# ** **

# **UNITED STATESSECURITIES AND EXCHANGE**COMMISSION

**Washington, D.C.  20549**

 

# **FORM 10-Q**

# ** **

**(Mark One)**
| **ý**                                            | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13  OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**   |
|-------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|
| ** **                                            | ** ** | ** **                                                                                               |
| **For the  quarterly period ended July 1, 2005** |
| ** **                                            | ** ** | ** **                                                                                               |
| **or**                                                |
| ** **                                            | ** ** | ** **                                                                                               |
| **o**                                                 | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13  OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**For the transition period from                   to                   **

 

# **Commission file number:    333-11386-04**

 

# **CPI HOLDCO, INC.**

(Exact Name of Registrant as Specified in ItsCharter)

 

**Delaware**

(State or Other Jurisdiction of Incorporation orOrganization)

 

**75-3142681**

(I.R.S. Employer Identification No.)

 

**811 Hansen Way**

**Palo Alto,California 94303-1110**

**(650) 846-2900**

(Address of Principal Executive Offices and TelephoneNumber,Including Area Code)

 

Indicateby check mark whether each registrant (1) has filed all reports requiredto be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports) and (2) has been subject tosuch filing requirements for the past 90 days. Yes   ý      No  o

 

Indicateby check mark whether the registrant is an accelerated filer (as defined inExchange Act Rule 12b-2).   Yes   o      No  ý

 

**APPLICABLE ONLY TO CORPORATEISSUERS:**

 

Indicatethe number of shares outstanding for each of the Registrant’s classes of CommonStock, as of the latest practicable date: 4,275,566 shares of Common Stock,$.01 par value, at August 10, 2005.

#### * *

 

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**CPI Holdco, Inc.**

and Subsidiaries

 

#### ***Cautionary Statements Regarding Forward-Looking Statements***

#### * *

*This document contains forward-looking statements within the meaning ofSection 27A of the Securities Act of 1933, as amended, and Section 21Eof the Securities Exchange Act of 1934, as amended, that relate to futureevents or the future financial performance of CPI Holdco, Inc.(collectively, with its subsidiaries, the “Company”).  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 statements are only predictions. Actualevents or results may differ materially.*

 

*Although the Company believes that the expectations reflected in theforward-looking statements are reasonable, the Company cannot guarantee futureresults, levels of activity, performance or achievements. Moreover, neither theCompany nor any other person assumes responsibility for the accuracy andcompleteness of the forward-looking statements. All written and oral forward-looking statements made in connection withthis report that are attributable to the Company or persons acting on theCompany’s behalf are expressly qualified in their entirety by the “riskfactors,” and other cautionary statements included herein and in the otherfilings with the Securities and Exchange Commission (“SEC”) made by the Companyand its predecessor, Communications & Power Industries HoldingCorporation.  The Company is 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 the Company’sexpectations.*

 

#### *The information in this report is not a complete description of theCompany’s business or the risks and uncertainties associated with an investmentin the Company’s securities. You should carefully consider the various risksand uncertainties that impact the Company’s business and the other informationin this report and the Company’s other filings with the SEC before you decideto invest in the Company or to maintain or increase your investment.  Such risks and uncertainties include, but arenot limited to, the following:*

#### * *

•                  the Company’s indebtedness is substantial;

•                  the agreements and instruments governing the Company’s debt haverestrictions that could limit its flexibility in operating its business;

•                  the Company’s ability to generate the significant amount of cash neededto service its debt and to fund capital expenditures or other liquidity needsdepends on many factors beyond its control;

•                  the Company has had historical losses;

•                  the Company may be unable to retain and/or recruit key management and otherpersonnel;

•                  the markets in which the Company sells its products are competitive;

•                  the end markets in which the Company operates are subject totechnological change;

•                  a significant portion of the Company’s sales is, and is expected tocontinue to be, from contracts with the U.S. Government;

•                  the Company generates sales from contracts with foreign governments;

•                  the Company’s international operations subject it to social, politicaland economic risks of doing business in foreign countries;

•                  the Company may not be successful in obtaining the necessary exportlicenses and technical assistance agreements to conduct operations abroad andthe U.S. Congress may prevent proposed sales to foreign customers;

•                  the Company’s results of operations and financial condition may beadversely affected by increased or unexpected costs incurred by it on itscontracts and sales orders;

•                  environmental regulation and legislation, liabilities relating tocontamination and changes in the Company’s ability to recover under VarianMedical Systems Inc.’s indemnity obligations could adversely affect itsbusiness;

•                  the Company has only a limited ability to protect its intellectualproperty rights;

•                  the Company’s inability to obtain certain necessary raw materials andkey components could disrupt the manufacture of its products and cause itsfinancial condition and results of operations to suffer;

•                  the relocation of the Company’s San Carlos, California operatingdivision to Palo Alto, California could result in disruption to the Company’soperations;

•                  the Company may not be able to timely comply with the requirements of Section 404of the Sarbanes-Oxley Act of 2002; and

•                  the Company is controlled by affiliates of The Cypress Group L.L.C.

 

Any ofthe foregoing factors could cause the Company’s business, results ofoperations, or financial condition to suffer, and actual results could differmaterially from those expected.

 

2

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**CPI Holdco, Inc.**

and Subsidiaries

 

# **INDEX**

# ** **

| **PART I:  FINANCIAL INFORMATION**                                                             | ** ** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|------------|
| ** **                                                                                                    | ** ** | ** ** |
| **ITEM  1: UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**                                            | ** ** | ** ** |
| ** **                                                                                                    | ** ** | ** ** |
| Condensed  Consolidated Balance Sheets                                                                        |       | 4          |
|                                                                                                          |       |       |
| Condensed  Consolidated Statements of Operations and Comprehensive Income                                     |       | 5          |
|                                                                                                          |       |       |
| Condensed  Consolidated Statements of Cash Flows                                                              |       | 7          |
|                                                                                                          |       |       |
| Notes  to Condensed Consolidated Financial Statements                                                         |       | 8          |
|                                                                                                          |       |       |
| **ITEM 2: MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION  AND RESULTS OF OPERATIONS** |       | 27         |
|                                                                                                          |       |       |
| **ITEM 3: QUANTITATIVE AND  QUALITATIVE DISCLOSURES ABOUT MARKET RISK**                                       |       | 36         |
|                                                                                                          |       |       |
| **ITEM 4:  CONTROLS AND PROCEDURES**                                                                          |       | 37         |
|                                                                                                          |       |       |
| **PART II: OTHER  INFORMATION**                                                                          |       |       |
|                                                                                                          |       |       |
| **ITEM 6: EXHIBITS**                                                                                          |       | 38         |
|                                                                                                          |       |       |
| **SIGNATURES**                                                                                                |       | 39         |

 

3

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**CPI Holdco, Inc.**

and Subsidiaries

 

**CONDENSEDCONSOLIDATED BALANCE SHEETS****(in thousands-unaudited)**

 
| ** **                                        | ** ** | **July 1,** | ** ** | **October 1,** | ** ** |
|---------------------------------------------------|------------|------------------|------------|---------------------|------------|
| ** **                                        | ** ** | **2005**         | ** ** | **2004**            | ** ** |
|                                              |       |             |       |                |       |
| **Assets**                                        |       |             |       |                |       |
| Cash and cash equivalents                         |       | $                | 17,108     |                | $          | 40,476 |   |
| Restricted cash                                   |       | 2,019            |       | 2,279               |       |
| Accounts receivable, net                          |       | 48,391           |       | 35,914              |       |
| Inventories                                       |       | 47,156           |       | 38,074              |       |
| Deferred tax assets                               |       | 12,535           |       | 12,285              |       |
| Prepaids and other current assets                 |       | 4,575            |       | 3,796               |       |
| Total current assets                              |       | 131,784          |       | 132,824             |       |
| Property, plant and equipment, net                |       | 77,312           |       | 70,127              |       |
| Debt issue costs, net                             |       | 11,416           |       | 8,910               |       |
| Intangible assets, net                            |       | 78,554           |       | 78,481              |       |
| Goodwill                                          |       | 145,462          |       | 139,614             |       |
| Other long-term assets                            |       | 1,853            |       | 1,251               |       |
| Total assets                                      |       | $                | 446,381    |                | $          | 431,207 |   |
|                                              |       |             |       |                |       |
| **Liabilities and stockholders’  equity**    |       |             |       |                |       |
| Current portion of long-term debt                 |       | $                | —     |                | $          | 3,944 |   |
| Accounts payable                                  |       | 17,902           |       | 15,790              |       |
| Accrued expenses                                  |       | 27,400           |       | 20,939              |       |
| Product warranty                                  |       | 6,031            |       | 6,074               |       |
| Income taxes payable                              |       | 5,851            |       | 1,661               |       |
| Advance payments from customers                   |       | 8,007            |       | 12,031              |       |
| Total current liabilities                         |       | 65,191           |       | 60,439              |       |
| Deferred income taxes                             |       | 34,989           |       | 39,118              |       |
| Advance payments from sale of San Carlos property |       | 13,450           |       | 13,450              |       |
| Long-term debt                                    |       | 284,218          |       | 210,606             |       |
| Other long-term liabilities                       |       | 84               |       | —              |       |
| Total liabilities                                 |       | 397,932          |       | 323,613             |       |
| Common stock                                      |       | 43               |       | 43                  |       |
| Additional paid-in capital                        |       | 28,601           |       | 103,534             |       |
| Accumulated other comprehensive income            |       | 1,041            |       | 1,369               |       |
| Retained earnings                                 |       | 18,764           |       | 2,648               |       |
| Net stockholders’ equity                     |       | 48,449           |       | 107,594             |       |
| Total liabilities and stockholders’ equity   |       | $                | 446,381    |                | $          | 431,207 |   |

 

Seeaccompanying notes to the condensed consolidated financial statements.

 

4

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**CPI Holdco, Inc.**

and Subsidiaries

 

# **CONDENSED CONSOLIDATEDSTATEMENTS OF OPERATIONS ANDCOMPREHENSIVE INCOME (in thousands - unaudited)**

 
| ** **                                             | ** ** | **13-Week**           | ** ** | **13-Week**           | ** ** |
|--------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                             | ** ** | **Period Ended**      | ** ** | **Period Ended**      | ** ** |
| ** **                                             | ** ** | **July 1, 2005** | ** ** | **July 2, 2004** | ** ** |
| Sales                                                  |       | $                     | 87,639     |                  | $          | 72,345 |   |
| Cost of sales                                          |       | 57,848                |       | 49,112                |       |
| Amortization of acquisition-related inventory write-up |       | —                |       | 1,280                 |       |
| Gross profit                                           |       | 29,791                |       | 21,953                |       |
| Operating costs and expenses:                          |       |                  |       |                  |       |
| Research and development                               |       | 1,899                 |       | 1,869                 |       |
| Selling and marketing                                  |       | 4,744                 |       | 3,856                 |       |
| General and administrative                             |       | 5,789                 |       | 5,011                 |       |
| Amortization of acquisition-related intangible assets  |       | 548                   |       | 4,682                 |       |
| Acquired in-process research and development           |       | —                |       | (9,000                | )          |
| Total operating costs and expenses                     |       | 12,980                |       | 6,418                 |       |
| Operating income                                       |       | 16,811                |       | 15,535                |       |
| Interest expense, net                                  |       | 5,697                 |       | 3,822                 |       |
| Income before income taxes                             |       | 11,114                |       | 11,713                |       |
| Income tax expense                                     |       | 4,416                 |       | 242                   |       |
|                                                   |       |                  |       |                  |       |
| Net income                                             |       | $                     | 6,698      |                  | $          | 11,471 |   |
|                                                   |       |                  |       |                  |       |
| Other comprehensive income/(loss), net of tax:         |       |                  |       |                  |       |
| Net unrealized loss on cash flow hedges                |       | (711                  | )          | (352                  | )          |
| Net Change                                             |       | (711                  | )          | (352                  | )          |
|                                                   |       |                  |       |                  |       |
| Comprehensive income                                   |       | $                     | 5,987      |                  | $          | 11,119 |   |

 

Seeaccompanying notes to the condensed consolidated financial statements.

 

5

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**CPI Holdco, Inc.**

and Subsidiaries

 

# **CONDENSED CONSOLIDATEDSTATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (in thousands - unaudited)**

 
| ** **                                             | ** ** | **Fiscal Year**       | ** ** |
|--------------------------------------------------------|------------|-----------------------|------------|
| ** **                                             | ** ** | **2005**              | ** ** | **2004** | ** ** |
| ** **                                             | ** ** | **39-Week**           | ** ** | **January 23, 2004** | ** ** | **October 4, 2003** | ** ** |
| ** **                                             | ** ** | **Period Ended**      | ** ** | **to** | ** ** | **to** | ** ** |
| ** **                                             | ** ** | **July 1, 2005** | ** ** | **July 2, 2004** | ** ** | **January 22, 2004** | ** ** |
| ** **                                             | ** ** | **(Successor)**       | ** ** | **(Successor)** | ** ** | **(Predecessor)** | ** ** |
| Sales                                                  |       | $                     | 245,835    |   | $ | 137,986 |   | $ | 79,919 |   |
| Cost of sales                                          |       | 162,912               |       | 90,919 |   | 56,189 |   |
| Amortization of acquisition-related inventory write-up |       | 351                   |       | 5,500 |   | — |   |
| Gross profit                                           |       | 82,572                |       | 41,567 |   | 23,730 |   |
| Operating costs and expenses:                          |       |                  |       |   |   |   |   |
| Research and development                               |       | 5,205                 |       | 3,333 |   | 2,200 |   |
| Selling and marketing                                  |       | 13,397                |       | 6,994 |   | 4,352 |   |
| General and administrative                             |       | 15,664                |       | 8,523 |   | 6,033 |   |
| Merger expenses                                        |       | —                |       | — |   | 6,374 |   |
| Amortization of acquisition-related intangible assets  |       | 6,940                 |       | 8,078 |   | — |   |
| Acquired in-process research and development           |       | —                |       | 2,500 |   | — |   |
| Total operating costs and expenses                     |       | 41,206                |       | 29,428 |   | 18,959 |   |
| Operating income                                       |       | 41,366                |       | 12,139 |   | 4,771 |   |
| Interest expense, net                                  |       | 14,509                |       | 6,772 |   | 8,902 |   |
| Income (loss) before income taxes                      |       | 26,857                |       | 5,367 |   | (4,131 | ) |
| Income tax expense                                     |       | 10,741                |       | 729 |   | 439 |   |
| Net income (loss)                                      |       | 16,116                |       | 4,638 |   | (4,570 | ) |
|                                                   |       |                  |       |   |   |   |   |
| Preferred dividends:                                   |       |                  |       |   |   |   |   |
| Senior redeemable preferred stock                      |       | —                |       | — |   | 3,861 |   |
| Junior preferred stock                                 |       | —                |       | — |   | 2,382 |   |
| Net income (loss) attributable to common stock         |       | $                     | 16,116     |   | $ | 4,638 |   | $ | (10,813 | ) |
|                                                   |       |                  |       |   |   |   |   |
| Other comprehensive income/(loss), net of tax:         |       |                  |       |   |   |   |   |
| Net unrealized (loss)/gain on cash flow hedges         |       | (328                  | )          | 13 |   | — |   |
| Net change                                             |       | (328                  | )          | 13 |   | — |   |
| Comprehensive income (loss)                            |       | $                     | 15,788     |   | $ | 4,651 |   | $ | (10,813 | ) |

 

Seeaccompanying notes to the condensed consolidated financial statements.

 

6

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**CPI Holdco, Inc.**

and Subsidiaries

 

# **CONDENSED CONSOLIDATEDSTATEMENTS OF CASH FLOWS (in thousands - unaudited)**

 
| ** **                                                                   | ** ** | **Fiscal Year**       | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                   | ** ** | **2005**              | ** ** | **2004** | ** ** |
| ** **                                                                   | ** ** | **39-Week**           | ** ** | **January 23, 2004** | ** ** | **October 4, 2003** | ** ** |
| ** **                                                                   | ** ** | **period ended**      | ** ** | **to** | ** ** | **to** | ** ** |
| ** **                                                                   | ** ** | **July 1, 2005** | ** ** | **July 2, 2004** | ** ** | **January 22, 2004** | ** ** |
| ** **                                                                   | ** ** | **(Successor)**       | ** ** | **(Successor)** | ** ** | **(Predecessor)** | ** ** |
| **OPERATING ACTIVITIES**                                                     |       |                  |       |   |   |   |   |
| Net cash provided by operating activities                                    |       | $                     | 15,283     |   | $ | 11,464 |   | $ | 8,213 |   |
| **INVESTING ACTIVITIES**                                                     |       |                  |       |   |   |   |   |
| Expenses relating to sale of San Carlos property                             |       | (216                  | )          | — |   | — |   |
| Purchase of Predecessor’s net assets, net of cash  acquired             |       | —                |       | (113,760 | ) | — |   |
| Purchase of Econco’s net assets, net of cash acquired                   |       | (18,325               | )          | — |   | — |   |
| Purchases of property, plant and equipment                                   |       | (8,867                | )          | (1,222 | ) | (459 | ) |
| Other investing activities                                                   |       | (16                   | )          | — |   | — |   |
| Net cash used in investing activities                                        |       | (27,424               | )          | (114,982 | ) | (459 | ) |
| **FINANCING ACTIVITIES**                                                     |       |                  |       |   |   |   |   |
| Retirement of debt and preferred stock:                                      |       |                  |       |   |   |   |   |
| Senior subordinated notes                                                    |       | —                |       | (74,000 | ) | (26,000 | ) |
| Senior redeemable preferred stock                                            |       | —                |       | (29,735 | ) | — |   |
| Junior preferred stock                                                       |       | —                |       | (32,336 | ) | — |   |
| Dividends on senior preferred stock                                          |       | —                |       | (19,310 | ) | — |   |
| Mortgage financing                                                           |       | —                |       | (17,500 | ) | — |   |
| Proceeds from/(payments for) the issuance of debt:                           |       |                  |       |   |   |   |   |
| Floating rate senior notes                                                   |       | 79,200                |       | — |   | — |   |
| Senior subordinated notes                                                    |       | —                |       | 125,000 |   | — |   |
| Senior term loans                                                            |       | —                |       | 90,000 |   | — |   |
| Debt issue costs                                                             |       | (3,455                | )          | (9,648 | ) | — |   |
| Proceeds from the repayment of Predecessor management  loans                 |       | —                |       | 1,266 |   | — |   |
| Net proceeds from the issuance of common stock                               |       | —                |       | 98,075 |   | — |   |
| Repayments on senior term loan                                               |       | (9,550                | )          | (225 | ) | — |   |
| Stockholder distribution payments                                            |       | (75,809               | )          | — |   | — |   |
| Payment of collateral on interest rate swap contract                         |       | (1,000                | )          | — |   | — |   |
| Other financing activities                                                   |       | (100                  | )          | — |   | — |   |
| Net (repayments) proceeds from bank overdraft                                |       | (513                  | )          | 2,150 |   | (1,639 | ) |
| Net cash (used in) provided by financing activities                          |       | (11,227               | )          | 133,737 |   | (27,639 | ) |
| **NET (DECREASE) INCREASE IN CASH  AND CASH EQUIVALENTS**                    |       | (23,368               | )          | 30,219 |   | (19,885 | ) |
| Cash  and cash equivalents at beginning of period                            |       | 40,476                |       | — |   | 33,751 |   |
| Cash  and cash equivalents at end of period                                  |       | $                     | 17,108     |   | $ | 30,219 |   | $ | 13,866 |   |
|                                                                         |       |                  |       |   |   |   |   |
| **Supplemental Disclosures of  Cash Flow Information**                       |       |                  |       |   |   |   |   |
| Cash paid for interest                                                       |       | $                     | 8,160      |   | $ | 5,662 |   | $ | 1,637 |   |
| Cash paid for taxes, net of refunds                                          |       | $                     | 10,820     |   | $ | 168 |   | $ | 2,376 |   |
| **Supplemental Disclosures of  Non-cash Investing and Financing Activities** |       |                  |       |   |   |   |   |
| Dividends on senior preferred stock                                          |       | $                     | —     |   | $ | — |   | $ | 3,861 |   |

 

Seeaccompanying notes to the condensed consolidated financial statements.

 

7

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**CPI Holdco, Inc.**

and Subsidiaries

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

***1.  Basis of Presentation***

 

For periods ending prior to January 23, 2004, the accompanyingcondensed consolidated financial statements represent the consolidated resultsand financial position of Communications & Power Industries HoldingCorporation (“Holding” or the “Predecessor”). On January 23, 2004, thePredecessor merged (the “Merger”) with CPI Merger Sub Corp. (“Merger Sub”), awholly-owned subsidiary of CPI Holdco, Inc. (“CPI Holdco” or the “Successor”),a Delaware corporation formerly known as CPI Acquisition Corp., controlled byaffiliates of The Cypress Group L.L.C. (“Cypress”) as more fully described inNote 3 “Mergers”. As a result of the Merger, the Predecessor became awholly-owned subsidiary of CPI Holdco. The financial statements for periodssubsequent to January 22, 2004 represent the condensed consolidatedfinancial statements of CPI Holdco after giving effect to the Merger.  References to the “Company” refer to thePredecessor prior to the Merger and the Successor post-Merger.

 

CPIHoldco’s fiscal years are the 52- or 53-week periods that end on the Fridaynearest September 30. The Successor’s fiscal year did not change from thatof the Predecessor. Fiscal year 2005 comprises the 52-week period ending September 30,2005, and fiscal year 2004 comprised the 52-week period ended October 1,2004.

 

Management believes that these unaudited interim condensed consolidatedfinancial statements contain all adjustments, all of which are of a normal,recurring nature, necessary to present fairly the financial position of theCompany and its results of operations and cash flows for the interim periodspresented. The results for the interim periods reported are not necessarilyindicative of the results for the complete fiscal year 2005. Certaininformation and footnote disclosures normally included in annual financialstatements have been condensed or omitted and, accordingly, these financialstatements should be read in conjunction with the financial statements and thenotes thereto contained in the Company’s Annual Report on Form 10-K forthe fiscal year ended October 1, 2004.

 

There is currently no public market for CPI Holdco’s common stock.

 

***2.******             ******Stock-based Compensation***

 

As allowed by Statement of Financial Accounting Standards (“SFAS”) No. 123,“Accounting for Stock-Based Compensation,” as amended by SFAS No. 148, “Accountingfor Stock-Based Compensation – Transition and Disclosure,” the Company appliesthe intrinsic value-based method of accounting prescribed by AccountingPrinciples Board Opinion No. 25, “Accounting for Stock Issued toEmployees,” and related interpretations. Under this method, compensationexpense is recorded only if the quoted market price of the stock exceeded theexercise price at the measurement date. Since the Company’s stock is not publicly traded and therefore does nothave a quoted market price, the Company computes an estimated market price ofits stock based on valuation techniques for determining the fair value ofclosely held stock.  The exercise pricesof all stock options issued by the Successor were at, or above, the estimatedmarket price of the underlying stock at the date of issuance.  The Company charges stock-based compensationexpense against income under the caption “General and administrative” in theCondensed Consolidated Statements of Operations and Comprehensive Income.

 

Infiscal year 2005, stock-based compensation determined under the intrinsicvalue-based method was recorded for performance stock options that vest infiscal years 2005 through 2008. Stock-based compensation expense is charged to income over the stock optionvesting period that corresponds with the performance measurement period.Stock-based compensation expense is determined based on an estimate of thenumber of performance stock options expected to vest multiplied by thedifference between a) the estimated market price of the stock at theperformance measurement date and b) the option exercise price.  The estimated market price at the performancemeasurement date was based on the fair value of CPI Holdco’s common stock atthe end of the most recent quarter.  TheCompany expects to meet the performance targets for all outstanding performancestock options.  Net income includes stockcompensation expense of $0.4 million for the 13-week period ended July 1,2005, $0.9 million for the 39-week period ended July 1, 2005 and $1.3million for the period from October 4, 2003 to January 22, 2004.

 

During fiscal year 2003, the Predecessor issued stock options to employeesthat were subsequently determined to have been issued below the estimatedmarket price of the stock on the date of grant. The compensation costassociated with the 2003 stock options was amortized as a charge against income

 

8

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on a straight-line basis over the four-year vesting period until the stockoptions became fully vested at the time of the Merger.

 

If compensation cost for the Company’s stock-based compensation plan hadbeen determined using the fair value-based method of accounting, then theCompany’s net income (loss) would have changed to the pro forma amountsindicated below (in thousands):

 
| ** **             | ** **                                                                                                  | **13-Week**           | ** ** | **13-Week**           | ** ** |
|------------------------|-------------------------------------------------------------------------------------------------------------|-----------------------|------------|-----------------------|------------|
| ** **             | ** **                                                                                                  | **Period ended**      | ** ** | **Period ended**      | ** ** |
| ** **             | ** **                                                                                                  | **July 1, 2005** | ** ** | **July 2, 2004** | ** ** |
| Net income as reported |                                                                                                        | $                     | 6,698      |                  | $          | 11,471 |   |
| Add:                   | Stock-based  compensation included in net income determined under intrinsic value-based  method, net of tax |                  | 266        |                  | —     |   |
| Deduct:                | Stock-based  compensation determined under fair value-based method, net of tax                              |                  | (339       | )                     | (77        | ) |
| Pro  forma net income  |                                                                                                        | $                     | 6,625      |                  | $          | 11,394 |   |

 
| ** **                    | ** **                                                                                                         | **Fiscal Year**       | ** ** |
|-------------------------------|--------------------------------------------------------------------------------------------------------------------|-----------------------|------------|
| ** **                    | ** **                                                                                                         | **2005**              | ** ** | **2004** | ** ** |
| ** **                    | ** **                                                                                                         | **39-Week**           | ** ** | **January 23, 2004** | ** ** | **October 4, 2003** | ** ** |
| ** **                    | ** **                                                                                                         | **Period ended**      | ** ** | **to** | ** ** | **to** | ** ** |
| ** **                    | ** **                                                                                                         | **July 1, 2005** | ** ** | **July 2, 2004** | ** ** | **January 22, 2004** | ** ** |
| ** **                    | ** **                                                                                                         | **(Successor)**       | ** ** | **(Successor)** | ** ** | **(Predecessor)** | ** ** |
| Net income (loss) as reported |                                                                                                               | $                     | 16,116     |   | $ | 4,638 |   | $ | (4,570 | ) |
| Add:                          | Stock-based  compensation included in net income (loss) determined under intrinsic  value-based method, net of tax |                  | 523        |   | — |   | 773 |   |
| Deduct:                       | Stock-based  compensation determined under fair value-based method, net of tax                                     |                  | (788       | ) | (102 | ) | (136 | ) |
| Pro forma net income (loss)   |                                                                                                               | $                     | 15,851     |   | $ | 4,536 |   | $ | (3,933 | ) |

 

***3.******             ******Mergers***

 

*CypressMerger*

 

On January 23, 2004, CPI Holdco’s wholly-ownedsubsidiary, Merger Sub, merged with and into Holding pursuant to the terms ofthe Agreement and Plan of Merger (the “Merger Agreement”), dated as of November 17,2003, by and among Holding, CPI Holdco, Merger Sub and Green Equity InvestorsII, L.P., as the representative of the security holders of Holding, under whichCPI Holdco, Merger Sub’s parent corporation and a corporation controlled byaffiliates of Cypress, agreed to acquire Holding. In the Merger, each share ofHolding’s common stock and stock options outstanding immediately prior to theMerger, other than a portion of stock options held by certain members ofmanagement (which were converted into options to purchase shares of CPI Holdco)and other than any shares of common stock owned by Holding or CPI Holdco, wereconverted into the right to receive a pro rata portion of the aggregate mergerconsideration of $131.7 million. In connection with the Merger, CPI Holdco received anequity contribution of $100.0 million before expenses from affiliates ofCypress in exchange for 4,251,122 shares of common stock of CPI Holdco. Membersof management of Holding, as a result of rolling over their options to purchasecommon stock of Holding, received stock options to purchase 167,513 shares ofcommon stock of CPI Holdco (“Rollover Options”).  The estimated fair value of Rollover Optionswas $5.0 million and was accounted for as Merger purchase price as of January 23,2004.   Members of Holding managementthat were residents of Canada received 1,485 stock options to purchase sharesof common stock of CPI Holdco as payment of Merger escrow proceeds in respectof their options to purchase shares of Holding.

 

Inconnection with the Merger, Holding and Communications & PowerIndustries, Inc. (“CPI”) refinanced all of their outstandingindebtedness.  As part of therefinancing, CPI effected a covenant defeasance of $74.0 million outstanding

 

9

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aggregateprincipal amount of its 12% Senior Subordinated Notes (“12% Notes”) andredeemed the 12% Notes in full, each pursuant to the terms of the Indenturegoverning the 12% Notes. In addition, CPI terminated its credit facility, andHolding paid off all amounts owing under, and terminated, the loan agreementrelated to its San Carlos property. CPI also redeemed all of the outstandingshares of its 14% Junior Cumulative Preferred Stock and its Series B 14%Senior Redeemable Exchangeable Cumulative Preferred Stock.

 

TheMerger transaction was accounted for using the purchase method of accounting asrequired by the SFAS No.141, “Business Combinations”. Accordingly, the assetsacquired and liabilities assumed were recorded at fair value, and the excess ofthe purchase price over the fair value of the assets acquired was recorded asgoodwill. The allocation of the purchase price to specific assets andliabilities was based, in part, upon independent appraisals and internalestimates of cash flow and recoverability. The following table summarizes the final allocation of fair value of theassets acquired and liabilities assumed at January 23, 2004 (inthousands):

 
| Cash                                                     |   | $        | 13,866  |   |
|----------------------------------------------------------|--------|----------|---------|--------|
| Accounts receivable                                      |   | 29,587   |    |
| Inventory, including $5.5 million of fair value write-up |   | 43,608   |    |
| Other current assets                                     |   | 3,241    |    |
| Property, plant and equipment                            |   | 70,079   |    |
| Identifiable intangible assets                           |   | 92,160   |    |
| Acquired in-process research and development             |   | 2,500    |    |
| Goodwill                                                 |   | 139,614  |    |
| Debt and preferred stock                                 |   | (172,881 | )       |
| Deferred tax liabilities, net                            |   | (33,169  | )       |
| Other liabilities                                        |   | (56,934  | )       |
| Total                                                    |   | $        | 131,671 |   |
|                                                          |        |          |         |        |  |

 

The$2.5 million of acquired in-process research and development represents theestimated fair value of acquired in-process research and development projectsthat had not yet reached technological feasibility on January 23, 2004 andhad no alternative future use. Accordingly, this amount was written off at theMerger date.  The value assigned toacquired in-process research and development is related to technologyapplication projects involving development of Vacuum Electron Devices (“VEDs”)for communications, scientific and military applications and development ofpower supplies, x-ray generators and transmitters for industrial, medical andmilitary applications.

 

Thefollowing unaudited pro forma summary presents information as if the Merger hadtaken place at the beginning of each period presented. The pro forma amountsinclude certain adjustments, including depreciation based on the allocatedpurchase price of property and equipment, amortization of finite-livedintangible assets acquired, interest expense and taxes. One-time charges forthe inventory write-up, merger expenses, acquired in-process research anddevelopment and backlog amortization, net of applicable taxes, are excluded fromthe pro forma net income amounts (in thousands):

 
| ** **           | ** ** | **13-Week**           | ** ** | **13-Week**           | ** ** |
|----------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **           | ** ** | **period ended**      | ** ** | **period ended**      | ** ** |
| ** **           | ** ** | **July 1, 2005** | ** ** | **July 2, 2004** | ** ** |
| Sales                |       | $                     | 87,639     |                  | $          | 72,345 |   |
| Pro forma net income |       | $                     | 6,698      |                  | $          | 5,564 |   |
|                 |       |                  |       |                  |       |
| ** **           | ** ** | **39-Week**           | ** ** | **39-Week**           | ** ** |
| ** **           | ** ** | **period ended**      | ** ** | **period ended**      | ** ** |
| ** **           | ** ** | **July 1, 2005** | ** ** | **July 2, 2004** | ** ** |
| Sales                |       | $                     | 245,835    |                  | $          | 217,905 |   |
| Pro forma net income |       | $                     | 19,297     |                  | $          | 17,011 |   |
|                      |            |                       |            |                       |            |  |  |  |  |

 

*Corporate Reorganization*

 

On March 12, 2004, Holding was merged with and into its wholly-ownedsubsidiary, CPI, with CPI as the surviving

 

10

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corporation (the “Intercompany Merger”). As a result of the IntercompanyMerger, the corporate structure of the Company and its subsidiaries consists ofone parent holding corporation, CPI Holdco, and all of the obligations ofHolding existing prior to the Intercompany Merger became obligations of CPI.

 

***4.******             ******Inventories***

 

Inventoriesare stated at the lower of average cost or market (net realizable value).  The main components of inventories were asfollows (in thousands):

 
| ** **              | ** ** | **July 1,** | ** ** | **October 1,** | ** ** |
|-------------------------|------------|------------------|------------|---------------------|------------|
| ** **              | ** ** | **2005**         | ** ** | **2004**            | ** ** |
| Raw materials and parts |       | $                | 29,279     |                | $          | 23,500 |   |
| Work in process         |       | 10,995           |       | 10,067              |       |
| Finished goods          |       | 6,882            |       | 4,507               |       |
| Total                   |       | $                | 47,156     |                | $          | 38,074 |   |
|                         |            |                  |            |                     |            |  |  |  |

 

***5.******             ******Product Warranty***

 

TheCompany’s products are generally warranted for a variety of periods, typicallyone to three years or a predetermined product usage life.  The Company assesses the adequacy of itspreexisting warranty liabilities and adjusts the balance based on actualexperience and changes in future expectations. The following table reconciles the changes in the Company’s accruedwarranty (in thousands):

 
| ** **                    | ** ** | **13-Week**           | ** ** | **13-Week**           | ** ** | ** ** | ** ** |
|-------------------------------|------------|-----------------------|------------|-----------------------|------------|------------|------------|
| ** **                    | ** ** | **Period ended**      | ** ** | **Period ended**      | ** ** | ** ** | ** ** |
| ** **                    | ** ** | **July 1, 2005** | ** ** | **July 2, 2004** | ** ** | ** ** | ** ** |
| Beginning accrued warranty    |       | $                     | 5,666      |                  | $          | 5,889      |       |   |   |
| Cost of warranty claims       |       | (1,355                | )          | (1,421                | )          |       |       |
| Accruals for product warranty |       | 1,720                 |       | 1,546                 |       |       |       |
| Ending accrued warranty       |       | $                     | 6,031      |                  | $          | 6,014      |       |   |   |

 
| ** **                    | ** ** | **Fiscal Year**       | ** ** |
|-------------------------------|------------|-----------------------|------------|
| ** **                    | ** ** | **2005**              | ** ** | **2004** | ** ** |
| ** **                    | ** ** | **39-Week**           | ** ** | **January 23, 2004** | ** ** | **October 4, 2003** | ** ** |
| ** **                    | ** ** | **Period ended**      | ** ** | **to** | ** ** | **to** | ** ** |
| ** **                    | ** ** | **July 1, 2005** | ** ** | **July 2, 2004** | ** ** | **January 22, 2004** | ** ** |
| ** **                    | ** ** | **(Successor)**       | ** ** | **(Successor)** | ** ** | **(Predecessor)** | ** ** |
| Beginning accrued warranty    |       | $                     | 6,074      |   | $ | 5,839 |   | $ | 5,401 |   |
| Amount acquired from Econco   |       | 112                   |       | — |   | — |   |
| Cost of warranty claims       |       | (3,831                | )          | (2,247 | ) | (1,241 | ) |
| Accruals for product warranty |       | 3,676                 |       | 2,422 |   | 1,679 |   |
| Ending accrued warranty       |       | $                     | 6,031      |   | $ | 6,014 |   | $ | 5,839 |   |

 

***6.******             ******Long-Term Debt***

 

Long-termdebt comprises the following (in thousands):

 
| ** **                                                           | ** ** | **July 1, 2005** | ** ** | **October 1, 2004** | ** ** |
|----------------------------------------------------------------------|------------|-----------------------|------------|--------------------------|------------|
|                                                                 |       |                  |       |                     |       |
| Term loan, expiring 2010                                             |       | $                     | 80,000     |                     | $          | 89,550 |   |
| 8% Senior subordinated notes, due 2012                               |       | 125,000               |       | 125,000                  |       |
| Floating rate senior notes, due 2015, net of issue  discount of $782 |       | 79,218                |       | —                   |       |
|                                                                 |       | 284,218               |       | 214,550                  |       |
| Less: Current portion                                                |       | —                |       | 3,944                    |       |
|                                                                 |       | $                     | 284,218    |                     | $          | 210,606 |   |

 

11

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*Senior CreditFacility*

 

Inconnection with the Merger, CPI entered into a $130.0 million credit agreement(the “Senior Credit Facility”), which was amended and restated on November 29,2004, and further amended on February 16, 2005 and April 13, 2005.The Senior Credit Facility consists of a $40.0 million revolving commitment,with a sub-facility of $15.0 million for letters of credit and $5.0 million forswingline loans (“Revolver”), which expires on January 23, 2010, and anoriginal $90.0 million term loan (“Term Loan”), which expires on July 23,2010.  At July 1, 2005, the amountoutstanding for letters of credit was $4.7 million. The Senior Credit Facilityis guaranteed by CPI Holdco and all of CPI’s domestic subsidiaries and issecured by substantially all of their assets. The Senior Credit Facility provides that upon specified conditions, CPImay seek commitments for a new class of term loans, not to exceed $75 million.

 

TheRevolver borrowings currently bear interest at a rate equal to LIBOR plus 2.75%per annum or the Alternate Base Rate (“ABR”) plus 1.75% per annum.  The Term Loan borrowings currently bearinterest at a rate equal to LIBOR plus 2.25% per annum or the ABR plus 1.25%per annum, payable quarterly.  The ABR isthe greater of (a) the Prime Rate and (b) the Federal Funds Rate plus0*.*50%. As of July 1, 2005, the Term Loan borrowings comprised two tranchesof $40 million each; the first tranche is payable on August 11, 2005 at 5.25%per annum and the second tranche, also payable on August 11, 2005, at 5.50%per annum.  In addition to customaryfronting and administrative fees under the Senior Credit Facility, CPI paysletter of credit participation fees equal to the applicable Revolver LIBORmargin per annum on the average daily amount of the letter of credit exposure,and a commitment fee of 0.50% per annum on the average daily unused amount ofrevolving commitment.

 

TheTerm Loan requires 1.0% of the original loan amount to be repaid annually inquarterly installments of 0.25% beginning June 30, 2004 and continuing forfive years, with the remainder due in equal quarterly installmentsthereafter.  The Term Loan also requiresan annual prepayment to be made within 90 days after the end of the fiscal yearbased on a calculation of Excess Cash Flow (“ECF”), as defined in the SeniorCredit Facility, multiplied by a factor of 25%, 50% or 75% depending on theleverage ratio at the end of the fiscal year, less optional prepayments madeduring the fiscal year.  On December 30, 2004, CPI made an ECFpayment of $3.9 million.  The ECF paymentis applied pro rata, in accordance with the provisions of the Term Loan,against the remaining scheduled installments of principal due up to, but notincluding, the September 30, 2009 scheduled principal installment.   On March 30, 2005, CPI made an optionalprepayment of $5.7 million, in addition to the quarterly scheduled amortizationpayment.  The optional prepayment wasapplied pro rata, in accordance with the provisions of the Term Loan, againstthe remaining scheduled installments of principal due up to June 30, 2009,with the balance applied to the September 30, 2009 installment.  Based on a forecasted calculation of ECF, CPIdoes not anticipate that it will be required to make an ECF payment for thefiscal year ending September 30, 2005.

 

On February 16,2005, in connection with the offering of the FR Notes, CPI Holdco and itswholly owned subsidiary, CPI, entered into Amendment No.1 of the Senior CreditFacility.  Amendment No.1 permitted CPIHoldco to consummate the offering of the FR Notes.  In addition, among other things, AmendmentNo.1 (1) permits (subject to certain conditions) CPI to pay dividends toCPI Holdco to fund cash interest payments on the FR Notes, (2) amends thedefinition of Excess Cash Flow in CPI’s credit facility to decrease Excess CashFlow by the amount of dividends paid by CPI to CPI Holdco to fund cash interestpayments on the FR Notes, (3) subjects CPI Holdco to minimum interestcoverage ratio, minimum fixed charge coverage ratio and maximum leverage ratiofinancial maintenance covenants, calculated on a consolidated basis for CPIHoldco and its subsidiaries and (4) permits CPI to pay up to $1.0 millionannually in management fees to The Cypress Group L.L.C. and its affiliates(subject to certain conditions), in each case, subject to the qualificationsset forth in the Amendment.

 

On April 13,2005, CPI Holdco and its wholly owned subsidiary, CPI, entered into Amendment No. 2of the Senior Credit Facility.  AmendmentNo. 2 permits CPI Holdco to enter into agreements to hedge its interestrate exposure with respect to CPI Holdco’s FR Notes and provide cash collateralto the hedging counterparty to secure its obligations under any such hedgingagreement.  The agreement also permits, among other things, CPI to paycash dividends to CPI Holdco to allow CPI Holdco to satisfy its obligationsunder any such hedge agreement.

 

As of July 1, 2005, CPI was in compliance withall Senior Credit Facility financial covenants.

 

*8% Senior Subordinated Notes*

 

Inconnection with the Merger, CPI issued an aggregate principal amount of $125.0million of its 8% Senior Subordinated Notes due 2012 (“8% Notes”), which willmature in their entirety on February 1, 2012; there are no sinking fundrequirements. CPI is required to pay interest on the 8% Notes semiannually,beginning on August 1, 2004.

 

12

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*Floating Rate Senior Notes*

 

On February 22,2005, CPI Holdco issued $80.0 million in principal amount of Floating RateSenior Notes due 2015 (the “FR Notes”).  The FR Notes were issued at a 1%discount; the gross cash proceeds from the issuance of the FR Notes were $79.2million.  The proceeds from the issuance of FR Notes were used to make adistribution to stockholders of CPI Holdco of approximately $75.8 million andto pay fees and expenses of approximately $3.5 million associated with theissuance of FR Notes.

 

The FRNotes 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 the first day of August and February. CPIHoldco may, at its option, elect to pay interest through the issuance ofadditional FR Notes for any interest payment date on or after August 1,2006 and on or before February 1, 2010. If CPI Holdco elects to payinterest through the issuance of additional FR Notes, the annual interest rateon the FR Notes will increase by an additional 1% step-up, with the step-upincreasing by an additional 1% for each interest payment made through theissuance of additional FR Notes (up to a maximum of 4%). There are no sinkingfund requirements associated with the FR Notes, which will mature in theirentirety on February 1, 2015.

 

The FR Notes are general unsecured obligations of CPIHoldco.  The FR Notes are not guaranteedby any of CPI Holdco’s subsidiaries and are structurally subordinated to allexisting and future indebtedness and other liabilities of CPI Holdco’ssubsidiaries.  The FR Notes are senior inright of payment to CPI Holdco’s existing and future indebtedness that isexpressly subordinated to the FR Notes. The indenture governing the FR Notes (the “FR Indenture”) containscertain covenants that, among other things, limit the ability of CPI Holdco andits restricted subsidiaries (as defined in the FR Indenture) to incuradditional indebtedness, sell assets, consolidate or merge with or into othercompanies, pay dividends or repurchase or redeem capital stock, make certaininvestments, issue capital stock of their subsidiaries, incur liens and enterinto certain types of transactions with their affiliates.  In addition, the FR Indenture provides thatupon a change of control (as defined in the FR Indenture), subject to certainconditions and restrictions, the holders of the FR Notes will be entitled torequire CPI Holdco to purchase all or a portion of their FR Notes at a purchaseprice equal to 101% of the principal amount of the FR Notes, plus accrued andunpaid interest.

 

At any time or from time to time prior to February 1,2007, CPI Holdco, at its option, may redeem the FR Notes at a “make whole”premium, plus accrued and unpaid interest to the date of redemption.  At any time or from time to time after February 1,2007, CPI Holdco, at its option, may redeem the FR Notes in whole or in part atthe redemption prices (expressed as percentages of principal amount) set forthbelow, in each case, plus accrued and unpaid interest to the date ofredemption, if redeemed during the 12-month period beginning on February 1of the years indicated:

 
| **Dates**           | ** ** | **Optional Redemption  Prices** | ** ** |
|---------------------|------------|---------------------------------|------------|
| 2007                |       | 103                             | %          |
| 2008                |       | 102                             | %          |
| 2009                |       | 101                             | %          |
| 2010 and thereafter |       | 100                             | %          |

 

At any time or from time to time prior to February 1,2007, and subject to certain conditions, CPI Holdco, at its option, may redeemup to 35% of the aggregate principal amount of the FR Notes at a redemptionprice equal to 100% of the principal amount of the FR Notes to be redeemed,plus a premium equal to the interest rate per annum on the FR Notes applicableon the date on which the notice of redemption is given, plus accrued and unpaidinterest to the date of redemption, with the net cash proceeds of one or morequalified equity offerings.

 

Events of default under the FR Indenture include (1) failureto make payments on the FR Notes when due, (2) failure to comply withcovenants in the FR Indenture, (3) failure to pay other indebtedness ofCPI Holdco or any of its restricted subsidiaries in an aggregate amount of $25million or more, or any default under such indebtedness resulting in theacceleration of the maturity of such indebtedness or commencement of judicialproceedings to foreclose upon or to exercise remedies to take ownership of anyassets securing such indebtedness, (4) failure to pay or discharge anyfinal judgment in excess of $25 million (net of insurance) that has not beensatisfied, stayed, annulled or rescinded within 60 days of having been enteredagainst CPI Holdco or any of the restricted subsidiaries, and (5) theoccurrence of certain insolvency events.

 

13

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The Company’s registration statement filed with theSecurities and Exchange Commission relating to the offer to exchange alloutstanding FR Notes due 2015 for FR Notes due 2015 that have been registeredunder the Securities Act of 1933, as amended, was declared effective on April 21,2005.

 

***7.******             ******Financial Instruments***

 

TheCompany uses forward exchange contracts to address the foreign currency riskassociated with anticipated manufacturing costs in Canada.  As of July 1, 2005, CPI had outstandingforward contract commitments to purchase Canadian dollars for an aggregate U.S.notional amount of $18.1 million; the last forward contract expires on March 10,2006.  At July 1, 2005, the fairvalue of unrealized foreign currency forward contracts was $1.8 million and theunrealized gain was approximately $1.2 million, net of related tax expense. TheCompany anticipates recognizing the entire unrealized gain in operatingearnings within the next twelve months.  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”.

 

Theunrealized gains and losses from foreign exchange forward contracts areincluded in “Accumulated Other Comprehensive Income” in the CondensedConsolidated Balance Sheet, and the Company anticipates recognizing the entireunrealized gain in operating earnings within the next twelve months.  At July 1, 2005, the fair value offoreign currency forward contracts was $1.8 million and the unrealized gain wasapproximately $1.2 million, net of related tax expense.  Realized gains and losses from foreigncurrency exchange contracts are recognized in Cost of Sales and General andAdministrative in the Condensed Consolidated Statements of Operations andComprehensive Income as the foreign currency contracts are settled.  Realized gains and losses from foreigncurrency contracts are recognized in Cost of Sales and General andAdministrative in the Condensed Consolidated Statements of Operations andComprehensive Income as the foreign currency contracts are settled.  Net income includes forward currency gains of$0.3 million and $0.1 million for the 13-week periods ended July 1, 2005and July 2, 2004, respectively, $1.0 million for the 39-week period ended July 1,2005 and $0.1 million for the period from January 23, 2004 to July 2,2004.

 

In April 2005,the Company expanded its use of derivatives to address the interest rate riskassociated with the FR Notes expiring February 1, 2015.  On April 15, 2005, the Company enteredinto an $80 million interest rate swap contract (“the Swap”) to receivevariable rate 6-month LIBOR interest and pay 4.15% fixed rate interest.  The Swap is for semi-annual interestpayments, beginning with interest payments due on February 1, 2006, andthe contract matures on January 31, 2008. The Swap is designated as a cash flow hedge under SFAS No. 133, andthe gain and loss from changes in fair value is expected to be highly effectiveat offsetting the gain or loss from changes in fair value of the FR Notesattributable to changes in interest rates over the contract period.  As of July 1, 2005, the Company had paid$1.0 million as collateral for the Swap, which is included as Other Long-termAssets in the accompanying Condensed Consolidated Balance Sheets.  The amount of collateral fluctuates based onthe fair value of the Swap. The unrealized gains and losses from the Swapcontract are included in “Accumulated Other Comprehensive Income” in theCondensed Consolidated Balance Sheet.  AtJuly 1, 2005 the fair value of the Swap was not material.  The Company anticipates recognizing the unrealizedgain or loss on the Swap over the contract period to effectively replace thevariable interest rate on the FR Notes with the fixed interest rate of theSwap.

 

***8.******             ******Segments and Related Information***

 

TheCompany has two reportable segments: VEDs and satcom equipment.   Summarizedfinancial information concerning the Company’s reportable segments is shown inthe following table (in thousands): 

 

14

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| ** **                       | ** ** | **13-Week**           | ** ** | **13-Week**           | ** ** | ** ** | ** ** |
|----------------------------------|------------|-----------------------|------------|-----------------------|------------|------------|------------|
| ** **                       | ** ** | **Period ended**      | ** ** | **Period ended**      | ** ** | ** ** | ** ** |
| ** **                       | ** ** | **July 1, 2005** | ** ** | **July 2, 2004** | ** ** | ** ** | ** ** |
| Revenues from external customers |       |                  |       |                  |       |       |       |
| VEDs                             |       | $                     | 70,363     |                  | $          | 62,651     |       |   |   |
| Satcom equipment                 |       | 17,276                |       | 9,694                 |       |       |       |
| Total                            |       | $                     | 87,639     |                  | $          | 72,345     |       |   |   |
| Intersegment product transfers   |       |                  |       |                  |       |       |       |
| VEDs                             |       | $                     | 6,935      |                  | $          | 4,161      |       |   |   |
| Satcom equipment                 |       | 3                     |       | 2                     |       |       |       |
| Total                            |       | $                     | 6,938      |                  | $          | 4,163      |       |   |   |
| EBITDA                           |       |                  |       |                  |       |       |       |
| VEDs                             |       | $                     | 20,499     |                  | $          | 16,350     |       |   |   |
| Satcom equipment                 |       | 2,415                 |       | 262                   |       |       |       |
| Other                            |       | (3,705                | )          | 4,776                 |       |       |       |
| Total                            |       | $                     | 19,209     |                  | $          | 21,388     |       |   |   |

 
| ** **                       | ** ** | **Fiscal Year**       | ** ** |
|----------------------------------|------------|-----------------------|------------|
| ** **                       | ** ** | **2005**              | ** ** | **2004** | ** ** |
| ** **                       | ** ** | **39-Week**           | ** ** | **January 23, 2004** | ** ** | **October 4, 2003** | ** ** |
| ** **                       | ** ** | **Period ended**      | ** ** | **to** | ** ** | **to** | ** ** |
| ** **                       | ** ** | **July 1, 2005** | ** ** | **July 2, 2004** | ** ** | **January 22, 2004** | ** ** |
| ** **                       | ** ** | **(Successor)**       | ** ** | **(Successor)** | ** ** | **(Predecessor)** | ** ** |
| Revenues from external customers |       |                  |       |   |   |   |   |
| VEDs                             |       | $                     | 200,977    |   | $ | 118,489 |   | $ | 68,960 |   |
| Satcom equipment                 |       | 44,858                |       | 19,497 |   | 10,959 |   |
| Total                            |       | $                     | 245,835    |   | $ | 137,986 |   | $ | 79,919 |   |
| Intersegment product transfers   |       |                  |       |   |   |   |   |
| VEDs                             |       | $                     | 19,719     |   | $ | 7,749 |   | $ | 4,070 |   |
| Satcom equipment                 |       | 82                    |       | 9 |   | 11 |   |
| Total                            |       | $                     | 19,801     |   | $ | 7,758 |   | $ | 4,081 |   |
| EBITDA                           |       |                  |       |   |   |   |   |
| VEDs                             |       | $                     | 56,386     |   | $ | 34,201 |   | $ | 15,889 |   |
| Satcom equipment                 |       | 6,204                 |       | 1,220 |   | (229 | ) |
| Other                            |       | (9,457                | )          | (13,011 | ) | (9,111 | ) |
| Total                            |       | $                     | 53,133     |   | $ | 22,410 |   | $ | 6,549 |   |

 

Intersegmentproduct transfers are recorded at cost.

 

Includedin the “Other” category of EBITDA are unallocated corporate operating expensesand amortization of acquisition-related inventory write-up.  The “Other” category of EBITDA for the 13-Weekperiod ended July 2, 2004 also includes a $7.7 million credit thatincreases EBITDA for purchase accounting related to the $9.0 million adjustmentfor acquired in-process research and development, partially offset by a $1.3million inventory valuation charge.  The “Other”category of EBITDA for the period January 23, 2004 to July 2, 2004also includes purchase accounting adjustments of $5.5 million related to theinventory write-up and $2.5 million for acquired in-process research anddevelopment.  The “Other” category ofEBITDA for the period October 4, 2003 to January 22, 2004 alsoincludes $6.4 million of merger expenses.

 

Managementevaluates performance and allocates resources based on earnings before interestexpense, provision for income taxes, depreciation and amortization (“EBITDA”).  EBITDAis presented because the Company believes that EBITDA is used by some investorsas a financial indicator of a company’s ability to service indebtedness.  While management considers EBITDA to be animportant measure of comparative operating performance, it should be consideredin addition to, but not as a substitute for or superior to, operating income,net earnings (loss), cash flow and other measures of financial performanceprepared in accordance with accounting principles generally accepted in theUnited States.  EBITDA does not reflectcash available to fund cash requirements, and the items excluded from EBITDA,such as depreciation and amortization, are significant components in assessingthe Company’s financial performance. Other significant uses of cash flows are required before cash will beavailable to the Company including debt service, taxes and cash expendituresfor

 

15

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variouslong-term assets.  The Company’scalculation of EBITDA may be different from the calculation used by othercompanies and, therefore, comparability may be limited. A reconciliation ofEBITDA from reportable segments to income before taxes is as follows (inthousands):

 
| ** **                    | ** ** | **13-Week**           | ** ** | **13-Week**           | ** ** | ** ** | ** ** |
|-------------------------------|------------|-----------------------|------------|-----------------------|------------|------------|------------|
| ** **                    | ** ** | **Period ended**      | ** ** | **Period ended**      | ** ** | ** ** | ** ** |
| ** **                    | ** ** | **July 1, 2005** | ** ** | **July 2, 2004** | ** ** | ** ** | ** ** |
| EBITDA                        |       | $                     | 19,209     |                  | $          | 21,388     |       |   |   |
| Less:                         |       |                  |       |                  |       |       |       |
| Depreciation and amortization |       | 2,398                 |       | 5,853                 |       |       |       |
| Interest expense, net         |       | 5,697                 |       | 3,822                 |       |       |       |
| Income before income taxes    |       | $                     | 11,114     |                  | $          | 11,713     |       |   |   |

 
| ** **                        | ** ** | **Fiscal Year**       | ** ** |
|-----------------------------------|------------|-----------------------|------------|
| ** **                        | ** ** | **2005**              | ** ** | **2004** |
| ** **                        | ** ** | **39-Week**           | ** ** | **January 23, 2004** | ** ** | **October 4, 2003** | ** ** |
| ** **                        | ** ** | **Period ended**      | ** ** | **to** | ** ** | **to** | ** ** |
| ** **                        | ** ** | **July 1, 2005** | ** ** | **July 2, 2004** | ** ** | **January 22, 2004** | ** ** |
| ** **                        | ** ** | **(Successor)**       | ** ** | **(Successor)** | ** ** | **(Predecessor)** | ** ** |
| EBITDA                            |       | $                     | 53,133     |   | $ | 22,410 |   | $ | 6,549 |   |
| Less:                             |       |                  |       |   |   |   |   |
| Depreciation and amortization     |       | 11,767                |       | 10,271 |   | 1,778 |   |
| Interest expense, net             |       | 14,509                |       | 6,772 |   | 8,902 |   |
| Income (loss) before income taxes |       | $                     | 26,857     |   | $ | 5,367 |   | $ | (4,131 | ) |

 

Salesby geographic area to unaffiliated customers (based on the location ofcustomer) were as follows (in thousands):

 
| ** **            | ** ** | **13-Week**           | ** ** | **13-Week**           | ** ** | ** ** | ** ** |
|-----------------------|------------|-----------------------|------------|-----------------------|------------|------------|------------|
| ** **            | ** ** | **Period ended**      | ** ** | **Period ended**      | ** ** | ** ** | ** ** |
| ** **            | ** ** | **July 1, 2005** | ** ** | **July 2, 2004** | ** ** | ** ** | ** ** |
| United States         |       | $                     | 55,913     |                  | $          | 50,617     |       |   |   |
| All foreign countries |       | 31,726                |       | 21,728                |       |       |       |
| Total sales           |       | $                     | 87,639     |                  | $          | 72,345     |       |   |   |

 
| ** **            | ** ** | **Fiscal Year**       | ** ** |
|-----------------------|------------|-----------------------|------------|
| ** **            | ** ** | **2005**              | ** ** | **2004** | ** ** |
| ** **            | ** ** | **39-Week**           | ** ** | **January 23, 2004** | ** ** | **October 4, 2003** | ** ** |
| ** **            | ** ** | **Period ended**      | ** ** | **to** | ** ** | **to** | ** ** |
| ** **            | ** ** | **July 1, 2005** | ** ** | **July 2, 2004** | ** ** | **January 22, 2004** | ** ** |
| ** **            | ** ** | **(Successor)**       | ** ** | **(Successor)** | ** ** | **(Predecessor)** | ** ** |
| United States         |       | $                     | 162,391    |   | $ | 98,017 |   | $ | 52,417 |   |
| All foreign countries |       | 83,444                |       | 39,969 |   | 27,502 |   |
| Total sales           |       | $                     | 245,835    |   | $ | 137,986 |   | $ | 79,919 |   |

 

TheCompany had one customer, the United States Government, that accounted for 10%or more of consolidated sales.  Sales tothis customer were $15.5 million, and $17.0 million of the Company’sconsolidated sales for the 13-week periods ended July 1, 2005 and July 2,2004, respectively.  Sales to thiscustomer were $45.1 million, $30.8 million and $17.0 million of the Company’sconsolidated sales for the 39-week period ended July 1, 2005, the periodfrom January 23, 2004 to July 2, 2004, and the period from October 4,2003 to January 22, 2004, respectively. A substantial majority of these sales were VED segment products, butthis customer also purchased satcom equipment products.

 

**9.**              ***Goodwill and Other Intangible Assets***

 

*Goodwill*

 

Thefollowing table presents the changes in goodwill by reportable segment duringthe nine months ended July 1, 2005 (in thousands): 

 

16

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| ** **       | ** ** | **October 1,** | ** ** | ** **   | ** ** | **July 1,** | ** ** |
|------------------|------------|---------------------|------------|--------------|------------|------------------|------------|
| ** **       | ** ** | **2004**            | ** ** | **Acquired** | ** ** | **2005**         | ** ** |
| VED’s       |       | $                   | 125,769    |         | $          | 5,848            |       | $ | 131,617 |   |
| Satcom Equipment |       | 13,845              |       | —       |       | 13,845           |       |
| Total            |       | $                   | 139,614    |         | $          | 5,848            |       | $ | 145,462 |   |

 

Asmore fully described in Note 10 “Econco Acquisition”, goodwill acquired iscomprised of the excess of the purchase price for Econco Broadcast Service, Inc.over the fair value of the assets acquired.

 

*Intangible Assets*

 

Thefollowing table presents the details of the Company’s total purchasedintangible assets (in thousands):

 
| **July 1, 2005**              | ** ** | **Cost** | ** ** | **Accumulated  Amortization** | ** ** | **Net** | ** ** |
|------------------------------------|------------|----------|------------|-------------------------------|------------|---------|------------|
| Technology                         |       | $        | 58,500     |                          | $          | (2,804  | )          | $ | 55,696 |   |
| Customer backlog                   |       | 17,450   |       | (17,450                       | )          | —  |       |
| Land lease                         |       | 11,810   |       | (379                          | )          | 11,431  |       |
| Tradename                          |       | 5,800    |       | —                        |       | 5,800   |       |
| Customer list and programs         |       | 5,700    |       | (154                          | )          | 5,546   |       |
| Noncompete agreement               |       | 110      |       | (29                           | )          | 81      |       |
| Net identifiable intangible assets |       | $        | 99,370     |                          | $          | (20,816 | )          | $ | 78,554 |   |
|                               |       |     |       |                          |       |    |       |
| **October 1, 2004**           | ** ** | **Cost** | ** ** | **Accumulated  Amortization** | ** ** | **Net** | ** ** |
| Technology                         |       | $        | 58,500     |                          | $          | (1,350  | )          | $ | 57,150 |   |
| Customer backlog                   |       | 17,450   |       | (12,148                       | )          | 5,302   |       |
| Land lease                         |       | 11,810   |       | (181                          | )          | 11,629  |       |
| Tradename                          |       | 4,400    |       | —                        |       | 4,400   |       |
| Net identifiable intangible assets |       | $        | 92,160     |                          | $          | (13,679 | )          | $ | 78,481 |   |

 

Theestimated future amortization expense of purchased intangibles as of July 1,2005 was as follows (in thousands):

 
| **Fiscal Year**               | ** ** | **Amount** | ** ** |
|-------------------------------|------------|------------|------------|
| 2005 (remaining three months) |       | $          | 612        |   |
| 2006                          |       | 2,452      |       |
| 2007                          |       | 2,452      |       |
| 2008                          |       | 2,452      |       |
| 2009                          |       | 2,452      |       |
| Thereafter                    |       | 68,134     |       |
| Total                         |       | $          | 78,554     |   |

 

**10.****      *****Econco Acquisition***

 

On October 8,2004, the Company purchased all of the outstanding stock of Econco BroadcastService, Inc. (“Econco”) of Woodland, California for cash consideration ofapproximately $18.3 million.  Econco is aprovider of rebuilding service for VEDs, allowing broadcasters and other usersof these critical products to extend the life of their devices at a cost thatis lower than buying a new VED.

 

TheEconco acquisition was accounted for using the purchase method of accounting asrequired by Financial Accounting Standards Board (“FASB”) Statement No. 141,“Business Combinations.”  Accordingly, the assets and liabilities ofEconco were adjusted to their fair values and the excess of the purchase priceover the fair value of the assets acquired was recorded as goodwill. Theallocation of the purchase price to specific assets and liabilities was based,in part, upon independent appraisals and internal estimates of cash flow andrecoverability.

 

Underthe Econco purchase agreement, the Company was required to reimburse theselling shareholders of Econco for certain costs associated with a tax electionto treat the transaction as an asset sale. Included in the preliminary estimate

 

17

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of thefair value of the Econco assets was an accrual for the estimated amount of thereimbursement to the selling shareholders. During the third quarter of fiscal year 2005, the shareholders were paidfor costs associated with the tax election and the final estimate of the fairvalue of the Econco assets was computed. The final purchase price was $0.4 million lower than the preliminaryestimate.  The following table summarizesthe final allocation of fair value of the Econco assets acquired andliabilities assumed at October 8, 2004 (in thousands):

 
| Cash                                             |   | $      | 21     |   |
|--------------------------------------------------|--------|--------|--------|--------|
| Accounts receivable                              |   | 1,346  |   |
| Inventory, including $351 of fair value write-up |   | 1,919  |   |
| Property, plant and equipment                    |   | 3,239  |   |
| Identifiable intangible assets                   |   | 7,210  |   |
| Goodwill                                         |   | 5,848  |   |
| Current liabilities                              |   | (1,237 | )      |
| Total                                            |   | $      | 18,346 |   |

 

Thefollowing table presents details of the purchased intangible assets acquired(dollars in thousands):

 
| ** **                 | ** ** | **Estimated  Useful Life** | ** ** | **Amount** | ** ** |
|----------------------------|------------|----------------------------|------------|------------|------------|
| Non-compete agreement      |       | 5 years                    |       | $          | 110        |   |
| Tradename                  |       | indefinite                 |       | 1,400      |       |
| Customer list and programs |       | 25 years                   |       | 5,700      |       |
| Total                      |       |                       |       | $          | 7,210      |   |

 

TheCondensed Consolidated Financial Statements include Econco’s financial resultsfrom the acquisition date.  Pro formaresults of operations have not been presented because the effect of the Econcoacquisition was not material to the Company’s results.

 

***11.******      ******Stockholders’ Equity***

 

In February 2005,the Board of Directors declared a cash distribution to stockholders ofapproximately $75.8 million, which was essentially a return of capital.  The cash distribution was made on the basisof the stockholders’ relative ownership in CPI Holdco’s outstanding commonstock and was paid out of the net proceeds from the issuance of the $80 millionin principal amount of FR Notes.

 

As aresult of the cash distribution to stockholders, CPI Holdco adjusted theoptions outstanding under the Predecessor’s 2000 Stock Option Plan and CPIHoldco’s 2004 Stock Incentive Plan pursuant to the terms of those plans to reflectthe distribution made to the stockholders of CPI Holdco.  As a result of these adjustments, theexercise price of the options outstanding under these plans was adjusted bydividing the prior exercise price of such options by 1.781, the number of sharesissuable upon exercise of those options was adjusted by multiplying the numberof shares previously issuable pursuant to the options by 1.781, and the totalnumber of shares reserved for issuance under each such plan was also increasedby a factor of 1.781.  These adjustmentsincreased the number of options outstanding from approximately 526,000 to937,000 and reduced the range of exercise prices of the options outstandingfrom $1.10 to $36.00 down to $0.62 to $20.21.

 

Inaccordance with FASB Interpretation 44, “Accounting for Certain Transactionsinvolving Stock Compensation”, the Company determined that there were noaccounting consequences for the adjustments made to the number of optionsissued and exercise prices.  It wasdetermined that the aggregate intrinsic value of the stock options immediatelyafter the adjustment was not greater that aggregate intrinsic value of thestock options immediately before the adjustment and the ratio of exercise priceper share to the market value was not reduced.

 

***12.******      ******Recent Accounting Pronouncements***

 

In March 2004,the Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 03-01,“The Meaning of Other-Than-Temporary Impairment and Its Application to CertainInvestments” (“EITF 03-01”). EITF 03-01 provides guidance onother-than-temporary impairment models for marketable debt and equitysecurities accounted for under SFAS No. 115, “Accounting for CertainInvestments in Debt and Equity Securities” and non-marketable equity securitiesaccounted for under the cost method. The EITF developed a basic three-stepmodel to evaluate whether an investment is other-than-

 

18

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temporarilyimpaired. The FASB issued EITF 03-01-1 in September 2004, which delayedthe effective date of the recognition and measurement provisions of EITF 03-01.The Company does not expect the adoption of EITF 03-01 to have a materialimpact on our results of operations or financial condition.

 

In November 2004,the FASB issued SFAS No. 151, “Inventory Costs—an amendment of ARB No. 43,Chapter 4”, which is the result of the FASB’s project to reduce differencesbetween U.S. and international accounting standards. SFAS No. 151 requiresidle facility costs, abnormal freight, handling costs, and amounts of wastedmaterials (spoilage) be treated as current-period costs. Under this concept, ifthe costs associated with the actual level of spoilage or production defectsare greater than the costs associated with the range of normal spoilage ordefects, the difference would be charged to current-period expense, notincluded in inventory costs. The Company is required to adopt SFAS No. 151in the beginning of fiscal year 2006 and its adoption is not expected to have asignificant impact on the Company’s results of operations or financialcondition.

 

In December 2004,the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets – Anamendment of APB Opinion No. 29,” which eliminates the exception fornonmonetary exchanges of similar productive assets and replaces it with ageneral exception for exchanges of nonmonetary assets that do not havecommercial substance.  The Company isrequired to adopt SFAS No. 153 for nonmonetary asset exchanges occurringin the first quarter of 2006 and its adoption is not expected to have asignificant impact on the Company’s results of operations or financialcondition.

 

In December 2004,the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123R”).SFAS No. 123R requires companies to recognize in the income statement thegrant-date fair value of stock options and other equity-based compensationissued to employees, but expresses no preference for a type of valuation model.SFAS No. 123R eliminates the intrinsic value-based method prescribed byAccounting Principles Board Opinion No. 25, “Accounting for Stock Issuedto Employees”, and related interpretations, that the Company currently uses. Asa nonpublic entity as defined by SFAS No. 123R, the Company is required toadopt SFAS No. 123R in the beginning of fiscal year 2007.  The Company has not yet determined the impactof applying the provisions of SFAS No. 123R.

 

In March 2005,the FASB issued Interpretation No. 47, “Accounting for Conditional AssetRetirement Obligations,” which clarifies that an entity is required torecognize a liability for the fair value of a conditional asset retirementobligation if the fair value can be reasonably estimated even thoughuncertainty exists about the timing and (or) method of settlement.  The Company is required to adoptInterpretation No. 47 by the end of 2006. The Company has not yet determined the impact of applying the provisionsof Interpretation No. 47.

 

In May 2005,the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections.”  SFAS No. 154 replaces APB Opinion No. 20,“Accounting Changes,” and SFAS No. 3, “Reporting Accounting Changes inInterim Financial Statement,” and changes the requirements for the accountingfor and reporting of a change in accounting principle.  The Company is required to adopt SFAS No. 154for accounting changes and error corrections in fiscal year 2007.  The Company’s results of operations andfinancial condition will only be impacted by SFAS No. 154 if it implementschanges in accounting principle that are addressed by the standard or correctsaccounting errors in future periods.

 

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

 

On January 23,2004, CPI issued $125.0 million of 8% Notes that are guaranteed by CPI Holdcoand all of CPI’s domestic subsidiaries. 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 consolidating condensed financial statements of: (a) theparent, CPI Holdco or Holding, (b) the issuer, CPI, (c) the guarantorsubsidiaries, our domestic subsidiaries (d) the non-guarantorsubsidiaries, (e) the consolidating elimination entries, and (f) theconsolidated total.  The Predecessor “parent”is Holding, and the Successor “parent” is CPI Holdco. The accompanyingconsolidating condensed financial statements should be read in connection withthe consolidated financial statements of CPI Holdco.

 

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

 

19

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**CONDENSED CONSOLIDATING BALANCE SHEET**

**As of July 1, 2005 (Successor)**

(in thousands)

 
| ** **                                        | ** ** | **Parent**  | ** ** | ** ** | ** ** | ** **       | ** ** | ** **        | ** ** | ** **        | ** ** | ** **       | ** ** |
|---------------------------------------------------|------------|-------------|------------|------------|------------|------------------|------------|-------------------|------------|-------------------|------------|------------------|------------|
| ** **                                        | ** ** | **(CPI**    | ** ** | **Issuer** | ** ** | **Guarantor**    | ** ** | **Non-Guarantor** | ** ** | **Consolidating** | ** ** | **Consolidated** | ** ** |
| ** **                                        | ** ** | **Holdco)** | ** ** | **(CPI)**  | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**  | ** ** | **Eliminations**  | ** ** | **Total**        | ** ** |
|                                              |       |        |       |       |       |             |       |              |       |              |       |             |       |
| **Assets**                                        |       |        |       |       |       |             |       |              |       |              |       |             |       |
| Cash and cash equivalents                         |       | $           | 33         |       | 14,614     |             | 514        |              | 1,947      |              | —     |             | 17,108     |   |
| Restricted cash                                   |       | —      |       | —     |       | 1,911            |       | 108               |       | —            |       | 2,019            |       |
| Accounts receivable, net                          |       | —      |       | 25,865     |       | 6,819            |       | 15,707            |       | —            |       | 48,391           |       |
| Inventories                                       |       | —      |       | 31,651     |       | 1,350            |       | 14,155            |       | —            |       | 47,156           |       |
| Deferred tax assets                               |       | —      |       | 12,499     |       | —           |       | 36                |       | —            |       | 12,535           |       |
| Prepaids and other current assets                 |       | —      |       | 3,241      |       | 268              |       | 1,066             |       | —            |       | 4,575            |       |
| Intercompany receivable                           |       | —      |       | 27,079     |       | 370              |       | 685               |       | (28,134           | )          | —           |       |
| Total current assets                              |       | 33          |       | 114,949    |       | 11,232           |       | 33,704            |       | (28,134           | )          | 131,784          |       |
| Property, plant and equipment, net                |       | —      |       | 66,194     |       | 3,188            |       | 7,930             |       | —            |       | 77,312           |       |
| Debt issue costs, net                             |       | 3,381       |       | 8,035      |       | —           |       | —            |       | —            |       | 11,416           |       |
| Intangible assets, net                            |       | —      |       | 61,899     |       | 7,027            |       | 9,628             |       | —            |       | 78,554           |       |
| Goodwill                                          |       | —      |       | 92,041     |       | 5,848            |       | 47,573            |       | —            |       | 145,462          |       |
| Other long-term assets                            |       | 1,000       |       | 853        |       | —           |       | —            |       | —            |       | 1,853            |       |
| Intercompany notes receivable                     |       | —      |       | 9,535      |       | —           |       | —            |       | (9,535            | )          | —           |       |
| Investment in subsidiaries                        |       | 154,074     |       | 47,690     |       | —           |       | —            |       | (201,764          | )          | —           |       |
| Total assets                                      |       | $           | 158,488    |       | 401,196    |             | 27,295     |              | 98,835     |              | (239,433   | )                | 446,381    |   |
|                                              |       |        |       |       |       |             |       |              |       |              |       |             |       |
| **Liabilities and stockholders’  equity**    |       |        |       |       |       |             |       |              |       |              |       |             |       |
| Accounts payable                                  |       | $           | —     |       | 11,373     |             | 540        |              | 5,989      |              | —     |             | 17,902     |   |
| Accrued expenses                                  |       | 2,551       |       | 20,114     |       | 925              |       | 3,810             |       | —            |       | 27,400           |       |
| Product warranty                                  |       | —      |       | 3,469      |       | 176              |       | 2,386             |       | —            |       | 6,031            |       |
| Income taxes payable                              |       | —      |       | 1,187      |       | 605              |       | 4,059             |       | —            |       | 5,851            |       |
| Advance payments from customers                   |       | —      |       | 3,754      |       | 1,346            |       | 2,907             |       | —            |       | 8,007            |       |
| Intercompany payable                              |       | 28,134      |       | —     |       | —           |       | —            |       | (28,134           | )          | —           |       |
| Total current liabilities                         |       | 30,685      |       | 39,897     |       | 3,592            |       | 19,151            |       | (28,134           | )          | 65,191           |       |
| Deferred income taxes                             |       | —      |       | 29,215     |       | —           |       | 5,774             |       | —            |       | 34,989           |       |
| Advance payments from sale of San Carlos property |       | —      |       | 13,450     |       | —           |       | —            |       | —            |       | 13,450           |       |
| Long-term debt                                    |       | 79,218      |       | 205,000    |       | —           |       | —            |       | —            |       | 284,218          |       |
| Other long-term liabilities                       |       | —      |       | 84         |       | —           |       | —            |       | —            |       | 84               |       |
| Intercompany notes payable                        |       | —      |       | —     |       | —           |       | 9,535             |       | (9,535            | )          | —           |       |
| Total liabilities                                 |       | 109,903     |       | 287,646    |       | 3,592            |       | 34,460            |       | (37,669           | )          | 397,932          |       |
| Common stock                                      |       | 43          |       | —     |       | —           |       | —            |       | —            |       | 43               |       |
| Additional paid-in capital                        |       | 28,601      |       | —     |       | —           |       | —            |       | —            |       | 28,601           |       |
| Parent investment                                 |       | —      |       | 92,160     |       | 22,228           |       | 57,216            |       | (171,604          | )          | —           |       |
| Accumulated other comprehensive income            |       | 1,177       |       | 1,041      |       | —           |       | 287               |       | (1,464            | )          | 1,041            |       |
| Retained earnings                                 |       | 18,764      |       | 20,349     |       | 1,475            |       | 6,872             |       | (28,696           | )          | 18,764           |       |
| Net stockholders’ equity                     |       | 48,585      |       | 113,550    |       | 23,703           |       | 64,375            |       | (201,764          | )          | 48,449           |       |
| Total liabilities and stockholders’ equity   |       | $           | 158,488    |       | 401,196    |             | 27,295     |              | 98,835     |              | (239,433   | )                | 446,381    |   |

 

20

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**CONDENSED CONSOLIDATING BALANCE SHEET**

**As of October 1, 2004 (Successor)**

(in thousands)

 
| ** **                                        | ** ** | **Parent**  | ** ** | ** ** | ** ** | ** **       | ** ** | ** **        | ** ** | ** **        | ** ** | ** **       | ** ** |
|---------------------------------------------------|------------|-------------|------------|------------|------------|------------------|------------|-------------------|------------|-------------------|------------|------------------|------------|
| ** **                                        | ** ** | **(CPI**    | ** ** | **Issuer** | ** ** | **Guarantor**    | ** ** | **Non-Guarantor** | ** ** | **Consolidating** | ** ** | **Consolidated** | ** ** |
| ** **                                        | ** ** | **Holdco)** | ** ** | **(CPI)**  | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**  | ** ** | **Eliminations**  | ** ** | **Total**        | ** ** |
|                                              |       |        |       |       |       |             |       |              |       |              |       |             |       |
| **Assets**                                        |       |        |       |       |       |             |       |              |       |              |       |             |       |
| Cash and cash equivalents                         |       | $           | —     |       | 38,131     |             | 113        |              | 2,232      |              | —     |             | 40,476     |   |
| Restricted cash                                   |       | —      |       | —     |       | 2,188            |       | 91                |       | —            |       | 2,279            |       |
| Accounts receivable, net                          |       | —      |       | 21,424     |       | 3,806            |       | 10,684            |       | —            |       | 35,914           |       |
| Inventories                                       |       | —      |       | 28,916     |       | 99               |       | 9,059             |       | —            |       | 38,074           |       |
| Deferred tax assets                               |       | —      |       | 12,285     |       | —           |       | —            |       | —            |       | 12,285           |       |
| Prepaids and other current assets                 |       | —      |       | 3,066      |       | 168              |       | 570               |       | (8                | )          | 3,796            |       |
| Intercompany receivable                           |       | —      |       | 26,841     |       | —           |       | 1,730             |       | (28,571           | )          | —           |       |
| Total current assets                              |       | —      |       | 130,663    |       | 6,374            |       | 24,366            |       | (28,579           | )          | 132,824          |       |
| Property, plant and equipment, net                |       | —      |       | 62,162     |       | 22               |       | 7,943             |       | —            |       | 70,127           |       |
| Debt issue costs, net                             |       | —      |       | 8,910      |       | —           |       | —            |       | —            |       | 8,910            |       |
| Intangible assets, net                            |       | —      |       | 67,847     |       | —           |       | 10,634            |       | —            |       | 78,481           |       |
| Goodwill                                          |       | —      |       | 92,041     |       | —           |       | 47,573            |       | —            |       | 139,614          |       |
| Other long-term assets                            |       | —      |       | 1,251      |       | —           |       | —            |       | —            |       | 1,251            |       |
| Intercompany notes receivable                     |       | —      |       | 13,335     |       | —           |       | —            |       | (13,335           | )          | —           |       |
| Investment in subsidiaries                        |       | 135,688     |       | 21,073     |       | —           |       | —            |       | (156,761          | )          | —           |       |
| Total assets                                      |       | $           | 135,688    |       | 397,282    |             | 6,396      |              | 90,516     |              | (198,675   | )                | 431,207    |   |
|                                              |       |        |       |       |       |             |       |              |       |              |       |             |       |
| **Liabilities and stockholders’  equity**    |       |        |       |       |       |             |       |              |       |              |       |             |       |
| Current portion of long-term debt                 |       | $           | —     |       | 3,944      |             | —     |              | —     |              | —     |             | 3,944      |   |
| Accounts payable                                  |       | —      |       | 11,556     |       | 99               |       | 4,135             |       | —            |       | 15,790           |       |
| Accrued expenses                                  |       | —      |       | 17,449     |       | 561              |       | 2,929             |       | —            |       | 20,939           |       |
| Product warranty                                  |       | —      |       | 3,877      |       | —           |       | 2,197             |       | —            |       | 6,074            |       |
| Income taxes payable                              |       | —      |       | 1,274      |       | —           |       | 395               |       | (8                | )          | 1,661            |       |
| Advance payments from customers                   |       | —      |       | 6,463      |       | 1,012            |       | 4,556             |       | —            |       | 12,031           |       |
| Intercompany payable                              |       | 28,094      |       | —     |       | 477              |       | —            |       | (28,571           | )          | —           |       |
| Total current liabilities                         |       | 28,094      |       | 44,563     |       | 2,149            |       | 14,212            |       | (28,579           | )          | 60,439           |       |
| Deferred income taxes                             |       | —      |       | 32,936     |       | —           |       | 6,182             |       | —            |       | 39,118           |       |
| Advance payments from sale of San Carlos property |       | —      |       | 13,450     |       | —           |       | —            |       | —            |       | 13,450           |       |
| Long-term debt                                    |       | —      |       | 210,606    |       | —           |       | —            |       | —            |       | 210,606          |       |
| Intercompany notes payable                        |       | —      |       | —     |       | —           |       | 13,335            |       | (13,335           | )          | —           |       |
| Total liabilities                                 |       | 28,094      |       | 301,555    |       | 2,149            |       | 33,729            |       | (41,914           | )          | 323,613          |       |
| Common stock                                      |       | 43          |       | —     |       | —           |       | —            |       | —            |       | 43               |       |
| Additional paid-in capital                        |       | 103,534     |       | —     |       | —           |       | —            |       | —            |       | 103,534          |       |
| Parent investment                                 |       | —      |       | 91,710     |       | 3,882            |       | 56,790            |       | (152,382          | )          | —           |       |
| Accumulated other comprehensive income            |       | 1,369       |       | 1,369      |       | —           |       | 54                |       | (1,423            | )          | 1,369            |       |
| Retained earnings (deficit)                       |       | 2,648       |       | 2,648      |       | 365              |       | (57               | )          | (2,956            | )          | 2,648            |       |
| Net stockholders’ equity                     |       | 107,594     |       | 95,727     |       | 4,247            |       | 56,787            |       | (156,761          | )          | 107,594          |       |
| Total liabilities and stockholders’ equity   |       | $           | 135,688    |       | 397,282    |             | 6,396      |              | 90,516     |              | (198,675   | )                | 431,207    |   |
|                                              |       |        |       |       |       |             |       |              |       |              |       |             |       |

 

21

----

 

**CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS**

**For the 13-Week Period Ended July 1, 2005 (Succecessor)**

(inthousands)

 
| ** **                                                                    | ** ** | **Parent**  | ** ** | ** ** | ** ** | ** **       | ** ** | ** **        | ** ** | ** **        | ** ** | ** **       | ** ** |
|-------------------------------------------------------------------------------|------------|-------------|------------|------------|------------|------------------|------------|-------------------|------------|-------------------|------------|------------------|------------|
| ** **                                                                    | ** ** | **(CPI**    | ** ** | **Issuer** | ** ** | **Guarantor**    | ** ** | **Non-Guarantor** | ** ** | **Consolidating** | ** ** | **Consolidated** | ** ** |
| ** **                                                                    | ** ** | **Holdco)** | ** ** | **(CPI)**  | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**  | ** ** | **Eliminations**  | ** ** | **Total**        | ** ** |
| Sales                                                                         |       | $           | —     |       | 61,172     |             | 12,679     |              | 32,818     |              | (19,030    | )                | 87,639     |   |
| Cost of sales                                                                 |       | —      |       | 43,244     |       | 10,214           |       | 23,420            |       | (19,030           | )          | 57,848           |       |
| Gross profit                                                                  |       | —      |       | 17,928     |       | 2,465            |       | 9,398             |       | —            |       | 29,791           |       |
| Operating costs and expenses:                                                 |       |        |       |       |       |             |       |              |       |              |       |             |       |
| Research and development                                                      |       | —      |       | 606        |       | —           |       | 1,293             |       | —            |       | 1,899            |       |
| Selling and marketing                                                         |       | —      |       | 1,852      |       | 876              |       | 2,016             |       | —            |       | 4,744            |       |
| General and administrative                                                    |       | —      |       | 4,146      |       | 701              |       | 942               |       | —            |       | 5,789            |       |
| Amortization of acquisition-related intangible assets                         |       | —      |       | 334        |       | 63               |       | 151               |       | —            |       | 548              |       |
| Total operating costs and expenses                                            |       | —      |       | 6,938      |       | 1,640            |       | 4,402             |       | —            |       | 12,980           |       |
| Operating income                                                              |       | —      |       | 10,990     |       | 825              |       | 4,996             |       | —            |       | 16,811           |       |
| Interest expense (income), net                                                |       | 1,832       |       | 3,600      |       | (8               | )          | 273               |       | —            |       | 5,697            |       |
| (Loss) income before income tax expense and equity in  income of subsidiaries |       | (1,832      | )          | 7,390      |       | 833              |       | 4,723             |       | —            |       | 11,114           |       |
| Income tax (benefit) expense                                                  |       | (733        | )          | 2,820      |       | 441              |       | 1,888             |       | —            |       | 4,416            |       |
| Equity in income of subsidiaries                                              |       | 7,797       |       | 3,227      |       | —           |       | —            |       | (11,024           | )          | —           |       |
| Net income                                                                    |       | $           | 6,698      |       | 7,797      |             | 392        |              | 2,835      |              | (11,024    | )                | 6,698      |   |

 

**CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS**

**For the 13-Week Period Ended July 2, 2004 (Successor)**

(inthousands - unaudited)

 
| ** **                                                           | ** ** | **Parent**  | ** ** | ** ** | ** ** | ** **       | ** ** | ** **        | ** ** | ** **        | ** ** | ** **       | ** ** |
|----------------------------------------------------------------------|------------|-------------|------------|------------|------------|------------------|------------|-------------------|------------|-------------------|------------|------------------|------------|
| ** **                                                           | ** ** | **(CPI**    | ** ** | **Issuer** | ** ** | **Guarantor**    | ** ** | **Non-Guarantor** | ** ** | **Consolidating** | ** ** | **Consolidated** | ** ** |
| ** **                                                           | ** ** | **Holdco)** | ** ** | **(CPI)**  | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**  | ** ** | **Eliminations**  | ** ** | **Total**        | ** ** |
| Sales                                                                |       | $           | —     |       | 56,223     |             | 8,901      |              | 24,935     |              | (17,714    | )                | 72,345     |   |
| Cost of sales                                                        |       | —      |       | 39,235     |       | 7,870            |       | 19,721            |       | (17,714           | )          | 49,112           |       |
| Amortization of acquisition-related inventory write-up               |       | —      |       | 1,000      |       | —           |       | 280               |       | —            |       | 1,280            |       |
| Gross profit                                                         |       | —      |       | 15,988     |       | 1,031            |       | 4,934             |       | —            |       | 21,953           |       |
| Operating costs and expenses:                                        |       |        |       |       |       |             |       |              |       |              |       |             |       |
| Research and development                                             |       | —      |       | 555        |       | —           |       | 1,314             |       | —            |       | 1,869            |       |
| Selling and marketing                                                |       | —      |       | 1,813      |       | 534              |       | 1,509             |       | —            |       | 3,856            |       |
| General and administrative                                           |       | —      |       | 3,964      |       | 80               |       | 967               |       | —            |       | 5,011            |       |
| Amortization of acquisition-related intangible assets                |       | —      |       | 3,988      |       | —           |       | 694               |       | —            |       | 4,682            |       |
| Acquired in-process research and development                         |       | —      |       | (4,485     | )          | —           |       | (4,515            | )          | —            |       | (9,000           | )          |
| Total operating costs and expenses                                   |       | —      |       | 5,835      |       | 614              |       | (31               | )          | —            |       | 6,418            |       |
| Operating income                                                     |       | —      |       | 10,153     |       | 417              |       | 4,965             |       | —            |       | 15,535           |       |
| Interest expense (income), net                                       |       | —      |       | 3,387      |       | (3               | )          | 438               |       | —            |       | 3,822            |       |
| Income before income tax expense and equity in loss of  subsidiaries |       | —      |       | 6,766      |       | 420              |       | 4,527             |       | —            |       | 11,713           |       |
| Income tax expense (benefit)                                         |       | —      |       | 583        |       | 4                |       | (345              | )          | —            |       | 242              |       |
| Equity in income of subsidiaries                                     |       | 11,471      |       | 5,288      |       | —           |       | —            |       | (16,759           | )          | —           |       |
| Net income                                                           |       | $           | 11,471     |       | 11,471     |             | 416        |              | 4,872      |              | (16,759    | )                | 11,471     |   |

 

22

----

 

**CONDENSEDCONSOLIDATING STATEMENT OF OPERATIONS**

**For the 39-Week Period Ended July 1, 2005 (Succecessor)**

(inthousands)

 
| ** **                                                                    | ** ** | **Parent**  | ** ** | ** ** | ** ** | ** **       | ** ** | ** **        | ** ** | ** **        | ** ** | ** **       | ** ** |
|-------------------------------------------------------------------------------|------------|-------------|------------|------------|------------|------------------|------------|-------------------|------------|-------------------|------------|------------------|------------|
| ** **                                                                    | ** ** | **(CPI**    | ** ** | **Issuer** | ** ** | **Guarantor**    | ** ** | **Non-Guarantor** | ** ** | **Consolidating** | ** ** | **Consolidated** | ** ** |
| ** **                                                                    | ** ** | **Holdco)** | ** ** | **(CPI)**  | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**  | ** ** | **Eliminations**  | ** ** | **Total**        | ** ** |
| Sales                                                                         |       | $           | —     |       | 174,738    |             | 33,934     |              | 88,636     |              | (51,473    | )                | 245,835    |   |
| Cost of sales                                                                 |       | —      |       | 123,035    |       | 27,507           |       | 63,843            |       | (51,473           | )          | 162,912          |       |
| Amortization of acquisition-related inventory write-up                        |       | —      |       | —     |       | 351              |       | —            |       | —            |       | 351              |       |
| Gross profit                                                                  |       | —      |       | 51,703     |       | 6,076            |       | 24,793            |       | —            |       | 82,572           |       |
| Operating costs and expenses:                                                 |       |        |       |       |       |             |       |              |       |              |       |             |       |
| Research and development                                                      |       | —      |       | 1,797      |       | —           |       | 3,408             |       | —            |       | 5,205            |       |
| Selling and marketing                                                         |       | —      |       | 5,547      |       | 2,522            |       | 5,328             |       | —            |       | 13,397           |       |
| General and administrative                                                    |       | —      |       | 10,438     |       | 1,538            |       | 3,688             |       | —            |       | 15,664           |       |
| Amortization of acquisition-related intangible assets                         |       | —      |       | 5,751      |       | 183              |       | 1,006             |       | —            |       | 6,940            |       |
| Total operating costs and expenses                                            |       | —      |       | 23,533     |       | 4,243            |       | 13,430            |       | —            |       | 41,206           |       |
| Operating income                                                              |       | —      |       | 28,170     |       | 1,833            |       | 11,363            |       | —            |       | 41,366           |       |
| Interest expense (income), net                                                |       | 2,643       |       | 11,044     |       | (23              | )          | 845               |       | —            |       | 14,509           |       |
| (Loss) income before income tax expense and equity in  income of subsidiaries |       | (2,643      | )          | 17,126     |       | 1,856            |       | 10,518            |       | —            |       | 26,857           |       |
| Income tax (benefit) expense                                                  |       | (1,057      | )          | 7,151      |       | 746              |       | 3,901             |       | —            |       | 10,741           |       |
| Equity in income of subsidiaries                                              |       | 17,702      |       | 7,727      |       | —           |       | —            |       | (25,429           | )          | —           |       |
| Net income                                                                    |       | $           | 16,116     |       | 17,702     |             | 1,110      |              | 6,617      |              | (25,429    | )                | 16,116     |   |

 

23

----

 

**CONDENSEDCONSOLIDATING STATEMENT OF OPERATIONS**

**From January 23, 2004 to July 2, 2004 (Successor)**

(inthousands - unaudited)

 
| ** **                                                      | ** ** | **Parent**  | ** ** | ** ** | ** ** | ** **       | ** ** | ** **        | ** ** | ** **        | ** ** | ** **       | ** ** |
|-----------------------------------------------------------------|------------|-------------|------------|------------|------------|------------------|------------|-------------------|------------|-------------------|------------|------------------|------------|
| ** **                                                      | ** ** | **(CPI**    | ** ** | **Issuer** | ** ** | **Guarantor**    | ** ** | **Non-Guarantor** | ** ** | **Consolidating** | ** ** | **Consolidated** | ** ** |
| ** **                                                      | ** ** | **Holdco)** | ** ** | **(CPI)**  | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**  | ** ** | **Eliminations**  | ** ** | **Total**        | ** ** |
| Sales                                                           |       | $           | —     |       | 105,192    |             | 15,579     |              | 47,163     |              | (29,948    | )                | 137,986    |   |
| Cost of sales                                                   |       | —      |       | 71,809     |       | 13,815           |       | 35,243            |       | (29,948           | )          | 90,919           |       |
| Amortization of acquisition-related inventory write-up          |       | —      |       | 4,300      |       | —           |       | 1,200             |       | —            |       | 5,500            |       |
| Gross profit                                                    |       | —      |       | 29,083     |       | 1,764            |       | 10,720            |       | —            |       | 41,567           |       |
| Operating costs and expenses:                                   |       |        |       |       |       |             |       |              |       |              |       |             |       |
| Research and development                                        |       | —      |       | 933        |       | —           |       | 2,400             |       | —            |       | 3,333            |       |
| Selling and marketing                                           |       | —      |       | 3,304      |       | 1,000            |       | 2,690             |       | —            |       | 6,994            |       |
| General and administrative                                      |       | —      |       | 6,099      |       | 396              |       | 2,028             |       | —            |       | 8,523            |       |
| Amortization of acquisition-related intangible assets           |       | —      |       | 7,084      |       | —           |       | 994               |       | —            |       | 8,078            |       |
| Acquired in-process research and development                    |       | —      |       | 1,415      |       | —           |       | 1,085             |       | —            |       | 2,500            |       |
| Total operating costs and expenses                              |       | —      |       | 18,835     |       | 1,396            |       | 9,197             |       | —            |       | 29,428           |       |
| Operating income                                                |       | —      |       | 10,248     |       | 368              |       | 1,523             |       | —            |       | 12,139           |       |
| Interest expense (income), net                                  |       | —      |       | 6,003      |       | (4               | )          | 773               |       | —            |       | 6,772            |       |
| Income before income tax expense and equity in of  subsidiaries |       | —      |       | 4,245      |       | 372              |       | 750               |       | —            |       | 5,367            |       |
| Income tax expense (benefit)                                    |       | —      |       | 1,194      |       | 11               |       | (476              | )          | —            |       | 729              |       |
| Equity in income of subsidiaries                                |       | 4,638       |       | 1,587      |       | —           |       | —            |       | (6,225            | )          | —           |       |
| Net income                                                      |       | $           | 4,638      |       | 4,638      |             | 361        |              | 1,226      |              | (6,225     | )                | 4,638      |   |

 

**CONDENSEDCONSOLIDATING STATEMENT OF OPERATIONS**

**From October 4, 2003 to January 22, 2004(Predecessor)**

(inthousands - unadudited)

 
| ** **                                                                    | ** ** | **Parent**   | ** ** | ** ** | ** ** | ** **       | ** ** | ** **        | ** ** | ** **        | ** ** | ** **       | ** ** |
|-------------------------------------------------------------------------------|------------|--------------|------------|------------|------------|------------------|------------|-------------------|------------|-------------------|------------|------------------|------------|
| ** **                                                                    | ** ** | **(CPI**     | ** ** | **Issuer** | ** ** | **Guarantor**    | ** ** | **Non-Guarantor** | ** ** | **Consolidating** | ** ** | **Consolidated** | ** ** |
| ** **                                                                    | ** ** | **Holding)** | ** ** | **(CPI)**  | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**  | ** ** | **Eliminations**  | ** ** | **Total**        | ** ** |
| Sales                                                                         |       | $            | —     |       | 60,721     |             | 10,673     |              | 26,470     |              | (17,945    | )                | 79,919     |   |
| Cost of sales                                                                 |       | —       |       | 43,551     |       | 9,448            |       | 21,223            |       | (18,033           | )          | 56,189           |       |
| Gross profit                                                                  |       | —       |       | 17,170     |       | 1,225            |       | 5,247             |       | 88                |       | 23,730           |       |
| Operating costs and expenses:                                                 |       |         |       |       |       |             |       |              |       |              |       |             |       |
| Research and development                                                      |       | —       |       | 607        |       | —           |       | 1,593             |       | —            |       | 2,200            |       |
| Selling and marketing                                                         |       | —       |       | 2,136      |       | 591              |       | 1,678             |       | (53               | )          | 4,352            |       |
| General and administrative                                                    |       | 355          |       | 4,973      |       | 236              |       | 1,508             |       | (1,039            | )          | 6,033            |       |
| Merger expenses                                                               |       | 5,074        |       | 1,300      |       | —           |       | —            |       | —            |       | 6,374            |       |
| Intercompany income                                                           |       | (755         | )          | (215       | )          | (53              | )          | —            |       | 1,023             |       | —           |       |
| Total operating costs and expenses                                            |       | 4,674        |       | 8,801      |       | 774              |       | 4,779             |       | (69               | )          | 18,959           |       |
| Operating (loss) income                                                       |       | (4,674       | )          | 8,369      |       | 451              |       | 468               |       | 157               |       | 4,771            |       |
| Interest expense (income), net                                                |       | 590          |       | 7,731      |       | (3               | )          | 584               |       | —            |       | 8,902            |       |
| (Loss) income before income tax expense and equity in  income of subsidiaries |       | (5,264       | )          | 638        |       | 454              |       | (116              | )          | 157               |       | (4,131           | )          |
| Income tax expense                                                            |       | —       |       | 334        |       | 55               |       | 50                |       | —            |       | 439              |       |
| Equity in income of subsidiaries                                              |       | 694          |       | 321        |       | —           |       | —            |       | (1,015            | )          | —           |       |
| Net (loss) income                                                             |       | $            | (4,570     | )          | 625        |             | 399        |              | (166       | )                 | (858       | )                | (4,570     | ) |

 

24

----

 

**CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS**

**For the 39-Week Period Ended July 1, 2005(Successor)**

(inthousands)

 
| ** **                                                 | ** ** | **Parent**  | ** ** | ** ** | ** ** | ** **       | ** ** | ** **        | ** ** | ** **        | ** ** | ** **       | ** ** |
|------------------------------------------------------------|------------|-------------|------------|------------|------------|------------------|------------|-------------------|------------|-------------------|------------|------------------|------------|
| ** **                                                 | ** ** | **(CPI**    | ** ** | **Issuer** | ** ** | **Guarantor**    | ** ** | **Non-Guarantor** | ** ** | **Consolidating** | ** ** | **Consolidated** | ** ** |
| ** **                                                 | ** ** | **Holdco)** | ** ** | **(CPI)**  | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**  | ** ** | **Eliminations**  | ** ** | **Total**        | ** ** |
| **OPERATING ACTIVITIES**                                   |       |        |       |       |       |             |       |              |       |              |       |             |       |
| Net cash provided by operating activities                  |       | $           | 1,097      |       | 13,519     |             | 553        |              | 114        |              | —     |             | 15,283     |   |
| **INVESTING ACTIVITIES**                                   |       |        |       |       |       |             |       |              |       |              |       |             |       |
| Expenses relating to sale of San Carlos property           |       | —      |       | (216       | )          | —           |       | —            |       | —            |       | (216             | )          |
| Purchase of Econco’s net assets, net of cash acquired |       | —      |       | (18,325    | )          | —           |       | —            |       | —            |       | (18,325          | )          |
| Purchase of property, plant, and equipment                 |       | —      |       | (8,336     | )          | (132             | )          | (399              | )          | —            |       | (8,867           | )          |
| Other investing activities                                 |       | —      |       | (16        | )          | —           |       | —            |       | —            |       | (16              | )          |
| Net cash used in investing activities                      |       | —      |       | (26,893    | )          | (132             | )          | (399              | )          | —            |       | (27,424          | )          |
| **FINANCING ACTIVITIES**                                   |       |        |       |       |       |             |       |              |       |              |       |             |       |
| Proceeds from issuance of floating rate senior notes       |       | 79,200      |       | —     |       | —           |       | —            |       | —            |       | 79,200           |       |
| Payments for debt issuance costs                           |       | (3,455      | )          | —     |       | —           |       | —            |       | —            |       | (3,455           | )          |
| Repayments on senior term loan                             |       | —      |       | (9,550     | )          | —           |       | —            |       | —            |       | (9,550           | )          |
| Stockholder distribution payments                          |       | (75,809     | )          | —     |       | —           |       | —            |       | —            |       | (75,809          | )          |
| Payment of collateral on interest rate swap contract       |       | (1,000      | )          | —     |       | —           |       | —            |       | —            |       | (1,000           | )          |
| Other financing activities                                 |       | —      |       | (80        | )          | (20              | )          | —            |       | —            |       | (100             | )          |
| Net repayments from bank overdraft                         |       | —      |       | (513       | )          | —           |       | —            |       | —            |       | (513             | )          |
| Net cash used in financing activities                      |       | (1,064      | )          | (10,143    | )          | (20              | )          | —            |       | —            |       | (11,227          | )          |
| **NET INCREASE (DECREASE) IN CASH  AND CASH EQUIVALENTS**  |       | 33          |       | (23,517    | )          | 401              |       | (285              | )          | —            |       | (23,368          | )          |
| Cash and cash equivalents at beginning of period           |       | —      |       | 38,131     |       | 113              |       | 2,232             |       | —            |       | 40,476           |       |
| Cash and cash equivalents at end of period                 |       | $           | 33         |       | 14,614     |             | 514        |              | 1,947      |              | —     |             | 17,108     |   |

 

25

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**CONDENSEDCONSOLIDATING STATEMENT OF CASH FLOWS**

**From January 23, 2004 to July 2, 2004 (Successor)**

(inthousands - unaudited)

 
| ** **                                                       | ** ** | **Parent**  | ** ** | ** ** | ** ** | ** **       | ** ** | ** **        | ** ** | ** **        | ** ** | ** **       | ** ** |
|------------------------------------------------------------------|------------|-------------|------------|------------|------------|------------------|------------|-------------------|------------|-------------------|------------|------------------|------------|
| ** **                                                       | ** ** | **(CPI**    | ** ** | **Issuer** | ** ** | **Guarantor**    | ** ** | **Non-Guarantor** | ** ** | **Consolidating** | ** ** | **Consolidated** | ** ** |
| ** **                                                       | ** ** | **Holdco)** | ** ** | **(CPI)**  | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**  | ** ** | **Eliminations**  | ** ** | **Total**        | ** ** |
| **OPERATING ACTIVITIES**                                         |       |        |       |       |       |             |       |              |       |              |       |             |       |
| Net cash provided by (used in) operating activities              |       | $           | 15,685     |       | (11,019    | )                | 2,917      |              | 3,881      |              | —     |             | 11,464     |   |
| **INVESTING ACTIVITIES**                                         | ** ** | ** **  | ** ** | ** ** | ** ** | ** **       | ** ** | ** **        | ** ** | ** **        | ** ** | ** **       | ** ** |
| Purchase of Predecessor’s net assets, net of cash  acquired |       | (113,760    | )          | —     |       | —           |       | —            |       | —            |       | (113,760         | )          |
| Purchase of property, plant and equipment, net                   |       | —      |       | (1,102     | )          | (13              | )          | (107              | )          | —            |       | (1,222           | )          |
| Net cash used in investing activities                            |       | (113,760    | )          | (1,102     | )          | (13              | )          | (107              | )          | —            |       | (114,982         | )          |
| **FINANCING ACTIVITIES**                                         |       |        |       |       |       |             |       |              |       |              |       |             |       |
| Retirement of debt and preferred stock:                          |       |        |       |       |       |             |       |              |       |              |       |             |       |
| Senior subordinated notes                                        |       | —      |       | (74,000    | )          | —           |       | —            |       | —            |       | (74,000          | )          |
| Senior redeemable preferred stock                                |       | —      |       | (29,735    | )          | —           |       | —            |       | —            |       | (29,735          | )          |
| Junior preferred stock                                           |       | —      |       | (32,336    | )          | —           |       | —            |       | —            |       | (32,336          | )          |
| Dividends on senior preferred stock                              |       | —      |       | (19,310    | )          | —           |       | —            |       | —            |       | (19,310          | )          |
| Mortgage financing                                               |       | —      |       | (17,500    | )          | —           |       | —            |       | —            |       | (17,500          | )          |
| Proceeds from/(payments for) the issuance of debt:               |       |        |       |       |       |             |       |              |       |              |       |             |       |
| Senior subordinated notes                                        |       | —      |       | 125,000    |       | —           |       | —            |       | —            |       | 125,000          |       |
| Senior term loans                                                |       | —      |       | 90,000     |       | —           |       | —            |       | —            |       | 90,000           |       |
| Debt issue costs                                                 |       | —      |       | (9,648     | )          | —           |       | —            |       | —            |       | (9,648           | )          |
| Proceeds from the repayment of Predecessor management  loans     |       | —      |       | 1,266      |       | —           |       | —            |       | —            |       | 1,266            |       |
| Net proceeds from the issuance of common stock                   |       | 98,075      |       |       |       |             |       |              |       |              |       | 98,075           |       |
| Repayments on senior term loan                                   |       | —      |       | (225       | )          |             |       |              |       |              |       | (225             | )          |
| Net proceeds from bank overdraft                                 |       | —      |       | 2,150      |       | —           |       | —            |       | —            |       | 2,150            |       |
| Net cash provided by financing activities                        |       | 98,075      |       | 35,662     |       | —           |       | —            |       | —            |       | 133,737          |       |
| **NET INCREASE IN CASH AND CASH  EQUIVALENTS**                   |       | —      |       | 23,541     |       | 2,904            |       | 3,774             |       | —            |       | 30,219           |       |
| Cash and cash equivalents at beginning of period                 |       | —      |       | —     |       | —           |       | —            |       | —            |       | —           |       |
| Cash and cash equivalents at end of period                       |       | $           | —     |       | 23,541     |             | 2,904      |              | 3,774      |              | —     |             | 30,219     |   |

 

**CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS**

**From October 4, 2003 to January 22, 2004(Predecessor)**

(inthousands - unaudited)

 
| ** **                                                | ** ** | **Parent**   | ** ** | ** ** | ** ** | ** **       | ** ** | ** **        | ** ** | ** **        | ** ** | ** **       | ** ** |
|-----------------------------------------------------------|------------|--------------|------------|------------|------------|------------------|------------|-------------------|------------|-------------------|------------|------------------|------------|
| ** **                                                | ** ** | **(CPI**     | ** ** | **Issuer** | ** ** | **Guarantor**    | ** ** | **Non-Guarantor** | ** ** | **Consolidating** | ** ** | **Consolidated** | ** ** |
| ** **                                                | ** ** | **Holding)** | ** ** | **(CPI)**  | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**  | ** ** | **Eliminations**  | ** ** | **Total**        | ** ** |
| **OPERATING ACTIVITIES**                                  |       |         |       |       |       |             |       |              |       |              |       |             |       |
| Net cash provided by (used in) operating activities       |       | $            | —     |       | 8,152      |             | 206        |              | (145       | )                 | —     |             | 8,213      |   |
| **INVESTING ACTIVITIES**                                  |       |         |       |       |       |             |       |              |       |              |       |             |       |
| Purchase of property, plant and equipment, net            |       | —       |       | (416       | )          | (2               | )          | (41               | )          | —            |       | (459             | )          |
| Retirement of senior subordinated notes                   |       | —       |       | (26,000    | )          | —           |       | —            |       | —            |       | (26,000          | )          |
| Net repayment of bank overdraft                           |       | —       |       | (1,639     | )          | —           |       | —            |       | —            |       | (1,639           | )          |
| Net cash used in financing activities                     |       | —       |       | (27,639    | )          | —           |       | —            |       | —            |       | (27,639          | )          |
| **NET (DECREASE) INCREASE IN CASH  AND CASH EQUIVALENTS** |       | —       |       | (19,903    | )          | 204              |       | (186              | )          | —            |       | (19,885          | )          |
| Cash and cash equivalents at beginning of period          |       | —       |       | 30,561     |       | 1,718            |       | 1,472             |       | —            |       | 33,751           |       |
| Cash and cash equivalents at end of period                |       | $            | —     |       | 10,658     |             | 1,922      |              | 1,286      |              | —     |             | 13,866     |   |

 

26

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**ITEM 2: MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

***Overview***

* *

*Thefollowing discussion and analysis should be read in conjunction with theCondensed Consolidated Financial Statements and notes thereto includedelsewhere within this report and the Annual Report on Form 10-K of CPIHoldco, Inc. (“CPI Holdco” or the “Successor”) for the fiscal year ended October 1,2004.  References to the “Company” referto Communications & Power Industries Holding Corporation (“Holding orthe “Predecessor”) and its subsidiaries prior to the Merger (defined below) andto the Successor and its subsidiaries post-Merger.*

* *

TheCompany is a leading designer, manufacturer and global marketer of vacuumelectron devices (“VEDs”), satellite communications amplifiers, medical x-raygenerators and other related products for critical defense and commercialapplications. The Company’s defense applications include radar, electronicwarfare and communications end markets and its commercial applications includecommunications, medical, industrial and scientific end markets. Communicationsapplications consist of applications for military and commercial satellitecommunications uses and broadcast uses. The Company defines and discusses itsrecorded orders and sales trends by these end markets in order to more clearlyrelate its business to outside investors. Internally, however, the Company isorganized into six operating divisions that are differentiated based onproducts operating in two segments.  TheCompany’s VED segment consists of five operating divisions.  The Company also has a satellitecommunications equipment segment that has one operating division.  Segment data is included in Note 8 of theNotes to Condensed Consolidated Financial Statements.

 

*Floating RateSenior Notes*

 

On February 22,2005, CPI Holdco issued $80 million in principal amount of Floating RateSenior Notes due 2015 (the “FR Notes”).  The FR Notes were issued at a 1%discount; the gross cash proceeds from the issuance of FR Notes were $79.2million.   The proceeds from the issuance of FR Notes were used tomake a distribution to stockholders of CPI Holdco of approximately $75.8million and to pay fees and expenses of approximately $3.5 million associatedwith the issuance of FR Notes.

 

The FRNotes 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. CPI Holdco may, at its option, elect to payinterest through the issuance of additional FR Notes for any interest paymentdate on or after August 1, 2006 and on or before February 1, 2010. IfCPI Holdco elects to pay interest through the issuance of additional FR Notes, theannual interest rate on the FR Notes will increase by an additional 1% step-up,with the step-up increasing by an additional 1% for each interest payment madethrough the issuance of additional FR Notes (up to a maximum of 4%).

 

The FRNotes are general unsecured obligations of CPI Holdco.  The FR Notes are not guaranteed by any of CPIHoldco’s subsidiaries and are structurally subordinated to all existing andfuture indebtedness and other liabilities of CPI Holdco’s subsidiaries.  The FR Notes are senior in right of paymentto the Company’s existing and future indebtedness that is expresslysubordinated to the FR Notes.  See Note 6to the Condensed Consolidated Financial Statements.

 

The Company’s registration statement filed with theSecurities and Exchange Commission relating to the offer to exchange alloutstanding FR Notes due 2015 for FR Notes due 2015 that have been registeredunder the Securities Act of 1933, as amended, was declared effective on April 21,2005.

 

*EconcoAcquisition*

 

On October 8,2004, the Company purchased all of the outstanding stock of Econco BroadcastService, Inc. (“Econco”) of Woodland, California for cash consideration ofapproximately $18.3 million.  Econco is aprovider of rebuilding service for VEDs, allowing broadcasters and other usersof these critical products to extend the life of their devices at a cost thatis lower than buying a new VED.  See Note10 to the Condensed Consolidated Financial Statements for additional informationabout the Econco acquisition.

 

*Merger*

 

On January 23,2004, CPI Holdco’s wholly-owned subsidiary, CPI Merger Sub Corp. (“Merger Sub”),merged with and into Holding pursuant to the terms of the Agreement and Plan ofMerger (the “Merger Agreement”), dated as of November 17, 2003, by andamong Holding, CPI Holdco, Merger Sub and Green Equity Investors II, L.P., asthe representative of the security holders of Holding, under which CPI Holdco,Merger Sub’s parent corporation and a corporation controlled by affiliates ofThe Cypress Group L.L.C. (“Cypress”), agreed to acquire Holding. In the Merger,each share of Holding’s common stock and stock options outstanding immediatelyprior to the Merger, other than a portion of stock options held by certainmembers of management (which were converted into options to purchase shares ofCPI Holdco) and other than any shares of common stock owned by Holding or CPIHoldco, were converted into the right to receive a pro rata portion of theaggregate merger consideration of $131.7 million. In connection with the Merger,CPI Holdco received an equity contribution

 

27

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of$100.0 million before expenses from affiliates of Cypress in exchange for4,251,122 shares of common stock of CPI Holdco. Members of management of Holding,as a result of rolling over their options to purchase common stock of Holding,received stock options to purchase 167,513 shares of common stock of CPI Holdco(“Rollover Options”).  The estimated fairvalue of Rollover Options was $5.0 million and was accounted for as Mergerpurchase price as of January 23, 2004.  Members of Holding management that were residents of Canada received1,485 stock options to purchase shares of common stock of CPI Holdco as paymentof Merger escrow proceeds in respect of their options to purchase shares ofHolding.

 

Althoughthe Merger, which essentially resulted in the recapitalization of the Company,triggered a change in the basis of many of the Company’s assets andliabilities, the underlying operations of the Company were not impacted by theMerger.

 

*San CarlosSale Agreement*

 

TheCompany entered into an agreement to sell the land and close its facilitieslocated in San Carlos, California.  Thepurchase price is $23.8 million.  Underthe sale agreement, the buyer has paid the Company a $13.0 million deposit onthe purchase price, which the Company is using to defray the costs of movingits San Carlos operations to its Palo Alto facility and to a new location inthe Palo Alto area.   The $13.0 milliondeposit is nonrefundable unless the Company breaches the sale agreement.  In connection with the sale agreement, theCompany entered into an agreement regarding environmental conditions at theproperty and was named as an additional insured on a pollution liabilityinsurance policy obtained by the purchaser that is intended to fund theremediation of the contamination of the San Carlos property to permit hospitaland other “unrestricted” uses under the direction of the applicableenvironmental regulatory agency.

 

Theclosing of the sale is subject to a number of conditions, including therequirement that the Company vacate its facilities and obtain regulatoryclosure of certain permitted equipment located on the property.  Although there can be no assurance that thesale of the San Carlos property will occur, the Company expects to close thesale of the property in the first quarter of fiscal year 2007.

 

Pursuantto the stock sale agreement by and between Varian Associates, Inc., thepredecessor of Varian Medical Systems, Inc. (“Varian”), and the Companydated June 9, 1995, as amended, the Company had agreed to certaindevelopment restrictions affecting the San Carlos property.  In connection with the San Carlos propertysale agreement, Varian agreed to waive certain of the development restrictionson the San Carlos property in the event that the sale closes, subject tocertain conditions, and further agreed to pay the Company $1.0 million, ofwhich $0.5 million was paid as of July 1, 2005. In addition, the Companyhas agreed to relieve Varian of certain of its indemnity obligations to theCompany for certain environmental liabilities related to the San Carlosproperty relating to periods prior to August 1995, and to reimburse Varianfor certain potential environmental costs related to the San Carlos propertythat are not covered by insurance. The Company and Varian have also agreed tocertain use restrictions and environmental cost-sharing provisions related tothe Company’s property in Beverly, Massachusetts, and the Company has relinquishedits right to redevelop that property for residential or similar use.

 

As of July 1,2005, the San Carlos land and building was classified as held for use inproperty, plant and equipment and the advance payments from the sale of theproperty, aggregating $13.5 million, are classified as a long-term liability inthe accompanying Condensed Consolidated Balance Sheet.  As of July 1, 2005, the Company haddeferred expenses of $0.7 million relating to the sale of the San Carlosproperty and classified these amounts as other long-term assets in theaccompanying Condensed Consolidated Balance Sheet.  As of July 1, 2005, the San Carlos landand building had a net book value of $23.7 million and the building continuesto be depreciated over its remaining useful life.  Based on current projections of costs, theCompany does not expect to recognize a loss on the sale of the San Carlosproperty.

 

***Critical Accounting Policies***

 

Managementis required to make judgments, assumptions and estimates in preparing itsfinancial statements and related disclosures in conformity with accountingprinciples generally accepted in the United States. The Company’s significantaccounting policies are described in Note 1 of the Notes to ConsolidatedFinancial Statements in the Annual Report on Form 10-K for the fiscal yearended October 1, 2004. The following critical accounting policies arethose policies that management believes affect its more significant estimatesand assumptions used in preparation of the Company’s consolidated financialstatements.

 

*Revenue Recognition*

 

Theestimated sales values of performance under certain contracts to commercialcustomers and U. S. Government fixed-price contracts are recognized under thepercentage of completion method of accounting. When applying the percentage of completion method, the Company relies onestimates of total expected contract revenue and costs. Recognized revenues andprofit are subject to revisions as the contract progresses towards completion.Revisions in profit estimates are charged to income in the period in which theybecome determinable.

 

*Allowance for Doubtful Accounts*

 

TheCompany monitors the creditworthiness of its customers based on a variety offactors including the length of time the

 

28

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receivablesare past due, the financial health of the customer, economic conditions andhistorical experience. If collectibility is considered uncertain, then theCompany will record a reserve to reduce the receivable to the amount consideredcollectable. If circumstances change, then further adjustments could berequired.

 

*Warranty Obligations*

 

TheCompany’s products are generally subject to warranties, and the Companyprovides for the estimated future costs of repair, replacement or customeraccommodation at the time of sale as an additional cost of the sales.Management’s estimates are based on historical costs for warranty, and areadjusted when circumstances indicate that future costs are expected to varyfrom historical levels. If actual product failure rates or material usageincurred differ from the Company’s estimates, then revisions to the estimatedwarranty liability would be required.

 

*Inventory Valuation*

 

TheCompany reviews inventory quantities on hand and adjusts for excess andobsolete inventory based primarily on historical usage rates and its estimatesof product demand and production. Actual demand may differ from our estimates,in which case the Company may have understated or overstated the provisionrequired for obsolete and excess inventory, which would have an impact on theCompany’s operating results.

 

TheCompany also reviews the carrying value of inventory for lower of cost ormarket on an individual product or contract basis. Analyses are performed basedon the estimated costs at completion and if necessary, a provision is recordedto properly reflect the inventory value of the products or contracts at thelower of cost or net realizable value (selling price less estimated cost ofdisposal). If estimated costs are different than originally estimated, theprovision adjustment would have an impact on the Company’s operating results.

 

*Goodwill and Other Intangibles Assets and Long-Lived Assets*

 

Goodwillrepresents the excess of acquisition costs over the estimated fair value of thenet assets acquired. The Financial Accounting Standards Board (“FASB”) issuedStatement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwilland Other Intangible Assets”, which requires that amortization of goodwillcease and that the Company evaluate the recoverability of goodwill and otherintangible assets annually, or more frequently if events or changes incircumstances, such as a decline in sales, earnings or cash flows, or materialadverse changes in the business climate, indicate that the carrying value of anasset might be impaired. Goodwill is considered to be impaired when the netbook value of a reporting unit exceeds its estimated fair value. The Company’ssix operating divisions comprise the reporting units.

 

Fairvalues are established using a discounted cash flow methodology (specifically,the income approach). The determination of discounted cash flows is based onthe Company’s strategic plans and long-range forecasts. The revenue growthrates included in the forecasts are the Company’s best estimates based oncurrent and anticipated market conditions, and the profit margin assumptionsare projected based on the current and anticipated costs structures.

 

TheCompany performs an annual evaluation for the impairment of long-lived assets,other than goodwill, based on expectations of non-discounted future cash flowscompared to the carrying value of the operating division in accordance withSFAS No. 144, “Accounting for the Impairment or Disposal of Long-LivedAssets”. The Company’s cash flow estimates are based upon historical cashflows, as well as management projections of future cash flows in connectionwith the annual Company wide planning process, and include a terminal valuationbased upon a multiple of earnings before interest expense, depreciation andamortization expense and income taxes (“EBITDA”). The Company estimates theEBITDA multiple by reviewing comparable company information and other industrydata. The Company believes that its procedures for estimating gross future cashflows, including the terminal valuation, are reasonable and consistent withcurrent market conditions.

 

***Effect of Merger on Financial Results***

 

As aresult of the Merger, the assets acquired and liabilities assumed were adjustedto reflect fair value, and the excess of the purchase price over the fair valuewas recorded as goodwill.  The revisedfair values significantly impacted the Company’s results of operationssubsequent to the Merger and their comparability to the results of operationsof the Predecessor.  The most significantpurchase accounting adjustments and their effect on results of operations arediscussed below:

 

•                  Customer backlog was valued at $17.5 million.  Customer backlog was amortized over the 12-monthexpected product delivery schedule of the contracts in backlog at theMerger closing date.   Customer backlogamortization was $12.1 million in fiscal year 2004, $4.4 million in the firstquarter of fiscal year 2005, and $1.0 million in the second quarter of fiscalyear 2005.

 

•                  Property, plant and equipment valuation wasincreased by $38.7 million.  Operatingincome will be charged approximately $3.1 million per year for the next 4years, and at a reduced rate thereafter, for additional depreciation from theincreased valuation of property, plant and equipment.  Property, plant and equipment are depreciatedover useful lives of 5 years to 25 years.

 

29

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•                  Technology-related intangible assets were valued at$58.5 million.  Operating income will becharged approximately $1.9 million per year for the next 14 years, and at areduced rate thereafter, for the amortization of technology-related intangibleassets.  Technology-related intangibleassets are depreciated over useful lives of 15 to 50 years.

 

•                  Land lease intangibles were valued at $11.8million.  Operating income will becharged approximately $0.3 million per year for the remaining 44 years of theland lease.  The Predecessor had a landlease with a net book value of $20.3 million that was being amortized over 55years at a rate of $0.5 million per year. Thus, the effect on future operating income is a reduction inamortization expense of $0.2 million per year.

 

•                  Deferred tax liabilities were increased by $46.5million.  Merger-related deferred taxliabilities were $37.8 million at July 1, 2005.  As the revalued assets noted above arecharged to operating income, their expense is not deductible for income taxpurposes.  The deferred tax liability ischarged against the income tax provision as the revalued assets are charged tooperating income.  In effect, revaluedassets are being charged to net income on an after-tax basis.

 

***Orders***

 

Incomingorder levels fluctuate significantly on a quarterly basis, and a particular quarter’sorder rate may not be indicative of future order levels.  In addition, the Company’s sales are highlydependent upon manufacturing scheduling, performance and shipments and,accordingly, it is not possible to accurately predict when orders will be recognizedas sales.

 

Marketsegment orders are summarized as follows (in millions):

 
| ** **         | ** ** | **39-Week Period Ended** | ** ** |
|--------------------|------------|--------------------------|------------|
| ** **         | ** ** | **July 1, 2005**    | ** ** | **July 2, 2004** | ** ** |
| ** **         | ** ** | ** **               | ** ** | **Percentage of** | ** ** | ** ** | ** ** | **Percentage of** | ** ** |
| ** **         | ** ** | **Amount**               | ** ** | **Total Orders** | ** ** | **Amount** | ** ** | **Total Orders** | ** ** |
| Radar              |       | $                        | 80.9       |   | 32 | % | $ | 81.4 |   | 37 | % |
| Electronic Warfare |       | 22.8                     |       | 9 | % | 22.6 |   | 10 | % |
| Communications     |       | 87.1                     |       | 34 | % | 58.6 |   | 27 | % |
| Medical            |       | 42.0                     |       | 16 | % | 32.9 |   | 15 | % |
| Industrial         |       | 17.5                     |       | 7 | % | 15.0 |   | 7 | % |
| Scientific         |       | 4.5                      |       | 2 | % | 9.4 |   | 4 | % |
| Total orders       |       | $                        | 254.8      |   | 100 | % | $ | 219.9 |   | 100 | % |

 

Ordersrecorded in the 39-week period ending July 1, 2005 were $254.8 million, anincrease of $34.9 million, or 16%, from $219.9 million in the comparable periodof fiscal year 2004. The increase primarily relates to increases in thecommunications, medical and industrial markets, partially offset by a decreasein the scientific market. Orders in the radar and electronic warfare marketsdid not change significantly from fiscal year 2004 to 2005.  The Econco acquisition represents $8.7million of the orders increase, while the remaining increase of $26.2 millionwas due to growth from our existing business.

 

Ordersin the communications market for the 39-week period ending July 1, 2005increased $28.5 million, or 49%, from the comparable period of fiscal year2004.  The increase in communicationsorders was attributable to the continued strength in orders for thedirect-to-home broadcast market, orders for Econco products, and a large orderfrom an international customer for traveling wave tubes used for terrestrialmicrowave relays.  Orders in the medicalmarket for the 39-week period ending July 1, 2005 increased $9.1 million,or 28%, from the comparable period of fiscal year 2004. The increase in medicalorders was primarily due to the continued strength in orders for VEDs used incancer therapy and x-ray generator systems and power supply products used inx-ray imaging systems, and the acceleration of orders for our Eimac divisiondue to its upcoming relocation from our San Carlos, CA facility to our PaloAlto, CA facility.  Orders in theindustrial market for the 39-week period ending July 1, 2005 increased$2.5 million, or 17%, from the comparable period of fiscal year 2004. Theincrease in industrial orders was primarily attributable to orders for Econcoproducts, partially offset by lower demand for products by semiconductorequipment companies.   Orders for products sold in the scientific marketfor the 39-week period ending July 1, 2005 decreased $4.9 million, or 52%,from the comparable period of fiscal year 2004. The decrease in scientificorders was primarily attributable to the receipt of a $3.8 million order in thefirst 39-week period of fiscal year 2004 for high frequency, high powergyrotrons for fusion research, which did not recur in the comparable period offiscal year 2005.  Orders in thescientific market, our smallest market, are historically one-time projects andcan fluctuate significantly from period to period.

 

Orderbacklog consists of firm orders for which goods and services are yet to beprovided.  As of July 1, 2005, theCompany had an order backlog of $190.6 million compared to an order backlog of$176.6 million as of July 2, 2004. Order backlog decreased during the third quarter of fiscal year 2005 by$9.4 million from $200.0 million as of April 1, 2005.  Although orders can be and sometimes aremodified or terminated, the amount of modifications and terminations hashistorically not

 

30

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beenmaterial compared to total contract volume.

 

***Results of Operations***

 

*Fiscal Year*

 

CPIHoldco’s fiscal years are the 52- or 53-week periods that end on the Fridaynearest September 30. The Successor’s fiscal year did not change from thatof the Predecessor.  Fiscal year 2005comprises the 52-week period ending September 30, 2005, and fiscal year2004 comprised the 52-week period ended October 1, 2004.

 

*Quarter Ended July 1, 2005 Compared to Quarter Ended July 2,2004*

 

Operatingresults for the third quarters of fiscal year 2005 and 2004 were as follows(dollars in millions):

 
| ** **                                             | ** ** | **Quarter Ended  July 1, 2005** | ** ** | **Quarter Ended  July 2, 2004** | ** ** |
|--------------------------------------------------------|------------|--------------------------------------|------------|--------------------------------------|------------|
| ** **                                             | ** ** | **Amount**                           | ** ** | **Percentage  of Sales**             | ** ** | **Amount** | ** ** | **Percentage of  Sales** | ** ** |
| Sales                                                  |       | $                                    | 87.6       |                                 | 100.0      | % | $ | 72.3 |   | 100.0 | % |
| Cost of sales                                          |       | 57.8                                 |       | 66.0                                 |       | 49.1 |   | 67.9 |   |
| Amortization of acquisition related inventory write-up |       | —                               |       | —                               |       | 1.3 |   | 1.8 |   |
| Gross profit                                           |       | 29.8                                 |       | 34.0                                 |       | 22.0 |   | 30.4 |   |
| Research and development                               |       | 1.9                                  |       | 2.2                                  |       | 1.9 |   | 2.6 |   |
| Selling and marketing                                  |       | 4.7                                  |       | 5.4                                  |       | 3.9 |   | 5.4 |   |
| General and administrative                             |       | 5.8                                  |       | 6.6                                  |       | 5.0 |   | 6.9 |   |
| Amortization of acquisition related intangibles        |       | 0.5                                  |       | 0.6                                  |       | 4.7 |   | 6.5 |   |
| Acquired in-process research and develpment            |       | —                               |       | 0.0                                  |       | (9.0 | ) | (12.4 | ) |
| Operating income                                       |       | 16.8                                 |       | 19.2                                 |       | 15.5 |   | 21.4 |   |
| Interest expense, net                                  |       | 5.7                                  |       | 6.5                                  |       | 3.8 |   | 5.3 |   |
| Income before taxes                                    |       | 11.1                                 |       | 12.7                                 |       | 11.7 |   | 16.2 |   |
| Income tax expense                                     |       | 4.4                                  |       | 5.0                                  |       | 0.2 |   | 0.3 |   |
| Net income                                             |       | $                                    | 6.7        |                                 | 7.6        | % | 11.5 |   | 15.9 | % |
| Other Data:                                            |       |                                 |       |                                 |       |   |   |   |   |
| EBITDA (a)                                             |       | $                                    | 19.2       |                                 | 21.9       | % | $ | 21.4 |   | 29.6 | % |

 

(a)          EBITDA represents earnings before provision forincome taxes, interest expense, depreciation and amortization. Other companiesmay define EBITDA differently and, as a result, the Company’s measure of EBITDAmay not be directly comparable to EBITDA of other companies. Managementbelieves that the presentation of EBITDA provides useful information toinvestors regarding the Company’s results of operations because it assists inanalyzing and benchmarking the performance and value of the Company’s business.Although management uses EBITDA as a financial measure to assess theperformance of the Company’s business, the use of EBITDA is limited because itdoes not include certain material costs, such as interest and taxes, necessaryto operate the Company’s business. EBITDA should be considered in addition to,and not as a substitute for, net income in accordance with Generally AcceptedAccounting Principles (“GAAP”) as a measure of performance or net cash providedby operating activities in accordance with GAAP as a measure of liquidity.  For reconciliation of EBITDA to Income beforetaxes, see Note 8 of the Notes to Condensed Consolidated Financial Statements.

 

*Sales.*

 

Thefollowing table compares total sales by market segment for the quarter ended July 1,2005 to the quarter ended July 2, 2004 (dollars in millions):

 
| ** **         | ** ** | **Quarter Ended**     | ** ** |
|--------------------|------------|-----------------------|------------|
| ** **         | ** ** | **July 1, 2005** | ** ** | **July 2, 2004** | ** ** |
| ** **         | ** ** | ** **            | ** ** | **Percentage of** | ** ** | ** ** | ** ** | **Percentage of** | ** ** |
| ** **         | ** ** | **Amount**            | ** ** | **Total Sales** | ** ** | **Amount** | ** ** | **Total Sales** | ** ** |
| Radar              |       | $                     | 28.3       |   | 32 | % | $ | 28.7 |   | 40 | % |
| Electronic Warfare |       | 8.5                   |       | 10 | % | 7.3 |   | 10 | % |
| Communications     |       | 29.4                  |       | 34 | % | 18.6 |   | 26 | % |
| Medical            |       | 13.6                  |       | 16 | % | 11.0 |   | 15 | % |
| Industrial         |       | 6.2                   |       | 7 | % | 4.5 |   | 6 | % |
| Scientific         |       | 1.6                   |       | 2 | % | 2.2 |   | 3 | % |
| Total sales        |       | $                     | 87.6       |   | 100 | % | $ | 72.3 |   | 100 | % |

 

Salesfor the third quarter of fiscal year 2005 of $87.6 million were $15.3 million,or 21%, higher than the prior year’s level of $72.3 million.  The sales increase was primarily related toincreases in the communications, medical and industrial markets.  The Econco acquisition represents $3.2million of the sales increase, while the remaining increase of $12.1 millionwas due to growth from our existing business.

 

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Communicationssales of $29.4 million in the third quarter of fiscal year 2005 were $10.8million, or 58%, higher than the third quarter of fiscal year 2004, primarilydue to the increased shipment of direct-to-home broadcast amplifiers and VEDcommunication products.  Medical sales of$13.6 million for the third quarter of fiscal year 2005 were $2.6 million, or24%, higher than the third quarter of fiscal year 2004, primarily due to increasedshipments of VEDs used in cancer therapy and magnetic resonance imagingsystems, and x-ray generator systems and power supply products used in x-rayimaging systems.  Industrial sales of$6.2 million in the third quarter of fiscal year 2005 were $1.7 million, or38%, higher than the third quarter of fiscal year 2004 primarily due toadditional sales from Econco.

 

*Gross Profit*.  Gross profit of $29.8 million, or 34.0% ofsales, in the third quarter of fiscal year 2005 was $7.8 million higher thanthe prior year’s level of $22.0 million, or 30.4% of sales.  The increase in gross profit was primarilydue to higher sales volume, incremental gross profit from the Econco operationin the third quarter of fiscal year 2005, and purchase accounting charges of$1.3 million in the third quarter of fiscal year 2004 that did not occur infiscal year 2005.

 

*Research and Development Expenses*.  Researchand development expenses of $1.9 million for the third quarter of fiscal year2005 were consistent with the $1.9 million expense for the third quarter offiscal year 2004.

 

*Selling and Marketing Expenses*. Selling and marketing expenses of $4.7 million, or 5.4% of sales, forthe third quarter of fiscal year 2005 were $0.8 million higher than the $3.9million, or 5.4% of sales, for the third quarter of fiscal year 2004.  The increase in selling and marketingexpenses in the third quarter of fiscal year 2005 was primarily due toadditional costs to support the increase in sales volume and incremental costsfor the Econco operation.

 

*General and Administrative Expenses.* General and administrative expenses of $5.8million, or 6.6% of sales, for the third quarter of fiscal year 2005 were $0.8million higher than $5.0 million, or 6.9% of sales, for the third quarter offiscal year 2004.   In the third quarterof fiscal year 2005, the Company incurred stock-based compensation expense forperformance stock options, moving and rearranging costs associated with therelocation of the San Carlos, California manufacturing division to Palo Alto,California and incremental costs for Econco.

 

*Amortization of Acquisition-Related Intangibles*. Amortization of acquisition-related intangibles of$0.5 million for the third quarter of fiscal year 2005 consists of purchaseaccounting charges for acquisition-related intangible assets.  Amortization of acquisition-relatedintangibles of $4.7 million for the third quarter of fiscal year 2004 consistsof $3.9 million for purchase accounting charges for customer backlog and $0.8million for amortization of other acquisition-related intangibles.  Customer backlog was fully amortized in January 2005,while the other acquisition-related intangible assets will continue to beamortized over the next 4 to 49 years. Amortization of acquisition-related intangibles is expected to beapproximately $0.6 million per quarter through fiscal year 2018.

 

*Acquired In-Process Research and Development*.  Theacquired in-process research and development credit of $9.0 million for thethird quarter of fiscal year 2004 represents an adjustment to the previouslyestimated fair value of $11.5 million for acquired in-process research anddevelopment projects that had not yet reached technological feasibility and hadno alternative future use as of the Merger closing date.

 

*EBITDA*.  EBITDA for the third quarter of fiscal year2005 was $19.2 million, a decrease of $2.2 million compared to $21.4 millionfor the third quarter of fiscal year 2004. The decrease in EBITDA from fiscal year 2004 to 2005 resulted primarilyfrom the a $9.0M acquired in-process and development credit adjustment infiscal year 2004, partially offset by higher gross profit in fiscal year2005.  For a reconciliation of EBITDA toincome (loss) before taxes, see Note 8 to the Condensed Consolidated FinancialStatements.

 

*Interest Expense, net*.  Interest expense, net, of $5.7million, or 6.5% of sales, for the third quarter of fiscal year 2005 was $1.9million higher than the $3.8 million, or 5.3% of sales, for the third quarterof fiscal year 2004.  Higher interest expensefor the third quarter of fiscal year 2005 compared to the third quarter offiscal year 2004 was primarily due to interest expense for the FR Notes issuedon February 22, 2005.

 

*Income Tax Expense*.  The Company recorded income tax expense of$4.4 million for the third quarter of fiscal year 2005, an increase of $4.2million, compared to $0.2 million for the third quarter of fiscal year2004.  The effective tax rates wereapproximately 40% and 2% for the third quarter of fiscal years 2005 and 2004,respectively.  The primary reason for thelower income tax expense in the third quarter of fiscal year 2004 was anadjustment of the second quarter tax provision related to non-deductibleacquired in-process research and development, which was decreased by $9.0million when the purchase price allocation was finalized in the third quarterof fiscal year 2004.

 

*Net Income*.  The Company recorded net income of $6.7million for the third quarter of fiscal year 2005, a decrease of $4.8 millioncompared to $11.5 million for the third quarter of fiscal year 2004. Lower netincome for the third quarter of fiscal year 2005 compared to the third quarterof fiscal year 2004 is primarily due to a $9.0M acquired in-process anddevelopment credit in fiscal year 2004, offset partially by improved operatingperformance in fiscal year 2005.

 

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*Nine Months Ended July 1, 2005 Compared to the Nine Months Ended July 2,2004*

 

Operatingresults for the first nine-months of fiscal years 2005 and 2004 were as follows(dollars in millions):

 
| ** **                                             | ** ** | **Nine-months Ended  July 1, 2005** | ** ** | **Nine-months Ended  July 2, 2004 (b)** | ** ** |
|--------------------------------------------------------|------------|------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                             | ** ** | **Amount**                               | ** ** | **Percentage  of Sales**                     | ** ** | **Amount** | ** ** | **Percentage  of Sales** | ** ** |
| Sales                                                  |       | $                                        | 245.8      |                                         | 100.0      | % | $ | 217.9 |   | 100.0 | % |
| Cost of sales                                          |       | 162.9                                    |       | 66.3                                         |       | 147.1 |   | 67.5 |   |
| Amortization of acquisition related inventory write-up |       | 0.4                                      |       | 0.2                                          |       | 5.5 |   | 2.5 |   |
| Gross profit                                           |       | 82.6                                     |       | 33.6                                         |       | 65.3 |   | 30.0 |   |
| Research and development                               |       | 5.2                                      |       | 2.1                                          |       | 5.5 |   | 2.5 |   |
| Selling and marketing                                  |       | 13.4                                     |       | 5.5                                          |       | 11.3 |   | 5.2 |   |
| General and administrative                             |       | 15.7                                     |       | 6.4                                          |       | 14.6 |   | 6.7 |   |
| Merger expenses                                        |       | —                                   |       | —                                       |       | 6.4 |   | 2.9 |   |
| Amortization of acquisition related intangibles        |       | 6.9                                      |       | 2.8                                          |       | 8.1 |   | 3.7 |   |
| Acquired in-process research and develpment            |       | —                                   |       | —                                       |       | 2.5 |   | 1.1 |   |
| Operating income                                       |       | 41.4                                     |       | 16.8                                         |       | 16.9 |   | 7.8 |   |
| Interest expense, net                                  |       | 14.5                                     |       | 5.9                                          |       | 15.7 |   | 7.2 |   |
| Income before taxes                                    |       | 26.9                                     |       | 10.9                                         |       | 1.2 |   | 0.6 |   |
| Income tax expense                                     |       | 10.7                                     |       | 4.4                                          |       | 1.2 |   | 0.6 |   |
| Net income                                             |       | $                                        | 16.1       |                                         | 6.6        | % | $ | 0.1 |   | 0.0 | % |
| Other Data:                                            |       |                                     |       |                                         |       |   |   |   |   |
| EBITDA (a)                                             |       | $                                        | 53.1       |                                         | 21.6       | % | $ | 29.0 |   | 13.3 | % |

 

(a)          EBITDA represents earnings beforeprovision for income taxes, interest expense, depreciation and amortization. Other companies may define EBITDAdifferently and, as a result, the Company’s measure of EBITDA may not bedirectly comparable to EBITDA of other companies. Management believes that thepresentation of EBITDA provides useful information to investors regarding theCompany’s results of operations because it assists in analyzing andbenchmarking the performance and value of the Company’s business. Althoughmanagement uses EBITDA as a financial measure to assess the performance of theCompany’s business, the use of EBITDA is limited because it does not includecertain material costs, such as interest and taxes, necessary to operate theCompany’s business. EBITDA should be considered in addition to, and not as asubstitute for, net income in accordance with GAAP as a measure of performanceor net cash provided by operating activities in accordance with GAAP as ameasure of liquidity.  For reconciliationof EBITDA to Income before taxes, see Note 8 of the Notes to CondensedConsolidated Financial Statements.

 

(b)         Representsthe combined pro forma results of CPI Holdco for the 23-week period ended July 2,2004 and the Predecessor for the 16-week period ended January 22, 2004.   Since the basis of accounting for CPI Holdcoand the Predecessor are not the same, the combined pro forma results are not inaccordance with GAAP.

 

*Sales.*

 

Thefollowing table compares total sales by market segment for the nine-monthsended July 1, 2005 to the nine-months ended July 2, 2004 (dollars inmillions):

 
| ** **         | ** ** | **Nine-months Ended** | ** ** |
|--------------------|------------|-----------------------|------------|
| ** **         | ** ** | **July 1, 2005** | ** ** | **July 2, 2004** | ** ** |
| ** **         | ** ** | ** **            | ** ** | **Percentage of** | ** ** | ** ** | ** ** | **Percentage of** | ** ** |
| ** **         | ** ** | **Amount**            | ** ** | **Total Sales** | ** ** | **Amount** | ** ** | **Total Sales** | ** ** |
| Radar              |       | $                     | 83.9       |   | 34 | % | $ | 86.2 |   | 40 | % |
| Electronic Warfare |       | 21.3                  |       | 9 | % | 19.9 |   | 9 | % |
| Communications     |       | 76.8                  |       | 31 | % | 57.4 |   | 26 | % |
| Medical            |       | 39.3                  |       | 16 | % | 31.7 |   | 15 | % |
| Industrial         |       | 18.0                  |       | 7 | % | 14.8 |   | 7 | % |
| Scientific         |       | 6.5                   |       | 3 | % | 7.9 |   | 4 | % |
| Total sales        |       | $                     | 245.8      |   | 100 | % | $ | 217.9 |   | 100 | % |

 

Salesfor the first nine months of fiscal year 2005 of $245.8 million were $27.9million, or 13%, higher than the prior year’s level of $217.9 million.  The sales increase was primarily related toincreases in the communications and medical markets.  The Econco acquisition represents $9.0million of the sales increase while the remaining increase of $18.9 million, or9%, was due to growth from our existing business.

 

Communicationssales of $76.8 million in the first nine months of fiscal year 2005 were $19.4million, or 34%, higher than the first nine-months of fiscal year 2004,primarily due to increased shipment of direct-to-home broadcast amplifiers, VEDcommunication products and additional sales from the Econco operation.  Medical sales of $39.3 million for the firstnine-

 

33

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monthsof fiscal year 2005 were $7.6 million, or 24%, higher than the first ninemonths of fiscal year 2004, primarily due to increased shipments of VEDs usedin cancer therapy and magnetic resonance imaging systems, and x-ray generatorsystems and power supply products used in x-ray imaging systems.

 

*Gross Profit*.  Gross profit of $82.6 million, or 33.6% ofsales, in the first nine months of fiscal year 2005 was $17.3 million higherthan the prior year’s level of $65.3 million, or 30.0% of sales. The increasein gross profit was primarily due to higher sales volume in fiscal year 2005and merger purchase accounting charges of $5.5 million for amortization ofacquisition-related inventory write-up in fiscal year 2004.

 

*Research and Development Expenses*.  Researchand development expenses of $5.2 million, or 2.1% of sales, for the first ninemonths of fiscal year 2005 were $0.3 million lower than fiscal year 2004 due toadditional engineering efforts on customer-funded development contracts ratherthan Company-funded research and development programs in fiscal year 2005.

 

*Selling and Marketing Expenses*. Selling and marketing expenses of $13.4 million, or 5.5% of sales, forthe first nine months of fiscal year 2005 were $2.1 million higher than the$11.3 million, or 5.2% of sales, for the first nine months of fiscal year2004.  The increase in selling andmarketing expenses in fiscal year 2005 was primarily due to additional costs tosupport the increase in sales volume and incremental costs for the Econcooperation.

 

*General and Administrative Expenses. *General andadministrative expenses of $15.7 million, or 6.4% of sales, for the first ninemonths of fiscal year 2005 were $1.1 million higher than $14.6 million, or 6.7%of sales, for the first nine months of fiscal year 2004.  During fiscal year 2005, the Company incurredincremental costs for the Econco operation, and moving and rearranging costsassociated with the relocation of the San Carlos, California manufacturingdivision to Palo Alto, California.

 

*Merger Expenses.*Mergerexpenses of $6.4 million for the first nine months of fiscal year 2004consisted of fees paid to investment bankers, legal expenses, transactionbonuses for management, and transaction fees paid pursuant to the ManagementServices Agreement with Leonard, Green & Partners, L.P., an affiliateof the former holder of a majority of the common stock of the Predecessor.  These expenses were incurred in connectionwith the Merger.

 

*Amortization of Acquisition-Related Intangibles*.  Amortization of acquisition-related intangibles of $6.9 million for thefirst nine months of fiscal year 2005 is $1.2 million lower than the first ninemonths of fiscal year 2004.  Amortizationof acquisition-related intangibles consists of purchase accounting charges,primarily for customer backlog and other intangible assets.  Customer backlog was fully amortized in January 2005while the other acquisition-related intangible assets will continue to be amortizedover the next 4 to 49 years. Amortization of acquisition-related intangibles is expected to beapproximately $0.6 million per quarter through fiscal year 2018.

 

*Acquired In-Process Research and Development.* Acquiredin-process research and development expense of $2.5 million for the first ninemonths of fiscal year 2004 represents the estimated fair value of acquiredin-process research and development projects that had not yet reachedtechnological feasibility and had no alternative future use as of the Mergerclosing date.

 

*EBITDA*.  EBITDA for the first nine months of fiscalyear 2005 was $53.1 million, an increase of $24.1 million compared to $29.0million for the first nine months of fiscal year 2004. The increase in EBITDAfrom fiscal year 2004 to 2005 resulted primarily from higher gross profit infiscal year 2005 and the write-off of acquired in-process research anddevelopment and Merger expenses in fiscal year 2004.  For a reconciliation of EBITDA to income(loss) before taxes, see Note 8 to the Condensed Consolidated FinancialStatements.

 

*Interest Expense, net*.  Interest expense, net, of $14.5million, or 5.9% of sales, for the first nine months of fiscal year 2005 was$1.2 million lower than the $15.7 million, or 7.2% of sales, for the first ninemonths of fiscal year 2004.  The decreasein interest expense in fiscal year 2005 is primarily due to fiscal year 2004interest costs associated with the early redemption of the Predecessor’s 12%Notes and the write-off of capitalized debt issue costs related to outstandingdebt at the time of the Merger, partially offset by additional interest expensefor the FR Notes issued on February 22, 2005.

 

*Income Tax Expense*.  The Company recorded income tax expense of$10.7 million for the first nine months of fiscal year 2005, an increase of$9.5 million, compared to income tax expense of $1.2 million for the first ninemonths of fiscal year 2004.  Theeffective income tax rates were 40% and 95% for the first nine months of fiscalyear 2005 and 2004, respectively.  Thechange in income tax expense is primarily due to non-deductible acquiredin-process research and development and other purchase accounting chargesrelated to the Merger recorded in the first nine months of fiscal year 2004.

 

*Net Income*.  The Company recorded net income of $16.1million for the first nine months of fiscal year 2005, an increase of $16.0million compared to $0.1 million for the first nine months of fiscal year2004.  Higher net income for the firstnine months of fiscal year 2005 compared to fiscal year 2004 is primarily dueto higher gross profit due to increased sales in fiscal year 2005 and mergerexpenses in fiscal year 2004, partially offset by higher income tax expenserecorded in fiscal year 2005.

 

***Financial Condition***

 

TheCompany generated net cash from operating activities of $15.3 million for thefirst nine months of fiscal year 2005,

 

34

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comparedto $19.7 million for the first nine months of fiscal year 2004.  The $4.4 million decrease in net cash fromoperating activities for the first nine months of fiscal year 2005 compared tothe first nine months of fiscal year 2004 was primarily due to increases ininventory and accounts receivable in fiscal year 2005, partially offset by theincrease in net income, excluding non-cash charges in fiscal year 2005.  The increase in accounts receivable was dueto increased sales, and the increase in inventory was due to increased productdelivery requirements in fiscal year 2005, each as compared to fiscal year2004.

 

Investingactivities used net cash of $27.4 million for the first nine months of fiscalyear 2005, compared to $115.4 million for the first nine months of fiscal year2004.  Investing activities for firstnine months of fiscal year 2005 include $18.3 million for the purchase ofEconco and $8.9 million for the purchases of property, plant and equipment,primarily in connection with the relocation of the San Carlos productionfacility to Palo Alto, California. Investing activities for the first nine months of fiscal year 2004consists primarily of the purchase of the Predecessor’s net assets.

 

TheCompany’s continuing operations typically do not have large capital expenditurerequirements.  Capital expenditures are generally made to replace existingassets, increase productivity, facilitate cost reductions or meet regulatoryrequirements.  Excluding fiscal year 2005 anticipated capital expendituresof approximately $12 to $14 million related to the relocation of the San Carlos,California facility to Palo Alto, California, the Company expects the level ofcapital expenditures in fiscal year 2005 to be consistent with fiscal year 2004levels.

 

Financingactivities used net cash of $11.2 million for the first nine months of fiscalyear 2005, compared to $106.1 million provided by financing activities for thefirst nine months of fiscal year 2004.  Financing activities for the firstnine months of fiscal year 2005 consist primarily of a $75.8 milliondistribution to stockholders of CPI Holdco, $9.6 million repayments on CPI’ssenior term loans, $3.5 million of debt costs incurred to issue the FR Notesand $1.0 million paid as collateral under the interest rate swap contract,partially offset by the $79.2 million of gross proceeds from the issuance of FRNotes.  The term loan repayments included $3.9 million of required annualrepayments and an optional prepayment of $5.7 million.

 

Workingcapital was $66.6 million at July 1, 2005 compared to $72.4 million at October 1,2004, representing a decrease of $5.8 million during the first three quartersof fiscal year 2005.  The decrease inworking capital was primarily due to the $18.3 million paid to purchase Econco’scommon stock and higher interest payable, partially offset by increases inaccounts receivable and inventory.

 

On July 1,2005, CPI had $17.1 million in cash and cash equivalents, compared to $40.5million on October 1, 2004.  Cashbalances in excess of operating requirements are invested daily in federalsecurities.

 

Thefollowing table summarizes future minimum principal payments on outstandingdebt and minimum rentals due for certain facilities and other leased assetsunder long-term non-cancelable operating leases as of July 1, 2005 (inthousands):

 
| ** **                      | ** ** | **Due in Fiscal Years** | ** ** |
|---------------------------------|------------|-------------------------|------------|
| **Description**                 | ** ** | **2005**                | ** ** | **2006** | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
|                            |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Debt obligations                |       | $                       | —     |   | — |   | — |   | — |   | 16,044 |   | 268,956 |   | 285,000 |   |
| Noncancellable operating leases |       | 309                     |       | 610 |   | 427 |   | 356 |   | 338 |   | 3,838 |   | 5,878 |   |
| Total cash obligations          |       | $                       | 309        |   | 610 |   | 427 |   | 356 |   | 16,382 |   | 272,794 |   | 290,878 |   |
| Standby letters of credit       |       | $                       | 4,710      |   | — |   | — |   | — |   | — |   | — |   | 4,710 |   |

 

TheCompany uses forward exchange contracts to address the foreign currency riskassociated with anticipated manufacturing costs in Canada.  As of July 1, 2005, CPI had outstandingforward contract commitments to purchase Canadian dollars for an aggregate U.S.notional amount of $18.1 million; the last forward contract expires on March 10,2006.  At July 1, 2005, the fairvalue of unrealized foreign currency forward contracts was $1.8 million and theunrealized gain was approximately $1.2 million, net of related tax expense. TheCompany anticipates recognizing the entire unrealized gain in operatingearnings within the next twelve months.

 

In April 2005,the Company expanded its use of derivatives to address the interest rate riskassociated with the FR Notes which mature on February 1, 2015.  On April 15, 2005, the Company enteredinto an $80 million interest rate swap contract (“the Swap”) to receivevariable rate 6-month LIBOR interest and pay 4.15% fixed rate interest.  The Swap is for semi-annual interestpayments, beginning with interest payments due on February 1, 2006, andthe contract matures on January 31, 2008. The Swap is designated as a cash flow hedge under SFAS No. 133, andthe gain and loss from changes in fair value is expected to be highly effectiveat offsetting the gain or loss from changes in fair value of the FR Notesattributable to changes in interest rates over the contract period.  As of July 1, 2005, the Company had paid$1.0 million as collateral for the Swap, which is included as Other Long-termAssets in the accompanying Condensed Consolidated Balance Sheets.  The amount of collateral fluctuates based onthe fair value of the Swap. The unrealized gains and losses from the Swapcontract are included in “Accumulated Other Comprehensive Income” in theCondensed Consolidated Balance Sheet.  AtJuly 1, 2005 the fair value of the Swap was not material.  The Company anticipates recognizing theunrealized gain or loss on the Swap over the contract

 

35

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periodto effectively replace the variable interest rate on the FR Notes with thefixed interest rate of the Swap.

 

The Company’sliquidity is affected by many factors, some of which are based on normalongoing operations of our business and others related to uncertainties in themarkets in which we compete and global economies. We believe that cash and cashequivalents on hand, cash expected to be generated from operations andborrowing capability under our senior credit facility will be sufficient tomeet the Company’s cash requirements for the next 12 months.

 

***Recent Accounting Pronouncements***

 

In March 2004,the Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 03-01,“The Meaning of Other-Than-Temporary Impairment and Its Application to CertainInvestments” (“EITF 03-01”). EITF 03-01 provides guidance onother-than-temporary impairment models for marketable debt and equitysecurities accounted for under SFAS No. 115, “Accounting for CertainInvestments in Debt and Equity Securities” and non-marketable equity securitiesaccounted for under the cost method. The EITF developed a basic three-stepmodel to evaluate whether an investment is other-than-temporarily impaired. TheFinancial Accounting Standards Board (“FASB”) issued EITF 03-01-1 in September 2004,which delayed the effective date of the recognition and measurement provisionsof EITF 03-01. The Company does not expect the adoption of EITF 03-01 to have amaterial impact on our results of operations or financial condition.

 

In November 2004,the FASB issued SFAS No. 151, “Inventory Costs—an amendment of ARB No. 43,Chapter 4”, which is the result of the FASB’s project to reduce differencesbetween U.S. and international accounting standards. SFAS No. 151 requiresidle facility costs, abnormal freight, handling costs, and amounts of wastedmaterials (spoilage) be treated as current-period costs. Under this concept, ifthe costs associated with the actual level of spoilage or production defectsare greater than the costs associated with the range of normal spoilage ordefects, the difference would be charged to current-period expense, notincluded in inventory costs. The Company is required to adopt SFAS No. 151in the beginning of fiscal year 2006 and its adoption is not expected to have asignificant impact on the Company’s results of operations or financialcondition.

 

In December 2004,the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets – Anamendment of APB Opinion No. 29,” which eliminates the exception fornonmonetary exchanges of similar productive assets and replaces it with ageneral exception for exchanges of nonmonetary assets that do not havecommercial substance.  The Company isrequired to adopt SFAS No. 153 for nonmonetary asset exchanges occurringin the first quarter of 2006 and its adoption is not expected to have asignificant impact on the Company’s results of operations or financialcondition.

 

In December 2004,the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123R”).SFAS No. 123R requires companies to recognize in the income statement thegrant-date fair value of stock options and other equity-based compensationissued to employees, but expresses no preference for a type of valuation model.SFAS No. 123R eliminates the intrinsic value-based method prescribed byAccounting Principles Board Opinion No. 25, “Accounting for Stock Issuedto Employees”, and related interpretations, that the Company currently uses. Asa nonpublic entity as defined by SFAS No. 123R, the Company is required toadopt SFAS No. 123R in the beginning of fiscal year 2007.  The Company has not yet determined the impactof applying the provisions of SFAS No. 123R.

 

In March 2005,the FASB issued Interpretation No. 47, “Accounting for Conditional AssetRetirement Obligations,” which clarifies that an entity is required torecognize a liability for the fair value of a conditional asset retirementobligation if the fair value can be reasonably estimated even thoughuncertainty exists about the timing and (or) method of settlement.  The Company is required to adoptInterpretation No. 47 by the end of 2006. The Company has not yet determined the impact of applying the provisionsof Interpretation No. 47.

 

In May 2005,the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections.”  SFAS No. 154 replaces APB Opinion No. 20,“Accounting Changes,” and SFAS No. 3, “Reporting Accounting Changes inInterim Financial Statement,” and changes the requirements for the accountingfor and reporting of a change in accounting principle.  The Company is required to adopt SFAS No. 154for accounting changes and error corrections in fiscal year 2007.  The Company’s results of operations andfinancial condition will only be impacted by SFAS No. 154 if it implementschanges in accounting principle that are addressed by the standard or correctsaccounting errors in future periods.

 

#### ***ITEM 3:*****QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT****MARKET RISK**

#### * *

TheCompany operates in a dynamic and rapidly changing environment that involvesnumerous risks and uncertainties.  Thefollowing section describes some, but not all, of these risks anduncertainties that we believe may adversely affect our business, financialcondition or results of operations.  Thissection should be read in conjunction with the unaudited CondensedConsolidated Financial Statements and Notes thereto, and Management’sDiscussion and Analysis of Financial Condition and Results of Operationscontained elsewhere in the Form 10-Q.

 

Thecompany does not enter into derivative financial instruments for trading orspeculative purposes.

 

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**Interest Rate Risk**

 

TheCompany’s exposure to market risk for changes in interest rates relatesprimarily to the fair value of long-term fixed interest rate debt and theinterest rate swap contract.  Generally,the fair value of fixed-interest rate debt will increase as interest rates falland decrease as interest rates rise.  TheCompany has an $80 million interest rate swap contract (“the Swap”) to receivevariable rate 6-month LIBOR interest and pay 4.15% fixed rate interest.  The Swap is for semi-annual interest payments,beginning with interest payments due on February 1, 2006, and the contractmatures on January 31, 2008.  As of July 1,2005, the fair value of the Company’s long-term fixed rate debt wasapproximately the same as the carrying value and the unrealized loss on theswap contract was not material.

 

**Foreign Currency Exchange Rate Risk**

 

Themajority of the Company’s revenue and expense activities are transacted in U.S.dollars. However, the Company incurs expenses, and receives limited revenue, inother currencies, primarily the Canadian dollar, the British pound, the Euro,the Australian dollar and the Swiss franc. The Company’s results of operationscan be impacted through foreign currency exchange rate risk (a) to thebalance sheet components (assets and liabilities) and (b) through itsimpact to foreign denominated expenses, primarily in Canada. The Company limitsits foreign currency exchange rate risk to the balance sheet componentsprimarily through natural hedging (offsetting foreign currency payables withforeign currency receivables). The most significant exposure to foreigndenominated expenses is in Canada, where the Company enters into forwardcontracts in an effort to reduce, but not eliminate, the impact of foreigncurrency rate movements. The fair value of forward contracts is subject toforeign currency risk.

 

**ITEM 4:****CONTROLS AND PROCEDURES**

 

Management, including the Company’s principal executiveofficer and principal financial officer, has evaluated, as of the end of theperiod covered by this report, the effectiveness of the design and operation ofthe Company’s disclosure controls and procedures with respect to theinformation generated for use in this report. Based upon, and as of the date ofthat evaluation, the principal executive officer and principal financialofficer concluded that the disclosure controls and procedures were effective toprovide reasonable assurances that information required to be disclosed in thereports filed or submitted under the Securities Exchange Act of 1934, asamended, is recorded, processed, summarized and reported within the timeperiods specified in the Securities and Exchange Commission’s rules andforms.

 

There have been no changes in the Company’s internalcontrol over financial reporting that occurred during the Company’s most recentfiscal quarter that have materially affected, or are reasonably likely tomaterially affect, the Company’s internal control over financial reporting.

 

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**PART II:  OTHER INFORMATION**

 

### **ITEM 1.  LEGAL PROCEEDINGS.**

 

None.

 

### **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.

 

### **ITEM 6.  EXHIBITS.**

 
| **Exhibit** | ** ** | ** **                                                                                                                                                        |
|-------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **No.**     | ** ** | **Description**                                                                                                                                                   |
| 31          |       | Certifications  of Chief Executive Officer and Chief Financial Officer pursuant to Section 302  of the Sarbanes-Oxley Act of 2002.                           |
|        |       |                                                                                                                                                              |
| 32          |       | Certifications  of Chief Executive Officer and Chief Financial Officer pursuant to Section 906  the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350. |

# ** **

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# **SIGNATURES**

 

Pursuantto the 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  HOLDCO, INC. |                                             |
|--------|-------------------|--------------------------------------------------|
|   |              |                                             |   |
|   |              |                                             |   |
|   | By:               | /s/ O. Joe Caldarelli                            |   |
|   |              | O. Joe Caldarelli                                |   |
|   |              | Chief Executive Officer                          |   |
|   |              | Date: August 12, 2005                       |   |
|   |              |                                             |   |
|   |              |                                             |   |
|   | By:               | /s/ Joel Littman                                 |   |
|   |              | Joel Littman                                     |   |
|   |              | Chief Financial Officer, Treasurer and Secretary |   |
|   |              | (Principal Financial and Accounting Officer)     |   |
|   |              | Date: August 12, 2005                       |   |

 

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