of term loans, not to exceed $125 million in the aggregate.  The Amended Credit Facility is guaranteed by CPIInternational and all of CPI’s domestic subsidiaries and is secured bysubstantially all of the assets of CPI International, CPI and CPI’s domesticsubsidiaries. See Note 12 of the accompanying unaudited condensed consolidatedfinancial statements for a summary of the terms and conditions of the AmendedCredit Facility.

TheAmended Credit Facility replaces CPI’s existing $130 million credit facility.On the Closing Date, CPI borrowed $100 million under the Term Loan, theproceeds of which were principally used to satisfy outstanding term loanamounts under our existing senior credit facilities and to pay a dividend toCPI International to permit CPI International to repurchase and redeem $58million aggregate principal amount of its FR Notes as described below.  Future borrowings under the Amended CreditFacility may be used for general corporate purposes.

**FR Notes repurchase:**On August 2, 2007, CPI International closed its tender offer for aportion of the FR Notes (which expired on August 1, 2007), with $38,175,000 inaggregate principal amount of the FR Notes tendered and accepted for purchase.Tendering holders were paid an aggregate of approximately $39.4 million,representing $1,032.50 per $1,000.00 principal amount of the FR Notes tendered,plus accrued interest up to, but not including, the date of purchase.

**FR Notes redemption:** On August 6, 2007, the trustee for the FR Notes, upon instruction of CPIInternational, notified the holders of the FR Notes that $19,825,000 aggregateprincipal amount of the FR Notes will be redeemed on September 5, 2007. Theaggregate redemption price will be approximately $20.4 million or $1,030 per$1,000 principal amount of the FR Notes, plus accrued and unpaid interest to,but not including, the date of redemption. 

We estimate that the Amended Credit Facilityand the repurchase and redemption of a portion of the FR Notes as describedabove will result in annual interest savings of approximately $2.0 million forthe twelve months following the September 5, 2007 redemption of a portion ofthe FR Notes. In addition, we expect to incur approximately $5.0 million inone-time, non-cash costs associated with the write-off of deferred debt issuecosts and approximately $2.0 million in redemption premiums and other expensesassociated with the redemption and repurchase of an aggregate of $58.0 millionof the FR Notes.

**Historical Operating, Investing and FinancingActivities**

***Operating Activities.***

Operatingactivities provided cash of $19.3 million in the nine months ended June 29,2007, which was attributable to net income of $19.7 million and depreciation,amortization and other non-cash charges of $8.8 million, partially offset by $9.2million for cash used for working capital. The primary uses of cash for workingcapital in the nine months ended June 29, 2007 were for increases ininventories of $6.3 million due to anticipated higher sales volume for theupcoming two quarters, particularly for the

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next three months, andaccounts receivable of $3.0 million due to the timing of customer shipments, andreduction in income taxes payable of $3.9 million due primarily to income tax paymentsfrom the taxable gain on the sale of our San Carlos property in fiscal year2006. The total amount of cash used for working capital was partially offset byincreases in accounts payable and accrued expenses of $4.3 million.

Operating activities provided cash ofapproximately $1.9 million in the in the nine months ended June 30, 2006, whichwas attributable to net income of $11.0 million, depreciation, amortization andother non-cash charges of $7.7 million; partially offset by $16.8 million forcash used for working capital. The principal uses of cash for working capitalin the nine months ended June 30, 2006 were for increases in accountsreceivable of $8.9 million, inventories of $3.6 million and decreases inadvance payments from customers of $6.8 million, partially offset by a $4.2million increase in income taxes payable.  

***Investing Activities.***

Net cash used in investing activities was $6.8million for the nine months ended June 29, 2007 and $8.6 million for the ninemonths ended June 30, 2006. The primary investing activity in each of theseperiods was for capital expenditures. For the nine months ended June 29, 2007,capital expenditures included $3.7 million for a building expansion project forour Canadian manufacturing facility which was substantially completed in June2007. Capital expenditures for the nine months ended June 30, 2006 included $4.4million for capital equipment, building and land lease improvements in PaloAlto, California related to the relocation of our Eimac division and $1.2million for a building expansion project at our Canadian facility.

Our continuing operations typically do nothave large recurring capital expenditure requirements. Capital expenditures aregenerally made to replace existing assets, increase productivity, facilitatecost reductions or meet regulatory requirements. In fiscal year 2007, ongoingcapital expenditures are expected to be approximately $4.5 million, excludingcosts incurred for our Canadian facility expansion.

***Financing Activities.***

Net cash used in financing activities was $3.2million for the nine months ended June 29, 2007, compared to net cash used infinancing activities of $7.2 million for the nine months ended June 30, 2006. Financingactivities for the nine months ended June 29, 2007 consisted primarily of a$5.0 million term loan repayment in December 2006 using available operatingcash, partially offset by proceeds of $1.1 million from the stock optionexercises and shares purchases under our employee stock purchase plan, and $0.7million of excess tax benefits from stock option exercises. The $5.0 millionterm loan repayment included a $1.7 million required annual excess cash flow prepaymentfor fiscal year 2006 and an optional prepayment of $3.3 million. No suchrequired prepayment was made in the nine months ended June 30, 2006.

Financing activities for the nine monthsended June 30, 2006 consisted of a $37.5 million in net repayments on our termloan and a $17.0 million special cash dividend to the holders of CPIInternational’s common stock in December 2005, partially offset by $47.3million of net proceeds from our initial public offering of common stock (the “IPO”),after deduction of IPO expenses of $5.6 million.  

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**Commitments**

***Leases***

**We arecommitted to minimum rentals under non-cancelable operating lease agreements,primarily for land and facility space, that expire on various dates through2050.**

***DebtObligations***

In addition to CPI’s Amended Credit Facilitydescribed above under the caption “Recent Refinancing Transactions,” CPI has senior subordinated notes bearinginterest at a rate of 8% per year, payable on February 1 and August 1of each year. The 8% Notes will mature on February 1, 2012. The 8% Notesare unsecured obligations, jointly and severally guaranteed by CPIInternational and each of CPI’s domestic subsidiaries. As of June 29, 2007, theoutstanding principal balance of the 8% Notes was $125.0 million.

After giving effect to thepurchase and redemption of the FR Notes described above under the caption “Recent Refinancing Transactions,” CPIInternational will have outstanding $22.0 million aggregate principal amount ofthe FR Notes issued at a 1% discount. The FR Notes require interest payments atan annual interest rate, reset at the beginning of each semi-annual period,equal to the then six-month LIBOR plus 5.75%, payable semiannually on February1 and August 1 of each year. The interest rate on the semi-annual interestpayment due August 1, 2007 is approximately 11.15% per annum. The FR Notes willmature on February 1, 2015. The FR Notes are general unsecured obligations ofCPI International. The FR Notes are not guaranteed by any of CPI International’ssubsidiaries but are structurally subordinated to all existing and futureindebtedness and other liabilities of CPI International’s subsidiaries. The FRNotes are senior in right of payment to CPI International’s existing and futureindebtedness that is expressly subordinated to the FR Notes.

***Interest Rate Swap***

To hedge the interest rateexposure associated with the FR Notes, on April 15, 2005, we entered into an$80.0 million interest rate swap contract (the “Swap”) to receive variable rate6-month LIBOR interest and pay 4.15% fixed rate interest, which when combinedwith the 5.75% margin, results in a fixed rate of 9.9% on the FR Notes throughJanuary 31, 2008. The Swap interest payments are made semi-annually, beginningwith the first payment on February 1, 2006. The Swap matures on January 31,2008.

***Guarantees***

We have restricted cash of$3.0 million and $1.7 million as of June 29, 2007 and September 29, 2006,consisting primarily of bank guarantees from customer advance payments to ourinternational subsidiaries and collateral for a construction contract. The bankguarantees become unrestricted cash when performance under the sales or supplycontract is complete. 

Under the terms of the Swap,we must provide collateral to match any unfavorable mark-to-market exposure(fair value) on the Swap. The collateral required totals a certain minimumamount plus an amount equal to the unfavorable mark-to-market exposure on the Swap.Generally, the required collateral will rise as interest rates decline. Weposted $0.5 million of collateral under the Swap, which is included in thecondensed consolidated balance sheet in “prepaid and other current assets” asof June 29, 2007 and in “other long-term assets” as of September 29, 2006.

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We believe that we have the financial resources tomeet our business requirements for the next twelve months, including capitalexpenditures and working capital requirements, and to comply with the financialcovenants in the documents governing our debt. Beyond the next twelve months,we expect our future cash flow from operations and the borrowing availabilityunder our senior credit facilities, to remain sufficient to fund any ongoinginvestments in capital equipment and interest payments on our senior notes.There are no arrangements or other relationships with unconsolidated entitiesor other persons that are reasonably likely to materially affect liquidity orthe availability of our requirements for capital.

**Recently Released Accounting Pronouncements**

In June 2006, the Financial AccountingStandards Board (“FASB”) issued FASB Interpretation (“FIN”) No. 48, “Accountingfor Income Tax Uncertainties.” FIN No. 48 defines the threshold for recognizingthe benefits of tax return positions in the financial statements as “more-likely-than-not”to be sustained by the taxing authority. The recently issued literature alsoprovides guidance on the derecognition, measurement and classification ofincome tax uncertainties, along with any related interest and penalties. FINNo. 48 also includes guidance concerning accounting for income taxuncertainties in interim periods and increases the level of disclosuresassociated with any recorded income tax uncertainties. FIN No. 48 is effectivefor fiscal years beginning after December 15, 2006. Any differencesbetween the amounts recognized in the statements of financial position prior tothe adoption of FIN No. 48 and the amounts reported after adoption will beaccounted for as a cumulative-effect adjustment recorded to the beginning balanceof retained earnings. We will be required to adopt FIN No. 48 in our fiscalyear 2008 commencing September 29, 2007 and are currently in the process ofdetermining the impact, if any, of adopting the provisions of this new standardon our financial position, results of operations and liquidity.

In September 2006, the FASB issued Statementof Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements,”which defines fair value, establishes a framework for measuring fair valueunder other accounting pronouncements that permit or require fair valuemeasurements, changes the methods used to measure fair value and expandsdisclosures about fair value measurements. In particular, disclosures arerequired to provide information on: the extent to which fair value is used tomeasure assets and liabilities; the inputs used to develop measurements; andthe effect of certain of the measurements on earnings (or changes in netassets). SFAS No. 157 is effective for fiscal years beginning after November 15,2007 and interim periods within those fiscal years. Early adoption, as of thebeginning of an entity’s fiscal year, is also permitted, provided interimfinancial statements have not yet been issued. We will be required to adoptSFAS No. 157 in our fiscal year 2009 commencing October 4, 2008 and arecurrently evaluating the potential impact, if any, that the adoption of thisnew standard will have on our consolidated financial statements.

In September 2006, the FASB issued SFAS No.158, “Employers’ Accounting for Defined Benefit Pension and OtherPostretirement Plans – an amendment of FASB Statements No. 87, 88, 106, and132(R),” which requires an employer to recognize the overfunded or underfundedstatus of a defined benefit plan as an asset or liability in its condensedconsolidated balance sheet. Under SFAS No. 158, actuarial gains and losses andprior service costs or credits that have not yet been recognized throughearnings as net periodic benefit cost will be recognized in other comprehensiveincome, net of tax, until they are amortized as a component of net periodicbenefit cost. SFAS No. 158 is effective as of the end of the fiscal year endingafter December 15, 2006 and shall not be applied retrospectively. We will berequired to adopt SFAS No. 158 in the fourth quarter of fiscal year 2007 andare currently evaluating the impact, if any, that the adoption of this newstandard will have on our consolidated financial statements.

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In September 2006, the Securities and Exchange Commission (“SEC”) issuedStaff Accounting Bulletin (“SAB”) No. 108, “Considering the Effects of PriorYear Misstatements when Quantifying Misstatements in Current Year FinancialStatements.” SAB No. 108 provides guidance on how prior year misstatementsshould be considered when quantifying misstatements in the current yearfinancial statements. SAB No. 108 requires registrants to quantifymisstatements using both a balance sheet and an income statement approach andevaluate whether either approach results in quantifying a misstatement that,when all relevant quantitative and qualitative factors are considered, ismaterial. SAB No. 108 does not change the guidance in SAB No. 99, “Materiality,”when evaluating the materiality of misstatements. SAB No. 108 is applicable forfiscal years ending after November 15, 2006. Upon initial application, SAB No.108 permits a one-time cumulative effect adjustment to beginning retainedearnings. We will adopt SAB No. 108 in the fourth quarter of fiscal year 2007and are currently evaluating what effect adopting the new guidance will have onour consolidated results of operations and financial condition.

 In February2007, the FASB issued SFAS No. 159, “The Fair Value Option forFinancial Assets and Financial Liabilities - Including an amendment of FASBStatement No. 115.” SFAS No. 159 permits companies to choose to measure manyfinancial instruments and certain other items at fair value that are notcurrently required to be measured at fair value. The objective of SFAS No. 159is to provide opportunities to mitigate volatility in reported earnings causedby measuring related assets and liabilities differently without having to applyhedge accounting provisions. SFAS No. 159 also establishes presentation anddisclosure requirements designed to facilitate comparisons between companiesthat choose different measurement attributes for similar types of assets andliabilities. SFAS No. 159 is effective for fiscal years beginning afterNovember 15, 2007. We will be required to adopt SFAS No. 159 in our fiscal year2009 commencing October 4, 2008 and are currently evaluating the impact, ifany, that the adoption of this new standard will have on our consolidatedfinancial statements.

**Critical Accounting Policies and Estimates**

Our consolidated financial statements arebased on the selection and application of significant accounting policies. Thepreparation of these financial statements and application of these policiesrequire management to make estimates and assumptions that affect the reportedamounts of assets and liabilities and the disclosure of contingent assets andliabilities at the date of the financial statements, as well as the reportedamounts of revenues and expenses during the reporting period. Actual resultscould differ from those estimates. However, we are not currently aware of anyreasonably likely events or circumstances that would result in materiallydifferent results from current estimates.

We believe the following critical accountingpolicies are the most significant to the presentation of our financialstatements and require the most subjective and complex judgments. Thesematters, and the judgments and uncertainties affecting them, are also essentialto understanding our reported and future operating results.

**Revenue recognition**

We generally recognize revenue upon shipmentof product, following receipt of written purchase orders, when the price isfixed or determinable, title has transferred and collectibility is reasonablyassured. Approximately 1% of our sales for our fiscal years 2004 through 2006are based on the percentage of completion method of accounting where the salesvalue is determined on the basis of costs incurred and estimates of costs atcompletion, which require management estimates of future costs. Changes inestimated costs at completion over time could have a material impact on ouroperating results.

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**Inventory reserves**

We assess the valuation of inventory andperiodically write down the value for estimated excess and obsolete inventorybased upon actual usage and estimates about future demand. The excess balancedetermined by this analysis becomes the basis for our excess inventory charge.Management personnel play a key role in our excess inventory review process byproviding updated sales forecasts, managing product rollovers and working withmanufacturing to maximize recovery of excess inventory. If our estimatesregarding demand are inaccurate or changes in technology affect demand forcertain products in an unforeseen manner, we may incur losses or gains inexcess of our established markdown reserve that could be material.

Management also reviews the carrying value ofinventory for lower of cost or market on an individual product or contractbasis. A loss reserve is charged to cost of sales if the estimated product costor the contract cost at completion is in excess of net realizable value(selling price less estimated cost of disposal). If the actual contract cost atcompletion is different than originally estimated, then a loss or gainprovision adjustment would be recorded that could have a material impact on ouroperating results.

**Product warranty**

Our products are generally warranted for avariety of periods, typically one to three years or a predetermined productusage life. A provision for estimated future costs of repair, replacement orcustomer accommodations is reflected in the consolidated financial statementsincluded in this report. We assess the adequacy of our preexisting warrantyliabilities and adjust the balance based on actual experience and changes infuture expectations. The determination of product warranty reserves requires usto make estimates of product return rates and expected cost to repair orreplace the products under warranty. If actual repair and replacement costsdiffer significantly from our estimates, then adjustments to recognizeadditional cost of sales may be required.

**Recoverability of long-lived assets**

We account for goodwill and other intangibleassets in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets.”SFAS No. 142 requires that goodwill and identifiable intangible assets withindefinite useful lives be tested for impairment at least annually. SFAS No.142 also requires that intangible assets with estimable useful lives beamortized over their respective estimated useful lives and reviewed forimpairment in accordance with SFAS No. 144, “Accounting for the Impairment orDisposal of Long-Lived Assets.” We amortize identifiable intangible assets on astraight-line basis over their useful lives of up to 50 years.

We assess the recoverability of the carryingvalue of goodwill and other intangible assets with indefinite useful lives atleast annually or whenever events or changes in circumstances indicate that thecarrying amount of the asset may not be fully recoverable. Recoverability ofgoodwill is measured at the reporting unit level (our five divisions) based ona two-step approach. First, the carrying amount of the reporting unit iscompared to the fair value as estimated by the future net discounted cash flowsexpected to be generated by the reporting unit. To the extent that the carryingvalue of the reporting unit exceeds the fair value of the reporting unit, asecond step is performed, wherein the reporting unit’s assets and liabilitiesare valued. The implied fair value of goodwill is calculated as the fair valueof the reporting unit in excess of the fair value of all non-goodwill assetsand liabilities allocated to the reporting unit. To the extent the reportingunit’s carrying value of goodwill exceeds its implied fair value, impairmentexists and must be recognized. This process requires the use of discounted cashflow models that utilize estimates of future revenue and expenses as well asthe selection of appropriate discount rates. There is inherent uncertainty inthese estimates, and changes in these factors over time could result in animpairment charge.

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At June 29, 2007 and September 29, 2006, the netcarrying amount of goodwill and other intangible assets was $221.0 million and $223.0million, respectively. As of June 29, 2007, no significant changes in theunderlying business assumptions or circumstances that drive the impairmentanalysis led us to believe that goodwill might have been impaired. We willcontinue to evaluate the need for impairment if changes in circumstances oravailable information indicate that impairment may have occurred, and at leastannually in the fourth quarter.

At June 29, 2007 and September 29, 2006, the netcarrying amount of property, plant and equipment was $65.0 million and $64.0 million,respectively. We assess the recoverability of property, plant and equipment tobe held and used by a comparison of the carrying amount of an asset or group ofassets to the future net undiscounted cash flows expected to be generated bythe asset or group of assets. If such assets are considered impaired, then theimpairment recognized is measured as the amount by which the carrying amount ofthe assets exceeds the fair value of the assets. This process requires the useof cash flow models that utilize estimates of future revenue and expenses.There is inherent uncertainty in these estimates, and changes in these factorsover time could result in an impairment charge.

A prolonged general economic downturn and,specifically, a prolonged downturn in the defense, communications or medicalmarkets, or technological changes, as well as other market factors couldintensify competitive pricing pressure, create an imbalance of industry supplyand demand, or otherwise diminish volumes or profits. Such events, combinedwith changes in interest rates, could adversely affect our estimates of futurenet cash flows to be generated by our long-lived assets. Consequently, it ispossible that our future operating results could be materially and adverselyaffected by additional impairment charges related to the recoverability of ourlong-lived assets.

**Accounting for stock-basedcompensation**

At the beginning of fiscal year 2006, weadopted SFAS No. 123 (revised 2004) or 123(R), “Share-Based Payment,” andSAB No. 107, “Share-Based Payment,” for our existing stock option plans underthe prospective method. Under the prospective method, only new awards (orawards modified, repurchased, or cancelled after the effective date) areaccounted for under the provisions of SFAS No. 123R. Previously, we applied theintrinsic-value method of accounting prescribed by Accounting Principles Board (APB)Opinion No. 25, “Accounting for Stock Issued to Employees,” and relatedinterpretations. Under the intrinsic-value method, compensation expense wasrecorded only if the market price of the stock exceeded the stock optionexercise price at the measurement date. We will continue to account for stockoption awards outstanding at September 30, 2005 using the intrinsic-valuemethod of measuring equity share options unless such options are modified.

The fair value of each option award isestimated on the date of grant using the Black-Scholes model. The Black-Scholesoption valuation model was developed for use in estimating the fair value oftraded options that have no vesting restrictions and are fully transferable andrequires the input of subjective assumptions, including the expected stockprice volatility and estimated option life.

In accordance with SFAS No. 123R, prior tobecoming a public entity in April 2006, we used the minimum value method todetermine a calculated value, rather than a fair value, of share awards. Underthe minimum value method, stock price volatility was assumed to be zero. Theestimated fair value (or calculated value, as applicable) of our stock-basedawards, less expected forfeitures, is amortized over the awards’ vesting periodon a straight-line basis for awards granted after the adoption of SFASNo. 123R and on a graded vesting basis for awards granted prior to theadoption of SFAS No. 123R. Since our

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common stock has not beenpublicly traded for a sufficient time period, the expected volatility is basedon expected volatilities of similar companies that have a longer history ofbeing publicly traded. The expected life of options granted is based on thesimplified method for plain vanilla options in accordance with SEC SAB No. 107.The risk-free rates are based on the U.S. Treasury yield in effect at the timeof the grant. For the three and nine months ended June 29, 2007, we recognized $0.3million and $0.9 million in stock-based compensation expense, respectively. Forthe three and nine months ended June 30, 2006, we recognized $0.1 million instock-based compensation expense.

## **Item 3.    Quantitative andQualitative Disclosures About Market Risk**

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

***Interest rate risk:*****Our exposure tomarket risk for changes in interest rates relates primarily to our long-termdebt.

Pro forma for our recent refinancing, described under the caption “RecentRefinancing Transactions” set forth under Liquidity and Capital Resourcesabove, and following the redemption of a portion of CPI International’s floatingrate senior notes (“FR Notes”) expected on September 5, 2007, we will have fixedrate senior notes of $125.0 million due in 2012, bearing interest at 8% peryear and variable rate debt that comprises $22.0 million FR Notes due in 2015 anda $100.0 million term loan under our newly amended credit facility due in 2014.Our variable rate debt is subject to changes in the prime rate and the LIBORrate. 

In order to manage interest costs and risk, we entered into an interestrate swap agreement (“Swap”) during fiscal year 2005 with a financial institutionon a total notional amount of $80 million whereby we receive variable rate6-month LIBOR interest and pay 4.15% fixed rate interest, which when combinedwith the 5.75% margin, results in a fixed rate of 9.9% on the floating ratenotes through January 31, 2008. The total fixed interest rate of 9.9% at June29, 2007, resulted in interest expense savings relative to variable rates ofapproximately $0.2 million and $0.8 million for the three and nine months endedJune 29, 2007.  Under the provisions of SFAS No. 133, “*Accounting for Derivative Instruments and HedgingActivities*,” as amended, this arrangement was initially designatedand qualified as an effective cash flow hedge of interest rate risk related tothe $80 million FR Notes which permitted recording the fair value of the Swapand corresponding unrealized gain or loss to accumulated other comprehensiveincome in the consolidated balance sheets.

 In accordance with SFAS No. 133,the portion of the Swap associated with the anticipated retirement of FR Notes asof June 29, 2007 became ineffective and no longer qualifies for special hedgeaccounting treatment.  Therefore, for thethree and nine months ended June 29, 2007, we reported approximately $0.1million reduction to interest expense in our consolidated statements ofoperations for the ineffective portion of the Swap. As of June 29, 2007, thefair value of the Swap included in accumulated other comprehensive income inthe consolidated balance sheets was $0.5 million. 

***Foreign currency exchange risk:*****Although themajority of our revenue and expense activities are transacted in U.S. dollars,we do transact business in foreign countries. Our primary foreign currency cashflows are in Canada and several European countries. In an effort to reduce ourforeign currency exposure to Canadian dollar denominated expenses, we enterinto Canadian dollar forward contracts to hedge the Canadian dollar denominatedcosts for our manufacturing operation in Canada. Our Canadian dollar forwardcontracts are designated as a cash flow hedge and are considered highlyeffective, as defined by SFAS No. 133. The unrealized gains and losses fromforeign exchange forward contracts are included in “accumulated othercomprehensive income” in the consolidated balance sheets. If the

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transaction being hedgedfails to occur, or if a portion of any derivative is ineffective, then wepromptly recognize the gain or loss on the associated financial instrument inthe consolidated statements of operations. No ineffective amounts were recognizeddue to anticipated transactions failing to occur in the three and nine monthsended June 29, 2007 and June 30, 2006.

As of June 29, 2007, we had entered intoCanadian dollar forward contracts for approximately $20.2 million (Canadiandollars), or 83% of estimated Canadian dollar denominated expenses throughDecember 2007, at an average rate of approximately $0.88 U.S. dollar toCanadian dollar. We estimate the impact of a one cent change in the U.S. dollarto Canadian dollar exchange rate (without giving effect to our Canadian dollarforward contracts) to be approximately $0.5 million annually to operatingincome or approximately 1.9 cents to basic earnings per share and 1.7 cents todiluted earnings per share.

Net income in the three and nine months endedJune 29, 2007 includes a recognized loss from foreign currency forwardcontracts of $0.2 million. Net income in the three and nine months ended June30, 2006 includes a recognized gain from foreign currency forward contracts of$0.3 million and $1.3 million, respectively. At June 29, 2007 and September 29,2006, the fair value of the unrealized gain, net of tax, on Canadian dollarforward contracts was $0.8 million and $8,000, respectively.

# **Item 4.Controls and Procedures**

Management, including our principal executiveofficer and principal financial officer, has evaluated, as of the end of theperiod covered by this report, the effectiveness of the design and operation ofour disclosure controls and procedures with respect to the information generatedfor use in this report. Based upon, and as of the date of that evaluation, theprincipal executive officer and principal financial officer concluded that thedisclosure controls and procedures were effective to provide reasonableassurances that information required to be disclosed in the reports filed orsubmitted under the Securities Exchange Act of 1934, as amended, is recorded,processed, summarized and reported within the time periods specified in the SEC’srules and forms.

There have been no changes in our internalcontrol over financial reporting that occurred during the most recent fiscal quarterthat 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 September 29, 2006. Therehave been no material changes from the risk factors disclosed in the “RiskFactors” section of our 2006 Form 10-K.

## **Item 2. Unregistered Sales ofEquity Securities and Use of Proceeds**

None.

## **Item 3. Defaults Upon SeniorSecurities**

None.

## **Item 4.  Submission of Matters to a Vote of SecurityHolders**

None.

## ** ****Item5. 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.       |

 

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**SIGNATURES**

Pursuant to the requirements of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe signed on its behalf by the undersigned, thereunto duly authorized.
|                             |                                                                                                            |
|-----------------------------|-----------------------------------------------------------------------------------------------------------------|
|                        |                                                                                                            |
|                        | CPI INTERNATIONAL, INC.                                                                                         |
|                        |                                                                                                            |
|                        |                                                                                                            |
|                        |                                                                                                            |
| Dated: August 13, 2007 | /s/ O. Joe Caldarelli                                                                                           |   |
|                        | O. Joe Caldarelli  Chief Executive Officer                                                                      |
|                        |                                                                                                            |
|                        |                                                                                                            |
| Dated: August 13, 2007 | /s/ Joel A. Littman                                                                                             |   |
|                        | Joel A. Littman  Chief Financial Officer, Treasurer and Secretary  (Principal Financial and Accounting Officer) |
|                             |                                                                                                                 |  |  |

 

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