** **

**UNITED STATESSECURITIES AND EXCHANGECOMMISSION**Washington,DC 20549

** **

**FORM 10-Q**

** **

**(MarkOne)**

**x****                       QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934**

 

**For thequarterly period ended December 28, 2007**

** **

** **or

** **

**o****                          TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGEACT OF 1934**

 

**For thetransition period from               to**

 

**Commission filenumber:     ****000-51928**

 

**CPI INTERNATIONAL, INC.**

(Exact Name of Registrant as Specified in Its Charter)

 

| **Delaware**                                                        | **75-3142681**                            |
|---------------------------------------------------------------------|-------------------------------------------|
| **(State or  Other Jurisdiction of Incorporation or Organization)** | **(I.R.S.  Employer Identification No.)** |

 

**811 HansenWay Palo Alto, California  94303-1110**

**(Address ofPrincipal Executive Offices and Zip Code)**

** **

**(650)846-2900**

(Telephone Number, including area code)

 

Indicate by check mark whether theregistrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports) and (2) has been subject to such filing requirements for thepast 90 days. Yes  x   No  o

 

Indicate by check mark whether theregistrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer.  See definition of“accelerated filer and large accelerated filer” in Rule 12b-2 of theExchange Act. (Check one):  Largeaccelerated filer  o    Accelerated filer  x      Non-acceleratedfiler  o

 

Indicate by check mark whether theregistrant is a shell company (as defined in Rule 12b-2 of the ExchangeAct).   Yes  o   No  x

 

**APPLICABLEONLY TO CORPORATE ISSUERS:**

** **

Indicate the number of sharesoutstanding for each of the registrant’s classes of Common Stock, as of thelatest practicable date: 16,454,498 shares of Common Stock, $0.01 par value, atJanuary 29, 2008.

 

 

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**CPI INTERNATIONAL, INC.**

and Subsidiaries

 

**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 | 34 |
|                            | Item 3.                | Quantitative  and Qualitative Disclosures About Market Risk                                 | 48 |
|                            | Item 4.                | Controls and  Procedures                                                                    | 49 |
|                            |                   |                                                                                        |   |
| Part II: OTHER INFORMATION | 50                     |
|                            |                   |
|                            | Item 1.                | Legal Proceedings                                                                           | 50 |
|                            | Item 1A.               | Risk Factors                                                                                | 50 |
|                            | Item 2.                | Unregistered Sales of Equity Seurities  and Use of Proceeds                                 | 50 |
|                            | Item 3.                | Defaults Upon  Senior Securities                                                            | 50 |
|                            | Item 4.                | Submission of  Matters to a Vote of Security Holders                                        | 50 |
|                            | Item 5.                | Other Information                                                                           | 50 |
|                            | Item 6.                | Exhibits                                                                                    | 51 |

 

2

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** **

**CPIINTERNATIONAL, INC.**

**and Subsidiaries**

** **

***CautionaryStatements Regarding Forward-Looking Statements***

** **

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

 

Although we believe thatthe expectations reflected in the forward-looking statements are reasonable, wecannot guarantee future results, levels of activity, performance orachievements. Moreover, neither we nor any other person assumes responsibilityfor the accuracy and completeness of the forward-looking statements.Forward-looking statements are subject to known and unknown risks anduncertainties, which could cause actual results to differ materially from theresults projected, expected or implied by the forward-looking statements. Theserisk factors include, without limitation, competition in our end markets; oursignificant amount of debt; changes or reductions in the U.S. defense budget;currency fluctuations; U.S. Government contracts laws and regulations; changesin technology; the impact of unexpected costs; and inability to obtain rawmaterials and components. All written and oral forward-looking statements madein connection with this report that are attributable to us or persons acting onour behalf are expressly qualified in their entirety by the foregoing riskfactors and other cautionary statements included herein and in our otherfilings with the Securities and Exchange Commission (“SEC”). We are under noduty to update any of the forward-looking statements after the date of thisreport to conform such statements to actual results or to changes in ourexpectations.

 

Theinformation in this report is not a complete description of our business or therisks and uncertainties associated with an investment in our securities. Youshould carefully consider the various risks and uncertainties that impact ourbusiness and the other information in this report and in our other filings withthe SEC before you decide to invest in our securities or to maintain or increaseyour investment.

 

3

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# ** **

**CPIINTERNATIONAL, INC.**

**and Subsidiaries**

 

# **Part I: FINANCIAL INFORMATION**

# ** **

## ***Item 1.    Unaudited Condensed Consolidated Financial Statements***

## *** ***

### **CONDENSEDCONSOLIDATED BALANCE SHEETS**

(In thousands, except per share data – unaudited)

 
|                                                                                                            | ** ** | **December 28,** | ** ** | **September 28,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|------------------------|------------|
|                                                                                                            | ** ** | **2007**              | ** ** | **2007**               | ** ** |
| **Assets**                                                                                                      |       |                  |       |                   |       |
| Current Assets:                                                                                                 |       |                  |       |                   |       |
| Cash and cash equivalents                                                                                       |       | $                     | 27,410     |                   | $          | 20,474 |   |
| Restricted cash                                                                                                 |       | 2,455                 |       | 2,255                  |       |
| Accounts receivable, net                                                                                        |       | 45,946                |       | 52,589                 |       |
| Inventories                                                                                                     |       | 69,183                |       | 67,447                 |       |
| Deferred tax assets                                                                                             |       | 9,803                 |       | 9,744                  |       |
| Prepaid and other current assets                                                                                |       | 3,961                 |       | 4,639                  |       |
| Total current assets                                                                                            |       | 158,758               |       | 157,148                |       |
| Property, plant, and equipment, net                                                                             |       | 65,894                |       | 66,048                 |       |
| Deferred debt issue costs, net                                                                                  |       | 6,230                 |       | 6,533                  |       |
| Intangible assets, net                                                                                          |       | 81,045                |       | 81,743                 |       |
| Goodwill                                                                                                        |       | 161,548               |       | 161,573                |       |
| Other long-term assets                                                                                          |       | 3,172                 |       | 3,177                  |       |
| Total assets                                                                                                    |       | $                     | 476,647    |                   | $          | 476,222 |   |
|                                                                                                            |       |                  |       |                   |       |
| **Liabilities and stockholders’ equity**                                                                   |       |                  |       |                   |       |
| Current Liabilities:                                                                                            |       |                  |       |                   |       |
| Current portion of long-term debt                                                                               |       | $                     | 250        |                   | $          | 1,000 |   |
| Accounts payable                                                                                                |       | 22,106                |       | 21,794                 |       |
| Accrued expenses                                                                                                |       | 29,007                |       | 26,349                 |       |
| Product warranty                                                                                                |       | 5,376                 |       | 5,578                  |       |
| Income taxes payable                                                                                            |       | 7,952                 |       | 8,748                  |       |
| Advance payments from customers                                                                                 |       | 9,798                 |       | 12,132                 |       |
| Total current liabilities                                                                                       |       | 74,489                |       | 75,601                 |       |
| Deferred income taxes                                                                                           |       | 27,395                |       | 28,394                 |       |
| Long-term debt, less current portion                                                                            |       | 245,321               |       | 245,567                |       |
| Other long-term liabilities                                                                                     |       | 1,578                 |       | 754                    |       |
| Total liabilities                                                                                               |       | 348,783               |       | 350,316                |       |
| Commitments and contingencies                                                                                   |       |                  |       |                   |       |
| Stockholders’ equity                                                                                       |       |                  |       |                   |       |
| Common stock ($0.01 par value, 90,000 shares authorized; 16,441 and  16,370 shares issued and outstanding) |       | 164                   |       | 164                    |       |
| Additional paid-in capital                                                                                      |       | 69,412                |       | 68,763                 |       |
| Accumulated other comprehensive (loss) income                                                                   |       | (264                  | )          | 937                    |       |
| Retained earnings                                                                                               |       | 58,552                |       | 56,042                 |       |
| Total stockholders’ equity                                                                                 |       | 127,864               |       | 125,906                |       |
| Total liabilities and stockholders’ equity                                                                 |       | $                     | 476,647    |                   | $          | 476,222 |   |

** **

**The accompanying notes are anintegral part of these unaudited condensed consolidated financial statements.**

### ** **

4

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### ** **

**CPIINTERNATIONAL, INC.**

**and Subsidiaries**

 

### **CONDENSEDCONSOLIDATEDSTATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME**

(In thousands, except per share data – unaudited)

** **
|                                                  | ** ** | **December 28,** | ** ** | **December 29,** | ** ** |
|-------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
|                                                  | ** ** | ** 2007**        | ** ** | ** 2006**        | ** ** |
| Sales                                                 |       | $                     | 85,910     |                  | $          | 83,723 |   |
| Cost of sales                                         |       | 61,774                |       | 57,142                |       |
| Gross profit                                          |       | 24,136                |       | 26,581                |       |
| Operating costs and expenses:                         |       |                  |       |                  |       |
| Research and development                              |       | 2,724                 |       | 1,891                 |       |
| Selling and marketing                                 |       | 5,172                 |       | 4,829                 |       |
| General and administrative                            |       | 6,153                 |       | 4,404                 |       |
| Amortization of acquisition-related intangible assets |       | 781                   |       | 548                   |       |
| Net loss on disposition of fixed assets               |       | 34                    |       | 18                    |       |
| Total operating costs and expenses                    |       | 14,864                |       | 11,690                |       |
| Operating income                                      |       | 9,272                 |       | 14,891                |       |
| Interest expense, net                                 |       | 4,812                 |       | 5,339                 |       |
| Income before income taxes                            |       | 4,460                 |       | 9,552                 |       |
| Income tax expense                                    |       | 1,950                 |       | 3,717                 |       |
| Net income                                            |       | $                     | 2,510      |                  | $          | 5,835 |   |
|                                                  |       |                  |       |                  |       |
| Other comprehensive income, net of tax                |       |                  |       |                  |       |
| Net unrealized loss on cash flow hedges               |       | (1,201                | )          | (389                  | )          |
| Comprehensive income                                  |       | $                     | 1,309      |                  | $          | 5,446 |   |
|                                                  |       |                  |       |                  |       |
| Earnings per share - Basic                            |       | $                     | 0.15       |                  | $          | 0.36 |   |
| Earnings per share - Diluted                          |       | $                     | 0.14       |                  | $          | 0.33 |   |
|                                                  |       |                  |       |                  |       |
| Shares used to compute earnings per share - Basic     |       | 16,371                |       | 16,063                |       |
| Shares used to compute earnings per share - Diluted   |       | 17,832                |       | 17,544                |       |

** **

**The accompanyingnotes are an integral part of these unaudited condensed consolidated financialstatements.**

** **

**5**

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### ** **

**CPIINTERNATIONAL, INC.**

**and Subsidiaries**

 

### **CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

 (In thousands – unaudited)

** **
|                                                | ** ** | **Quarter Ended** | ** ** |
|-----------------------------------------------------|------------|------------------------|------------|
|                                                | ** ** | **December 28,**  | ** ** | **December 29,** | ** ** |
|                                                | ** ** | **2007**               | ** ** | **2006** | ** ** |
|                                                | ** ** | ** **             | ** ** | ** ** | ** ** |
| **Cash flows from operating activities**            | ** ** | ** **             | ** ** | ** ** | ** ** |
| Net cash provided by operating activities           |       | $                      | 9,560      |   | $ | 10,042 |   |
|                                                |       |                   |       |   |   |
| **Cash flows from investing activities**            |       |                   |       |   |   |
| Capital expenditures                                |       | (1,687                 | )          | (2,871 | ) |
| Payment of patent application fees                  |       | (147                   | )          | — |   |
| Net cash used in investing activities               |       | (1,834                 | )          | (2,871 | ) |
|                                                |       |                   |       |   |   |
| **Cash flows from financing activities**            |       |                   |       |   |   |
| Repayments of debt                                  |       | (1,000                 | )          | (5,000 | ) |
| Proceeds from issuance of common stock to employees |       | 210                    |       | 197 |   |
| Proceeds from exercise of stock options             |       | —                 |       | 66 |   |
| Excess tax benefit on stock option exercises        |       | —                 |       | 42 |   |
| Net cash used in financing activities               |       | (790                   | )          | (4,695 | ) |
|                                                |       |                   |       |   |   |
| **Net increase in cash and cash equivalents**       |       | 6,936                  |       | 2,476 |   |
| Cash and cash equivalents at beginning of period    |       | 20,474                 |       | 30,153 |   |
| Cash and cash equivalents at end of period          |       | $                      | 27,410     |   | $ | 32,629 |   |
|                                                |       |                   |       |   |   |
| **Supplemental cash flow disclosures**              |       |                   |       |   |   |
| Cash paid for interest                              |       | $                      | 155        |   | $ | 961 |   |
| Cash paid for income taxes, net of refunds          |       | $                      | 2,533      |   | $ | 5,150 |   |

 

**The accompanyingnotes are an integral part of these unaudited condensed consolidated financialstatements.**

** **

**6**

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**CPI INTERNATIONAL, INC.****and Subsidiaries**

 

### **NOTESTO UNAUDITED 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*

 

Unlessthe context otherwise requires, “CPI International” means CPI International, Inc.,and “CPI” means Communications & Power Industries, Inc. CPI is adirect subsidiary of CPI International. CPI International is a holding company with no operations of itsown.  The term the “Company” refers toCPI International and its direct and indirect subsidiaries on a consolidatedbasis.

 

Theaccompanying consolidated financial statements represent the consolidatedresults and financial position of CPI International, which is controlled byaffiliates of The Cypress Group L.L.C. (“Cypress”).  CPI International, through its wholly ownedsubsidiary, CPI, develops, manufactures, and distributes microwave and powergrid Vacuum Electron Devices (“VEDs”), microwave amplifiers, modulators andvarious other power supply equipment and devices.  The Company has two reportable segments, VEDand satcom equipment.

 

*Basis of Presentation and Consolidation*

 

TheCompany’s fiscal year is the 52- or 53-week period that ends on the Fridaynearest September 30. Fiscal year 2008 comprises the 53-week period endingOctober 3, 2008 and fiscal year 2007 comprised the 52-week period ending September 28,2007. The first quarters of fiscal years 2008 and 2007 both include 13 weeks.All period references are to the Company’s fiscal periods unless otherwiseindicated.

 

Theaccompanying unaudited condensed consolidated financial statements of theCompany as of December 28, 2007 and for the first quarter of fiscal year2008 are unaudited and reflect all normal recurring adjustments which are, inthe opinion of management, necessary for the fair statement of such financialstatements. These unaudited condensed consolidated financial statementsshould be read in conjunction with the Company’s consolidated financialstatements and notes thereto included in the Company’s Annual Report on Form 10-Kfor the fiscal year ended September 28, 2007.  The condensedconsolidated balance sheet as of September 28, 2007 has been derived fromthe audited financial statements at that date. The results of operationsfor the interim period ended December 28, 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*

 

 Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe consolidated financial statements and the reported amounts of sales andcosts and expenses during the reporting period. On an ongoing basis, theCompany evaluates its estimates, including those related to provision for revenuerecognition; inventory and inventory reserves; product warranty; businesscombinations; recoverability and valuation of recorded amounts of long-livedassets and identifiable intangible assets, including goodwill; recognition ofshare-based compensation; and recognition and 

 

7

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**CPI INTERNATIONAL, INC.****and Subsidiaries**

 

### **NOTESTO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

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

 

measurementof current and deferred income tax assets and liabilities. The Company basesits estimates on various factors and information, which may include, but arenot limited to, history and prior experience, experience of other enterprisesin the same industry, new related events, current economic conditions andinformation from third party professionals that are believed to be reasonableunder the circumstances, the results of which form the basis for makingjudgments about the carrying values of assets and liabilities that are notreadily apparent from other sources.  Actual results may differ from theseestimates under different assumptions or conditions.

 

*Revenue Recognition*

 

Salesare recognized when persuasive evidence of an arrangement exists, delivery hasoccurred, the price is fixed or determinable, and collectibility is reasonablyassured. The Company’s products are generally subject to warranties, and theCompany provides for the estimated future costs of repair, replacement orcustomer accommodation in cost of sales.

 

TheCompany has commercial and U.S. Government fixed-price contracts that areaccounted for under American Institute of Certified Public AccountantsStatement of Position No. 81-1, “Accounting for Performance of Construction-Typeand Certain Production-Type Contracts.” These contracts are generally longerthan one year in duration and include a material amount of product development.The Company uses the percentage-of-completion method when reasonably dependableestimates of the extent of progress toward completion, contract revenues andcontract costs can be made. The portion of revenue earned or the amount ofgross profit earned for a period is determined by measuring the extent ofprogress toward completion using total cost incurred to date and estimatedcosts at contract completion.

 

**2.****                                     ****RecentlyIssued Accounting Standards**

 

InJune 2006, the Financial Accounting Standards Board (“FASB”) issuedFASB Interpretation (“FIN”) No. 48, “Accounting for Income Tax Uncertainties.”FIN No. 48 defines the threshold for recognizing the benefits of taxreturn positions in the financial statements as “more-likely-than-not” to besustained by the taxing authority. The recently issued literature also providesguidance on the derecognition, measurement and classification of income taxuncertainties, along with any related interest and penalties. FIN No. 48also includes guidance concerning accounting for income tax uncertainties ininterim periods and increases the level of disclosures associated with anyrecorded income tax uncertainties. Effective in the first quarter of fiscalyear 2008 starting September 29, 2007, the Company adopted FIN No. 48.The adoption of FIN No. 48 did not have any impact on the Company’sfinancial position, net earnings or prior year financial statements. See Note9, “Income Taxes,” for further discussion.

 

InSeptember 2006, the FASB issued Statement of Financial AccountingStandards (“SFAS”) No. 157, “Fair Value Measurements,” which defines fairvalue, establishes a framework for measuring fair value under other accountingpronouncements that permit or require fair value measurements, changes themethods used to measure fair value and expands disclosures about fair valuemeasurements. In particular, disclosures are required to provide informationon: the extent to which fair value is used to measure assets and liabilities;the inputs used to develop measurements; and the effect of certain of themeasurements on earnings (or changes in net assets). SFAS No. 157 iseffective for fiscal years beginning after November 15, 2007 for financialassets and liabilities and for fiscal years beginning after November 15,2008 for non-financial assets and liabilities. Early adoption, as of thebeginning of an entity’s fiscal year, is also 

 

8

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**CPI INTERNATIONAL, INC.****and Subsidiaries**

 

### **NOTESTO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

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

 

permitted,provided interim financial statements have not yet been issued. The Companywill be required to adopt SFAS No. 157 in its fiscal year 2009 commencing October 4,2008 for financial assets and liabilities and in its fiscal year 2010 commencingOctober 2, 2009 for non-financial assets and liabilities. The Company iscurrently evaluating the potential impact, if any, that the adoption of thisnew standard will have on its consolidated financial statements.

 

In February 2007, the FASB issued SFAS No. 159, “The FairValue Option for Financial Assets and Financial Liabilities - Including anamendment of FASB Statement No. 115.” SFAS No. 159 permits companiesto choose to measure many financial instruments and certain other items at fairvalue that are not currently required to be measured at fair value. Theobjective of SFAS No. 159 is to provide opportunities to mitigatevolatility in reported earnings caused by measuring related assets andliabilities differently without having to apply hedge accounting provisions.SFAS No. 159 also establishes presentation and disclosure requirementsdesigned to facilitate comparisons between companies that choose differentmeasurement attributes for similar types of assets and liabilities. SFAS No. 159is effective for fiscal years beginning after November 15, 2007. TheCompany will be required to adopt SFAS No. 159 in its fiscal year 2009commencing October 4, 2008 and is currently evaluating the impact, if any,that the adoption of this new standard will have on its consolidated financialstatements.

 

In December 2007, the FASB issued SFAS No. 160, “NoncontrollingInterests in Consolidated Financial Statement—amendments of ARB No. 51.”SFAS No. 160 states that accounting and reporting for minority interests willbe recharacterized as noncontrolling interests and classified as a component ofequity. SFAS No. 160 also establishes reporting requirements thatprovide sufficient disclosures that clearly identify and distinguish betweenthe interests of the parent and the interests of the noncontrolling owners.SFAS No. 160 applies to all entities that prepare consolidated financialstatements, except not-for-profit organizations, but will affect only thoseentities that have an outstanding noncontrolling interest in one or moresubsidiaries or that deconsolidate a subsidiary. SFAS No. 160 iseffective for fiscal years beginning after December 15, 2008. The Companywill be required to adopt SFAS No. 160 in its fiscal year 2010 commencing October 3,2009 and is currently evaluating the impact, if any, that the adoption of thisnew standard will have on its consolidated financial statements.

 

In December 2007, the FASB issued SFAS No. 141 (revised2007) (“SFAS No. 141(R)”), “Business Combinations,” which replaces SFAS No. 141.SFAS No. 141(R) establishes principles and requirements for howan acquirer recognizes and measures in its financial statements theidentifiable assets acquired, the liabilities assumed, any non controllinginterest in the acquiree and the goodwill acquired. The Statement alsoestablishes disclosure requirements which will enable users to evaluate thenature and financial effects of the business combination. SFAS No. 141(R) iseffective for fiscal years beginning after December 15, 2008. The Companywill be required to adopt SFAS No. 141(R) in its fiscal year 2010commencing October 3, 2009 and is currently evaluating the impact, if any,that the adoption of this new standard will have on its consolidated financialstatements.

 

9

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**CPI INTERNATIONAL, INC.****and Subsidiaries**

 

### **NOTESTO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

(All tabulardollar amounts in thousands except share and per share amounts)

 

**3.             SupplementalBalance Sheet Information**

 

**AccountsReceivable:**  Accountsreceivable are stated net of allowances for doubtful accounts as follows:

 
|                                  | ** ** | **December 28,** | ** ** | **September 28,** | ** ** |
|---------------------------------------|------------|-----------------------|------------|------------------------|------------|
|                                  | ** ** | **2007**              | ** ** | **2007**               | ** ** |
| Accounts receivable                   |       | $                     | 46,197     |                   | $          | 52,678 |   |
| Less: Allowance for doubtful accounts |       | (251                  | )          | (89                    | )          |
| Accounts receivable, net              |       | $                     | 45,946     |                   | $          | 52,589 |   |

 

**Inventories:**    The following table provides details ofinventories, net of reserves:

 
| ** **             | ** ** | **December 28,** | ** ** | **September 28,** | ** ** |
|------------------------|------------|-----------------------|------------|------------------------|------------|
| ** **             | ** ** | **2007**              | ** ** | **2007**               | ** ** |
| Raw material and parts |       | $                     | 37,964     |                   | $          | 40,725 |   |
| Work in process        |       | 19,934                |       | 18,168                 |       |
| Finished goods         |       | 11,285                |       | 8,554                  |       |
|                   |       | $                     | 69,183     |                   | $          | 67,447 |   |

 

**Reservefor excess, slow moving and obsolete inventory:**    The following table summarizes the activityrelated to reserves for excess, slow moving and obsolete inventory during the first quarter of fiscal years2008 and 2007:

 
| ** **                                    | ** ** | **Quarter Ended** | ** ** |
|-----------------------------------------------|------------|------------------------|------------|
| ** **                                    | ** ** | **December 28,**  | ** ** | **December 29,** | ** ** |
|                                          | ** ** | **2007**               | ** ** | **2006** | ** ** |
| Balance at beginning of period                |       | $                      | 9,784      |   | $ | 8,822 |   |
| Inventory provision, charged to cost of sales |       | 200                    |       | 307 |   |
| Inventory write-offs                          |       | (33                    | )          | (60 | ) |
| Balance at end of period                      |       | $                      | 9,951      |   | $ | 9,069 |   |

 

**Reservefor loss contracts:**   Thefollowing table summarizes the activity related to reserves for loss contractsduring the firstquarter of fiscal years 2008 and 2007:

 
| ** **                                             | ** ** | **Quarter Ended** | ** ** |
|--------------------------------------------------------|------------|------------------------|------------|
| ** **                                             | ** ** | **December 28,**  | ** ** | **December 29,** | ** ** |
| ** **                                             | ** ** | **2007**               | ** ** | **2006** | ** ** |
| Balance at beginning of period                         |       | $                      | 2,700      |   | $ | 1,702 |   |
| Provision for loss contracts, charged to cost of sales |       | 746                    |       | 149 |   |
| Reduction upon revenue recognition                     |       | (1,012                 | )          | (282 | ) |
| Balance at end of period                               |       | $                      | 2,434      |   | $ | 1,569 |   |

** **

**10**

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**CPI INTERNATIONAL, INC.****and Subsidiaries**

 

### **NOTESTO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

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

 

Reservefor loss contracts are reported in the condensed consolidated balance sheet inthe following accounts:

 
| ** **       | ** ** | **December 28,** | ** ** | **December 29,** | ** ** |
|------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **       | ** ** | **2007**              | ** ** | **2006**              | ** ** |
| Inventories      |       | $                     | 1,342      |                  | $          | 1,207 |   |
| Accrued expenses |       | 1,092                 |       | 362                   |       |
|             |       | $                     | 2,434      |                  | $          | 1,569 |   |

 

**Intangible Assets:** The followingtables present the details of the Company’s total acquisition-relatedintangible assets:

 
| ** **                    | ** ** | **Weighted Average  Useful Life  (in years)** | ** ** | **December28, 2007** | ** **                          | **September 28, 2007** | ** ** |
|-------------------------------|------------|-------------------------------------------------------------------|------------|---------------------------|-------------------------------------|-----------------------------|------------|
| ** **                    | ** ** | ** **                                                        | **Cost**   | ** **                | **Accumulated   Amortization** | ** **                  | **Net**    | ** ** | **Cost** | ** ** | **Accumulated  Amortization** | ** ** | **Net** | ** ** |
| VED Core Technology |       | 50                                                                |       | $                         |  30,700                        |                        | $          |  (2,426 | ) | $ |  28,274 |   | $ |  30,700 |   | $ |  (2,273 | ) | $ |  28,427 | ** ** |
| VED Application Technology    |       | 25                                                                |       | 19,800                    |                                | (3,119                      | )          | 16,681 |   | 19,800 |   | (2,921 | ) | 16,879 |   |
| X-ray Generator and Satcom    |       |                                                              |       |                      |                                |                        |       |   |   |   |   |   |   |   |   |
| Application Technology        |       | 15                                                                |       | 8,000                     |                                | (2,107                      | )          | 5,893 |   | 8,000 |   | (1,974 | ) | 6,026 |   |
| Antenna and Telemetry         |       |                                                              |       |                      |                                |                        |       |   |   |   |   |   |   |   |   |
| Technology                    |       | 25                                                                |       | 5,300                     |                                | (82                         | )          | 5,218 |   | 5,300 |   | (29 | ) | 5,271 |   |
| Customer backlog              |       | 1                                                                 |       | 580                       |                                | (223                        | )          | 357 |   | 580 |   | (78 | ) | 502 |   |
| Land lease                    |       | 46                                                                |       | 11,810                    |                                | (991                        | )          | 10,819 |   | 11,810 |   | (928 | ) | 10,882 |   |
| Tradename                     |       | Indefinite                                                        |       | 7,600                     |                                | —                      |       | 7,600 |   | 7,600 |   | — |   | 7,600 |   |
| Customer list and programs    |       | 25                                                                |       | 6,280                     |                                | (751                        | )          | 5,529 |   | 6,280 |   | (684 | ) | 5,596 |   |
| Noncompete agreement          |       | 5                                                                 |       | 640                       |                                | (112                        | )          | 528 |   | 640 |   | (80 | ) | 560 |   |
| Patent application fees       |       | —                                                            |       | 146                       |                                | —                      |       | 146 |   | — |   | — |   | — |   |
|                          |       |                                                              |       | $                         | 90,856                              |                        | $          | (9,811 | ) | $ | 81,045 |   | $ | 90,710 |   | $ | (8,967 | ) | $ | 81,743 |   |

 

Intangibleassets, net as of December 28, 2007 include a total of approximately $0.1million of application costs and associated legal costs incurred to obtaincertain patents. Upon obtaining these patents, they will be amortized on astraight-line basis and charged to operations over their estimated usefullives, not to exceed 17 years.

 

Theamortization of intangible assets amounted to $0.8 million and $0.5 million forthe first quarter of fiscal years 2008 and 2007, respectively.

 

Theestimated future amortization expense of intangible assets, excluding theCompany’s unamortized tradenames, is as follows:

 

11

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**CPI INTERNATIONAL, INC.****and Subsidiaries**

 

### **NOTESTO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

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

 
| **Fiscal Year**         | ** ** | **Amount** | ** ** |
|------------------------------|------------|------------|------------|
| 2008 (remaining nine months) |       | $          | 2,462      |   |
| 2009                         |       | 2,808      |       |
| 2010                         |       | 2,786      |       |
| 2011                         |       | 2,786      |       |
| 2012                         |       | 2,771      |       |
| Thereafter                   |       | 59,832     |       |
|                         |       | $          | 73,445     |   |
|                              |            |            |            |  |  |

 

**Goodwill:**    The following table sets forth the changesin goodwill by reportable segment during the first quarter of fiscal year 2008:

 
| ** **                             | ** ** | **Reportable Segments** | ** ** | ** ** | ** ** |
|----------------------------------------|------------|------------------------------|------------|------------|------------|
| ** **                             | ** ** | **VED**                      | ** ** | **Satcom** | ** ** | **Other** | ** ** | **Total** | ** ** |
| **Balance at September 28, 2007** |       | $                            | 132,897    |       | $          | 13,830 |   | $ | 14,846 |   | $ | 161,573 |   |
| Other                                  |       | —                       |       | —     |       | (25 | ) | (25 | ) |
| **Balance at December 29, 2007**  |       | $                            | 132,897    |       | $          | 13,830 |   | $ | 14,821 |   | $ | 161,548 |   |

 

                Other represents tax benefitfrom amortization expense for the second component of tax goodwill.

 

**Product Warranty:**    Thefollowing table summarizes the activity related to product warranty duringfiscal years 2007 and 2006:

 
| ** **                                               | ** ** | **Quarter Ended** | ** ** |
|----------------------------------------------------------|------------|------------------------|------------|
| ** **                                               | ** ** | **December 28,**  | ** ** | **December 29,** | ** ** |
| ** **                                               | ** ** | **2007**               | ** ** | **2006** | ** ** |
| Beginning accrued warranty                               |       | $                      | 5,578      |   | $ | 5,958 |   |
| Estimates for product warranty, charged to cost of sales |       | 872                    |       | 1,211 |   |
| Actual costs of warranty claims                          |       | (1,074                 | )          | (1,327 | ) |
| Ending accrued warranty                                  |       | $                      | 5,376      |   | $ | 5,842 |   |

 

**4.             Acquisition**

 

***MalibuResearch Associates***

 

On August 10, 2007,the Company completed its acquisition of all outstanding common stock of theprivately held Malibu Research Associates, Inc. (“Malibu”). Malibu,headquartered in Camarillo, California, is a designer, manufacturer andintegrator of advanced antenna systems for radar, radar simulators andtelemetry systems, as well as for data links used in ground, airborne, unmannedaerial vehicles (“UAV”) and shipboard systems. Under the terms of the purchaseagreement, the Company paid cash of approximately $22.4 million, which included$2.3 million and $1.0 million placed into indemnity and working capital escrowaccounts, respectively. The indemnity escrow amount was provided to ensurefunds are available to satisfy potential indemnification claims asserted priorto January 1, 2009, and the working capital escrow amount was provided tosatisfy any negative differences between the target working capital amount andthe actual working capital amount at the acquisition closing date. The Companyexpects that the working capital calculations will be finalized during fiscalyear 2008.

 

12

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**CPI INTERNATIONAL, INC.****and Subsidiaries**

 

### **NOTESTO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

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

 

Additionally,the Company may be required to pay a potential earnout to the former stockholders of Malibu of up to $14.0million, which is primarily contingent upon the achievement of certain financialobjectives over the three years following the acquisition; and a discretionary earnout of up to $1.0 million contingent upon achievement of certainsuccession planning goals by June 30, 2010. As of December 28,2007, the Company has not accrued any of these contingent earnout amounts asachievement of the objectives and goals has not occurred. Any earnout consideration paid based onfinancial performance will be recorded as additional goodwill. Anydiscretionary succession earnout consideration paid will be recorded as generaland administrative expense.

 

Underthe purchase method of accounting, the assets and liabilities of Malibu wereadjusted to their fair values and the excess of the purchase price over thefair value of the net assets acquired was recorded as goodwill. The allocationof the purchase price to specific assets and liabilities was based, in part,upon internal estimates of cash flow and recoverability. The valuation ofidentifiable intangible assets acquired was based on management’s estimates,currently available information and reasonable and supportable assumptions.This purchase price allocation was generally based on the fair value of theseassets determined using the income approach.

 

Thefollowing table summarizes the allocation of the fair value of the Malibu’sassets acquired and liabilities assumed:

 
| Net current liabilities        |   | $      | (3,938 | )      |
|--------------------------------|--------|--------|--------|--------|
| Property, plant and equipment  |   | 719    |   |
| Deferred tax liabilities       |   | (703   | )      |
| Identifiable intangible assets |   | 8,790  |   |
| Goodwill                       |   | 14,856 |   |
|                           |   | $      | 19,724 |   |

 

For financial reportingpurposes, consideration of approximately $2.6 million, which is included in theinitial cash consideration paid for Malibu, is excluded from the purchase priceallocation above and is reported as other long-term assets in the consolidatedbalance sheet at December 28, 2007 and September 28, 2007.  This consideration amount represents thedifference between the Company’s initial calculation of the target workingcapital amount and actual working capital amount as of the acquisition closingdate. In accordance with SFAS No. 141, any contingent consideration thathas not been determined beyond a reasonable doubt is excluded from the purchaseprice allocation until the contingency is resolved. The Company intends to makea claim against the working capital escrow account of $1.0 million and, ifnecessary, the indemnity escrow account of $2.3 million to recover the workingcapital shortfall once the amount of such shortfall has been finallydetermined.

 

13

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**CPI INTERNATIONAL, INC.****and Subsidiaries**

 

### **NOTESTO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

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

 

The following table presentsdetails of the purchased intangible assets acquired:

 
| ** **                       | ** ** | **Weighted Average Useful  Life (in years)** | ** ** | **Amount** | ** ** |
|----------------------------------|------------|------------------------------------------------------------------|------------|------------|------------|
| Non compete agreements           |       | 5                                                                |       | $          | 530        |   |
| Tradename                        |       | Indefinite                                                       |       | 1,800      |       |
| Antenna and Telemetry technology |       | 25                                                               |       | 5,300      |       |
| Backlog                          |       | 1                                                                |       | 580        |       |
| Customer relationships           |       | 15                                                               |       | 580        |       |
|                             |       |                                                             |       | $          | 8,790      |   |

 

In accordance with SFAS No. 142,“Goodwill and Other Intangible Assets,” goodwill and indefinite livedintangibles will not be amortized but will be tested for impairment at leastannually.

 

TheCompany’s consolidated financial statements include Malibu’s financial resultsfrom the acquisition date.

 

*Pro Forma Results*

 

Proforma information giving effect to the Malibu acquisition has not beenpresented because the pro forma information would not differ materially fromthe historical results of the Company.

 

**5.             Long-Term Debt**

 

Long-termdebt comprises the following:

 
| ** **                               | ** ** | **December 28,** | ** ** | **September 28,** | ** ** |
|------------------------------------------|------------|-----------------------|------------|------------------------|------------|
| ** **                               | ** ** | **2007**              | ** ** | **2007**               | ** ** |
| Term loan, expiring 2014                 |       | $                     | 98,750     |                   | $          | 99,750 |   |
| 8% Senior subordinated notes due 2012    |       | 125,000               |       | 125,000                |       |
| Floating rate senior notes due 2015, net |       |                  |       |                   |       |
| of issue discount of $179 and $183       |       | 21,821                |       | 21,817                 |       |
|                                     |       | 245,571               |       | 246,567                |       |
| Less: Current portion                    |       | 250                   |       | 1,000                  |       |
| Long-term portion                        |       | $                     | 245,321    |                   | $          | 245,567 |   |
| Standby letters of credit                |       | $                     | 4,029      |                   | $          | 3,725 |   |

 

***Senior Credit Facilities:***** **On August 1, 2007, CPIamended and restated its then existing senior credit facilities. The amendedand restated senior credit facilities (the “Senior Credit Facilities”) providefor borrowings of up to an aggregate principal amount of $160 million,consisting of a $100 million term loan facility (“Term Loan”) and a $60 millionrevolving credit facility (“Revolver”), with a sub-facility of $15 million forletters of credit and $5 million for swing line loans. Upon certain specifiedconditions, including maintaining a senior secured leverage ratio of 3.75:1 orless on a pro forma basis, CPI may seek commitments for a new class of termloans, not to exceed $125 million in the aggregate.  The Senior Credit Facilities are guaranteedby CPI International and all of CPI’s domestic subsidiaries and are secured bysubstantially all of the assets of CPI International, CPI and CPI’s domesticsubsidiaries.

 

14

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**CPI INTERNATIONAL, INC.****and Subsidiaries**

 

### **NOTESTO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

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

 

Except as provided in the following sentence, theTerm Loan will mature on August 1, 2014 and the Revolver will mature on August 1,2013.  However, if, prior to August 1,2011, CPI has not repaid or refinanced its $125 million 8% Senior SubordinatedNotes due 2012, both the Term Loan and the Revolver will mature on August 1,2011.

 

TheSenior Credit Facilities replaced CPI’s previous senior credit facilities of$130 million. On the closing date of the Senior Credit Facilities, CPI borrowed$100 million under the Term Loan. Borrowings under the Senior Credit Facilitiesbear interest at a rate equal to, at CPI’s option, LIBOR or the ABR plus theapplicable margin. The ABR is the greater of the (a) the prime rate and (b) thefederal funds rate plus 0.50%. For Term Loans, the applicable margin will be2.00% for LIBOR borrowings and 1.00% for ABR borrowings. The applicable marginsunder the Revolver vary depending on CPI’s leverage ratio, as defined in theSenior Credit Facilities, and range from 1.25% to 2.00% for LIBOR borrowingsand from 0.25% to 1.00% for ABR borrowings.

 

In addition to customaryfronting and administrative fees under the Senior Credit Facilities, CPI willpay letter of credit participation fees equal to the applicable LIBOR marginper annum on the average daily amount of the letter of credit exposure, and acommitment fee on the average daily unused commitments under the Revolver.  The commitment fee will vary depending on CPI’sleverage ratio, as defined in the Senior Credit Facilities, and will range from0.25% to 0.50%.

 

The Senior Credit Facilitiesrequire that CPI repay $250,000 of the Term Loan at the end of each fiscalquarter prior to the maturity date of the Term Loan, with the remainder due onthe maturity date.  CPI is required toprepay its outstanding loans under the Senior Credit Facilities, subject tocertain exceptions and limitations, with net cash proceeds received fromcertain events, including, without limitation (1) all such proceedsreceived from certain asset sales by CPI International, CPI or any of CPI’ssubsidiaries, (2) all such proceeds received from issuances of debt (otherthan certain specified permitted debt) or preferred stock by CPI International,CPI or any of CPI’s subsidiaries, and (3) all such proceeds paid to CPIInternational, CPI or any of CPI’s subsidiaries from casualty and condemnationevents in excess of amounts applied to replace, restore or reinvest in anyproperties for which proceeds were paid within a specified period.

 

If CPI’s leverage ratio, asdefined in the Senior Credit Facilities, exceeds 3.5:1 at the end of any fiscalyear, CPI will also be required to make an annual prepayment within 90 daysafter the end of such fiscal year equal to 50% of excess cash flow, as definedin the Senior Credit Facilities, less optional prepayments made during thefiscal year.  CPI can make optionalprepayments on the outstanding loans at any time without premium or penalty,except for customary “breakage” costs with respect to LIBOR loans.

 

The Senior Credit Facilitiescontain a number of covenants that, among other things, restrict, subject tocertain exceptions, the ability of CPI International, CPI or any of CPI’ssubsidiaries to: sell assets; engage in mergers and acquisitions; pay dividendsand distributions or repurchase their capital stock; incur additionalindebtedness or issue equity interests; make investments and loans; createliens or further negative pledges on assets; engage in certain transactionswith affiliates; enter into sale and leaseback transactions; amend agreementsor make prepayments relating to subordinated indebtedness; and amend or waiveprovisions of charter documents in a manner materially adverse to the lenders.CPI and its subsidiaries must comply with a maximum capital expenditurelimitation and a maximum total secured leverage ratio, each calculated on aconsolidated basis for CPI.

 

15

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**CPI INTERNATIONAL, INC.****and Subsidiaries**

 

### **NOTESTO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

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

 

CPI made repayments on theTerm Loan of $1.0 million during the first quarter of fiscal year 2008 and$250,000 during the fourth quarter of fiscal year 2007, leaving a principalbalance of $98.75 million as of December 28, 2007. The $1.0 million TermLoan repayment during the first quarter of fiscal year 2008 comprised thescheduled amortization payment of $250,000 and an optional payment of $750,000.The optional payment will be applied against the scheduled amortizationpayments due for the second, third and fourth quarters of fiscal year 2008.

 

At December 28, 2007,the amount available for borrowing under the Revolver, after taking intoaccount the Company’s outstanding letters of credit of $4.0 million, wasapproximately $56.0 million.

 

***8% Senior Subordinated Notes due 2012 ofCPI: ***Asof December 28, 2007, CPI had $125.0 million in aggregate principalamount of its 8% Senior Subordinated******Notes due 2012 (the “8%Notes”). The 8% Notes have no sinking fund requirements.

 

The8% Notes bear interest at the rate of 8.0% per year, payable on February 1and August 1 of each year. The 8% Notes will mature on February 1,2012. The 8% Notes are unsecured obligations, jointly and severally guaranteedby CPI International and each of CPI’s domestic subsidiaries. The payment ofall obligations relating to the 8% Notes are subordinated in right of paymentto the prior payment in full in cash or cash equivalents of all senior debt (asdefined in the indenture governing the 8% Notes) of CPI, including debt underthe Senior Credit Facilities. Each guarantee of the 8% Notes is and will besubordinated to guarantor senior debt (as defined in the indenture governingthe 8% Notes) on the same basis as the 8% Notes are subordinated to CPI’ssenior debt.

 

Atany time or from time to time on or after February 1, 2008, CPI, at itsoption, may redeem the 8% Notes, in whole or in part, at the redemption prices(expressed as percentages of principal amount) set forth below, together withaccrued and unpaid interest thereon, if any, to the redemption date, ifredeemed during the 12-month period beginning on February 1 of the yearsindicated below:

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

 

Upona change of control, CPI may be required to purchase all or any part of the 8%Notes for a cash price equal to 101% of the principal amount, plus accrued andunpaid interest thereon, if any, to the date of purchase.

 

Theindenture governing the 8% Notes contains a number of covenants that, amongother things, restrict, subject to certain exceptions, the ability of CPI andits restricted subsidiaries (as defined in the indenture governing the 8%Notes) to incur additional indebtedness, sell assets, consolidate or merge withor into other companies, pay dividends or repurchase or redeem capital stock orsubordinated indebtedness, make certain investments, issue capital stock oftheir subsidiaries, incur liens and enter into certain types of transactionswith their affiliates.

 

16

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**CPI INTERNATIONAL, INC.****and Subsidiaries**

 

### **NOTESTO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

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

 

Eventsof default under the indenture governing the 8% Notes include: failure to makepayments on the 8% Notes when due; failure to comply with covenants in theindenture governing the 8% Notes; a default under certain other indebtedness ofCPI or any of its restricted subsidiaries that is caused by a failure to makepayments on such indebtedness or that results in the acceleration of thematurity of such indebtedness; the existence of certain final judgments ororders against CPI or any of the restricted subsidiaries; and the occurrence ofcertain insolvency or bankruptcy events.

 

***Floating RateSenior Notes due 2015 of CPI International:***Asof December 28, 2007, CPI International had $22 million inaggregate principal amount of its Floating Rate Senior Notes due 2015 (the “FR Notes”).The FR Notes were issued at a 1% discount. The FR Notes have no sinking fundrequirements.

 

TheFR Notes require interest payments at an annual interest rate, reset at thebeginning of each semi-annual period, equal to the then six-month LIBOR plus5.75%, payable semiannually on February 1 and August 1 of each year.The interest rate on the semi-annual interest payment due February 1, 2008is approximately 11.0625% per annum. CPI International may, at its option,elect to pay interest through the issuance of additional FR Notes for anyinterest payment date on or after August 1, 2006 and on or before February 1,2010. If CPI International elects to pay interest through the issuance ofadditional FR Notes, the annual interest rate on the FR Notes will increase byan additional 1% step-up, with the step-up increasing by an additional 1% foreach interest payment made through the issuance of additional FR Notes (up to amaximum of 4%). The FR Notes will mature on February 1, 2015.

 

TheFR Notes are general unsecured obligations of CPI International. The FR Notesare not guaranteed by any of CPI International’s subsidiaries but arestructurally subordinated to all existing and future indebtedness and otherliabilities of CPI International’s subsidiaries. The FR Notes are senior inright of payment to CPI International’s existing and future indebtedness thatis expressly subordinated to the FR Notes.

 

BecauseCPI International is a holding company with no operations of its own, CPIInternational relies on distributions from Communications & PowerIndustries to satisfy its obligations under the FR Notes. The Senior CreditFacilities and the indenture governing the 8% Notes restrict CPI’s ability tomake distributions to CPI International. The Senior Credit Facilities prohibitCPI from making distributions to CPI International unless there is no defaultunder the Senior Credit Facilities and CPI satisfies a senior secured leverageratio of 3.75:1, and in the case of distributions to pay amounts other thaninterest on the FR Notes, the amount of the distribution and all prior suchdistributions do not exceed a specified amount. The indenture governing the 8%Notes prohibits CPI from making distributions to CPI International unless,among other things, there is no default under the indenture and the amount ofthe proposed dividend plus all previous Restricted Payments (as defined in theindenture governing the 8% Notes) does not exceed a specified amount.

 

17

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**CPI INTERNATIONAL, INC.****and Subsidiaries**

 

### **NOTESTO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

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

 

Atany time or from time to time on or after February 1, 2007, CPIInternational, at its option, may redeem the FR Notes in whole or in part atthe redemption 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                             | %          |

 

Upona change of control, as defined in the indenture governing the FR Notes, CPIInternational may be required to purchase all or any part of the outstanding FRNotes for a cash price equal to 101% of the principal amount, plus accrued andunpaid interest thereon, if any, to the date of purchase.

 

Theindenture governing the FR Notes contains certain covenants that, among otherthings, limit the ability of CPI International and its restricted subsidiaries(as defined in the indenture governing the FR Notes) to incur additionalindebtedness, sell assets, consolidate or merge with or into other companies,pay dividends or repurchase or redeem capital stock or subordinatedindebtedness, make certain investments, issue capital stock of theirsubsidiaries, incur liens and enter into certain types of transactions withtheir affiliates.

 

Eventsof default under the indenture governing the FR Notes include: failure to makepayments on the FR Notes when due; failure to comply with covenants in theindenture governing the FR Notes; a default under certain other indebtedness ofCPI International or any of its restricted subsidiaries that is caused by afailure to make payments on such indebtedness or that results in theacceleration of the maturity of such indebtedness; the existence of certainfinal judgments or orders against CPI International or any of the restrictedsubsidiaries; and the occurrence of certain insolvency or bankruptcy events.

 

**DebtMaturities:**    As of December 28,2007, maturities on long-term debt were as follows:

 
| **Fiscal Year**         | ** ** | **Term  Loan** | ** ** | **8% Senior  Subordinated  Notes** | ** ** | **Floating Rate  Senior Notes** | ** ** | **Total** | ** ** |
|------------------------------|------------|----------------|------------|-----------------------------------------|------------|--------------------------------------|------------|-----------|------------|
| 2008 (remaining nine months) |       | $              | —     |                                    | $          | —                               |       | $         | —     |   | $ | — |   |
| 2009                         |       | 1,000          |       | —                                  |       | —                               |       | 1,000     |       |
| 2010                         |       | 1,000          |       | —                                  |       | —                               |       | 1,000     |       |
| 2011                         |       | 96,750         |       | —                                  |       | —                               |       | 96,750    |       |
| 2012                         |       | —         |       | 125,000                                 |       | —                               |       | 125,000   |       |
| Thereafter                   |       | —         |       | —                                  |       | 22,000                               |       | 22,000    |       |
|                         |       | $              | 98,750     |                                    | $          | 125,000                              |       | $         | 22,000     |   | $ | 245,750 |   |

 

Theabove table assumes (1) that the respective debt instruments will beoutstanding until their scheduled maturity dates, except for the Term Loanunder the Senior Credit Facilities, which is assumed to mature on the earlierdate of August 1, 2011 as described above under “Senior Credit Facilities,”and (2) a debt level based on mandatory repayments according to thecontractual amortization schedule. The above table also excludes any optionalprepayments.

 

18

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**CPI INTERNATIONAL, INC.****and Subsidiaries**

 

### **NOTESTO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

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

 

Asof December 28, 2007, the Company was in compliance with the covenantsunder the indentures governing the 8% Notes and FR Notes and the agreementsgoverning the Senior Credit Facilities, and the Company expects to remain incompliance with those covenants throughout the remainder of fiscal year 2008.

 

                ***Interest rate swap agreements***:  See Note 6 for information on the interestrate swap agreements entered into by the Company to hedge the interest rateexposure associated with the Term Loan.

 

**6.             Derivative Financial Instruments**

 

TheCompany uses forward exchange contracts to hedge the foreign currency exposureassociated with forecasted manufacturing costs in Canada. As of December 28,2007, the Company had outstanding forward contract commitments to purchaseCanadian dollars for an aggregate U.S. notional amount of $19.1 million; thelast forward contract expires on June 23, 2008. At December 28, 2007and September 28, 2007, the fair value of foreign currency forwardcontracts was a net asset of $0.7 million and $1.3 million, respectively, andthe unrealized gain, net of related tax expense, was $0.8 million and $1.2million, respectively.

 

TheCompany’s foreign currency forward contracts are designated as a cash flowhedge and are considered highly effective, as defined by SFAS No. 133, “Accountingfor Derivative Instruments and Hedging Activities.” The unrealized gains andlosses from foreign exchange forward contracts are included in “accumulatedother comprehensive income” in the condensed consolidated balance sheets, andthe Company anticipates recognizing the entire unrealized gain in operatingearnings within the next 12 months. Changes in the fair value of foreigncurrency forward contracts due to changes in time value are excluded from theassessment of effectiveness, and are immediately recognized in general andadministrative in the consolidated statements of operations. The time value wasnot material for the first quarter of fiscal years 2008 and 2007. If thetransaction being hedged fails to occur, or if a portion of any derivative isineffective, then the Company promptly recognizes the gain or loss on theassociated financial instrument in the consolidated statements of operations.No ineffective amounts were recognized due to anticipated transactions failingto occur in the first quarter of fiscal years 2008 and 2007. 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 for the first quarter of fiscal years 2008 and 2007includes a recognized gain of $3,000 and a recognized loss of $0.1 million,respectively, from foreign currency forward contracts.

 

TheCompany also uses derivatives to hedge the interest rate exposure associatedwith its long term debt. Most recently, on September 21, 2007, the Companyentered into an interest rate swap contract (the “2007 Swap”) to receivethree-month USD-LIBOR-BBA (British Bankers’ Association) interest and pay 4.77%fixed rate interest. Net interest positions are settled quarterly. The Companyhas structured the 2007 Swap with decreasing notional amounts to match theexpected pay down of its Term Loan under the Senior Credit Facilities discussedin Note 5. The notional value of the 2007 Swap was $90.0 million at December 28,2007 and represented approximately 91% of the aggregate Term Loan balance. TheSwap agreement is effective through June 30, 2011. Under the provisions ofSFAS No. 133, “*Accounting for*

 

19

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**CPI INTERNATIONAL, INC.****and Subsidiaries**

 

### **NOTESTO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

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

 

*Derivative Instruments and Hedging Activities*,” as amended,this arrangement was initially designated and qualified as an effective cashflow hedge of interest rate risk related to the Term Loan, which permittedrecording the fair value of the 2007 Swap and corresponding unrealized gain orloss to accumulated other comprehensive income in the condensed consolidatedbalance sheets. The interest rate swap gain or loss is included in theassessment of hedge effectiveness. At December 28, 2007, the fair value ofthe short-term and long-term portions of the 2007 Swap was a liability of $0.4million (accrued expenses) and $1.1 million (other long-term liabilities),respectively. At September 28, 2007, the fair value of the short-term andlong-term portions of the 2007 Swap was an asset of $0.1 million (other currentassets) and a liability of $0.3 million (other long-term liabilities),respectively. At December 28, 2007 and September 28, 2007, theunrealized loss, net of tax, was $0.9 million and $0.1 million, respectively.

 

**7.             Commitments and Contingencies**

 

**Leases:**The Company is committed to minimum rentals under non-cancelableoperating lease agreements, primarily for land and facility space, that expireon various dates through 2050. Certain of the leases provide for escalatinglease payments. Future minimum lease payments for all non-cancelable operatinglease agreements at December 28, 2007 were as follows:

 
| **Fiscal Year**                | ** ** | **Operating Leases** | ** **  |
|-------------------------------------|------------|---------------------------|-------------|
| 2008 (remaining nine months)        |       | $                         |  1,432 |   |
| 2009                                |       | 1,290                     |        |
| 2010                                |       | 1,052                     |        |
| 2011                                |       | 437                       |        |
| 2012                                |       | 358                       |        |
| Thereafter                          |       | 3,094                     |        |
| Total future minimum lease payments |       | $                         |  7,663 |   |

 

Real estate taxes,insurance, and maintenance are also obligations of the Company. Rental expenseunder non-cancelable operating leases amounted to $0.6 million and $0.5 millionfor the first quarter of fiscal years 2008 and 2007, respectively. Assetssubject to capital leases at December 28, 2007 and September 28, 2007were not material.

 

**Guarantees:**The Company has restrictedcash of $2.5 million and $2.3 million as of December 28, 2007 and September 28,2007, respectively, consisting primarily of bank guarantees from customeradvance payments to the Company’s international subsidiaries. The bankguarantees become unrestricted cash when performance under the sales or supplycontract is complete.

 

20

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**CPI INTERNATIONAL, INC.****and Subsidiaries**

 

### **NOTESTO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

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

 

**Purchase commitments:**As of December 28, 2007, the Companyhad the following known purchase commitments, which include primarily futurepurchases for inventory-related items under various purchase arrangements aswell as other obligations in the ordinary course of business that the Companycannot cancel or where it would be required to pay a termination fee in theevent of cancellation:

**** ****
| **Fiscal Year**         | ** ** | **Purchase Contracts** | ** ** |
|------------------------------|------------|-----------------------------|------------|
| 2008 (remaining nine months) |       | $                           | 38,333     |   |
| 2009                         |       | 2,086                       |       |
| 2010                         |       | 25                          |       |
| Total purchase commitments   |       | $                           | 40,444     |   |

 

**Contingent Earnout Consideration:**As discussed in Note 4, inaddition to the $22.2 million of net cash consideration paid for the Malibuacquisition, there is a potential earnout payable to the former stockholders ofMalibu of up to $14.0 million, which is primarily contingent upon the achievementof certain financial objectives over the three years following the acquisition;and a discretionary earnout ofup to $1.0 million contingent upon achievementof certain succession planning goals by June 30, 2010.

 

****Indemnification:****As permitted under Delawarelaw, the Company has agreements whereby the Company indemnifies its officers,directors and certain employees for certain events or occurrences while theemployee, officer or director is, or was serving, at the Company’s request insuch capacity. The term of the indemnification period is for the officer’s ordirector’s lifetime. The maximum potential amount of future payments theCompany could be required to make under these indemnification agreements isunlimited; however, the Company has Director and Officer insurance policiesthat limit its exposure and may enable it to recover a portion of any futureamounts paid.

 

TheCompany has entered into other standard indemnification agreements in itsordinary course of business. Pursuant to these agreements, the Company agreesto indemnify, defend, hold harmless, and to reimburse the indemnified party forlosses suffered or incurred by the indemnified party, generally the Company’sbusiness partners or customers, in connection with any patent, copyright orother intellectual property infringement claim by any third party with respectto its products. The term of these indemnification agreements is generallyperpetual after execution of the agreement. The maximum potential amount offuture 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 that the estimated fair valueof these agreements is minimal. Accordingly, the Company has no liabilitiesrecorded for these agreements as of December 28, 2007.

 

**Employment Agreements:** The Company has enteredinto employment agreements with certain members of executive management thatinclude provisions for the continued payment of salary, benefits and a pro-rataportion of annual bonus upon employment termination for periods ranging from 12months to 30 months.

 

**Contingencies:** From time to time, the Company may besubject to claims that arise in the ordinary course of business. In the opinionof management, all such matters involve amounts that would not have a materialadverse effect on the Company’s consolidated financial position if unfavorablyresolved.

 

21

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**CPI INTERNATIONAL, INC.****and Subsidiaries**

 

### **NOTESTO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

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

 

**8.****                                     ****Stock-basedCompensation Plans**

 

Asof December 28, 2007, the Company had an aggregate of 1.3 million sharesof its common stock available for future grant and approximately 3.4 millionoptions that were outstanding under its various equity plans. Awards aresubject to terms and conditions as determined by the Company’s Board ofDirectors.

 

****Stock Options:****The following table summarizes stockoption activity as of December 28, 2007, and changes during the firstquarter of fiscal year 2008 under the Company’s stock option plans:

 
| ** **                                        | ** ** | **Oustanding Options** | ** ** | **Exercisable Options**              | ** ** |
|---------------------------------------------------|------------|-----------------------------|------------|-------------------------------------------|------------|
| ** **                                        | ** ** | **Number  of  Shares**      | ** ** | **Weighted-Average  Exercise Price** | ** ** | **Weighted-Average  Remaining  Contractual Term  (Years)** | ** ** | **Aggregate  Intrinsic Value** | ** ** | **Number  of  Shares** | ** ** | **Weighted-Average  Exercise Price** | ** ** | **Weighted-Average  Remaining  Contractual Term  (Years)** | ** ** | **Aggregate  Intrinsic Value** | ** ** |
| Balance at September 28, 2007 | ** ** | 3,171,081                   |       | $                                         |  5.61 |   | 6.58 |   | $ |  42,513 |   | 2,259,528 |   | $ |  3.00 |   | 5.98 |   | $ |  36,184 | ** ** |
| Granted                                           | ** ** | 208,750                     |       | 16.79                                     |       |   |   |   |   |   |   |   |   |   |   |   | ** ** |
| Exercised                                         | ** ** | —                      |       | —                                    |       |   |   |   |   |   |   |   |   |   |   |   | ** ** |
| Forfeited or  cancelled                           |       | —                      |       | —                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Balance at  December 28, 2007                |       | 3,379,831                   |       | $                                         | 6.30       |   | 6.55 |   | $ | 39,004 |   | 2,330,778 |   | $ | 3.34 |   | 5.83 |   | $ | 33,729 |   |

 

Theaggregate intrinsic value in the preceding table represents the total intrinsicvalue, based on the Company’s closing stock price of $17.81 as of December 28,2007, which would have been received by the option holders had all optionholders exercised their options as of that date. As of December 28, 2007,2,328,778 exercisable options were in-the-money.

 

Therewere no options exercised during the first quarter of fiscal year 2008. Duringthe first quarter of fiscal year 2007, cash received from option exercises wasapproximately $0.1 million, and the total intrinsic value of options exercisedwas $0.2 million. As of December 28, 2007, there was approximately $5.5million of total unrecognized compensation costs related to nonvested stockoptions, which is expected to be recognized over a weighted-average vestingperiod of 2.2 years.

 

**Stock Purchase Plan: **Employees purchased approximately13,000 shares in the first quarter of fiscal year 2008 for $0.2 million underthe 2006 Employee Stock Purchase Plan (the “2006 ESPP”). As of December 28,2007, there were no unrecognized compensation costs related to rights toacquire stock under the Company’s stock purchase plan.

 

**Restricted Stock and Restricted Stock Units:**There were94,966 and 11,466 shares outstanding of nonvested restricted stock andrestricted stock units granted to directors and employees as of December 28,2007 and September 28, 2007, respectively. The restricted stock andrestricted stock units vest over periods of one to four years and have a 10year contractual life.

 

22

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**CPI INTERNATIONAL, INC.****and Subsidiaries**

 

### **NOTESTO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

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

 

A summary of the status of the Company’s nonvestedrestricted stock awards as of December 28, 2007, and changes during thequarter then ended is presented below:

 
| ** **                                          | ** ** | **Number  of Shares** | ** ** | **Weighted-  Average Grant-Date Fair Value** | ** **  |
|-----------------------------------------------------|------------|----------------------------|------------|--------------------------------------------------------|-------------|
| Nonvested at September 28, 2007 | ** ** | 11,466                     |       | $                                                      |  17.44 | ** ** |
| Granted                                             | ** ** | 83,500                     |       | 16.79                                                  | ** **  |
| Vested                                              |       | —                     |       | —                                                 |        |
| Forfeited                                           |       | —                     |       | —                                                 |        |
| Nonvested at December 28, 2007                 |       | 94,966                     |       | $                                                      | 16.87       |   |

 

Aggregateintrinsic value of the nonvested restricted stock awards at December 28,2007 was $1.7 million. As of December 28, 2007, there was $1.5 million oftotal unrecognized compensation costs related to nonvested restricted stock andrestricted stock units, which is expected to be recognized over a weightedaverage vesting period of 2.4 years.

 

TheCompany settles stock option exercises and restricted stock awards with newlyissued common shares.

 

*Valuation and Expense Information under SFAS No. 123(R)*

 

OnOctober 1, 2005, the Company adopted SFAS No. 123 (revised 2004) (“SFASNo. 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 2006 ESPPbased on estimated fair values. The following table summarizes stock-basedcompensation expense for the first quarter of fiscal years 2008 and 2007, whichwas allocated as follows:

 

23

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** **

**CPI INTERNATIONAL, INC.****and Subsidiaries**

 

### **NOTESTO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

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

** **
| ** **                                                                    | ** ** | **Quarter Ended**          | ** ** |
|-------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                    | ** ** | **December 28, 2007** | ** ** | **December 29, 2006** | ** ** |
| Share-based compensation cost recognized in the  income statement by caption: | ** ** | ** **                      | ** ** | ** ** | ** ** |
| Cost of sales                                                                 |       | $                               | 80         |   | $ | 39 |   |
| Research and development                                                      |       | 31                              |       | 10 |   |
| Selling and marketing                                                         |       | 45                              |       | 19 |   |
| General and administrative                                                    |       | 268                             |       | 137 |   |
|                                                                          |       | $                               | 424        |   | $ | 205 |   |
| Share-based compensation cost capitalized in inventory                        |       | $                               | 96         |   | $ | 44 |   |
| Share-based compensation cost remaining in inventory                          |       |                            |       |   |   |
| at end of period                                                              |       | $                               | 64         |   | $ | 29 |   |
|                                                                          |       |                            |       |   |   |
| Share-based compensation expense by type of award:                            | ** ** | ** **                      | ** ** | ** ** | ** ** |
| Stock options and stock purchase plan                                         |       | $                               | 374        |   | $ | 175 |   |
| Restricted stock                                                              |       | 50                              |       | 30 |   |
|                                                                          |       | $                               | 424        |   | $ | 205 |   |

 

Therewere no options exercised or restricted stock vested and hence no tax benefitrealized during the first quarter of fiscal year 2008. The tax benefit realizedfrom option exercises and restricted stock vesting totaled approximately $0.1million during the first quarter of fiscal year 2007.

 

Theweighted-average estimated fair value of stock options granted during the firstquarter of fiscal years 2008 and 2007 was $7.83 and $7.66 per share,respectively, using the Black-Scholes model with the following weighted-averageassumptions:

 
| ** **               | ** ** | **Quarter Ended**          | ** ** |
|--------------------------|------------|---------------------------------|------------|
| ** **               | ** ** | **December 28, 2007** | ** ** | **December 29, 2006** | ** ** |
| Expected term (in years) |       | 6.25                            |       | 6.25 |   |
| Expected volatility      |       | 41.20                           | %          | 49.33 | % |
| Risk-free rate           |       | 3.82                            | %          | 4.56 | % |
| Dividend yield           |       | 0                               | %          | 0 | % |

 

Sincethe Company’s common stock has not been publicly traded for a sufficient timeperiod, the expected volatility is based on expected volatilities of similarcompanies that have a longer history of being publicly traded. The expectedterm of options granted is based on the simplified method for plain vanillaoptions in accordance with Securities and Exchange Commission Staff AccountingBulletin No. 107. The risk-free rates are based on the U.S. Treasury yieldin effect at the time of the grant.

 

Theweighted-average fair value of shares issued under the 2006 ESPP during thefirst quarter of fiscal years 2008 and 2007 was $2.61 and $2.20, respectively, based on the 15% discount received by the employees.

 

Theweighted-average estimated fair value of restricted stock and restricted stockunits granted during the first quarter of fiscal year 2008 was $16.79 per shareusing the market price of the Company’s common stock on the date of grant.There were no restricted stock and restricted stock units granted during thefirst quarter of fiscal year 2007.

 

24

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**CPI INTERNATIONAL, INC.****and Subsidiaries**

 

### **NOTESTO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

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

 

Asstock-based compensation expense recognized in the condensed consolidatedstatement of operations for the first quarter of fiscal years 2008 and 2007 isbased on awards ultimately expected to vest, it has been reduced for estimatedforfeitures. SFAS No. 123(R) requires forfeitures to be estimated atthe time of grant and revised, if necessary, in subsequent periods if actualforfeitures differ from those estimates.

 

**9.             Income Taxes**

 

TheCompany’s effective tax rate was approximately 44% and 39% for the firstquarter of fiscal years 2008 and 2007, respectively.

 

CPIInternational adopted FIN No. 48, “Accounting for Uncertainty in IncomeTaxes,” in the first quarter of fiscal year 2008 commencing on September 29,2007. Prior to adoption, the Company’s policy was to establish reserves thatreflected the probable outcome of known tax contingencies. The effects offinal resolution, if any, were recognized as changes to the effective incometax rate in the period of resolution.

 

UnderFIN No. 48, tax positions are evaluated for recognition using amore-likely-than-not threshold, and those tax positions eligible forrecognition are measured as the largest amount of tax benefit that is greaterthan 50% likelihood of being realized upon ultimate settlement with a taxingauthority that has full knowledge of all relevant information. Inconnection with the Company’s adoption of FIN No. 48, there was nocumulative effect adjustment necessary to the September 29, 2007 balanceof retained earnings. The total unrecognized tax benefit was $6.6 million and$6.3 million as of December 28, 2007 and September 29, 2007,respectively, and is reported as a current liability (income taxes payable)since it is expected to be settled within 12 months of the reportingdate. Of the total unrecognized tax benefit balance, $5.9 million and $5.7million of unrecognized tax benefits would reduce the effective tax rateif recognized as of December 28, 2007 and September 29, 2007,respectively. The interest expense with uncertain tax positions are accrued asa component of income tax expense in the consolidated statement of operations.As of December 28, 2007 and September 29, 2007, the Company hadaccrued $1.5 million and $1.3 million of interest, respectively. The Companyhad minimal penalties accrued in income tax expense.

 

TheCompany is subject to U.S. federal, California, Massachusetts and Canada incometax as well as income tax in various other states, local and internationaljurisdictions. Fiscal years 2004 to 2007 remain open to examination by themajor taxing jurisdictions to which the Company is subject, with theexception of California which is open from 2003 to 2007. The Companyhas not been audited for U.S. federal income tax matters. The Company hasincome tax audits in progress in Canada and in several states, local andinternational jurisdictions in which it operates. The years under examinationby the Canadian taxing authorities are 2001 to 2002. The years underexamination by other taxing authorities vary, with the earliest year being2004.

 

25

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**CPI INTERNATIONAL, INC.****and Subsidiaries**

 

### **NOTESTO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

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

 

Basedon the outcome of examinations of the Company, the result of the expiration ofstatutes of limitations for specific jurisdictions, it is reasonably possiblethat the related unrecognized tax benefits could change from those recorded inthe statement of financial position. The majority of the Company’sunrecognized tax benefit is attributable to the Canada Revenue Agency (“CRA”)income tax contingency. The CRA is conducting an audit of the Company’sincome tax returns in Canada for fiscal years 2001 and 2002. The Companyreceived a proposed tax assessment, including interest expense from the CRA forfiscal years 2001 and 2002. The tax assessment is based on tax deductionsrelated to the valuation of the Satcom business, which was purchased byCommunications & Power Industries Canada Inc. from CPI in fiscal years2001 and 2002. While the Company believes that it has meritorious defensesand intends to vigorously defend its position, it is reasonably possible thatthe CRA may issue a formal tax assessment requiring the Company to settle thetax deficiency within 12 months.

 

**10.          Earnings Per Share**

 

Basic earnings per share are computed using theweighted-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.

 

The following table is a reconciliation of the sharesused to calculate basic and diluted earnings per share (in thousands):

 
| ** **                                                                        | ** ** | **Quarter Ended**          | ** ** |
|-----------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                        | ** ** | **December 28, 2007** | ** ** | **December 29, 2006** | ** ** |
| Weighted average common shares outstanding — Basic                           |       | 16,371                          |       | 16,063 |   |
| Effect of dilutive stock options and nonvested restricted stock  awards and units |       | 1,461                           |       | 1,481 |   |
| Weighted average common shares outstanding — Diluted                         |       | 17,832                          |       | 17,544 |   |

 

The calculation of diluted net income per share excludes allanti-dilutive shares. For the first quarter of fiscal years 2008 and 2007, thenumber of anti-dilutive shares, as calculated based on the weighted averageclosing price of the Company’s common stock for the periods, was approximately0.5 million and 0.4 million shares, respectively.

 

**11.          Segments, Geographicand Customer Information**

 

TheCompany’s reportable segments are VED and satcom equipment. The VED segmentdevelops, manufactures and distributes high power/high frequency microwave andradio frequency signal components. The satcom equipment segment manufacturesand supplies high power amplifiers and networks for satellite communicationuplink and industrial applications. Segment information reported below is consistentwith the manner in which it is reviewed and evaluated by the Company’s chiefoperating decision maker (“CODM”), its chief executive officer, and is based onthe nature of the Company’s operations and products offered to customers.

 

26

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**CPI INTERNATIONAL, INC.****and Subsidiaries**

 

### **NOTESTO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

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

 

Amountsnot reported as VED or satcom equipment are reported as Other.  In accordance with quantitative andqualitative guidelines established by SFAS No. 131, Other includes theactivities of the Company’s recently acquired Malibu division and unallocatedcorporate expenses, such as business combination-related expenses, share-basedcompensation expense, and certain non-recurring or unusual expenses. The Malibudivision is a designer, manufacturer and integrator of advanced antenna systemsfor radar, radar simulators and telemetry systems, as well as for data linksused in ground, airborne, UAV and shipboard systems.

 

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

 
| ** **                         | ** ** | **Quarter Ended** | ** ** |
|------------------------------------|------------|------------------------|------------|
| ** **                         | ** ** | **December 28,**  | ** ** | **December 29,** | ** ** |
| ** **                         | ** ** | **2007**               | ** ** | **2006** | ** ** |
| **Sales from external customers**  |       |                   |       |   |   |
| VED                                |       | $                      | 63,990     |   | $ | 66,975 |   |
| Satcom equipment                   |       | 17,575                 |       | 16,748 |   |
| Other                              |       | 4,345                  |       | — |   |
|                               |       | $                      | 85,910     |   | $ | 83,723 |   |
| **Intersegment product transfers** |       |                   |       |   |   |
| VED                                |       | $                      | 5,861      |   | $ | 5,123 |   |
| Satcom equipment                   |       | 49                     |       | — |   |
|                               |       | $                      | 5,910      |   | $ | 5,123 |   |
| **Capital expenditures**           |       |                   |       |   |   |
| VED                                |       | $                      | 842        |   | $ | 2,802 |   |
| Satcom equipment                   |       | 444                    |       | — |   |
| Other                              |       | 401                    |       | 69 |   |
|                               |       | $                      | 1,687      |   | $ | 2,871 |   |
| **EBITDA**                         |       |                   |       |   |   |
| VED                                |       | $                      | 13,640     |   | $ | 17,584 |   |
| Satcom equipment                   |       | 1,721                  |       | 1,497 |   |
| Other                              |       | (3,439                 | )          | (1,996 | ) |
|                               |       | $                      | 11,922     |   | $ | 17,085 |   |

 
| ** **       | ** ** | **December 28,** | ** **    | **September 28,** | ** ** |
|------------------|------------|-----------------------|---------------|------------------------|------------|
| ** **       | ** ** | **2007**              | ** **    | **2007**               | ** ** |
| **Total assets** |       |                  |          |                   |       |
| VED              |       | $                     | 334,094       |                   | $          |  335,926 |   |
| Satcom equipment |       | 48,805                |          | 49,266                 |       |
| Other            |       | 93,748                |          | 91,030                 |       |
|             |       | $                     |  476,647 |                   | $          |  476,222 |   |

 

EBITDA represents earnings before provision for incometaxes, net interest expense and depreciation and amortization. For the reasonslisted below, the Company believes that GAAP-based financial information forleveraged businesses such as the Company’s business should be supplemented byEBITDA so that investors better understand the Company’s financial performancein connection with their analysis of the Company’s business:

 

27

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**CPI INTERNATIONAL, INC.****and Subsidiaries**

 

### **NOTESTO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

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

 

·                                          EBITDA is a component of the measuresused by the Company’s board of directors and management team to evaluate theCompany’s operating performance;

 

·                                          the Senior Credit Facilities contain acovenant that requires the Company to maintain a senior secured leverage ratiothat contains EBITDA as a component, and the Company’s management team usesEBITDA to monitor compliance with this covenant;

 

·                                          EBITDA is a component of the measuresused by the Company’s management team to make day-to-day operating decisions;

 

·                                          EBITDA facilitates comparisons betweenthe Company’s operating results and those of competitors with different capitalstructures and therefore is a component of the measures used by the Company’smanagement to facilitate internal comparisons to competitors’ results and theCompany’s industry in general; and

 

·                                          the payment of management bonuses iscontingent upon, among other things, the satisfaction by the Company of certaintargets that contain EBITDA as a component.

 

Othercompanies may define EBITDA differently and, as a result, the Company’s measureof EBITDA may not be directly comparable to EBITDA of other companies. Althoughthe Company uses EBITDA as a financial measure to assess the performance of itsbusiness, the use of EBITDA is limited because it does not include certainmaterial costs, such as interest and taxes, necessary to operate the Company’sbusiness. When analyzing the Company’s performance, EBITDA should be consideredin addition to, and not as a substitute for, net income, cash flows fromoperating activities or other statements of operations or statements of cashflows data prepared in accordance with GAAP.

 

The following table reconciles net income to EBITDA:

 
| ** **                    | ** ** | **Quarter Ended** | ** ** |
|-------------------------------|------------|------------------------|------------|
| ** **                    | ** ** | **December 28,**  | ** ** | **December 29,** | ** ** |
| ** **                    | ** ** | **2007**               | ** ** | **2006** | ** ** |
| Net income                    |       | $                      | 2,510      |   | $ | 5,835 |   |
| Depreciation and amortization |       | 2,650                  |       | 2,194 |   |
| Interest expense, net         |       | 4,812                  |       | 5,339 |   |
| Income tax expense            |       | 1,950                  |       | 3,717 |   |
| EBITDA                        |       | $                      | 11,922     |   | $ | 17,085 |   |

 

Net property, plant and equipment by geographic areawas as follows:

 
| ** **    | ** ** | **December 28,** | ** ** | **September 28,** | ** ** |
|---------------|------------|-----------------------|------------|------------------------|------------|
| ** **    | ** ** | **2007**              | ** ** | **2007**               | ** ** |
| United States |       | $                     | 51,569     |                   | $          | 51,704 |   |
| Canada        |       | 14,298                |       | 14,308                 |       |
| Other         |       | 27                    |       | 36                     |       |
|          |       | $                     | 65,894     |                   | $          | 66,048 |   |

 

Withthe exception of goodwill, the Company does not identify or allocate assets byoperating segment, nor does its CODM evaluate operating segments using discreteasset information.

 

28

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**CPI INTERNATIONAL, INC.****and Subsidiaries**

 

### **NOTESTO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

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

 

Goodwill by geographic area was as follows:

 
| ** **    | ** ** | **December 28,** | ** ** | **September 28,** | ** ** |
|---------------|------------|-----------------------|------------|------------------------|------------|
| ** **    | ** ** | **2007**              | ** ** | **2007**               | ** ** |
| United States |       | $                     | 113,234    |                   | $          | 113,310 |   |
| Canada        |       | 48,314                |       | 48,263                 |       |
|          |       | $                     | 161,548    |                   | $          | 161,573 |   |

 

Thedecrease in goodwill from September 28, 2007 to December 28, 2007 wasdue to a tax benefit related to the amortization of the second component of taxgoodwill associated with the acquisition of Malibu.

 

Geographic sales by customer location were as followsfor external customers:

 
| ** **            | ** ** | **Quarter Ended** | ** **   |
|-----------------------|------------|------------------------|--------------|
| ** **            | ** ** | **December 28,**  | ** **   | **December 29,** | ** ** |
| ** **            | ** ** | **2007**               | ** **   | **2006** | ** ** |
| United States         |       | $                      |  54,523 |   | $ |  49,504 |   |
| All foreign countires |       | 31,387                 |         | 34,219 |   |
| Total sales           |       | $                      |  85,910 |   | $ |  83,723 |   |

 

There were no individual foreign countries withsales greater than 10% of total sales for the periods presented.

 

The U.S. Government is the only customer that accountedfor 10% or more of the Company’s consolidated sales in the first quarter offiscal years 2008 and 2007. Direct sales to the U.S. Government were $14.8million and $14.9 million for the first quarter of fiscal years 2008 and 2007,respectively. Accounts receivable from this customer represented 12% and 15% ofconsolidated accounts receivable as of December 28, 2007 and September 28,2007, respectively.

 

**12.          SupplementalGuarantors Condensed Consolidating Financial Information (Unaudited)**

 

On January 23, 2004, CPI issued $125.0 million of8% Notes that are guaranteed by CPI International and all of CPI’s domesticsubsidiaries. Separate financial statements of the guarantors are not presentedbecause (i) the guarantors are wholly-owned and have fully andunconditionally guaranteed the 8% Notes on a joint and several basis and (ii) theCompany’s management has determined that such separate financial statements arenot material to investors. Instead, presented below are the consolidatingfinancial statements of: (a) the parent, CPI International, (b) theissuer, CPI, (c) the guarantor subsidiaries (all of the domesticsubsidiaries), (d) the non-guarantor subsidiaries, (e) theconsolidating elimination entries, and (f) the consolidated totals. Theaccompanying consolidating financial information should be read in connectionwith the condensed consolidated financial statements of CPI International.

 

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

 

29

----

** **

**CPI INTERNATIONAL, INC.****and Subsidiaries**

 

### **NOTESTO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS** (Continued)

(All tabular dollaramounts in thousands except share and per share amounts)

 

**CONDENSEDCONSOLIDATING BALANCE SHEETAs of December 28, 2007**

 
| ** **                                      | ** ** | **Parent  (CPI Int’l)** | ** ** | **Issuer  (CPI)** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Consolidating  Eliminations** | ** ** | **Consolidated  Total** | ** ** |
|-------------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|-----------------------------|------------|---------------------------------|------------|---------------------------------|------------|-------------------------|------------|
| **Assets**                                      |       |                              |       |              |       |                        |       |                            |       |                            |       |                    |       |
| Cash and cash equivalents                       |       | $                                 | 1,390      |              | $          | 21,237                      |       | $                               | 1,198      |                            | $          | 3,585                   |       | $ | — |   | $ | 27,410 |   |
| Restricted cash                                 |       | —                            |       | —            |       | 2,127                       |       | 328                             |       | —                          |       | 2,455                   |       |
| Accounts receivable, net                        |       | —                            |       | 19,857            |       | 10,651                      |       | 15,438                          |       | —                          |       | 45,946                  |       |
| Inventories                                     |       | (678                              | )          | 44,901            |       | 7,100                       |       | 17,229                          |       | 631                             |       | 69,183                  |       |
| Deferred tax assets                             |       | —                            |       | 9,291             |       | 3                           |       | 509                             |       | —                          |       | 9,803                   |       |
| Intercompany receivable                         |       | —                            |       | 26,070            |       | 3,040                       |       | 4,064                           |       | (33,174                         | )          | —                  |       |
| Prepaid and other current assets                |       | —                            |       | 2,645             |       | 576                         |       | 740                             |       | —                          |       | 3,961                   |       |
| Total current assets                            |       | 712                               |       | 124,001           |       | 24,695                      |       | 41,893                          |       | (32,543                         | )          | 158,758                 |       |
| Property, plant and equipment, net              |       | —                            |       | 48,297            |       | 3,275                       |       | 14,322                          |       | —                          |       | 65,894                  |       |
| Deferred debt issue costs, net                  |       | 777                               |       | 5,453             |       | —                      |       | —                          |       | —                          |       | 6,230                   |       |
| Intangible assets, net                          |       | —                            |       | 66,376            |       | 6,550                       |       | 8,119                           |       | —                          |       | 81,045                  |       |
| Goodwill                                        |       | —                            |       | 107,437           |       | 5,848                       |       | 48,263                          |       | —                          |       | 161,548                 |       |
| Other long-term assets                          |       | —                            |       | 3,072             |       | —                      |       | 100                             |       | —                          |       | 3,172                   |       |
| Intercompany notes receivable                   |       | —                            |       | 1,035             |       | —                      |       | —                          |       | (1,035                          | )          | —                  |       |
| Investment in subsidiaries                      |       | 177,305                           |       | 65,669            |       | —                      |       | —                          |       | (242,974                        | )          | —                  |       |
| Total assets                                    |       | $                                 | 178,794    |              | $          | 421,340                     |       | $                               | 40,368     |                            | $          | 112,697                 |       | $ | (276,552 | ) | $ | 476,647 |   |
|                                            |       |                              |       |              |       |                        |       |                            |       |                            |       |                    |       |
| **Liabilities and stockholders’ equity**   |       |                              |       |              |       |                        |       |                            |       |                            |       |                    |       |
| Current portion of long-term debt               |       | $                                 | —     |              | $          | 250                         |       | $                               | —     |                            | $          | —                  |       | $ | — |   | $ | 250 |   |
| Accounts payable                                |       | 249                               |       | 10,699            |       | 2,170                       |       | 8,988                           |       | —                          |       | 22,106                  |       |
| Accrued expenses                                |       | 1,000                             |       | 18,689            |       | 3,128                       |       | 6,190                           |       | —                          |       | 29,007                  |       |
| Product warranty                                |       | —                            |       | 3,080             |       | 481                         |       | 1,815                           |       | —                          |       | 5,376                   |       |
| Income taxes payable                            |       | —                            |       | 1,507             |       | 346                         |       | 6,099                           |       | —                          |       | 7,952                   |       |
| Advance payments from customers                 |       | —                            |       | 4,745             |       | 3,622                       |       | 1,431                           |       | —                          |       | 9,798                   |       |
| Intercompany payable                            |       | 27,852                            |       | —            |       | —                      |       | —                          |       | (27,852                         | )          | —                  |       |
| Total current liabilities                       |       | 29,101                            |       | 38,970            |       | 9,747                       |       | 24,523                          |       | (27,852                         | )          | 74,489                  |       |
| Deferred income taxes                           |       | 8                                 |       | 21,939            |       | —                      |       | 5,448                           |       | —                          |       | 27,395                  |       |
| Intercompany notes payable                      |       | —                            |       | —            |       | —                      |       | 1,035                           |       | (1,035                          | )          | —                  |       |
| Long-term debt, less current portion            |       | 21,821                            |       | 223,500           |       | —                      |       | —                          |       | —                          |       | 245,321                 |       |
| Other long-term liabilities                     |       | —                            |       | 1,381             |       | —                      |       | 197                             |       | —                          |       | 1,578                   |       |
| Total liabilities                               |       | 50,930                            |       | 285,790           |       | 9,747                       |       | 31,203                          |       | (28,887                         | )          | 348,783                 |       |
| Common stock                                    |       | 164                               |       | —            |       | —                      |       | —                          |       | —                          |       | 164                     |       |
| Parent investment                               |       | —                            |       | 61,314            |       | 19,167                      |       | 57,809                          |       | (138,290                        | )          | —                  |       |
| Additional paid-in capital                      |       | 69,412                            |       | —            |       | —                      |       | —                          |       | —                          |       | 69,412                  |       |
| Accumulated other comprehensive (loss) income   |       | (264                              | )          | (277              | )          | —                      |       | 234                             |       | 43                              |       | (264                    | )          |
| Retained earnings                               |       | 58,552                            |       | 74,513            |       | 11,454                      |       | 23,451                          |       | (109,418                        | )          | 58,552                  |       |
| Net stockholders’ equity                   |       | 127,864                           |       | 135,550           |       | 30,621                      |       | 81,494                          |       | (247,665                        | )          | 127,864                 |       |
| Total liabilities and stockholders’ equity |       | $                                 | 178,794    |              | $          | 421,340                     |       | $                               | 40,368     |                            | $          | 112,697                 |       | $ | (276,552 | ) | $ | 476,647 |   |

 

30

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**CPI INTERNATIONAL, INC.****and Subsidiaries**

 

### **NOTESTO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS** (Continued)

(All tabular dollaramounts in thousands except share and per share amounts)

 

**CONDENSED CONSOLIDATING BALANCESHEETAs of September 28, 2007**

 
| ** **                                      | ** ** | **Parent  (CPI Int’l)** | ** ** | **Issuer  (CPI)** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Consolidating  Eliminations** | ** ** | **Consolidated  Total** | ** ** |
|-------------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|-----------------------------|------------|---------------------------------|------------|---------------------------------|------------|-------------------------|------------|
| **Assets**                                      |       |                              |       |              |       |                        |       |                            |       |                            |       |                    |       |
| Cash and cash equivalents                       |       | $                                 | 1,378      |              | $          | 16,518                      |       | $                               | 958        |                            | $          | 1,620                   |       | $ | — |   | $ | 20,474 |   |
| Restricted cash                                 |       | —                            |       | —            |       | 1,945                       |       | 310                             |       | —                          |       | 2,255                   |       |
| Accounts receivable, net                        |       | —                            |       | 25,857            |       | 10,816                      |       | 15,916                          |       | —                          |       | 52,589                  |       |
| Inventories                                     |       | —                            |       | 43,949            |       | 7,092                       |       | 17,084                          |       | (678                            | )          | 67,447                  |       |
| Deferred tax assets                             |       | —                            |       | 9,272             |       | 3                           |       | 469                             |       | —                          |       | 9,744                   |       |
| Intercompany receivable                         |       | —                            |       | 23,323            |       | 2,076                       |       | 2,725                           |       | (28,124                         | )          | —                  |       |
| Prepaid and other current assets                |       | —                            |       | 3,250             |       | 545                         |       | 844                             |       | —                          |       | 4,639                   |       |
| Total current assets                            |       | 1,378                             |       | 122,169           |       | 23,435                      |       | 38,968                          |       | (28,802                         | )          | 157,148                 |       |
| Property, plant and equipment, net              |       | —                            |       | 48,327            |       | 3,382                       |       | 14,339                          |       | —                          |       | 66,048                  |       |
| Deferred debt issue costs, net                  |       | 795                               |       | 5,738             |       | —                      |       | —                          |       | —                          |       | 6,533                   |       |
| Intangible assets, net                          |       | —                            |       | 67,008            |       | 6,465                       |       | 8,270                           |       | —                          |       | 81,743                  |       |
| Goodwill                                        |       | —                            |       | 107,462           |       | 5,848                       |       | 48,263                          |       | —                          |       | 161,573                 |       |
| Other long-term assets                          |       | —                            |       | 3,077             |       | —                      |       | 100                             |       | —                          |       | 3,177                   |       |
| Intercompany notes receivable                   |       | —                            |       | 1,035             |       | —                      |       | —                          |       | (1,035                          | )          | —                  |       |
| Investment in subsidiaries                      |       | 175,889                           |       | 65,491            |       | —                      |       | —                          |       | (241,380                        | )          | —                  |       |
| Total assets                                    |       | $                                 | 178,062    |              | $          | 420,307                     |       | $                               | 39,130     |                            | $          | 109,940                 |       | $ | (271,217 | ) | $ | 476,222 |   |
|                                            |       |                              |       |              |       |                        |       |                            |       |                            |       |                    |       |
| **Liabilities and stockholders’ equity**   |       |                              |       |              |       |                        |       |                            |       |                            |       |                    |       |
| Current portion of long-term debt               |       | $                                 | —     |              | $          | 1,000                       |       | $                               | —     |                            | $          | —                  |       | $ | — |   | $ | 1,000 |   |
| Accounts payable                                |       | 224                               |       | 10,421            |       | 2,430                       |       | 8,719                           |       | —                          |       | 21,794                  |       |
| Accrued expenses                                |       | 404                               |       | 16,695            |       | 3,991                       |       | 5,259                           |       | —                          |       | 26,349                  |       |
| Product warranty                                |       | —                            |       | 3,141             |       | 481                         |       | 1,956                           |       | —                          |       | 5,578                   |       |
| Income taxes payable                            |       | —                            |       | 1,888             |       | 562                         |       | 6,298                           |       | —                          |       | 8,748                   |       |
| Advance payments from customers                 |       | —                            |       | 5,926             |       | 4,933                       |       | 1,273                           |       | —                          |       | 12,132                  |       |
| Intercompany payable                            |       | 28,124                            |       | —            |       | —                      |       | —                          |       | (28,124                         | )          | —                  |       |
| Total current liabilities                       |       | 28,752                            |       | 39,071            |       | 12,397                      |       | 23,505                          |       | (28,124                         | )          | 75,601                  |       |
| Deferred income taxes                           |       | 31                                |       | 22,833            |       | —                      |       | 5,530                           |       | —                          |       | 28,394                  |       |
| Intercompany notes payable                      |       | —                            |       | —            |       | —                      |       | 1,035                           |       | (1,035                          | )          | —                  |       |
| Long-term debt, less current portion            |       | 21,817                            |       | 223,750           |       | —                      |       | —                          |       | —                          |       | 245,567                 |       |
| Other long-term liabilities                     |       | —                            |       | 547               |       | —                      |       | 207                             |       | —                          |       | 754                     |       |
| Total liabilities                               |       | 50,600                            |       | 286,201           |       | 12,397                      |       | 30,277                          |       | (29,159                         | )          | 350,316                 |       |
| Common stock                                    |       | 164                               |       | —            |       | —                      |       | —                          |       | —                          |       | 164                     |       |
| Parent investment                               |       | —                            |       | 60,705            |       | 19,167                      |       | 57,746                          |       | (137,618                        | )          | —                  |       |
| Additional paid-in capital                      |       | 68,763                            |       | —            |       | —                      |       | —                          |       | —                          |       | 68,763                  |       |
| Accumulated other comprehensive income (loss)   |       | 1,110                             |       | 1,059             |       | —                      |       | 155                             |       | (1,387                          | )          | 937                     |       |
| Retained earnings                               |       | 57,425                            |       | 72,342            |       | 7,566                       |       | 21,762                          |       | (103,053                        | )          | 56,042                  |       |
| Net stockholders’ equity                   |       | 127,462                           |       | 134,106           |       | 26,733                      |       | 79,663                          |       | (242,058                        | )          | 125,906                 |       |
| Total liabilities and stockholders’ equity |       | $                                 | 178,062    |              | $          | 420,307                     |       | $                               | 39,130     |                            | $          | 109,940                 |       | $ | (271,217 | ) | $ | 476,222 |   |

 

**31**

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** **

**CPI INTERNATIONAL, INC.****and Subsidiaries**

 

### **NOTESTO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS** (Continued)

(All tabular dollaramounts in thousands except share and per share amounts)

** **

**CONDENSEDCONSOLIDATING STATEMENT OF OPERATIONS  For the Three Months Ended December 28,2007**

** **
| ** **                                                                    | ** ** | **Parent  (CPI Int’l)** | ** ** | **Issuer  (CPI)** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Consolidating  Eliminations** | ** ** | **Consolidated  Total** | ** ** |
|-------------------------------------------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|-----------------------------|------------|---------------------------------|------------|---------------------------------|------------|-------------------------|------------|
| Sales                                                                         |       | $                                 | —     |              | $          | 49,763                      |       | $                               | 19,826     |                            | $          | 34,838                  |       | $ | (18,517 | ) | $ | 85,910 |   |
| Cost of sales                                                                 |       | —                            |       | 37,432            |       | 16,585                      |       | 26,227                          |       | (18,470                         | )          | 61,774                  |       |
| Gross profit                                                                  |       | —                            |       | 12,331            |       | 3,241                       |       | 8,611                           |       | (47                             | )          | 24,136                  |       |
| Operating costs and expenses:                                                 |       |                              |       |              |       |                        |       |                            |       |                            |       |                    |       |
| Research and development                                                      |       | —                            |       | 892               |       | 149                         |       | 1,683                           |       | —                          |       | 2,724                   |       |
| Selling and marketing                                                         |       | —                            |       | 1,923             |       | 1,012                       |       | 2,237                           |       | —                          |       | 5,172                   |       |
| General and administrative                                                    |       | —                            |       | 3,718             |       | 1,070                       |       | 1,365                           |       | —                          |       | 6,153                   |       |
| Amortization of acquisition-related intangible assets                         |       | —                            |       | 568               |       | 62                          |       | 151                             |       | —                          |       | 781                     |       |
| Net loss on disposition of assets                                             |       | —                            |       | 22                |       | 2                           |       | 10                              |       | —                          |       | 34                      |       |
| Total operating costs and expenses                                            |       | —                            |       | 7,123             |       | 2,295                       |       | 5,446                           |       | —                          |       | 14,864                  |       |
| Operating income (loss)                                                       |       | —                            |       | 5,208             |       | 946                         |       | 3,165                           |       | (47                             | )          | 9,272                   |       |
| Interest expense (income), net                                                |       | 545                               |       | 4,285             |       | (20                         | )          | 2                               |       | —                          |       | 4,812                   |       |
| (Loss) income before income tax expense and equity in income of  subsidiaries |       | (545                              | )          | 923               |       | 966                         |       | 3,163                           |       | (47                             | )          | 4,460                   |       |
| Income tax (benefit) expense                                                  |       | (207                              | )          | 741               |       | 254                         |       | 1,162                           |       | —                          |       | 1,950                   |       |
| Equity in income of subsidiaries                                              |       | 2,848                             |       | 2,666             |       | —                      |       | —                          |       | (5,514                          | )          | —                  |       |
| Net income                                                                    |       | $                                 | 2,510      |              | $          | 2,848                       |       | $                               | 712        |                            | $          | 2,001                   |       | $ | (5,561 | ) | $ | 2,510 |   |

** **

** **

**CONDENSEDCONSOLIDATING STATEMENT OF OPERATIONSFor the Three Months Ended December 29, 2006**

 
| ** **                                                                    | ** ** | **Parent  (CPI Int’l)** | ** ** | **Issuer  (CPI)** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Consolidating  Eliminations** | ** ** | **Consolidated  Total** | ** ** |
|-------------------------------------------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|-----------------------------|------------|---------------------------------|------------|---------------------------------|------------|-------------------------|------------|
| Sales                                                                         |       | $                                 | —     |              | $          | 51,365                      |       | $                               | 14,580     |                            | $          | 34,543                  |       | $ | (16,765 | ) | $ | 83,723 |   |
| Cost of sales                                                                 |       | —                            |       | 35,495            |       | 12,065                      |       | 26,426                          |       | (16,844                         | )          | 57,142                  |       |
| Gross profit                                                                  |       | —                            |       | 15,870            |       | 2,515                       |       | 8,117                           |       | 79                              |       | 26,581                  |       |
| Operating costs and expenses:                                                 |       |                              |       |              |       |                        |       |                            |       |                            |       |                    |       |
| Research and development                                                      |       | —                            |       | 643               |       | —                      |       | 1,248                           |       | —                          |       | 1,891                   |       |
| Selling and marketing                                                         |       | —                            |       | 1,969             |       | 829                         |       | 2,031                           |       | —                          |       | 4,829                   |       |
| General and administrative                                                    |       | —                            |       | 3,691             |       | 207                         |       | 506                             |       | —                          |       | 4,404                   |       |
| Amortization of acquisition-related intangible assets                         |       | —                            |       | 334               |       | 63                          |       | 151                             |       | —                          |       | 548                     |       |
| Net loss on disposition of assets                                             |       | —                            |       | —            |       | —                      |       | 18                              |       | —                          |       | 18                      |       |
| Total operating costs and expenses                                            |       | —                            |       | 6,637             |       | 1,099                       |       | 3,954                           |       | —                          |       | 11,690                  |       |
| Operating income                                                              |       | —                            |       | 9,233             |       | 1,416                       |       | 4,163                           |       | 79                              |       | 14,891                  |       |
| Interest expense (income), net                                                |       | 2,048                             |       | 3,291             |       | (6                          | )          | 6                               |       | —                          |       | 5,339                   |       |
| (Loss) income before income tax expense and equity in income of  subsidiaries |       | (2,048                            | )          | 5,942             |       | 1,422                       |       | 4,157                           |       | 79                              |       | 9,552                   |       |
| Income tax (benefit) expense                                                  |       | (779                              | )          | 2,571             |       | 381                         |       | 1,544                           |       | —                          |       | 3,717                   |       |
| Equity in income of subsidiaries                                              |       | 7,104                             |       | 3,733             |       | —                      |       | —                          |       | (10,837                         | )          | —                  |       |
| Net income                                                                    |       | $                                 | 5,835      |              | $          | 7,104                       |       | $                               | 1,041      |                            | $          | 2,613                   |       | $ | (10,758 | ) | $ | 5,835 |   |

** **

32

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** **

**CPI INTERNATIONAL, INC.****and Subsidiaries**

 

### **NOTESTO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS** (Continued)

(All tabular dollaramounts in thousands except share and per share amounts)

 

**CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWSFor the Three Months Ended December 28, 2007**

 
| ** **                                          | ** ** | **Parent  (CPI Int’l)** | ** ** | **Issuer  (CPI)** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Consolidating  Eliminations** | ** ** | **Consolidated  Total** | ** ** |
|-----------------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|-----------------------------|------------|---------------------------------|------------|---------------------------------|------------|-------------------------|------------|
| **Cash flows from operating activities**            |       |                              |       |              |       |                        |       |                            |       |                            |       |                    |       |
| Net cash (used in) provided by operating activities |       | $                                 | (198       | )                 | $          | 7,103                       |       | $                               | 421        |                            | $          | 2,234                   |       | $ | — |   | $ | 9,560 |   |
| **Cash flows from investing activities**            |       |                              |       |              |       |                        |       |                            |       |                            |       |                    |       |
| Capital expenditures                                |       | —                            |       | (1,384            | )          | (34                         | )          | (269                            | )          | —                          |       | (1,687                  | )          |
| Payment of patent application fees                  |       | —                            |       | —            |       | (147                        | )          | —                          |       | —                          |       | (147                    | )          |
| Net cash used in investing activities               |       | —                            |       | (1,384            | )          | (181                        | )          | (269                            | )          | —                          |       | (1,834                  | )          |
| **Cash flows from financing activities**            |       |                              |       |              |       |                        |       |                            |       |                            |       |                    |       |
| Repayments of debt                                  |       | —                            |       | (1,000            | )          | —                      |       | —                          |       | —                          |       | (1,000                  | )          |
| Proceeds from issuance of common stock to employees |       | 210                               |       | —            |       | —                      |       | —                          |       | —                          |       | 210                     |       |
| Net cash provided by (used in) financing activities |       | 210                               |       | (1,000            | )          | —                      |       | —                          |       | —                          |       | (790                    | )          |
| **Net increase in cash and cash equivalents**       |       | 12                                |       | 4,719             |       | 240                         |       | 1,965                           |       | —                          |       | 6,936                   |       |
| Cash and cash equivalents at beginning of period    |       | 1,378                             |       | 16,518            |       | 958                         |       | 1,620                           |       | —                          |       | 20,474                  |       |
| Cash and cash equivalents at end of period          |       | $                                 | 1,390      |              | $          | 21,237                      |       | $                               | 1,198      |                            | $          | 3,585                   |       | $ | — |   | $ | 27,410 |   |

 

 

**CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWSFor the Three Months Ended December 29, 2006**

 
| ** **                                          | ** ** | **Parent  (CPI Int’l)** | ** ** | **Issuer  (CPI)** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Consolidating  Eliminations** | ** ** | **Consolidated  Total** | ** ** |
|-----------------------------------------------------|------------|-----------------------------------|------------|-------------------|------------|-----------------------------|------------|---------------------------------|------------|---------------------------------|------------|-------------------------|------------|
| **Cash flows from operating activities**            |       |                              |       |              |       |                        |       |                            |       |                            |       |                    |       |
| Net cash (used in) provided by operating activities |       | $                                 | (126       | )                 | $          | 7,006                       |       | $                               | 642        |                            | $          | 2,520                   |       | $ | — |   | $ | 10,042 |   |
| **Cash flows from investing activities**            |       |                              |       |              |       |                        |       |                            |       |                            |       |                    |       |
| Capital expenditures                                |       | —                            |       | (819              | )          | (2                          | )          | (2,050                          | )          | —                          |       | (2,871                  | )          |
| Net cash used in investing activities               |       | —                            |       | (819              | )          | (2                          | )          | (2,050                          | )          | —                          |       | (2,871                  | )          |
| **Cash flows from financing activities**            |       |                              |       |              |       |                        |       |                            |       |                            |       |                    |       |
| Repayments of debt                                  |       | —                            |       | (5,000            | )          | —                      |       | —                          |       | —                          |       | (5,000                  | )          |
| Proceeds from issuance of common stock to employees |       | 197                               |       | —            |       | —                      |       | —                          |       | —                          |       | 197                     |       |
| Proceeds from exercise of stock options             |       | 66                                |       | —            |       | —                      |       | —                          |       | —                          |       | 66                      |       |
| Excess tax benefit on stock option exercises        |       | —                            |       | 42                |       | —                      |       | —                          |       | —                          |       | 42                      |       |
| Net cash provided by (used in) financing activities |       | 263                               |       | (4,958            | )          | —                      |       | —                          |       | —                          |       | (4,695                  | )          |
| **Net increase in cash and cash equivalents**       |       | 137                               |       | 1,229             |       | 640                         |       | 470                             |       | —                          |       | 2,476                   |       |
| Cash and cash equivalents at beginning of period    |       | 139                               |       | 28,299            |       | 290                         |       | 1,425                           |       | —                          |       | 30,153                  |       |
| Cash and cash equivalents at end of period          |       | $                                 | 276        |              | $          | 29,528                      |       | $                               | 930        |                            | $          | 1,895                   |       | $ | — |   | $ | 32,629 |   |

 

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## ***Item 2.   Management’s Discussion and Analysis ofFinancial Condition and Results of Operations***

## *** ***

*Our fiscal years are the 52- or 53-week periods that end on the Fridaynearest September 30. Fiscal year 2008 comprises the 53-week period endingOctober 3, 2008 and fiscal year 2007 comprised the 52-week period ended September 28,2007. The following discussion should be read in conjunction with theaccompanying unaudited condensed consolidated financial statements, and thenotes thereto, of CPI International, Inc.*

 

**Overview**

 

CPI International, Inc.,headquartered in Palo Alto, California, is the parent company ofCommunications & Power Industries, a provider of microwave, radiofrequency, power and control solutions for critical defense, communications,medical, scientific and other applications. Communications & PowerIndustries develops, manufactures and distributes products used to generate,amplify and transmit high-power/high-frequency microwave and radio frequencysignals and/or provide power and control for various applications. End-useapplications of these systems include the transmission of radar signals fornavigation and location; transmission of deception signals for electroniccountermeasures; transmission and amplification of voice, data and videosignals for broadcasting, Internet and other types of commercial and militarycommunications; providing power and control for medical diagnostic imaging; andgenerating microwave energy for radiation therapy in the treatment of cancerand for various industrial and scientific applications.

 

Unlessthe context otherwise requires, “CPI International” means CPI International, Inc.,and “CPI” means Communications & Power Industries, Inc. CPI is adirect subsidiary of CPI International. CPI International is a holding companywith no operations of its own. The terms “we,” “us,” “our” and the “Company”refer to CPI International and its direct and indirect subsidiaries on a consolidatedbasis.

 

**Acquisition of Malibu Research Associates, Inc.**

 

On August 10, 2007, we completed the acquisitionof all of the outstanding common stock of Malibu Research Associates, Inc.(“Malibu”). Malibu, headquartered in Camarillo, California, is a designer,manufacturer and integrator of advanced antenna systems for radar, radarsimulators and telemetry systems, as well as for data links used in ground,airborne, unmanned aerial vehicles and shipboard systems. Under the terms ofthe purchase agreement, we paid cash of approximately $22.4 million, whichincluded $2.3 million and $1.0 million placed into indemnity and workingcapital escrow accounts, respectively. The indemnity escrow amount was providedto ensure funds are available to satisfy potential indemnification claimsasserted prior to January 1, 2009, and the working capital escrow amountwas provided to satisfy any negative differences between the target workingcapital amount and the actual working capital amount at the acquisition closingdate. We expect that the working capital calculations will be finalized duringfiscal year 2008.

 

Additionally, we may be required to pay a potential earnout to theformer stockholders of Malibu of up to $14.0 million, which is primarilycontingent upon the achievement of certain financial objectives over the threeyears following the acquisition; and adiscretionary earnout of up to $1.0 million contingent upon achievement of certain succession planning goals.

 

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**Orders**

 

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

 

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

 

Ourorders by market for the first quarter of fiscal years 2008 and 2007 aresummarized as follows (dollars in millions):

 
| ** **                                  | ** ** | **Quarter Ended**            | ** ** | ** **                        | ** ** | ** ** |       |
|---------------------------------------------|------------|-----------------------------------|------------|-----------------------------------|------------|------------|------------|
| ** **                                  | ** ** | **December 28,   2007** | ** ** | **December 29,   2006** | ** ** | ** ** |       |
| ** **                                  | ** ** | ** **                        | ** ** | **% of**                     | ** ** | ** ** | ** ** | **% of** | ** ** | **Increase (Decrease)** |   |
| ** **                                  | ** ** | **Amount**                        | ** ** | **Orders**                        | ** ** | **Amount** | ** ** | **Orders** | ** ** | **Amount** | ** ** | **Percent** |   |
| Radar and Electronic Warfare | ** ** | $                                 | 37.6       |                              | 42         | %          | $          | 42.6 |   | 51 | % | $ | (5.0 | ) | (12 | )% |
| Medical                                     |       | 11.7                              |       | 13                                |       | 10.9       |       | 13 |   | 0.8 |   | 7 |   |
| Communications                              |       | 26.3                              |       | 29                                |       | 24.3       |       | 29 |   | 2.0 |   | 8 |   |
| Industrial                                  |       | 7.6                               |       | 9                                 |       | 4.3        |       | 5 |   | 3.3 |   | 77 |   |
| Scientific                                  |       | 6.7                               |       | 7                                 |       | 2.2        |       | 2 |   | 4.5 |   | 205 |   |
| Total                                       |       | $                                 | 89.9       |                              | 100        | %          | $          | 84.3 |   | 100 | % | $ | 5.6 |   | 7 | % |

 

Inthe first quarter of fiscal year 2008, our new Malibu division received orderstotaling $8.0 million, split approximately equally between the radar andcommunications markets. As we acquired Malibu in August 2007, orders fromthe Malibu division are not included in our results for the first quarter offiscal year 2007. Excluding the Malibu division’s orders, in comparison to thefirst quarter of fiscal year 2007, our orders in the first quarter of fiscal year 2008 decreased by$2.4 million, or 2.8%, to $81.9 million.

 

Explanationsfor the order increase or decrease by market for the first quarter of fiscalyear 2008 compared to the first quarter of fiscal year 2007 are as follows:

 

·                  **Radar and Electronic Warfare:** The majority of oursales in the radar and electronic warfare markets are for products for domesticand international defense and government end uses. Orders in these markets arecharacterized by many smaller orders in the $0.5 million to $3.0 million rangeby product or program, and the timing of these orders may vary from year toyear. On a combined basis, orders for the radar and electronic warfare marketsdecreased approximately 12% from an aggregate of $42.6 million in the firstquarter of fiscal year 2007 to an aggregate of $37.6 million in the firstquarter of fiscal year 2008. The decrease in orders for these combined marketsprimarily resulted from decreased demand for radar products to support theAegis weapons system and delays in the receipt of orders for radar products tosupport the HAWK missile system. The decrease was partially offset by radarorders received by our recently acquired Malibu division.

 

35

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                        Over the pastseveral years, in addition to demand for spare and repair products to supportthe Aegis weapons system, we have seen high demand for products to support asignificant number of new ship builds for this program for U.S. andinternational military customers.  Withfuture new ship builds anticipated at a reduced rate, we expect the demand forproducts to support the Aegis weapons system to continue at lower levels thanin the past several years until the new ships are commissioned and deployed and require spare andrepair products.  Futureorders for this program are expected to be primarily for spare and repairproducts.

 

·                  **Medical: **Orders for our medicalproducts consist of orders for medical imaging applications, such as x-rayimaging, positron emission tomography (“PET”) and magnetic resonance imaging (“MRI”)applications, and for radiation therapy applications for the treatment ofcancer. The 7% increase in medical orders resulted primarily from an increasein demand for products used in x-ray imaging applications.

 

·                  **Communications: **The 8% increase incommunications orders was primarily attributable to telemetry orders receivedby our recently acquired Malibu division, as well as increases in orders forinternational direct-to-home broadcast applications. These increases were partially offset bya decrease in orders for certain military communications programs for which wehad strong demand in the first quarter of fiscal year 2007.

 

·                  **Industrial:**Orders in the industrialmarket are cyclical. The $3.3 million increase in industrial orders wasprimarily attributable to orders for products used in international testsystems, industrial heating applications and other industrial fabricationapplications.

 

·                  **Scientific:** Orders in the scientific market are historicallyone-time projects and can fluctuate significantly from period to period. The$4.5 million increase in scientific orders was primarily the result of ordersfor products to support anew accelerator project for fusion research at an international scientificinstitute.

 

Incomingorder levels fluctuate significantly on a quarterly or annual basis, and aparticular quarter’s or year’s order rate may not be indicative of future orderlevels. In addition, our sales are highly dependent upon manufacturingscheduling and performance and, accordingly, it is not possible to accuratelypredict when orders will be recognized as sales.

 

**Backlog**

 

Asof December 28, 2007, we had an order backlog of $200.7 million comparedto an order backlog of $188.4 million as of December 29, 2006. Theincrease in backlog during the past year is primarily due to the acquisition ofMalibu.  Because our orders forgovernment end-use products generally have much longer delivery terms than ourorders for commercial business (which require quicker turn-around), our backlogis primarily composed of government orders. As a result, we expect that ourtotal backlog will not generally grow at the same rate as our total sales,because the markets where we are expecting higher growth (i.e., themedical and communications markets) are primarily commercial rather thangovernment.

 

Backlog represents the cumulative balance, at agiven point in time, of recorded customer sales orders that have not yet beenshipped or recognized as sales. Backlog is increased when an order is received,and backlog is decreased when we recognize sales. We believe backlog and ordersinformation is helpful to investors because this information may be indicativeof future sales results. Although backlog consists of firm orders for whichgoods and services are yet to be provided, customers can, and sometimes do,terminate or modify these orders. However, historically the amount ofmodifications and terminations has not been material compared to total contractvolume.

 

36

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**Results of Operations**

** **

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 costs for rawmaterials, manufacturing costs, including allocation of overhead and otherindirect 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.

 

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

 
| ** **                                      | ** ** | **Quarter Ended**            | ** ** | ** **                        | ** ** | ** **                   | ** ** |
|-------------------------------------------------|------------|-----------------------------------|------------|-----------------------------------|------------|------------------------------|------------|
| ** **                                      | ** ** | **December 28,   2007** | ** ** | **December 29,   2006** | ** ** | **Increase (Decrease)** | ** ** |
| ** **                                      | ** ** | ** **                        | ** ** | **% of**                     | ** ** | ** **                   | ** ** | **% of** | ** ** | ** ** | ** ** | **% of** | ** ** |
| ** **                                      | ** ** | **Amount**                        | ** ** | **Sales**                         | ** ** | **Amount**                   | ** ** | **Sales** | ** ** | **Amount** | ** ** | **Sales** | ** ** |
| Sales                                           |       | $                                 | 85.9       |                              | 100.0      | %                            | $          | 83.7 |   | 100.0 | % | $ | 2.2 |   | — | % |
| Cost of sales                                   |       | 61.8                              |       | 71.9                              |       | 57.1                         |       | 68.2 |   | 4.7 |   | 3.7 |   |
| Gross profit                                    |       | 24.1                              |       | 28.1                              |       | 26.6                         |       | 31.8 |   | (2.5 | ) | (3.7 | ) |
| Research and development                        |       | 2.7                               |       | 3.1                               |       | 1.9                          |       | 2.3 |   | 0.8 |   | 0.8 |   |
| Selling and marketing                           |       | 5.2                               |       | 6.1                               |       | 4.8                          |       | 5.7 |   | 0.4 |   | 0.4 |   |
| General and administrative                      |       | 6.2                               |       | 7.2                               |       | 4.4                          |       | 5.3 |   | 1.8 |   | 1.9 |   |
| Amortization of acquisition-related intangibles |       |  

0.8                       |       | 0.9                               |       | 0.5                          |       | 0.0  0.6 |   | 0.3 |   | 0.3 |   |
| Net loss on disposition of assets               |       | —                            |       | 0.0                               |       | —                       |       | 0.0 |   | — |   | — |   |
| Operating income                                |       | 9.3                               |       | 10.8                              |       | 14.9                         |       | 17.8 |   | (5.6 | ) | (7.0 | ) |
| Interest expense, net                           |       | 4.8                               |       | 5.6                               |       | 5.3                          |       | 6.3 |   | (0.5 | ) | (0.7 | ) |
| Income before taxes                             |       | 4.5                               |       | 5.2                               |       | 9.6                          |       | 11.5 |   | (5.1 | ) | (6.3 | ) |
| Income tax expense                              |       | 1.9                               |       | 2.2                               |       | 3.7                          |       | 4.4 |   | (1.8 | ) | (2.2 | ) |
| Net income                                      |       | $                                 | 2.5        |                              | 2.9        | %                            | $          | 5.8 |   | 6.9 | % | $ | (3.3 | ) | (4.0 | )% |
| Other Data:                                     |       |                              |       |                              |       |                         |       |   |   |   |   |   |   |
| EBITDA (a)                                      |       | $                                 | 11.9       |                              | 13.9       | %                            | $          | 17.1 |   | 20.4 | % | $ | (5.2 | ) | (6.5 | )% |

 

----

 

Note:Totalsmay not equal the sum of the component line items due to independent rounding.Percentages are calculated based on    rounded dollar amountspresented.

 

(a)          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:

 

·                  EBITDA is a component of the measuresused by our board of directors and management team to evaluate our operatingperformance;

 

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·                  our senior credit facilities containcovenants that require us to maintain certain interest expense coverage andleverage ratios that contain EBITDA as a component, and our management teamuses EBITDA to monitor compliance with such covenants;

 

·                  EBITDA is a component of the measuresused by our management team to make day-to-day operating decisions;

 

·                  EBITDA facilitates comparisons betweenour operating results and those of competitors with different capitalstructures and therefore is a component of the measures used by the managementto facilitate internal comparisons to competitors’ results and our industry ingeneral; and

 

·                  the payment of management bonuses iscontingent upon, among other things, the satisfaction by us of certain targetsthat contain EBITDA as a component.

 

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

 

For a reconciliation ofNet Income to EBITDA, see Note 11 of the accompanying unaudited condensedconsolidated financial statements.

 

**Sales:** Our sales by market for thefirst quarter of fiscal years 2008 and 2007 are summarized as follows (dollarsin millions):

 
| ** **                   | ** ** | **Quarter Ended**      | ** ** | ** **                  | ** ** | ** ** | ** ** |
|------------------------------|------------|-----------------------------|------------|-----------------------------|------------|------------|------------|
| ** **                   | ** ** | **December 28,  2007** | ** ** | **December 29,  2006** | ** ** | ** ** | ** ** |
| ** **                   | ** ** | ** **                  | ** ** | **% of**               | ** ** | ** ** | ** ** | **% of** | ** ** | **Increase (Decrease)** | ** ** |
| ** **                   | ** ** | **Amount**                  | ** ** | **Sales**                   | ** ** | **Amount** | ** ** | **Sales** | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| Radar and Electronic Warfare |       | $                           | 35.3       |                        | 41         | %          | $          | 33.9 |   | 41 | % | $ | 1.4 |   | 4 | % |
| Medical                      |       | 15.6                        |       | 18                          |       | 17.1       |       | 20 |   | (1.5 | ) | (9 | ) |
| Communications               |       | 26.9                        |       | 31                          |       | 26.1       |       | 31 |   | 0.8 |   | 3 |   |
| Industrial                   |       | 5.6                         |       | 7                           |       | 5.0        |       | 6 |   | 0.6 |   | 12 |   |
| Scientific                   |       | 2.5                         |       | 3                           |       | 1.6        |       | 2 |   | 0.9 |   | 56 |   |
| Total                        |       | $                           | 85.9       |                        | 100        | %          | $          | 83.7 |   | 100 | % | $ | 2.2 |   | 3 | % |

 

In the first quarter of fiscal year 2008, our newMalibu division generated sales totaling $4.3 million, split approximatelyequally between the radar and communications markets.  As we acquired Malibu in August 2007,sales from the Malibu division are not included in our results for the firstquarter of fiscal year 2007. Excluding the Malibu division’s sales, incomparison to the first quarter of fiscal year 2007, our sales in the firstquarter of fiscal year 2008 decreased by $2.1 million, or 2.5%, to $81.6million.

 

Sales for the first quarter of fiscal year 2008 of$85.9 million were $2.2 million, or approximately 3%, more than sales of $83.7million for the first quarter of fiscal year 2007. Explanations for the salesincrease or decrease by market for the first quarter of fiscal year 2008compared to the first quarter of fiscal year 2007 are as follows:

 

·                  **Radar and ElectronicWarfare: **Themajority of our sales in the radar and electronic warfare markets are forproducts for domestic and international defense and government end uses.  The timing of orders receipts and subsequentshipments in these markets may vary from year to year.  On a combined basis, sales for these twomarkets increased approximately

 

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4% from $33.9 million inthe first quarter of fiscal year 2007 to $35.3 million in the first quarter offiscal year 2008, primarily due to sales of radar products by our recentlyacquired Malibu division. Management believes that, on a combined basis, thesemarkets will experience low single digit percentage average long-term annualgrowth.

 

·                  **Medical:** Sales of our medical products consist ofsales for medical imaging applications, such as x-ray imaging, PET and MRIapplications, and for radiation therapy applications for the treatment ofcancer. In the first quarter of fiscal year 2007, our medical sales were verystrong. The 9% decrease in sales of our medical products in the first quarterof fiscal 2008 in comparison to the first quarter of fiscal year 2007 wasprimarily due to what we believe is a short-term decrease in demand for ourproducts used in radiation therapy and MRI applications.

 

·                  **Communications: **The 3% increase in sales in thecommunications market was primarily the result of sales of telemetry productsby our recently acquired Malibu division, as well as increased sales ofsatellite communications products for domestic and foreign broadcast networkapplications and foreign direct-to-home applications. These increases werepartially offset by a decrease in sales of products for certain militarycommunications programs for which we had strong sales in the first quarter offiscal year 2007.

 

·                  **Industrial:**Sales in theindustrial market are cyclical. The $0.6 million increase in industrial sales wasprimarily due to sales of products used in industrial heating applications,analytical instrument programs, industrial fabrication applications andinternational test systems.

 

·                  **Scientific: **Sales in the scientific market arehistorically one-time projects and can fluctuate significantly from period toperiod. The $0.9 million increase in scientific sales was primarily the resultof increased product shipments for the Spallation Neutron Source at OakridgeNational Laboratory. We received approximately $5.4 million in orders for thisprogram in fiscal year 2007 and expect to complete our shipments of productsfor this program in the second quarter of fiscal year 2009.

 

**Gross Profit**. Gross profit was $24.1 million, or28.1% of sales, for the first quarter of fiscal year 2008 as compared to $26.6million, or 31.8% of sales, for the first quarter of fiscal year 2007.  For the first quarter of fiscal year 2008 ascompared to the first quarter of fiscal year 2007, gross profit was unfavorablyimpacted by the shipment of products with lower gross margins including from anincrease in customer funded engineering development programs that generally havelower gross margins, and due to technical problems on several developmentprograms and in a vacuum electron device (“VED”) product line that resulted inhigher provisions for loss contracts, scrap and rework. Lower gross marginsfrom the unfavorable sales mix and technical problems were partially offset byadditional gross profit from higher sales volume. In addition, the weakness ofthe U.S. dollar for the first quarter of fiscal year 2008 as compared to thefirst quarter of fiscal year 2007 caused a reduction in gross profit ofapproximately $0.3 million from the translation of Canadian dollar denominatedmanufacturing expenses to U.S. dollars, net of currency hedging contracts.

 

**Research and Development**. Research and development expenses were$2.7 million, or 3.1% of sales, for the first quarter of fiscal year 2008, a$0.8 million increase from $1.9 million, or 2.3% of sales, for the firstquarter of fiscal year 2007.  Theincrease in research and development for the first quarter of fiscal year 2008compared to the first quarter of fiscal year 2007 was due primarily to theplanned expenditures of $0.6 million on the Army’s Warfighter InformationNetwork-Tactical (WIN-T) program and $0.1 million in development expenses atour recently acquired Malibu division. Total spending on research anddevelopment, including customer-sponsored research and development, was $4.9million for the first quarter of fiscal year 2008 and $3.4 million in the firstquarter of fiscal year 2007.

 

39

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**Selling and Marketing**. Selling and marketingexpenses were $5.2 million, or 6.1% of sales, for the first quarter of fiscalyear 2008, a $0.4 million increase from the $4.8 million, or 5.7% of sales, forthe first quarter of fiscal year 2007. The increase in selling and marketingexpenses for the first quarter of fiscal year 2008 compared to the firstquarter of fiscal year 2007 reflects the $0.1 million effect of exchange rateson our foreign sales operations, as well as selling and marketing expenses of$0.1 million at our recently acquired Malibu division.

 

**General and Administrative**. General and administrativeexpenses were $6.2 million, or 7.2% of sales, for the first quarter of fiscalyear 2008, a $1.8 million increase from the $4.4 million, or 5.3% of sales, forthe first quarter of fiscal year 2007. The increase in general andadministrative expenses in the first quarter of fiscal year 2008 was primarilydue to the $0.7 million impact of foreign currency translation and $0.7 millionof general and administrative expenses at our recently acquired Malibudivision. The foreign currency translation impact was a loss of approximately$0.1 million for the first quarter of fiscal year 2008, compared to a gain ofapproximately $0.6 million for the first quarter of fiscal year 2007.

 

**Amortization of Acquisition-Related Intangibles**. Amortizationof acquisition-related intangibles consists of purchase accounting charges fortechnology and other intangible assets. Amortization of acquisition-relatedintangibles was $0.8 million for the first quarter of fiscal year 2008 and $0.5million for the first quarter of fiscal year 2007.  The $0.3 million dollar increase inamortization of acquisition-related intangibles is due to amortization of intangibleassets for our recently acquired Malibu division.

 

**Interest Expense, net (“Interest Expense”)**. InterestExpense was $4.8 million, or 5.6% of sales, for the first quarter of fiscalyear 2008, a $0.5 million decrease from the $5.3 million, or 6.3% of sales, forthe first quarter of fiscal year 2007. The reduction in interest expense forthe first quarter of fiscal year 2008 was primarily due to lower interest rateson our debt obligations during this period compared to the first quarter offiscal year 2007.  The reduction ininterest rates was primarily due to the refinancing of senior credit facilitiesand repayment of floating rate senior notes during the fourth quarter of fiscalyear 2007.

 

**Income Tax Expense**. We recorded an income taxexpense of $1.9 million and $3.7 million for the first quarter of fiscal years2008 and 2007, respectively. Our effective tax rate was approximately 44%for the first quarter of fiscal year 2008 as compared to approximately 39% forthe first quarter of fiscal year 2007. The effective tax rate for thefirst quarter of fiscal year 2008 includes a currency translation charge ofapproximately $0.1 million related to Canadian income tax liabilities.  Our estimated fiscal year 2008 effectiveincome tax rate is expected to be approximately 38%.

 

**Net Income**. Net income was $2.5 million, or 2.9% of sales, forthe first quarter of fiscal year 2008 as compared to $5.8 million, or 6.9% ofsales, in the first quarter of fiscal year 2007. The decrease in net income inthe first quarter of fiscal year 2008 as compared to the first quarter offiscal year 2007 was due primarily to the following items: the shipment ofproducts with lower gross margins, including from an increase in customerfunded engineering development programs that generally have lower grossmargins; technical problems on several development programs and in a VEDproduct line that resulted in higher loss contract reserves, scrap and rework;unfavorable currency effects from the weakness of the U.S. dollar; operatingexpenses from our recently acquired Malibu division; and increases in researchand development expenses. The foregoing were partially offset by lower incometax expense and interest expense.

 

40

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** **

**EBITDA**. EBITDA was $11.9 million, or 13.9% of sales, forthe first quarter of fiscal year 2008 as compared to $17.1 million, or 20.4% ofsales, for the first quarter of fiscal year 2007. The decrease in EBITDA in thefirst quarter of fiscal year 2008 as compared to the first quarter of fiscalyear 2007 was due primarily to: the shipment of products with lower grossmargins, including from an increase in customer-funded engineering developmentprograms that realized lower gross margins; technical problems on severaldevelopment programs and in a VED product line that resulted in higher losscontract reserves, scrap and rework; unfavorable currency effects from theweakness of the U.S. dollar; operating expenses from our recently acquiredMalibu division; and increases in research and development expenses.

 

**Liquidity and Capital Resources**

** **

**Overview**

** **

Ourliquidity is affected by many factors, some of which are based on normalongoing operations of our business and others that are related to uncertaintiesin the markets in which we compete and other global economic factors. We havehistorically financed, and intend to continue to finance, our capital andworking capital requirements, including debt service and internal growth,through a combination of cash flows from our operations and borrowings underour senior credit facilities. Our primary uses of cash are cost of sales,operating expenses, debt service and capital expenditures.

 

We believe that we have thefinancial resources to meet our business requirements for the next12 months, including capital expenditures and working capitalrequirements.

 

*Cash and Working Capital*

 

The following summarizes our cash and cash equivalentsand working capital (in thousands):

 

| ** **                | ** ** | **December 28,** | ** ** | **September 28,** | ** ** |
|---------------------------|------------|-----------------------|------------|------------------------|------------|
| ** **                | ** ** | **2007**              | ** ** | **2007**               | ** ** |
| Cash and cash equivalents |       | $                     | 27,410     |                   | $          | 20,474 |   |
| Working capital           |       | 84,269                |       | 81,547                 |       |
|                           |            |                       |            |                        |            |  |  |

 

Weinvest cash balances in excess of operating requirements in overnight U.S.Government securities and money market accounts. In addition to the above cashand cash equivalents, we had restricted cash of $2.5 million as of December 28,2007, consisting primarily of bank guarantees from customer advance payments toour international subsidiaries. The bank guarantees become unrestricted cashwhen performance under the sales or supply contract is complete.

 

Thesignificant factors underlying the net increase in cash and cash equivalentsduring the first quarter of fiscal year 2008 were the net cash provided by ouroperating activities of $9.6 million, partially offset by capitalexpenditures of $1.7 million and a repayment of our senior term loan inthe amount of $1.0 million.

 

Asof December 28, 2007, we had $245.75 million in total principalamount of debt outstanding, compared to $246.75 million as of September 28,2007. As of December 28, 2007, we had borrowing availability of$56.0 million under the revolver under our senior credit facilities.

 

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**HistoricalOperating, Investing and Financing Activities**

** **

***Operating Activities***

 

Duringthe first quarter of fiscal years 2008 and 2007, we funded our operatingactivities through cash generated internally. For the first quarter of fiscalyear 2008, net cash provided by operating activities was $9.6 millioncompared to $10.0 million for the first quarter of fiscal year 2007.

 

The$0.4 million decrease in net cash provided by operating activities for thefirst quarter of fiscal year 2008 compared to the first quarter of fiscal year2007 was primarily due to $2.8 million less cash generated from netincome, excluding non-cash charges, partially offset by $2.4 million lesscash used for working capital in the first quarter of fiscal year 2008. Ascompared to the first quarter of fiscal year 2007, the first quarter of fiscal year2008 had a lower net income of $3.3 million and a slightly higher totaldepreciation, amortization and other non-cash charges of $0.5 million.

 

Operatingactivities provided cash of $10.0 million in the first quarter of fiscal year2007, which was attributable to net income of $5.8 million, depreciation,amortization and other non-cash charges of $2.8 million and $1.4 milliondecrease in net operating assets and liabilities.

 

***Investing Activities***

 

Forthe first quarter of fiscal year 2008, net cash used in investing activitieswas $1.8 million, compared to $2.9 million for the first quarter offiscal year 2007.

 

Investingactivities for the first quarter of fiscal year 2008 consisted primarily of$1.7 million capital expenditures and $0.1 million payment of patentapplication fees.

 

Netcash used in investing activities for the first quarter of fiscal year 2007 was$2.9 million of capital expenditures, of which $2.0 million was for thebuilding expansion project for our Canadian manufacturing facility.

 

***Financing Activities***

 

Forthe first quarter of fiscal year 2008, net cash used in financing activitieswas $0.8 million, compared to $4.7 million for the first quarter offiscal year 2007.

 

Netcash used in financing activities for the first quarter of fiscal year 2008consisted primarily of term loan repayment of $1.0 million, whichcomprised the scheduled amortization payment of $250,000 and an optionalpayment of $750,000. The cash used in financing activities for the firstquarter of fiscal year 2008 was slightly offset by $0.2 million in proceedsfrom employee stock purchases.

 

Financingactivities for the first quarter of fiscal year 2007 consisted primarily of a$5.0 million term loan repayment in December 2006 using availableoperating cash. The $5.0 million term loan repayment included a $1.7 millionrequired annual excess cash flow prepayment, described below, for fiscal year2006 and an optional prepayment of $3.3 million.

 

Ifthe leverage ratio under our amended and restated senior credit facilities exceeds3.5:1 at the end of any fiscal year, then we are required to make an annualprepayment within 90 days after the end of the fiscal year based on acalculation of excess cash flow, as defined in the senior credit facilities,multiplied by a factor of 50%, less any optional prepayments made during thefiscal year. There was no excess cash flow payment due for fiscal year 2007,and, therefore, no excess cash flow payment was made in the first quarter offiscal year 2008.

 

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**Capital Expenditures**

 

Ourcontinuing operations typically do not have large recurring capital expenditurerequirements. Capital expenditures are generally made to replace existingassets, increase productivity, facilitate cost reductions or meet regulatoryrequirements. Total capital expenditures for the first quarter of fiscal year2008 were $1.7 million. In the remainder of fiscal year 2008, ongoingcapital expenditures are expected to be approximately $4.0 to$5.0 million.

 

**Recently Released Accounting Pronouncements**

 

In June 2006, theFinancial Accounting Standards Board (“FASB”) issued FASB Interpretation (“FIN”)No. 48, “Accounting for Income Tax Uncertainties.” FIN No. 48 definesthe threshold for recognizing the benefits of tax return positions in thefinancial statements as “more-likely-than-not” to be sustained by the taxingauthority. The recently issued literature also provides guidance on thederecognition, measurement and classification of income tax uncertainties,along with any related interest and penalties. FIN No. 48 also includesguidance concerning accounting for income tax uncertainties in interim periodsand increases the level of disclosures associated with any recorded income taxuncertainties. Effective September 29, 2007, we adopted FIN No. 48.The adoption of FIN No. 48 did not have any impact on our financialposition, net earnings or prior year financial statements. See Note 9, “IncomeTaxes,” to consolidated condensed financial statements of this Form 10-Qfor further discussion.

 

In September 2006, the FASB issued Statement ofFinancial 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 for financial assets and liabilities and for fiscal years beginning after November 15,2008 for non-financial assets and liabilities. 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 forfinancial assets and liabilities and in our fiscal year 2010 commencing October 2,2009 for non-financial assets and liabilities. We are currently evaluating thepotential impact, if any, that the adoption of this new standard will have onour consolidated financial statements.

 

InFebruary 2007, the FASB issued SFAS No. 159, “The Fair Value Optionfor Financial Assets and Financial Liabilities - Including an amendment of FASBStatement No. 115.” SFAS No. 159 permits companies to choose tomeasure many financial instruments and certain other items at fair value thatare not currently 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 presentationand disclosure requirements designed to facilitate comparisons betweencompanies that choose different measurement attributes for similar types ofassets and liabilities. SFAS No. 159 is effective for fiscal yearsbeginning after November 15, 2007. We will be required to adopt SFAS No. 159in our fiscal year 2009 commencing October 4, 2008 and are currentlyevaluating the impact, if any, that the adoption of this new standard will haveon our consolidated financial statements.

 

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In December 2007, the FASB issued SFAS No. 160, “NoncontrollingInterests in Consolidated Financial Statement—amendments of ARB No. 51.”SFAS No. 160 states that accounting and reporting for minority interestswill be recharacterized as noncontrolling interests and classified as acomponent of equity. SFAS No. 160 also establishes reportingrequirements that provide sufficient disclosures that clearly identify anddistinguish between the interests of the parent and the interests of thenoncontrolling owners. SFAS No. 160 applies to all entities that prepareconsolidated financial statements, except not-for-profit organizations, butwill affect only those entities that have an outstanding noncontrollinginterest in one or more subsidiaries or that deconsolidate a subsidiary. SFASNo. 160 is effective for fiscal years beginning after December 15,2008. We will be required to adopt SFAS No. 160 in our fiscal year 2010commencing October 3, 2009 and are currently evaluating the impact, ifany, that the adoption of this new standard will have on our consolidatedfinancial statements.

 

In December 2007, the FASB issued SFAS No. 141 (revised2007) (“SFAS No. 141(R)”), “Business Combinations,” which replaces SFAS No. 141.SFAS No. 141(R) establishes principles and requirements for howan acquirer recognizes and measures in its financial statements theidentifiable assets acquired, the liabilities assumed, any non controllinginterest in the acquiree and the goodwill acquired. The Statement alsoestablishes disclosure requirements which will enable users to evaluate thenature and financial effects of the business combination. SFAS No. 141(R) iseffective for fiscal years beginning after December 15, 2008. We will berequired to adopt SFAS No. 141(R) in our fiscal year 2010 commencing October 3,2009 and are currently evaluating the impact, if any, that the adoption of thisnew standard will have on our consolidated financial statements.

 

**Critical Accounting Policies and Estimates**

 

Ourconsolidated financial statements are prepared in accordance with generallyaccepted accounting principles, or GAAP, in the United States of America, whichrequire us to make certain estimates, judgments and assumptions. We believethat the estimates, judgments and assumptions upon which we rely are reasonablebased upon various factors and information available to us at the time thatthese estimates, judgments and assumptions are made. These factors andinformation may include, but are not limited to, history and prior experience,experience of other enterprises in the same industry, new related events,current economic conditions and information from third party professionals. Theestimates, judgments and assumptions we make can affect the reported amountsof  assets and liabilities as of the dateof the financial statements, as well as the reported amounts of revenues andexpenses during the periods presented. To the extent there are materialdifferences between these estimates, judgments or assumptions and actualresults, our financial statements will be affected.

 

Webelieve the following critical accounting policies are the most significant tothe presentation of our financial statements and require the most subjectiveand complex judgments. These matters, and the judgments and uncertainties affectingthem, are also essential to understanding our reported and future operatingresults.

 

***Revenue recognition***

 

Wegenerally recognize revenue upon shipment of product, following receipt ofwritten purchase orders, when the price is fixed or determinable, title hastransferred and collectibility is reasonably assured. Value of sales under  percentage of completion method of accountingis 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***

 

Weassess the valuation of inventory and periodically write down the value forestimated excess and obsolete inventory based upon actual usage and estimatesabout future demand. The excess balance determined by this analysis becomes thebasis for our excess inventory charge. Management personnel play a key role inour excess inventory review process by providing updated sales forecasts,managing product rollovers and working with manufacturing to maximize recoveryof excess inventory. If our estimates regarding demand are inaccurate orchanges in technology affect demand for certain products in an unforeseenmanner, we may incur losses or gains in excess of our established markdownreserve that could be material.

 

Managementalso reviews the carrying value of inventory for lower of cost or market on anindividual product or contract basis. A loss reserve is charged to cost ofsales if the estimated product cost or the contract cost at completion is inexcess of net realizable value (selling price less estimated cost of disposal).If the actual contract cost at completion is different than originallyestimated, then a loss or gain provision adjustment would be recorded thatcould have a material impact on our operating results.

 

***Product warranty***

 

Ourproducts are generally warranted for a variety of periods, typically one tothree years or a predetermined product usage life. A provision for estimatedfuture costs of repair, replacement or customer accommodations is reflected inthe consolidated financial statements included in this report. We assess theadequacy of our preexisting warranty liabilities and adjust the balance basedon actual experience and changes in future expectations. The determination ofproduct warranty reserves requires us to make estimates of product return ratesand expected cost to repair or replace the products under warranty. If actualrepair and replacement costs differ significantly from our estimates, thenadjustments to recognize additional cost of sales may be required.

 

***Business combination and related goodwilland intangibles***

 

Weaccount for business combinations using the purchase method of accountingpursuant to SFAS No. 141, “Business Combinations.” Intangible assetsacquired in a purchase method business combination are recognized and reportedapart from goodwill, pursuant to the criteria specified by SFAS No. 141.

 

Accountingfor business combinations requires the allocation of purchase price toidentifiable tangible and intangible assets and liabilities based upon theirfair value. The allocation of purchase price is a matter of judgment andrequires the use of estimates and fair value assumptions. The allocation ofpurchase price to finite-lived assets can have a significant impact onoperating results because finite-lived assets are depreciated or amortized overtheir remaining useful lives.

 

Thevalues assigned to acquired identifiable intangible assets for technology weredetermined based on the excess earnings method of the income approach. Thismethod determines fair market value using estimates and judgments regarding theexpectations of future after-tax cash flows from those assets over their lives,including the probability of expected future contract renewals and sales, allof which are discounted to their present value.

 

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***Recoverability of long-lived assets***

* *

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

 

Weassess the recoverability of the carrying value of goodwill and otherintangible assets with indefinite useful lives at least annually or wheneverevents or changes in circumstances indicate that the carrying amount of theasset may not be fully recoverable. Recoverability of goodwill is measured atthe reporting unit level (our six divisions) based on a two-step approach.First, the carrying amount of the reporting unit is compared to the fair valueas estimated by the future net discounted cash flows expected to be generatedby the reporting unit. To the extent that the carrying value of the reportingunit exceeds the fair value of the reporting unit, a second step is performed,wherein the reporting unit’s assets and liabilities are valued. The impliedfair value of goodwill is calculated as the fair value of the reporting unit inexcess of the fair value of all non-goodwill assets and liabilities allocatedto the reporting unit. To the extent the reporting unit’s carrying value ofgoodwill exceeds its implied fair value, impairment exists and must berecognized. This process requires the use of discounted cash flow models thatutilize estimates of future revenue and expenses as well as the selection ofappropriate discount rates. There is inherent uncertainty in these estimates,and changes in these factors over time could result in an impairment charge.

 

AtDecember 28, 2007 and September 28, 2007, the carrying amount ofgoodwill and other intangible assets, net was $242.6 million and$243.3 million, respectively. As of December 28, 2007, no significantchanges in the underlying business assumptions or circumstances that drive theimpairment analysis led us to believe that goodwill might have been impaired.We will continue to evaluate the need for impairment if changes incircumstances or available information indicate that impairment may have occurred,and at least annually in the fourth quarter.

 

AtDecember 28, 2007 and September 28, 2007, the carrying amount ofproperty, plant and equipment was $65.9 million and $66.0 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.

 

Aprolonged general economic downturn and, specifically, a prolonged downturn inthe defense, communications or medical markets, or technological changes, as wellas other market factors could intensify competitive pricing pressure, create animbalance of industry supply and demand, or otherwise diminish volumes orprofits. Such events, combined with changes in interest rates, could adverselyaffect our estimates of future net cash flows to be generated by our long-livedassets. Consequently, it is possible that our future operating results could bematerially and adversely affected by additional impairment charges related tothe recoverability of our long-lived assets.

 

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***Accounting forstock-based compensation***

 

At the beginning of fiscal year 2006, we adopted SFAS No. 123(revised 2004), “Share-Based Payment” (“SFAS No. 123R”), and StaffAccounting Bulletin (“SAB”) No. 107, “Share-Based Payment,” for ourexisting stock option plans under the prospective method. Under the prospectivemethod, only new awards (or awards modified, repurchased, or cancelled afterthe effective date) are accounted for under the provisions of SFAS No. 123R.Previously, we applied the intrinsic-value method of accounting prescribed byAccounting Principles Board Opinion No. 25, “Accounting for Stock Issuedto Employees,” and related interpretations. Under the intrinsic-value method,compensation expense was recorded only if the market price of the stockexceeded the stock option exercise price at the measurement date. We willcontinue to account for stock option awards outstanding at September 30,2005 using the intrinsic-value method of measuring equity share options.

 

Thefair value of each option award is estimated on the date of grant using theBlack-Scholes model. The Black-Scholes option valuation model was developed foruse in estimating the fair value of traded options that have no vestingrestrictions and are fully transferable and requires the input of subjectiveassumptions, including the expected stock price volatility and estimated optionlife. If such goals are not met, no compensation cost is recognized and anyrecognized compensation cost is reversed. For purposes of this valuation model,no dividends have been assumed.

 

Inaccordance with SFAS No. 123R, prior to becoming a public entity in April 2006,we used the minimum value method to determine a calculated value, rather than afair value, of share awards. Under the minimum value method, stock pricevolatility was assumed to be zero. The estimated fair value (or calculatedvalue, as applicable) of our stock-based awards, less expected forfeitures, isamortized over the awards’ vesting period on a straight-line basis for awardsgranted after the adoption of SFAS No. 123R and on a graded vesting basisfor awards granted prior to the adoption of SFAS No. 123R. Since ourcommon stock has not been publicly traded for a sufficient time period, theexpected volatility is based on expected volatilities of similar companies thathave a longer history of being publicly traded. The expected life of optionsgranted is based on the simplified method for plain vanilla options inaccordance with SAB No. 107. The risk-free rates are based on the U.S.Treasury yield in effect at the time of the grant. In the first quarter offiscal years 2008 and 2007, we recognized $0.4 million and$0.2 million, respectively, in stock-based compensation expense.

 

***Income taxes***

 

We must make certain estimates and judgments indetermining income tax expense for financial statement purposes. Theseestimates and judgments occur in the calculation of tax credits, tax benefitsand deductions and in the calculation of certain tax assets and liabilities,which arise from differences in the timing of recognition of revenue andexpense for tax and financial statement purposes. Significant changes to theseestimates may result in an increase or decrease to our tax provision in asubsequent period.

 

Wemust assess the likelihood that we will be able to recover our deferred taxassets. If recovery is not likely, we must increase our provision for taxes byrecording a valuation allowance against the deferred tax assets that we estimatewill not ultimately be recoverable. We believe that all of the deferred taxassets recorded on our consolidated balance sheets will ultimately berecovered. However, should there be a change in our ability to recover ourdeferred tax assets, our tax provision would increase in the period in which wedetermined that the recovery was not probable.

 

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Inaddition, the calculation of our tax liabilities involves dealing withuncertainties in the application of complex tax regulations. In the firstquarter of fiscal year 2008, we adopted FIN No. 48 and related guidance.See Note 9 to consolidated condensed financial statements of this Form 10-Qfor further discussion. FIN No. 48 requires that we recognize liabilitiesfor uncertain tax positions based on the two-step process prescribed within theinterpretation. The first step is to evaluate the tax position for recognitionby determining if the weight of available evidence indicates that it is morelikely than not that the position will be sustained on audit, includingresolution of related appeals or litigation processes, if any. The second steprequires us to estimate and measure the tax benefit as the largest amount thatis more than 50% likely of being realized upon ultimate settlement. It isinherently difficult and subjective to estimate such amounts, as this requiresus to determine the probability of various possible outcomes. We reevaluatethese uncertain tax positions on a quarterly basis. This evaluation is based onfactors including, but not limited to, changes in facts or circumstances,changes in tax law, effectively settled issues under audit, and new auditactivity. Such a change in recognition or measurement would result in therecognition of a tax benefit or an additional charge to the tax provision.

 

**Item 3.****        ****Quantitativeand Qualitative Disclosures About Market Risk**

 

Wedo not use market risk sensitive instruments for trading or speculativepurposes.

 

***Interest rate risk***

 

Ourexposure to market risk for changes in interest rates relates primarily to ourlong-term debt. As of December 28, 2007, we had fixed rate senior notes of$125.0 million due in 2012, bearing interest at 8% per year and variablerate debt consisting of $22.0 million floating rate senior notes due in2015 and a $98.75 million term loan under our newly amended and restatedsenior credit facilities due in 2014. Our variable rate debt is subject tochanges in the prime rate and the LIBOR rate.

 

Weuse derivative instruments from time to time in order to manage interest costsand risk associated with our long-term debt. Most recently on September 21,2007, we entered into an interest rate swap contract to receive three-monthUSD-LIBOR-BBA interest and pay 4.77% fixed rate interest. Net interestpositions are settled quarterly. We have structured the swap with decreasingnotional amounts to match the expected pay down of the term loan. The notionalvalue of the swap was $90.0 million at December 28, 2007 andrepresented approximately 91% of the aggregate term loan balance. The swapagreement is effective through June 30, 2011. Under the provisions of SFASNo. 133, “*Accounting for DerivativeInstruments and Hedging Activities*,” as amended, this arrangementwas initially designated and qualified as an effective cash flow hedge ofinterest rate risk related to the term loan under our senior credit facilitieswhich permitted recording the fair value of the swap and correspondingunrealized gain or loss to accumulated other comprehensive income in theconsolidated balance sheets. At December 28, 2007, the unrealized loss,net of tax, on the swap was $0.9 million.

 

Weperformed a sensitivity analysis to assess the potential loss in futureearnings that a 10% increase in interest rates over a one-year period wouldhave on our floating rate senior notes and term loan under our senior creditfacilities. The impact was determined based on the hypothetical change from theend of period market rates over a period of one year and results in a net decreaseof future annual earnings of approximately $0.2 million.

 

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***Foreign currency exchange risk***

 

Although the majority of our revenue and expenseactivities are transacted in U.S. dollars, we do transact business in foreigncountries. Our primary foreign currency cash flows are in Canada and severalEuropean countries. In an effort to reduce our foreign currency exposure toCanadian dollar denominated expenses, we enter into Canadian dollar forwardcontracts to hedge the Canadian dollar denominated costs for our manufacturingoperation in Canada. Our Canadian dollar forward contracts are designated as acash flow hedge and are considered highly effective, as defined by SFAS No. 133.The unrealized gains and losses from foreign exchange forward contracts areincluded in “accumulated other comprehensive income” in the consolidatedbalance sheets. If the transaction being hedged fails to occur, or if a portionof any derivative is ineffective, then we promptly recognize the gain or losson the associated financial instrument in the consolidated statements ofoperations. No ineffective amounts were recognized due to anticipatedtransactions failing to occur in the first quarter of fiscal years 2008 and2007.

 

Asof January 16, 2008, we entered into Canadian dollar forward contracts forapproximately $20.9 million (Canadian dollars), or approximately 88% ofestimated Canadian dollar denominated expenses for January 2008 through June 2008,at an average rate of approximately $0.98 U.S. dollar to Canadian dollar. Weestimate the impact of a 1 cent change in the U.S. dollar to Canadian dollarexchange rate (without giving effect to our Canadian dollar forward contracts)to be approximately $0.4 million annually to our net income orapproximately 2.2 cents to basic earnings per share and 2.0 cents todiluted earnings per share.

 

Netincome for the first quarter of fiscal year 2008 includes a recognized gainfrom foreign currency forward contracts of $3,000. Net income for the firstquarter of fiscal year 2007 includes a recognized loss from foreign currencyforward contracts of $0.1 million. At December 28, 2007 and September 28,2007, the unrealized gain, net of tax, on Canadian dollar forward contracts was$0.8 million and $1.2 million, respectively.

 

**Item 4.****        ****Controls and Procedures**

 

Management,including our principal executive officer and principal financial officer, hasevaluated, as of the end of the period covered by this report, theeffectiveness of the design and operation of our disclosure controls andprocedures with respect to the information generated for use in this report.Based upon, and as of the date of that evaluation, the principal executiveofficer and principal financial officer concluded that the disclosure controlsand procedures were effective to provide reasonable assurances that informationrequired to be disclosed in the reports filed or submitted under the SecuritiesExchange Act of 1934, as amended, is recorded, processed, summarized andreported within the time periods specified in the Securities and ExchangeCommission’s rules and forms.

 

There have been no changes in our internal controlover 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 28, 2007.  There have been no material changes from the risk factors disclosed in the  “Risk Factors” section of our 2007 Form 10-K. |
| *** ***                                                                                                                                                                                                                                                                                                        |                                                             |
| ***Item 2.***                                                                                                                                                                                                                                                                                                       | **Unregistered Sales of Equity Securities and Use  of Proceeds** |
| *** ***                                                                                                                                                                                                                                                                                                        | ** **                                                       |
| *** ***                                                                                                                                                                                                                                                                                                        | None.                                                            |
|                                                                                                                                                                                                                                                                                                                |                                                             |
| ***Item 3.***                                                                                                                                                                                                                                                                                                       | **Defaults Upon Senior Securities**                              |
| *** ***                                                                                                                                                                                                                                                                                                        | ** **                                                       |
| *** ***                                                                                                                                                                                                                                                                                                        | None.                                                            |
| *** ***                                                                                                                                                                                                                                                                                                        |                                                             |
| ***Item 4.***                                                                                                                                                                                                                                                                                                       | **Submission  of Matters to a Vote of Security Holders**         |
| *** ***                                                                                                                                                                                                                                                                                                        | ** **                                                       |
| *** ***                                                                                                                                                                                                                                                                                                        | None.                                                            |
| *** ***                                                                                                                                                                                                                                                                                                        | * *                                                         |
| ***Item 5.***                                                                                                                                                                                                                                                                                                       | **Other  Information**                                           |
| *** ***                                                                                                                                                                                                                                                                                                        | ** **                                                       |
| *** ***                                                                                                                                                                                                                                                                                                        | None.                                                            |

 

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## ***Item 6.***           Exhibits

 
| **No.** | ** ** | **Description**                                                                                                                                                                  |
|---------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|    |       |                                                                                                                                                                             |
| 10.1    |       | Amended  and Restated Employment Agreement, dated as of January 17, 2008, by and  between Communications & Power Industries, Inc. and Robert A.  Fickett.     |
|    |       |                                                                                                                                                                             |
| 10.2    |       | Amended  and Restated Employment Agreement, dated as of January 17, 2008, by and  between Communications & Power Industries, Inc. and Joel A.  Littman.       |
|    |       |                                                                                                                                                                             |
| 10.3    |       | First  Amendment and Restatement of the Communications & Power  Industries, Inc. Non-Qualified Deferred Compensation Plan, effective as  of December 1, 2004. |
|    |       |                                                                                                                                                                             |
| 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 tothe requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.

 

 
|   | CPI  INTERNATIONAL, INC. |
|--------|--------------------------|

 

 
| Dated:  February 6,  2008 | /s/  JOEL A. LITTMAN                                                                                                      |
|------------------------------------------|---------------------------------------------------------------------------------------------------------------------------|
|                                     | Joel  A. Littman  Chief Financial Officer, Treasurer and Secretary  (Duly Authorized Officer and Chief Financial Officer) |

** **

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