**UNITEDSTATESSECURITIES AND EXCHANGECOMMISSION**Washington,DC 20549

**FORM10-Q**

**(MarkOne)**

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

** **

**For the quarterly period ended December 29, 2006**

**or**

| **o** | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15  (d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|------------|------------------------------------------------------------------------------------------------|

** **

**For thetransition period from                to               **

**Commission file number:****000-51928**

**CPI INTERNATIONAL, INC.**

(Exact Name of Registrant asSpecified in Its Charter)

**Delaware**

(State or Other Jurisdiction ofIncorporation or Organization)

**75-3142681**

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

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

(Address of Principal ExecutiveOffices and Telephone Number,Including Area Code)

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

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

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

**APPLICABLE ONLY TO CORPORATE ISSUERS:**

Indicate the number of shares outstanding for each of theregistrant’s classes of Common Stock, as of the latest practicable date:16,261,173 shares of Common Stock, $.01 par value, at January 31, 2007.

 

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**CPI INTERNATIONAL, INC.**

**andsubsidiaries**

**INDEX**
| **Part I:   Financial Information** |   |                                                                                        |
|-----------------------------------------------|--------|---------------------------------------------------------------------------------------------|
| Item 1.                                       |   | Financial Statements                                                                        |   |   |
|                                          |   | Unaudited  Condensed Consolidated Balance Sheets                                            |   | 4 |
|                                          |   | Unaudited  Condensed Consolidated Statements of Operations and Comprehensive Income         |   | 5 |
|                                          |   | Unaudited  Condensed Consolidated Statements of Cash Flows                                  |   | 6 |
|                                          |   | Notes to  Unaudited Condensed Consolidated Financial Statements                             |   | 7 |
| Item 2.                                       |   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |   | 30 |
| Item 3.                                       |   | Quantitative  and Qualitative Disclosures About Market Risk                                 |   | 42 |
| Item 4.                                       |   | Controls and  Procedures                                                                    |   | 43 |
| **Part II:  Other Information**          |   |                                                                                        |
| Item  1.                                      |   | Legal  Proceedings                                                                          |   | 44 |
| Item  1A.                                     |   | Risk  Factors                                                                               |   | 44 |
| Item 2.                                       |   | Unregistered Sales  of Equity Securities and Use of Proceeds                                |   | 44 |
| Item 3.                                       |   | Defaults Upon  Senior Securities                                                            |   | 44 |
| Item 4.                                       |   | Submission of  Matters to a Vote of Security Holders                                        |   | 44 |
| Item  5.                                      |   | Other  Information                                                                          |   | 44 |
| Item 6.                                       |   | Exhibits                                                                                    |   | 44 |

 

2

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**CPI INTERNATIONAL, INC.**

**and subsidiaries**

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

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

Althoughwe believe that the expectations reflected in the forward-looking statementsare reasonable, we cannot guarantee future results, levels of activity,performance or achievements. Moreover, neither we nor any other person assumesresponsibility for the accuracy and completeness of the forward-lookingstatements. Forward-looking statements are subject to known and unknown risksand uncertainties, which could cause actual results to differ materially fromthe results projected, expected or implied by the forward-looking statements.These risk factors include, without limitation, competition in our end markets;our significant amount of debt; changes or reductions in the U.S. defensebudget; U.S. government contracts laws and regulations; changes in technology;the impact of unexpected costs; inability to obtain raw materials andcomponents; and currency fluctuations. All written and oral forward-lookingstatements made in connection with this report that are attributable to us orpersons acting on our behalf are expressly qualified in their entirety by theforegoing risk factors and other cautionary statements included herein and inour other filings with the Securities and Exchange Commission (“SEC”). We areunder no duty to update any of the forward-looking statements after the date ofthis report to conform such statements to actual results or to changes in ourexpectations.

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

3

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**CPI INTERNATIONAL, INC.**

**andsubsidiaries**

**PART I: FINANCIAL INFORMATION**

**Item 1. Financial Statements**

**CONDENSED CONSOLIDATED BALANCESHEETS**(in thousands, except share and per share data – unaudited)
| ** **                                                                                                              | ** ** | **December 29,** | ** ** | **September 29,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|------------------------|------------|
| ** **                                                                                                              | ** ** | **2006**              | ** ** | **2006**               | ** ** |
| **Assets**                                                                                                              | ** ** | ** **            | ** ** | ** **             | ** ** |
| Current Assets:                                                                                                         |       |                  |       |                   |       |
| Cash and cash  equivalents                                                                                              |       | $                     | 32,629     |                   | $          | 30,153 |   |
| Restricted cash                                                                                                         |       | 1,951                 |       | 1,746                  |       |
| Accounts receivable,  net                                                                                               |       | 40,744                |       | 43,628                 |       |
| Inventories                                                                                                             |       | 54,640                |       | 54,031                 |       |
| Deferred tax assets                                                                                                     |       | 11,884                |       | 11,520                 |       |
| Prepaid and other  current assets                                                                                       |       | 3,260                 |       | 3,080                  |       |
| Total current assets                                                                                                    |       | 145,108               |       | 144,158                |       |
| Property, plant, and  equipment, net                                                                                    |       | 65,120                |       | 63,851                 |       |
| Deferred debt issue  costs, net                                                                                         |       | 9,285                 |       | 9,644                  |       |
| Intangible assets, net                                                                                                  |       | 74,878                |       | 75,489                 |       |
| Goodwill                                                                                                                |       | 147,459               |       | 147,489                |       |
| Other long-term assets                                                                                                  |       | 976                   |       | 1,128                  |       |
| Total assets                                                                                                            |       | $                     | 442,826    |                   | $          | 441,759 |   |
| ** **                                                                                                              | ** ** | ** **            | ** ** | ** **             | ** ** |
| **Liabilities and stockholders’  equity**                                                                          | ** ** | ** **            | ** ** | ** **             | ** ** |
| Current Liabilities:                                                                                                    |       |                  |       |                   |       |
| Current portion of  long-term debt                                                                                      |       | $                     | —     |                   | $          | 1,714 |   |
| Accounts payable                                                                                                        |       | 15,707                |       | 19,101                 |       |
| Accrued expenses                                                                                                        |       | 27,936                |       | 23,269                 |       |
| Product warranty                                                                                                        |       | 5,842                 |       | 5,958                  |       |
| Income taxes payable                                                                                                    |       | 9,105                 |       | 10,693                 |       |
| Advance payments from  customers                                                                                        |       | 6,824                 |       | 6,310                  |       |
| Total current  liabilities                                                                                              |       | 65,414                |       | 67,045                 |       |
| Deferred income taxes                                                                                                   |       | 29,977                |       | 29,933                 |       |
| Long-term debt, less  current portion                                                                                   |       | 241,794               |       | 245,067                |       |
| Other long-term liabilities                                                                                             |       | 51                    |       | 41                     |       |
| Total liabilities                                                                                                       |       | 337,236               |       | 342,086                |       |
| Commitments and  contingencies                                                                                          |       |                  |       |                   |       |
| Stockholders’ equity                                                                                               |       |                  |       |                   |       |
| Common stock ($0.01 par  value, 90,000,000 shares authorized; 16,086,445 and 16,049,577 shares issued and  outstanding) |       | 161                   |       | 160                    |       |
| Additional paid-in  capital                                                                                             |       | 65,765                |       | 65,295                 |       |
| Accumulated other  comprehensive income                                                                                 |       | 290                   |       | 679                    |       |
| Retained earnings                                                                                                       |       | 39,374                |       | 33,539                 |       |
| Total stockholders’  equity                                                                                        |       | 105,590               |       | 99,673                 |       |
| Total liabilities and stockholders’ equity                                                                         |       | $                     | 442,826    |                   | $          | 441,759 |   |

 

**See accompanying notes to the condensed consolidatedfinancial statements.**

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**CPI INTERNATIONAL, INC.**

**andsubsidiaries**

**CONDENSED CONSOLIDATEDSTATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME**(in thousands, except share and per share data — unaudited)
| ** **                                                                      | ** ** | **Quarter Ended**      | ** ** |
|---------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                      | ** ** | **December 29,  2006** | ** ** | **December 30,  2005** | ** ** |
| Sales                                                                           |       | $                           | 83,723     |   | $ | 82,379 |   |
| Cost of sales                                                                   |       | 57,142                      |       | 57,171 |   |
| Gross profit                                                                    |       | 26,581                      |       | 25,208 |   |
| Operating costs  and expenses:                                                  |       |                        |       |   |   |
| Research and  development                                                       |       | 1,891                       |       | 1,910 |   |
| Selling and  marketing                                                          |       | 4,829                       |       | 5,024 |   |
| General and  administrative                                                     |       | 4,404                       |       | 7,302 |   |
| Amortization of  acquisition-related intangible assets                          |       | 548                         |       | 548 |   |
| Net loss on  disposition of fixed assets                                        |       | 18                          |       | 65 |   |
| Total operating  costs and expenses                                             |       | 11,690                      |       | 14,849 |   |
| Operating income                                                                |       | 14,891                      |       | 10,359 |   |
| Interest  expense, net                                                          |       | 5,339                       |       | 6,064 |   |
| Income before  income taxes                                                     |       | 9,552                       |       | 4,295 |   |
| Income tax  expense                                                             |       | 3,717                       |       | 2,080 |   |
| Net income                                                                      |       | $                           | 5,835      |   | $ | 2,215 |   |
|                                                                            |       |                        |       |   |   |
| Other comprehensive income, net of tax Net  unrealized loss on cash flow hedges |       | (389                        | )          | (183 | ) |
| Comprehensive  income                                                           |       | $                           | 5,446      |   | $ | 2,032 |   |
|                                                                            |       |                        |       |   |   |
| Earnings per  share - Basic                                                     |       | $                           | 0.36       |   | $ | 0.17 |   |
| Earnings per  share - Diluted                                                   |       | $                           | 0.33       |   | $ | 0.15 |   |
|                                                                            |       |                        |       |   |   |
| Shares used to  compute earnings per share - Basic                              |       | 16,063,221                  |       | 13,078,954 |   |
| Shares used to compute  earnings per share - Diluted                            |       | 17,544,363                  |       | 14,768,082 |   |

 

**See accompanying notes to the condensed consolidatedfinancial statements.**

5

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**CPI INTERNATIONAL, INC.**

**andsubsidiaries**

**CONDENSED CONSOLIDATED STATEMENTSOF CASH FLOWS**(in thousands — unaudited)
| ** **                                                | ** ** | **Quarter Ended** | ** ** |
|-----------------------------------------------------------|------------|------------------------|------------|
| ** **                                                | ** ** | **December 29,**  | ** ** | **December 30,** | ** ** |
| ** **                                                | ** ** | **2006**               | ** ** | **2005** | ** ** |
| ** **                                                | ** ** | ** **             | ** ** | ** ** | ** ** |
| **Cash  flows from operating activities**                 | ** ** | ** **             | ** ** | ** ** | ** ** |
| Net cash  provided by operating activities                |       | $                      | 10,042     |   | $ | 198 |   |
| ** **                                                | ** ** | ** **             | ** ** | ** ** | ** ** |
| **Cash  flows from investing activities**                 | ** ** | ** **             | ** ** | ** ** | ** ** |
| Expenses  relating to sale of San Carlos property         |       | —                 |       | (3 | ) |
| Capital expenditures                                      |       | (2,871                 | )          | (2,945 | ) |
| Net cash used in  investing activities                    |       | (2,871                 | )          | (2,948 | ) |
| ** **                                                | ** ** | ** **             | ** ** | ** ** | ** ** |
| **Cash  flows from financing activities**                 | ** ** | ** **             | ** ** | ** ** | ** ** |
| Proceeds from  issuance of debt                           |       | —                 |       | 10,000 |   |
| Repayments of  debt                                       |       | (5,000                 | )          | — |   |
| Proceeds from  issuance of common stock to employees      |       | 197                    |       | — |   |
| Proceeds from  exercise of stock options                  |       | 66                     |       | — |   |
| Stockholder  distribution payments                        |       | —                 |       | (17,000 | ) |
| Excess tax  benefit on stock option exercises             |       | 42                     |       | — |   |
| Net cash used in  financing activities                    |       | (4,695                 | )          | (7,000 | ) |
| ** **                                                | ** ** | ** **             | ** ** | ** ** | ** ** |
| **Net  increase (decrease) in cash and cash equivalents** |       | 2,476                  |       | (9,750 | ) |
| Cash and cash  equivalents at beginning of period         |       | 30,153                 |       | 26,511 |   |
| Cash and cash  equivalents at end of period               |       | $                      | 32,629     |   | $ | 16,761 |   |
| ** **                                                | ** ** | ** **             | ** ** | ** ** | ** ** |
| **Supplemental  cash flow disclosures**                   | ** ** | ** **             | ** ** | ** ** | ** ** |
| Cash paid for  interest                                   |       | $                      | 961        |   | $ | 1,810 |   |
| Cash paid for taxes,  net of refunds                      |       | $                      | 5,150      |   | $ | 2,554 |   |

 

**See accompanying notes to the condensed consolidatedfinancial statements.**

6

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# **CPI INTERNATIONAL, INC.**

and subsidiaries

# **NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

(All tabular dollar amounts in thousands except shareand per share amounts)

# **1.****                                     ****Organization and Basis ofPresentation**

Unlessthe context otherwise requires, “CPI International” means CPI International,Inc., and “CPI” means Communications & Power Industries, Inc. CPI is adirect subsidiary of CPI International. CPI International is a holding companywith no operations of its own. The term the “Company” refers to CPIInternational and its subsidiaries on a consolidated basis.

Theaccompanying condensed consolidated financial statements represent theconsolidated results and financial position of CPI International, which iscontrolled by affiliates of The Cypress Group (“Cypress”). CPI International,through its wholly owned subsidiary, CPI, develops, manufactures, anddistributes microwave and power grid Vacuum Electron Devices (“VEDs”),microwave amplifiers, modulators and various other power supply equipment anddevices. The Company has two reportable segments, VED and satcom equipment.

Thecondensed consolidated financial statements include those of the Company andits subsidiaries. Significant intercompany balances, transactions, andstockholdings have been eliminated in consolidation.

The Company’s fiscal year is the 52- or 53-weekperiod that ends on the Friday nearest September 30. Fiscal year 2007 comprisesthe 52-week period ending September 28, 2007 and fiscal year 2006 comprised the52-week period ended September 29, 2006. All period references are to theCompany’s fiscal periods unless otherwise indicated. These interimfinancial statements should be read in conjunction with the condensedconsolidated financial statements and accompanying notes included in theCompany’s Annual Report on Form 10-K for the year ended September 29,2006.

OnMay 3, 2006, the Company completed the initial public offering of its commonstock (see Note 4 for further disclosure).

# **2.****                                     ****Supplemental Balance SheetInformation**

**Accounts Receivable:** Accounts receivable are stated net ofallowances for doubtful accounts of $0.2 million and $0.5 million atDecember 29, 2006 and September 29, 2006, respectively.

**Inventories:** The following table provides details of inventories,net of reserves: 
|                         | ** ** | **December 29,** | ** ** | **September 29,** | ** ** |
|-------------------------|------------|-----------------------|------------|------------------------|------------|
| ** **              | ** ** | **2006**              | ** ** | **2006**               | ** ** |
| Raw material and  parts |       | $                     | 34,427     |                   | $          | 35,160 |   |
| Work in process         |       | 12,418                |       | 10,481                 |       |
| Finished goods          |       | 7,795                 |       | 8,390                  |       |
|                    |       | $                     | 54,640     |                   | $          | 54,031 |   |

 

7

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**Reserve for excess, slow moving and obsoleteinventory:** Thefollowing table summarizes the activity related to reserves for excess, slowmoving and obsolete inventory during the first quarter of fiscal years 2007 and2006: 
|                                                | ** ** | **Quarter Ended**      | ** ** |
|------------------------------------------------|------------|-----------------------------|------------|
| ** **                                     | ** ** | **December 29,  2006** | ** ** | **December 30,  2005** | ** ** |
| Balance at  beginning of period                |       | $                           | 8,822      |   | $ | 8,655 |   |
| Inventory  provision, charged to cost of sales |       | 307                         |       | 316 |   |
| Inventory  write-offs                          |       | (60                         | )          | (28 | ) |
| Balance at end of  period                      |       | $                           | 9,069      |   | $ | 8,943 |   |

 

**Reserve for loss contracts and cost in excess ofmarket inventory:**The following table summarizes the activity related to reserves for losscontracts and cost in excess of market inventory during first quarter of fiscalyears 2007 and 2006: 
|                                                                                                 | ** ** | **Quarter Ended**      | ** ** |
|-------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                                      | ** ** | **December 29,  2006** | ** ** | **December 30,  2005** | ** ** |
| Balance at  beginning of period                                                                 |       | $                           | 1,702      |   | $ | 1,430 |   |
| Provision for  loss contracts and cost in excess of market inventory, charged to cost of  sales |       | 32                          |       | 306 |   |
| Credit to cost  of sales upon revenue recognition                                               |       | (101                        | )          | (222 | ) |
| Balance at end of period                                                                        |       | $                           | 1,633      |   | $ | 1,514 |   |

 

**Product Warranty:** The following table summarizes theactivity related to product warranty during the first quarter of fiscal years2007 and 2006: 
|                                                          | ** ** | **Quarter Ended**      | ** ** |
|----------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                               | ** ** | **December 29,  2006** | ** ** | **December 30,  2005** | ** ** |
| Beginning  accrued warranty                              |       | $                           | 5,958      |   | $ | 6,359 |   |
| Accruals for  product warranty, charged to cost of sales |       | 1,211                       |       | 1,048 |   |
| Cost of warranty  claims                                 |       | (1,327                      | )          | (1,217 | ) |
| Ending accrued warranty                                  |       | $                           | 5,842      |   | $ | 6,190 |   |

 

8

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**Intangible Assets:** The following tables present the detailsof the Company’s total acquisition-related intangible assets: 
|                                                   | ** ** | **December 29, 2006** | ** ** | **September 29, 2006**    | ** ** |
|---------------------------------------------------|------------|---------------------------------|------------|-------------------------------------|------------|
| ** **                                        | ** ** | **Cost**                        | ** ** | **Accumulated   Amortization** | ** ** | **Net** | ** ** | **Cost** | ** ** | **Accumulated  Amortization** | ** ** | **Net** | ** ** |
| ** **                                        | ** ** | ** **                      | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| VED Core  Technology                              |       | $                               | 30,700     |                                | $          | (1,813 | ) | $ | 28,887 |   | $ | 30,700 |   | $ | (1,659 | ) | $ | 29,041 |   |
| VED Application  Technology                       |       | 19,800                          |       | (2,328                              | )          | 17,472 |   | 19,800 |   | (2,130 | ) | 17,670 |   |
| X-ray Generator  and Satcom ApplicationTechnology |       | 8,000                           |       | (1,574                              | )          | 6,426 |   | 8,000 |   | (1,441 | ) | 6,559 |   |
| Customer backlog                                  |       | 17,450                          |       | (17,450                             | )          | — |   | 17,450 |   | (17,450 | ) | — |   |
| Land lease                                        |       | 11,810                          |       | (769                                | )          | 11,041 |   | 11,810 |   | (706 | ) | 11,104 |   |
| Tradename                                         |       | 5,800                           |       | —                              |       | 5,800 |   | 5,800 |   | — |   | 5,800 |   |
| Customer list  and programs                       |       | 5,700                           |       | (508                                | )          | 5,192 |   | 5,700 |   | (451 | ) | 5,249 |   |
| Noncompete  agreement                             |       | 110                             |       | (50                                 | )          | 60 |   | 110 |   | (44 | ) | 66 |   |
|                                              |       | $                               | 99,370     |                                | $          | (24,492 | ) | $ | 74,878 |   | $ | 99,370 |   | $ | (23,881 | ) | $ | 75,489 |   |

 

The estimated future amortization expense of purchasedintangibles as of December 29, 2006, excluding the Company’s unamortizedtradename, is as follows: 
| Fiscal Year              | ** ** | **Amount** | ** ** |
|-------------------------------|------------|------------|------------|
| 2007 (remaining  nine months) |       | 1,831      |       |
| 2008                          |       | 2,441      |       |
| 2009                          |       | 2,441      |       |
| 2010                          |       | 2,419      |       |
| 2011                          |       | 2,419      |       |
| Thereafter                    |       | 57,527     |       |
|                          |       | $          | 69,078     |   |
|                               |            |            |            |  |

 

**Goodwill:** The following table presents goodwill byreportable segment at December 29, 2006 and September 29, 2006: 
|                  | ** ** | **December 29,** | ** ** | **September 29,** | ** ** |
|------------------|------------|-----------------------|------------|------------------------|------------|
| ** **       | ** ** | **2006**              | ** ** | **2006**               | ** ** |
| VED              |       | $                     | 133,607    |                   | $          | 133,637 |   |
| Satcom Equipment |       | 13,852                |       | 13,852                 |       |
|             |       | $                     | 147,459    |                   | $          | 147,489 |   |

 

The decrease in goodwillfrom September 29, 2006 to December 29, 2006 was due to an adjustment for taxbenefits realized from the exercise of fully vested stock options that wereacquired in a business combination.

9

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# **3.****                                     ****Long-Term Debt**

Long-term debt comprises the following: 
|                                                                               | ** ** | **December 29,** | ** ** | **September 29,** | ** ** |
|-------------------------------------------------------------------------------|------------|-----------------------|------------|------------------------|------------|
| ** **                                                                    | ** ** | **2006**              | ** ** | **2006**               | ** ** |
|                                                                          |       |                  |       |                   |       |
| Term loan,  expiring 2010                                                     |       | $                     | 37,500     |                   | $          | 42,500 |   |
| 8% Senior  subordinated notes, due 2012                                       |       | 125,000               |       | 125,000                |       |
| Floating rate  senior notes, due 2015, net of issue discount of $706 and $719 |       | 79,294                |       | 79,281                 |       |
|                                                                          |       | 241,794               |       | 246,781                |       |
| Less: Current portion                                                         |       | —                |       | 1,714                  |       |
| Long-term portion                                                             |       | $                     | 241,794    |                   | $          | 245,067 |   |

 

**Senior Credit Facility and Term Loan of CPI:**In fiscal year 2004, CPI entered into a$130.0 million credit agreement, which was amended and restated on November 29,2004, and further amended on February 16, 2005, April 13, 2005, and December15, 2005 (the “Senior Credit Facility”). The Senior Credit Facility consists ofa $40.0 million revolving commitment, with a sub-facility of $15.0 million forletters of credit and $5.0 million for swingline loans (“Revolver”), whichexpires on January 23, 2010, and a $90.0 million term loan (“Term Loan”), whichexpires on July 23, 2010. As of December 29, 2006, the Company had nooutstanding borrowings under the Revolver and $37.5 million outstanding underthe Term Loan, after taking into account a $5.0 million Term Loan repayment in December2006 using available operating cash. The $5.0 million Term Loan repaymentincluded a $1.7 million ECF (as defined below) payment, and an optionalprepayment of $3.3 million. In December 2005, CPI borrowed $10.0 million on theTerm Loan to pay a dividend to CPI International.  CPI International used the proceeds of thatdividend to pay a portion of the special cash dividend of $17.0 million to itsstockholders. Upon certain specified conditions, including compliance on a proforma basis with the covenants in the Senior Credit Facility, CPI may seek commitments for a new class of termloans, not to exceed $65.0 million. The Senior Credit Facility is guaranteed byCPI International and all of CPI’s domestic subsidiaries and is secured bysubstantially all of their assets.

Any borrowings under the Revolver would currentlybear interest at a rate equal to, at CPI’s option, LIBOR plus 2.75% per annum,or the Alternate Base Rate (“ABR”) plus 1.75% per annum. Available borrowingsunder the Revolver are reduced by any amounts secured through letters ofcredit; at December 29, 2006, the Company had letters of credit commitments for$3.8 million. The Term Loan borrowings currently bear interest at a rate equalto, at CPI’s option, LIBOR plus 2.25% per annum or the ABR plus 1.25% perannum, payable quarterly. The ABR is the greater of (a) the Prime Rate and (b)the Federal Funds Rate plus 0.50%. In addition to customary fronting and administrativefees under the Senior Credit Facility, CPI pays letter of credit participationfees equal to the applicable Revolver LIBOR margin per annum on the averagedaily amount of the letter of credit exposure, and a commitment fee of 0.50%per annum on the average daily unused amount of revolving commitment. As ofDecember 29, 2006 (1) the Term Loan borrowing consisted of one tranche of $5.5million and one tranche of $32.0 million with interest payable on January 11,2007 and January 22, 2007, each at 7.6% per annum, and (2) a Revolvingcommitment of $3.8 million for letter of credit exposure, with letter of creditparticipation fees and fronting fees payable quarterly at a combined interestrate of 3.0% per annum.

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The Senior Credit Facility requires 1.0% of theoriginal Term Loan amount to be repaid annually in quarterly installments of0.25% beginning June 30, 2004 and continuing for five years, with the remainderdue in equal quarterly installments thereafter. CPI is required to prepay itsoutstanding loans, subject to certain exceptions and limitations, with net cashproceeds received from certain events, including, without limitation (1) allsuch proceeds received from certain asset sales by CPI International, CPI orany of CPI’s subsidiaries, (2) all such proceeds received from issuances ofdebt (other than certain specified permitted debt) or preferred stock by CPIInternational, CPI or any of CPI’s subsidiaries, (3) all such proceeds paid toCPI International, CPI or any of CPI’s subsidiaries from casualty andcondemnation events in excess of amounts applied to replace, restore orreinvest in any properties for which proceeds were paid within a specifiedperiod and (4) 50% of such proceeds received from issuances of common equityby, or equity contributions to, CPI International.

CPI is also required to make an annual prepaymentwithin 90 days after the end of each fiscal year based on a calculation ofExcess Cash Flow, as defined in the Senior Credit Facility (“ECF”), multipliedby a factor of 25%, 50% or 75% depending on the leverage ratio at the end ofthe fiscal year, less optional prepayments made during the fiscal year. OnDecember 30, 2004, CPI made an ECF payment of $3.9 million. The ECF payment wasapplied pro rata, in accordance with the provisions of the Senior CreditFacility, against the remaining scheduled installments of Term Loan principaldue up to, but not including, the September 30, 2009 scheduled principalinstallment. The Company made an ECF payment of $1.7 million for the fiscal yearended September 29, 2006 in December 2006 and there is no expected ECF paymentdue for fiscal year 2007, primarily because of the $3.3 million optionalprepayment that was made in December 2006.

CPI can make optional prepayments on the outstandingloans at any time without premium or penalty, except for customary “breakage”costs with respect to LIBOR loans. In March 2005, CPI made an optionalprepayment of $5.7 million; in May 2006, CPI made additional optionalprepayments of $47.5 million in the aggregate using proceeds from the initialpublic offering of CPI International’s common stock (the “IPO”); and inDecember 2006, CPI made an additional prepayment of $3.3 million. The optionalprepayments were applied pro rata, in accordance with the provisions of theSenior Credit Facility, against the remaining scheduled installments of TermLoan principal due up to June 30, 2009, with the balance applied to scheduledinstallment amounts on or after September 30, 2009, in direct order ofmaturity.

The Senior Credit Facility contains a number ofcovenants that, among other things, restrict, subject to certain exceptions,the ability of CPI International, CPI and CPI’s domestic subsidiaries to: sellassets; engage in mergers and acquisitions; pay dividends and distributions orrepurchase their capital stock; incur additional indebtedness or issue equityinterests; make investments and loans; create liens or further negative pledgeson assets; engage in certain transactions with affiliates; enter into sale andleaseback transactions; amend agreements or make prepayments relating tosubordinated indebtedness; and amend or waive provisions of charter documentsin a manner materially adverse to the lenders. CPI and CPI’s subsidiaries mustcomply with: a minimum interest coverage ratio; a maximum total leverage ratio;a minimum fixed charge coverage ratio; and a maximum capital expenditureslimitation, each calculated on a consolidated basis for CPI and CPI’ssubsidiaries. CPI International must also comply with a minimum interestcoverage ratio, a minimum fixed charge coverage ratio and a maximum leverageratio, each calculated on a consolidated basis for CPI International and itssubsidiaries. As of December 29, 2006, CPI and CPI International were incompliance with all Senior Credit Facility financial covenants.

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Subject in certain cases to applicable noticeprovisions and grace periods, events of default under the Senior CreditFacility include, among other things: failure to make payments when due;breaches of representations and warranties in the documents governing theSenior Credit Facility; non-compliance by CPI International, CPI and/or CPI’ssubsidiaries with certain covenants; failure by CPI International, CPI and/orCPI’s subsidiaries to pay certain other indebtedness or to observe any othercovenants or agreements that would allow acceleration of such indebtedness,collectively in excess of $5.0 million at any time; events of bankruptcy orinsolvency of CPI International, CPI and/or CPI’s subsidiaries; certainuninsured and unstayed judgments of $5.0 million or more against CPIInternational; impairment of the security interests in the collateral or theguarantees under the Senior Credit Facility; and a change in control, asdefined in the documents governing the Senior Credit Facility.

**8% Senior subordinated notesof CPI:** In connection with abusiness combination on January 23, 2004, CPI issued $125.0 million inaggregate principal amount of its 8% Senior Subordinated Notes (the “8% Notes”).The 8% Notes have no sinking fund requirements.

The 8% Notes bear interest at the rate of 8.0% peryear, payable on February 1 and August 1 of each year. The 8% Noteswill mature on February 1, 2012. The 8% Notes are unsecured obligations,jointly and severally guaranteed by CPI International and each of CPI’sdomestic subsidiaries. The payment of all obligations relating to the 8% Notesare subordinated in right of payment to the prior payment in full in cash orcash equivalents of all senior debt (as defined in the indenture governing the8% Notes) of CPI, including debt under the Senior Credit Facility. Eachguarantee of the 8% Notes is and will be subordinated to guarantor senior debt(as defined in the indenture governing the 8% Notes) on the same basis as the8% Notes are subordinated to CPI’s senior debt.

At any time or from time to time on or afterFebruary 1, 2008, CPI, at its option, may redeem the 8% Notes, in whole orin part, at the redemption prices (expressed as percentages of principalamount) set forth below, together with accrued and unpaid interest thereon, ifany, to the redemption date, if redeemed during the 12-month period beginningon February 1 of the years indicated below:
| Year                | ** ** | **Optional  Redemption  Price** | ** ** |
|---------------------|------------|---------------------------------|------------|
| 2008                |       | 104                             | %          |
| 2009                |       | 102                             | %          |
| 2010 and thereafter |       | 100                             | %          |

 

Atany time on or prior to February 1, 2008, the 8% Notes may also be redeemed orpurchased (by CPI or any other person) in whole but not in part, at CPI’soption, upon the occurrence of a change of control (as defined in the indenturegoverning the 8% Notes) at a price equal to 100% of the principal amount of the8% Notes, plus a “make-whole” premium (as defined in the indenture governingthe 8% Notes) to the redemption price on February 1, 2008, and accrued andunpaid interest, if any, to, the date of redemption or purchase.  Upon a change of control, CPI may be requiredto purchase all or any part of the 8% Notes for a cash price equal to 101% ofthe principal amount, plus accrued and unpaid interest thereon, if any, to thedate of purchase.

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

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

**Floating rate senior notes of CPI International:**On February 22, 2005, CPI Internationalissued $80.0 million in principal amount of its Floating Rate Senior Notes (“FRNotes”). The FR Notes were issued at a 1% discount. The proceeds from theissuance of FR Notes were used to make a distribution to stockholders of CPIInternational of approximately $75.8 million and to pay fees and expenses ofapproximately $3.5 million associated with the issuance of FR Notes. The FRNotes have no sinking fund requirements.

TheFR Notes require interest payments at an annual interest rate, reset at thebeginning of each semi-annual period, equal to the then six-month LIBOR plus5.75%, payable semiannually on February 1 and August 1 of each year. Theinterest rate on the semi-annual interest payment due February 1, 2007 isapproximately 11.30% per annum. CPI International may, at its option, elect topay interest through the issuance of additional FR Notes for any interestpayment date on or before February 1, 2010. If CPI International elects topay interest through the issuance of additional FR Notes, the annual interestrate on the FR Notes will increase by an additional 1% step-up, with thestep-up increasing by an additional 1% for each interest payment made throughthe issuance of additional FR Notes (up to a maximum of 4%). The FR Notes willmature on February 1, 2015.

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

BecauseCPI International is a holding company with no operations of its own, CPIInternational relies on distributions from CPI to satisfy its obligations underthe FR Notes. The Senior Credit Facility and the indenture governing the 8%Notes restrict CPI’s ability to make distributions to CPI International. TheSenior Credit Facility prohibits CPI from making distributions to CPIInternational unless there is no default under the Senior Credit Facility andCPI International and CPI satisfy certain leverage ratios. The indenturegoverning the 8% Notes prohibits CPI from making distributions to CPIInternational unless, among other things, there is no default under theindenture and the amount of the proposed dividend plus all previous RestrictedPayments (as defined in the indenture governing the 8% Notes) does not exceed aspecified amount.

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At any time or from time to time CPI International,at its option, may redeem the Notes in whole or in part at the redemptionprices (expressed as percentages of principal amount) set forth below, togetherwith accrued and unpaid interest thereon, if any, to the redemption date, ifredeemed during the 12-month period beginning on February 1 of the yearsindicated below:
|                     | ** ** | **Optional**         | ** ** |
|---------------------|------------|----------------------|------------|
| ** **          | ** ** | **Redemption ** | ** ** |
| **Year**            | ** ** | **Price**            | ** ** |
| 2007                |       | 103                  | %          |
| 2008                |       | 102                  | %          |
| 2009                |       | 101                  | %          |
| 2010 and thereafter |       | 100                  | %          |

 

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

Theindenture governing the FR Notes contains certain covenants that, among otherthings, limit the ability of CPI International and its restricted subsidiaries(as defined in the indenture governing the FR Notes) to incur additional indebtedness,sell assets, consolidate or merge with or into other companies, pay dividendsor repurchase or redeem capital stock or subordinated indebtedness, makecertain investments, issue capital stock of their subsidiaries, incur liens andenter into certain types of transactions with their affiliates.

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

**Debt Maturities:** As of December 29, 2006, maturities onlong-term debt were as follows: 
|                      | ** ** | ** ** | ** ** | ** **             | ** ** | **8% Senior** | ** ** | ** ** | ** ** |
|----------------------|------------|------------|------------|------------------------|------------|--------------------|------------|------------|------------|
| ** **           | ** ** | **Term**   | ** ** | **Floating Rate** | ** ** | **Subordinated**   | ** ** | ** ** | ** ** |
| **Fiscal Year** | ** ** | **Loan**   | ** ** | **Senior Notes**  | ** ** | **Notes**          | ** ** | **Total**  | ** ** |
| 2007                 |       | $          | —     |                   | $          | —             |       | $          | —     |   | $ | — |   |
| 2008                 |       | —     |       | —                 |       | —             |       | —     |       |
| 2009                 |       | —     |       | —                 |       | —             |       | —     |       |
| 2010                 |       | 37,500     |       | —                 |       | —             |       | 37,500     |       |
| 2011                 |       | —     |       | —                 |       | —             |       | —     |       |
| Thereafter           |       | —     |       | 80,000                 |       | 125,000            |       | 205,000    |       |
|                 |       | $          | 37,500     |                   | $          | 80,000             |       | $          | 125,000    |   | $ | 242,500 |   |

 

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# **4.****                                      Stockholders’Equity**

**Common and Preferred Stock:** On April 7, 2006, the Company amendedand restated its certificate of incorporation to provide for 90,000,000authorized shares of Common Stock, par value $0.01 per share, and 10,000,000authorized shares of Preferred Stock, par value $0.01 per share. The holder ofeach share of Common Stock has the right to one vote. The board of directorshas the authority to issue the undesignated Preferred Stock in one or moreseries and to fix the rights, preferences, privileges and restrictions thereof.As of December 29, 2006 and September 29, 2006, there were no shares ofPreferred Stock outstanding.

OnApril 7, 2006, in connection with the amendment and restatement of itscertificate of incorporation, the Company also effected a 3.059-to-1 stocksplit of its outstanding shares of common stock as of such date. All share andper share amounts in the accompanying condensed consolidated financial statementsand accompanying notes have been retroactively restated to reflect this stocksplit.

OnMay 3, 2006, the Company completed the IPO of its common stock. The Companysold 2,941,200 shares of common stock and the selling stockholders sold4,117,670 shares, at an initial public offering price to the public of $18.00per share, resulting in proceeds to the Company of approximately $47.3 million,net of IPO transaction costs of approximately $5.6 million. The Company usedthe net proceeds to repay $47.3 million of the Term Loan under the SeniorCredit Facility.

# **5.****                                      Share-basedCompensation Plans**

TheCompany has four stock plans: the 2006 Equity and Performance Incentive Plan(the “2006 Plan”), the 2006 Employee Stock Purchase Plan (the “2006 ESPP”), the2004 Stock Incentive Plan (the “2004 Plan”) and the 2000 Stock Option Plan (the“2000 Plan”).

**2006 Plan:** The 2006 Plan provides for an aggregate of up to1,400,000 shares of CPI International’s common stock to be available forawards, plus the number of shares subject to awards granted under the 2004 Planand the 2000 Plan that are forfeited, expire or are cancelled after theeffective date of the 2006 Plan. All of the Company’s employees (includingofficers), directors, and consultants are eligible for awards under the 2006Plan. The 2006 Plan is administered by the Compensation Committee of the Boardof Directors (“Compensation Committee”) and awards may consist of options,stock appreciation rights, restricted stock, other stock unit awards,performance awards, dividend equivalents or any combination of the foregoing.The exercise price for stock options generally cannot be less than 100% of thefair market value of the shares on the date of grant.

**2006 ESPP:** The 2006 ESPP permits eligible employees to purchasecommon stock at a discounted price. An aggregate of 760,000 shares of commonstock is reserved for issuance under this plan. The stock purchase plan isadministered by the Compensation Committee of the board of directors. Employeesparticipating in the plan may purchase stock for their accounts according to aprice formula set by the Compensation Committee, as administrator, before theapplicable offering period, which cannot exceed 24 months. The price per sharewill equal a fixed percentage (which may not be lower than 85%) of the fairmarket value of a share of common stock on the last day of the purchase periodin the offering, or the lower of (1) a fixed percentage (not to be less than85%) of the fair market value of a share of common stock on the date of commencementof participation in the offering and (2) a fixed percentage (not to be lessthan 85%) of the fair market value of a share of common stock on the date ofpurchase. The initial 2006 ESPP offering period began on July 1, 2006; theparticipants’ purchase price for CPI

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International, Inc. common stock will be 85% of theclosing market price on the last trading day of each quarter. Under the 2006ESPP, the Company issued 13,387 and 14,954 shares at a discounted purchaseprice of $12.75 and $11.19 per share in January 2007 and October 2006,respectively.

**2004 Plan:** No further options are available for issuance underthe 2004 Plan. The Company issued both time and performance stock option awardsunder the 2004 Plan. All stock option grants under the 2004 Plan were issued atexercise prices equal to or greater than the estimated market price of theCompany’s common stock at option grant date.

**2000 Plan:**No further options are available for issuance underthe 2000 Plan. In accordance with the terms of the stock option agreements, theunvested stock options outstanding under the 2000 Plan became fully vested inFebruary 2004 in connection with a business combination. The 2000 Plan optionholders were offered the opportunity to either roll over their stock optionsfrom the predecessor company into options to purchase common stock of CPIInternational or exercise their stock options. Management elected to roll overoptions to purchase 912,613 shares of common stock at prices ranging from $0.20to $0.74 per share.

**StockOptions:**Asummary of the Company’s stock option activity as of December 29, 2006, andchanges during the fiscal quarter then ended is presented below:
|                                    | ** ** | ** **         | ** ** | ** **              | ** ** | **Weighted-**         | ** ** | ** **          | ** ** |
|------------------------------------|------------|--------------------|------------|-------------------------|------------|-----------------------|------------|---------------------|------------|
| ** **                         | ** ** | ** **         | ** ** | ** **              | ** ** | **Average **     | ** ** | ** **          | ** ** |
| ** **                         | ** ** | ** **         | ** ** | **Weighted **      | ** ** | **Remaining **   | ** ** | **Aggregate ** | ** ** |
| ** **                         | ** ** | **Number of** | ** ** | **Average**             | ** ** | **Contractual ** | ** ** | **Intrinsic ** | ** ** |
| ** **                         | ** ** | **Shares**         | ** ** | **Exercise Price** | ** ** | **Term (Years)** | ** ** | **Value**           | ** ** |
| Outstanding at  September 29, 2006 |       | 3,163,057          |       | $                       | 4.51       |                  |       |                |       |   |
| Granted                            |       | 285,000            |       | 14.22                   |       |                  |       |                |       |
| Exercised                          |       | (21,914            | )          | 3.03                    |       |                  |       |                |       |
| Forfeited or  expired              |       | —             |       | —                  |       |                  |       |                |       |
| Outstanding at  December 29, 2006  |       | 3,426,143          |       | $                       | 5.33       |                  | 7.25       |                | $          | 34,009 |   |
| Vested and  expected to vest       |       | 3,380,178          |       | $                       | 5.21       |                  | 7.22       |                | $          | 33,922 |   |
| Exercisable at  December 29, 2006  |       | 2,323,919          |       | $                       | 2.85       |                  | 6.67       |                | $          | 28,230 |   |

 

Thegrant date fair value of awards granted during the first quarter of fiscal year2007 was estimated as of the date of grant using the Black-Scholes optionspricing model, assuming no expected dividends and the following assumptions: 
| Expected term (in years) |   | 6.25  |   |
|--------------------------|--------|-------|--------|
| Expected  volatility     |   | 49.33 | %      |
| Risk-free rate           |   | 4.56  | %      |
| Grant date fair value    |   | $     | 7.66   |   |
|                          |        |       |        |  |

 

Sincethe Company’s common stock has not been publicly traded for a sufficient timeperiod, the expected volatility is based on expected volatilities of similarcompanies that have a longer history of

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being publicly traded. The expected life of optionsgranted is based on the simplified method for plain vanilla options inaccordance with Securities and Exchange Commission Staff Accounting BulletinNo. 107. The risk-free rates are based on the U.S. Treasury yield in effect atthe time of the grant.

Thetotal intrinsic value of options exercised was $0.2 million during firstquarter of fiscal year 2007. There were no options granted or exercised duringthe first quarter of fiscal year 2006.

Outstanding and exercisable options presented byexercise price as of December 29, 2006 are as follows:
|                                                                                                                                                                                     | ** ** | **Options Outstanding** | ** ** | **Options Exercisable**    | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                                                                                          | ** ** | ** **                   | ** ** | **Weighted-Average**            | ** ** | ** ** | ** ** | **Weighted-Average ** | ** ** |
| ** **                                                                                                                                                                          | ** ** | **Number of **     | ** ** | **Remaining**                   | ** ** | **Number of** | ** ** | **Remaining** | ** ** |
| ** **                                                                                                                                                                          | ** ** | **Options**                  | ** ** | **Contractual Life ** | ** ** | **Options** | ** ** | **Contractual Life ** | ** ** |
| **Exercise   Price**                                                                                                                                                           | ** ** | **Outstanding**              | ** ** | **(Years)**                     | ** ** | **Exercisable** | ** ** | **(Years)** | ** ** |
| $                             0.20 |       | 695,126                      |       | 6.20                            |       | 695,126 |   | 6.20 |   |
| $                             0.74 |       | 194,292                      |       | 3.68                            |       | 194,292 |   | 3.68 |   |
| $                             1.08 |       | 8,079                        |       | 7.10                            |       | 8,079 |   | 7.10 |   |
| $                             4.32 |       | 1,864,578                    |       | 7.25                            |       | 1,352,824 |   | 7.27 |   |
| $                             6.61 |       | 54,480                       |       | 7.75                            |       | 54,480 |   | 7.75 |   |
| $                             6.98 |       | 30,588                       |       | 8.20                            |       | 19,118 |   | 8.20 |   |
| $                           14.22            |       | 285,000                      |       | 9.94                            |       | — |   | — |   |
| $                           18.00            |       | 294,000                      |       | 9.33                            |       | — |   | — |   |
|                                                                                                                                                                                |       | 3,426,143                    |       | 7.25                            |       | 2,323,919 |   | 6.67 |   |

 

Asof December 29, 2006, there was approximately $4.5 million of totalunrecognized compensation costs related to nonvested stock options, which isexpected to be recognized over a weighted-average vesting period of 2.7 years.

**Restricted Stock Awards:**There were 9,999 shares of restrictedstock outstanding as of December 29, 2006 and September 29, 2006. Therestricted stock awards vest over periods of one to three years and have a 10year contractual life.

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Asummary of the status of the Company’s nonvested restricted stock awards as ofDecember 29, 2006, and changes during the fiscal quarter then ended ispresented below:
|                                  | ** ** | ** **               | ** ** | **Weighted-**           | ** ** |
|----------------------------------|------------|--------------------------|------------|-------------------------|------------|
| ** **                       | ** ** | ** **               | ** ** | **Average Grant-** | ** ** |
| ** **                       | ** ** | **Number of ** | ** ** | **Date **          | ** ** |
| ** **                       | ** ** | **Shares**               | ** ** | **Fair Value**     | ** ** |
| Nonvested at  September 29, 2006 |       | 9,999                    |       | $                       | 18.00      |   |
| Granted                          |       | —                   |       | —                  |       |
| Vested                           |       | —                   |       | —                  |       |
| Forfeited                        |       | —                   |       | —                  |       |
| Nonvested at  December 29, 2006  |       | 9,999                    |       | $                       | 18.00      |   |

 

Asof December 29, 2006, there was $0.1 million of total unrecognized compensationcosts related to nonvested restricted stock awards, which is expected to be recognizedover a weighted average vesting period of 1.2 years.

**Share-Based Compensation Cost:** There was nounrecognized compensation cost relating to stock options outstanding at thebeginning of fiscal year 2006 and no stock options were granted during thefirst quarter of fiscal year 2006. Therefore, there was no share-basedcompensation cost in the first quarter of fiscal year 2006.  Total share-based compensation cost for the Company’sstock plans in first quarter of fiscal year 2007 comprise the following:
|                                                                               | ** ** | **Quarter Ended**          | ** ** |
|-------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                    | ** ** | **December 29, 2006** | ** ** |
| Share-based  compensation cost recognized in the income statement by caption: |       |                            |       |
| Cost of sales                                                                 |       | $                               | 39         |   |
| Research and development                                                      |       | 10                              |       |
| Selling and marketing                                                         |       | 19                              |       |
| General and administrative                                                    |       | 137                             |       |
|                                                                          |       | $                               | 205        |   |
| Share-based  compensation cost capitalized in inventory                       |       | $                               | 44         |   |
| Share-based  compensation cost remaining in inventory  at end of period       |       | $                          | 29         |   |
| Share-based  compensation expense by type of award:                           |       |                            |       |
| Stock options                                                                 |       | $                               | 175        |   |
| Restricted stock                                                              |       | 30                              |       |
|                                                                          |       | $                               | 205        |   |

 

# **6.****                                      DerivativeFinancial Instruments**

TheCompany uses forward exchange contracts to hedge the foreign currency exposureassociated with forecasted manufacturing costs in Canada. As of December 29,2006, CPI had outstanding forward contract commitments to purchase Canadiandollars for an aggregate U.S. notional amount of $17.3 million; the lastforward contract expires on September 24, 2007. At December 29, 2006 and 

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September 29, 2006, the fair value of foreign currencyforward contracts was a liability of $0.5 million and an asset of $0.1 million,respectively, and the unrealized (loss) gain was approximately $(0.3) millionand $8 thousand, net of related tax expense, respectively.

TheCompany’s foreign currency forward contracts are designated as a cash flowhedge and are considered highly effective, as defined by Statement of FinancialAccounting Standards (“SFAS”) No. 133, “Accounting for Derivative Instrumentsand Hedging Activities.” The unrealized gains and losses from foreign exchangeforward contracts are included in “Accumulated other comprehensive income” inthe condensed consolidated balance sheets, and the Company anticipatesrecognizing the entire unrealized loss in operating earnings within the nexttwelve months. Changes in the fair value of foreign currency forward contractsdue to changes in time value are excluded from the assessment of effectiveness,and are recognized in General and Administrative in the condensed consolidatedstatements of operations when the hedged item affects earnings. The time valuewas not material for first quarter of fiscal years 2007 and 2006. If thetransaction being hedged fails to occur, or if a portion of any derivative isineffective, the Company promptly recognizes the gain or loss on the associatedfinancial instrument in the condensed consolidated statements of operations. Noineffective amounts were recognized due to anticipated transactions failing tooccur in the first quarter of fiscal years 2007 and 2006. Realized gains andlosses from foreign currency forward contracts are recognized in cost of salesand general and administrative in the condensed consolidated statements ofoperations.  Net income in the first quarterof fiscal year 2007 includes a recognized loss from foreign currency forwardcontracts of $0.1 million.  Net income inthe first quarter of fiscal year 2006 includes a recognized gain from foreigncurrency forward contracts of $0.4 million.

InApril 2005, the Company expanded its use of derivatives to hedge the interestrate exposure associated with the FR Notes. On April 15, 2005, the Companyentered into an $80 million interest rate swap contract (“the Swap”) to receivevariable rate 6-month LIBOR interest and pay 4.15% fixed rate interest, whichwhen combined with the 5.75% margin, results in a fixed rate of 9.9% on the FRNotes through January 31, 2008. The Swap interest payments are madesemi-annually, beginning with the first payment on February 1, 2006. The Swapmatures on January 31, 2008. In fiscal year 2005, the Company deposited $1.0million as collateral for the Swap; the amount of collateral fluctuates basedon the fair value of the Swap.  In fiscalyear 2006, the Company received a $0.5 million refund of the Swap collateral.The Swap collateral remaining is reported as Other long-term assets in theaccompanying condensed consolidated balance sheets. The unrealized gains andlosses from the Swap are included in “Accumulated other comprehensive income”in the condensed consolidated balance sheets. The ineffective portion of theSwap was not significant and the interest rate swap gain or loss are includedin the assessment of hedge effectiveness. At December 29, 2006 and September29, 2006, the fair value of the Swap was an asset of $1.0 million and $1.1million, respectively, and the unrealized gain, net of related tax expense, wasapproximately $0.6 million and $0.7 million, respectively.

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

TheCompany’s effective tax rate was approximately 39% for the first quarter offiscal year 2007 and 48% for the first quarter of fiscal year 2006.  Theeffective tax rate for the first quarter of fiscal year 2006 included a $0.3million charge attributable to the fourth quarter of fiscal year 2005;consisting of $0.5 million to correct the overstatement of tax benefitsrecorded in the fourth quarter of fiscal year 2005 for stock-based compensationexpense that is not deductible for income tax purposes in a foreign taxjurisdiction, offset by reversal of a $0.2 million tax contingency reserve thatwas no longer required. 

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Without the correction to the overstatement of taxbenefits, the Company’s effective tax rate for the first quarter of fiscal year2006 would have been approximately 41%.

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

Basicearnings per share is computed using the weighted-average number of commonshares outstanding during the period. Diluted earnings per share is computedusing the weighted-average number of common and dilutive potential commonequivalent shares outstanding during the period. Potential common equivalentshares consist of common stock issuable upon exercise of stock options usingthe treasury stock method.

The following table is a reconciliation of the sharesused to calculate basic and diluted earnings per share: 
|                                                            | ** ** | **Quarter Ended** | ** ** |
|------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                 | ** ** | **December 29,**  | ** ** | **December 30,** | ** ** |
| ** **                                                 | ** ** | **2006**               | ** ** | **2005** | ** ** |
|                                                       |       |                   |       |   |   |
| Weighted average  common shares outstanding – Basic   |       | 16,063,221             |       | 13,078,954 |   |
| Effect of  dilutive stock options                          |       | 1,481,142              |       | 1,689,128 |   |
| Weighted average common  shares outstanding – Diluted |       | 17,544,363             |       | 14,768,082 |   |

 

Asfurther discussed in Note 4, on April 7, 2006, in connection with the amendmentand restatement of its certificate of incorporation, the Company effected a3.059-to-1 split of its outstanding shares of common stock as of such date. Allshare and per share amounts have been retroactively restated to reflect thisstock split.

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

TheCompany’s reportable segments are VED and satcom equipment. The VED segmentdevelops, manufactures and distributes high power/high frequency microwave andradio frequency signal components. The satcom equipment segment manufacturesand supplies high power amplifiers and networks for satellite communicationuplink and industrial applications. Segment information reported below isconsistent with the manner in which it is reviewed and evaluated by the Company’schief operating decision maker, its Chief Executive Officer, and is based onthe nature of the Company’s operations and products offered to customers.

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Summarized financial information concerning theCompany’s reportable segments is shown in the following tables:
|                                 | ** ** | **Quarter Ended** | ** ** |
|---------------------------------|------------|------------------------|------------|
| ** **                      | ** ** | **December 29,**  | ** ** | **December 30,** | ** ** |
| ** **                      | ** ** | **2006**               | ** ** | **2005** | ** ** |
| Sales from  external customers  |       |                   |       |   |   |
| VEDs                            |       | $                      | 66,975     |   | $ | 63,196 |   |
| Satcom equipment                |       | 16,748                 |       | 19,183 |   |
|                            |       | $                      | 83,723     |   | $ | 82,379 |   |
| Intersegment  product transfers |       |                   |       |   |   |
| VEDs                            |       | $                      | 5,123      |   | $ | 6,208 |   |
| Satcom equipment                |       | —                 |       | — |   |
|                            |       | $                      | 5,123      |   | $ | 6,208 |   |
| EBITDA                          |       |                   |       |   |   |
| VEDs                            |       | $                      | 17,584     |   | $ | 16,065 |   |
| Satcom equipment                |       | 1,497                  |       | 2,891 |   |
| Other                           |       | (1,996                 | )          | (6,441 | ) |
|                            |       | $                      | 17,085     |   | $ | 12,515 |   |

 

Amounts not reported as VED or satcom equipment arereported as other.  Other consistsprimarily of corporate operating expenses and certain other expenses that aremanaged by the corporate organization, such as business combination-relatedexpenses, share-based compensation expense, and certain non-recurring orunusual expenses. The first quarter of fiscal year 2006 included non-recurringexpenses for a special bonus of $3.25 million and expenses of $1.8 millionrelated to the relocation of the Company’s Eimac operations from its former SanCarlos, California facility to its nearby Palo Alto, California and MountainView, California facilities.  The special bonus was paid to employees anddirectors (other than directors who are employees or affiliates of Cypress) toreward them for the increase in Company value.  Relocation expensesincluded move expenses and unfavorable overhead absorption and manufacturingvariances for the Eimacoperations.

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

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

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

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

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

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

Other companies may define EBITDA differently and,as a result, our measure of EBITDA may not be directly comparable to EBITDA ofother companies. Although the Company uses EBITDA as a financial measure toassess the performance of its 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. When analyzing the Company’s performance,EBITDA should be considered in addition to, and not as a substitute for, netincome, cash flows from operating activities or other statements of operationsor statements of cash flows data prepared in accordance with GAAP.

Thefollowing table reconciles net income to EBITDA: 
|                               | ** ** | **Quarter Ended** | ** ** |
|-------------------------------|------------|------------------------|------------|
| ** **                    | ** ** | **December 29,**  | ** ** | **December 30,** | ** ** |
| ** **                    | ** ** | **2006**               | ** ** | **2005** | ** ** |
| Net income                    |       | $                      | 5,835      |   | $ | 2,215 |   |
| Depreciation and amortization |       | 2,194                  |       | 2,156 |   |
| Interest expense, net         |       | 5,339                  |       | 6,064 |   |
| Income tax expense            |       | 3,717                  |       | 2,080 |   |
| EBITDA                        |       | $                      | 17,085     |   | $ | 12,515 |   |

 

Geographicsales by customer location were as follows for external customers: 
|                        | ** ** | **Quarter Ended** | ** ** |
|------------------------|------------|------------------------|------------|
| ** **             | ** ** | **December 29,**  | ** ** | **December 30,** | ** ** |
| ** **             | ** ** | **2006**               | ** ** | **2005** | ** ** |
|                   |       |                   |       |   |   |
| United States          |       | $                      | 49,504     |   | $ | 51,000 |   |
| All foreign  countries |       | 34,219                 |       | 31,379 |   |
| Total sales            |       | $                      | 83,723     |   | $ | 82,379 |   |

 

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Net property, plant and equipment by geographic areawas as follows:
|               | ** ** | **December 29, 2006** | ** ** | **September 29, 2006**                 | ** ** |
|---------------|------------|---------------------------------|------------|--------------------------------------------------|------------|
| ** **    | ** ** | **Cost**                        | ** ** | **Accumulated  Depreciation  and  Amortization** | ** ** | **Net Property,  Plant and  Equipment** | ** ** | **Cost** | ** ** | **Accumulated  Depreciation  and  Amortization** | ** ** | **Net Property,  Plant and  Equipment** | ** ** |
| United States |       | $                               | 65,345     |                                             | $          | (12,614 | ) | $ | 52,731 |   | $ | 64,527 |   | $ | (11,221 | ) | $ | 53,306 |   |
| Canada        |       | 13,935                          |       | (1,603                                           | )          | 12,332 |   | 11,915 |   | (1,440 | ) | 10,475 |   |
| Other         |       | 173                             |       | (116                                             | )          | 57 |   | 177 |   | (107 | ) | 70 |   |
| Total         |       | $                               | 79,453     |                                             | $          | (14,333 | ) | $ | 65,120 |   | $ | 76,619 |   | $ | (12,768 | ) | $ | 63,851 |   |

 

TheUnited States Government is the only customer that accounted for 10% or more ofthe Company’s consolidated sales in the first quarter of fiscal years 2007 and2006.  Direct sales to the United StatesGovernment were $14.9 million and $12.7 million for first quarter of fiscalyears 2007 and 2006, respectively. Accounts receivable from this customerrepresented 14% of consolidated accounts receivable as of December 29, 2006 andSeptember 29, 2006.

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

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

InFebruary 2003, the Company entered into an agreement to sell the land and closeits facilities located in San Carlos, California to consolidate the San Carlosoperations into the Company’s existing facility in nearby Palo Alto,California. In September 2006, the sale was completed.  The aggregate sales proceeds were $24.8million, of which $11.3 million was received in September 2006 and $13.5million was received as advance payments in fiscal 2004. The Company had totalselling costs of $1.3 million related to the sale of the San Carlos property.The aggregate sales proceeds of $24.8 million less the related selling costs of$1.3 million, offset by the land and building’s net book value of approximately$23.5 million, resulted in no gain or loss on sale.

# **11.****                              ****Special Cash Dividend**

InDecember 2005, the Board of Directors declared and paid a special cash dividendto stockholders of $17.0 million. This dividend was paid using (a) the $10.0million in net proceeds obtained from the additional borrowing under the SeniorCredit Facility in connection with the December 2005 amendment thereto, and (b)available cash.

# **12.****                              ****Recently Released AccountingPronouncements**

InJune 2006, the Emerging Issues Task Force reached a consensus, ratified by theFinancial Accounting Standards Board (“FASB”) in June 2006, on Issue No. 06-3, “HowTaxes Collected from Customers and Remitted to Governmental Authorities ShouldBe Presented in the Income Statement (i.e., Gross versus Net Presentation).”The primary focus of this Issue is to require the disclosure of the accountingpolicy for any tax assessed by a government authority that is directly imposedon a revenue producing transaction (i.e., gross or net basis) for each periodfor which an income statement is presented if those amounts are significant.The Company is required to adopt the provisions of Issue No. 06-3 beginning inits second quarter of fiscal 2007 and its adoption is not expected to have amaterial impact on its financial condition or results of operations.

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InJune 2006, the FASB issued Interpretation 48, “Accounting for IncomeTax Uncertainties” (“FIN 48”). FIN 48 defines the threshold for recognizing thebenefits of tax return positions in the financial statements as “more-likely-than-not”to be sustained by the taxing authority. The recently issued literature alsoprovides guidance on the derecognition, measurement and classification ofincome tax uncertainties, along with any related interest and penalties. FIN 48also includes guidance concerning accounting for income tax uncertainties ininterim periods and increases the level of disclosures associated with anyrecorded income tax uncertainties. FIN 48 is effective for fiscal yearsbeginning after December 15, 2006. Any differences between the amountsrecognized in the statements of financial position prior to the adoption of FIN48 and the amounts reported after adoption will be accounted for as acumulative-effect adjustment recorded to the beginning balance of retainedearnings. The Company is currently in the process of determining the impact, ifany, of adopting the provisions of FIN 48 on its financial position, results ofoperations and liquidity.

InSeptember 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” whichdefines fair value, establishes a framework for measuring fair value underother accounting pronouncements that permit or require fair value measurements,changes the methods used to measure fair value and expands disclosures aboutfair value measurements. In particular, disclosures are required to provideinformation on the extent to which fair value is used to measure assets andliabilities; the inputs used to develop measurements; and the effect of certainof the measurements on earnings (or changes in net assets). SFAS No. 157 iseffective for fiscal years beginning after November 15, 2007 and interimperiods within those fiscal years. Early adoption, as of the beginning of anentity’s fiscal year, is also permitted, provided interim financial statementshave not yet been issued. The Company is currently evaluating the potentialimpact, if any, that the adoption of SFAS No. 157 will have on its condensedconsolidated financial statements.

InSeptember 2006, the FASB issued SFAS No. 158, “Employers’ Accounting forDefined Benefit Pension and Other Postretirement Plans—an amendment of FASBStatements No. 87, 88, 106, and 132(R),” which requires an employer torecognize the overfunded or underfunded status of a defined benefit plan as anasset or liability in its condensed consolidated balance sheet. Under SFAS No.158, actuarial gains and losses and prior service costs or credits that havenot yet been recognized through earnings as net periodic benefit cost will berecognized in other comprehensive income, net of tax, until they are amortizedas a component of net periodic benefit cost. SFAS No. 158 is effective as ofthe end of the fiscal year ending after December 15, 2006 and shall not beapplied retrospectively. The Company is currently evaluating the impact, ifany, that the adoption of SFAS No. 158 will have on its condensed consolidatedfinancial statements.

InSeptember 2006, the Securities and Exchange Commission issued Staff AccountingBulletin No. 108, “Considering the Effects of Prior Year Misstatements whenQuantifying Misstatements in Current Year Financial Statements” (“SAB No. 108”).SAB No. 108 provides guidance on how prior year misstatements should beconsidered when quantifying misstatements in the current year financialstatements. SAB No. 108 requires registrants to quantify misstatements usingboth a balance sheet and an income statement approach and evaluate whethereither approach results in quantifying a misstatement that, when all relevantquantitative and qualitative factors are considered, is material. SAB No. 108does not change the guidance in SAB No. 99, “Materiality,” when evaluating themateriality of misstatements. SAB No. 108 is effective for fiscal years endingafter November 15, 2006. Upon initial application, SAB No. 108 permits aone-time cumulative effect adjustment to beginning retained earnings. TheCompany

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believes at this time that the adoption of SAB No. 108will not have a material impact on its condensed consolidated financialstatements.

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

OnJanuary 23, 2004, CPI issued $125.0 million of 8% Notes that are guaranteed byCPI International and all of CPI’s domestic subsidiaries. Separate financialstatements of the guarantors are not presented because (i) the guarantors arewholly-owned and have fully and unconditionally guaranteed the 8% Notes on ajoint and several basis, and (ii) the Company’s management has determined thatsuch separate financial statements are not material to investors. Instead,presented below are the consolidating financial statements of: (a) the parentor CPI International, (b) the issuer, CPI, (c) the guarantor subsidiaries (allof the domestic subsidiaries), (d) the non-guarantor subsidiaries, (e) theconsolidating elimination entries, and (f) the consolidated totals. Theaccompanying consolidating financial information should be read in connectionwith the condensed consolidated financial statements of CPI International.

Investmentsin subsidiaries are accounted for based on the equity method. The principalelimination entries eliminate investments in subsidiaries, intercompanybalances, intercompany transactions and intercompany sales.

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**CONDENSED CONSOLIDATING BALANCE SHEETAs of December 29, 2006**
| ** **                                      | ** ** | **Parent**                | ** ** | **Issuer** | ** ** | **Guarantor**    | ** ** | **Non-Guarantor** | ** ** | **Consolidating** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------|------------|---------------------------|------------|------------|------------|------------------|------------|-------------------|------------|-------------------|------------|------------------|------------|
| ** **                                      | ** ** | **(CPI Int’l)** | ** ** | **(CPI)**  | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**  | ** ** | **Eliminations**  | ** ** | **Total**        | ** ** |
|                                            |       |                      |       |       |       |             |       |              |       |              |       |             |       |
| **Assets**                                      | ** ** | ** **                | ** ** | ** ** | ** ** | ** **       | ** ** | ** **        | ** ** | ** **        | ** ** | ** **       | ** ** |
| Cash and cash  equivalents                      |       | $                         | 276        |       | $          | 29,528           |       | $                 | 930        |              | $          | 1,895            |       | $ | — |   | $ | 32,629 |   |
| Restricted cash                                 |       | —                    |       | —     |       | 1,174            |       | 777               |       | —            |       | 1,951            |       |
| Accounts receivable,  net                       |       | —                    |       | 19,883     |       | 7,983            |       | 12,878            |       | —            |       | 40,744           |       |
| Inventories                                     |       | —                    |       | 36,692     |       | 2,424            |       | 16,828            |       | (1,304            | )          | 54,640           |       |
| Deferred tax assets                             |       | —                    |       | 11,100     |       | 3                |       | 781               |       | —            |       | 11,884           |       |
| Intercompany receivable                         |       | —                    |       | 26,193     |       | 977              |       | 446               |       | (27,616           | )          | —           |       |
| Prepaid and other  current assets               |       | 907                       |       | 1,422      |       | 182              |       | 749               |       | —            |       | 3,260            |       |
| Total current  assets                           |       | 1,183                     |       | 124,818    |       | 13,673           |       | 34,354            |       | (28,920           | )          | 145,108          |       |
| Property, plant and  equipment, net             |       | —                    |       | 49,843     |       | 2,904            |       | 12,373            |       | —            |       | 65,120           |       |
| Deferred debt issue  costs, net                 |       | 3,068                     |       | 6,217      |       | —           |       | —            |       | —            |       | 9,285            |       |
| Intangible assets, net                          |       | —                    |       | 59,504     |       | 6,652            |       | 8,722             |       | —            |       | 74,878           |       |
| Goodwill                                        |       | —                    |       | 93,348     |       | 5,848            |       | 48,263            |       | —            |       | 147,459          |       |
| Other long-term assets                          |       | 569                       |       | 407        |       | —           |       | —            |       | —            |       | 976              |       |
| Intercompany notes  receivable                  |       | —                    |       | 1,035      |       | —           |       | —            |       | (1,035            | )          | —           |       |
| Investment in  subsidiaries                     |       | 212,913                   |       | 57,567     |       | —           |       | —            |       | (270,480          | )          | —           |       |
| Total assets                                    |       | $                         | 217,733    |       | $          | 392,739          |       | $                 | 29,077     |              | $          | 103,712          |       | $ | (300,435 | ) | $ | 442,826 |   |
|                                            |       |                      |       |       |       |             |       |              |       |              |       |             |       |
| **Liabilities and stockholders’  equity**  | ** ** | ** **                | ** ** | ** ** | ** ** | ** **       | ** ** | ** **        | ** ** | ** **        | ** ** | ** **       | ** ** |
| Accounts payable                                |       | $                         | 201        |       | $          | 6,877            |       | $                 | 424        |              | $          | 8,205            |       | $ | — |   | $ | 15,707 |   |
| Accrued expenses                                |       | 3,278                     |       | 17,232     |       | 921              |       | 6,505             |       | —            |       | 27,936           |       |
| Product warranty                                |       | —                    |       | 3,489      |       | 204              |       | 2,149             |       | —            |       | 5,842            |       |
| Income taxes payable                            |       | —                    |       | 3,089      |       | 310              |       | 5,706             |       | —            |       | 9,105            |       |
| Advance payments from  customers                |       | —                    |       | 3,923      |       | 1,686            |       | 1,215             |       | —            |       | 6,824            |       |
| Intercompany payable                            |       | 27,616                    |       | —     |       | —           |       | —            |       | (27,616           | )          | —           |       |
| Total current  liabilities                      |       | 31,095                    |       | 34,610     |       | 3,545            |       | 23,780            |       | (27,616           | )          | 65,414           |       |
| Deferred income taxes                           |       | 371                       |       | 23,742     |       | —           |       | 5,864             |       | —            |       | 29,977           |       |
| Intercompany notes  payable                     |       | —                    |       | —     |       | —           |       | 1,035             |       | (1,035            | )          | —           |       |
| Long-term debt, less  current portion           |       | 79,294                    |       | 162,500    |       | —           |       | —            |       | —            |       | 241,794          |       |
| Other long-term  liabilities                    |       | —                    |       | 51         |       | —           |       | —            |       | —            |       | 51               |       |
| Total liabilities                               |       | 110,760                   |       | 220,903    |       | 3,545            |       | 30,679            |       | (28,651           | )          | 337,236          |       |
| Common stock                                    |       | 161                       |       | —     |       | —           |       | —            |       | —            |       | 161              |       |
| Parent investment                               |       | —                    |       | 121,692    |       | 22,228           |       | 57,572            |       | (201,492          | )          | —           |       |
| Additional paid-in  capital                     |       | 65,765                    |       | —     |       | —           |       | —            |       | —            |       | 65,765           |       |
| Accumulated other  comprehensive income         |       | 290                       |       | (315       | )          | —           |       | (19               | )          | 334               |       | 290              |       |
| Retained earnings                               |       | 40,757                    |       | 50,459     |       | 3,304            |       | 15,480            |       | (70,626           | )          | 39,374           |       |
| Net stockholders’  equity                  |       | 106,973                   |       | 171,836    |       | 25,532           |       | 73,033            |       | (271,784          | )          | 105,590          |       |
| Total liabilities and stockholders’ equity |       | $                         | 217,733    |       | $          | 392,739          |       | $                 | 29,077     |              | $          | 103,712          |       | $ | (300,435 | ) | $ | 442,826 |   |

 

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

 

27

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**CONDENSEDCONSOLIDATING STATEMENT OF OPERATIONSFor the Quarter Ended December 29, 2006**
|                                                                               | ** ** | **Parent**                | ** ** | **Issuer** | ** ** | **Guarantor**    | ** ** | **Non-Guarantor** | ** ** | **Consolidating** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------------------------|------------|---------------------------|------------|------------|------------|------------------|------------|-------------------|------------|-------------------|------------|------------------|------------|
| ** **                                                                    | ** ** | **(CPI Int’l)** | ** ** | **(CPI)**  | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**  | ** ** | **Eliminations**  | ** ** | **Total**        | ** ** |
| Sales                                                                         |       | $                         | —     |       | $          | 51,365           |       | $                 | 14,580     |              | $          | 34,543           |       | $ | (16,765 | ) | $ | 83,723 |   |
| Cost of sales                                                                 |       | —                    |       | 35,495     |       | 12,065           |       | 26,426            |       | (16,844           | )          | 57,142           |       |
| Gross profit                                                                  |       | —                    |       | 15,870     |       | 2,515            |       | 8,117             |       | 79                |       | 26,581           |       |
| Operating costs  and expenses:                                                |       |                      |       |       |       |             |       |              |       |              |       |             |       |
| Research and  development                                                     |       | —                    |       | 643        |       | —           |       | 1,248             |       | —            |       | 1,891            |       |
| Selling and  marketing                                                        |       | —                    |       | 1,969      |       | 829              |       | 2,031             |       | —            |       | 4,829            |       |
| General and  administrative                                                   |       | —                    |       | 3,691      |       | 207              |       | 506               |       | —            |       | 4,404            |       |
| Amortization of  acquisition-related intangible assets                        |       | —                    |       | 334        |       | 63               |       | 151               |       | —            |       | 548              |       |
| Net loss on disposition  of assets                                            |       | —                    |       | —     |       | —           |       | 18                |       | —            |       | 18               |       |
| Total operating  costs and expenses                                           |       | —                    |       | 6,637      |       | 1,099            |       | 3,954             |       | —            |       | 11,690           |       |
| Operating income                                                              |       | —                    |       | 9,233      |       | 1,416            |       | 4,163             |       | 79                |       | 14,891           |       |
| Interest expense  (income), net                                               |       | 2,048                     |       | 3,291      |       | (6               | )          | 6                 |       | —            |       | 5,339            |       |
| (Loss) income  before income tax expense and equity in income of subsidiaries |       | (2,048                    | )          | 5,942      |       | 1,422            |       | 4,157             |       | 79                |       | 9,552            |       |
| Income tax  (benefit) expense                                                 |       | (779                      | )          | 2,571      |       | 381              |       | 1,544             |       | —            |       | 3,717            |       |
| Equity in income  of subsidiaries                                             |       | 7,104                     |       | 3,733      |       | —           |       | —            |       | (10,837           | )          | —           |       |
| Net income                                                                    |       | $                         | 5,835      |       | $          | 7,104            |       | $                 | 1,041      |              | $          | 2,613            |       | $ | (10,758 | ) | $ | 5,835 |   |

 

**CONDENSEDCONSOLIDATING STATEMENT OF OPERATIONSFor the Quarter Ended December 30, 2005**
|                                                                               | ** ** | **Parent**                | ** ** | **Issuer** | ** ** | **Guarantor**    | ** ** | **Non-Guarantor** | ** ** | **Consolidating** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------------------------|------------|---------------------------|------------|------------|------------|------------------|------------|-------------------|------------|-------------------|------------|------------------|------------|
| ** **                                                                    | ** ** | **(CPI Int’l)** | ** ** | **(CPI)**  | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**  | ** ** | **Eliminations**  | ** ** | **Total**        | ** ** |
| Sales                                                                         |       | $                         | —     |       | $          | 52,004           |       | $                 | 12,942     |              | $          | 34,808           |       | $ | (17,375 | ) | $ | 82,379 |   |
| Cost of sales                                                                 |       | —                    |       | 38,289     |       | 10,702           |       | 25,469            |       | (17,289           | )          | 57,171           |       |
| Gross profit                                                                  |       | —                    |       | 13,715     |       | 2,240            |       | 9,339             |       | (86               | )          | 25,208           |       |
| Operating costs  and expenses:                                                |       |                      |       |       |       |             |       |              |       |              |       |             |       |
| Research and  development                                                     |       | —                    |       | 844        |       | —           |       | 1,066             |       | —            |       | 1,910            |       |
| Selling and  marketing                                                        |       | —                    |       | 2,165      |       | 869              |       | 1,990             |       | —            |       | 5,024            |       |
| General and  administrative                                                   |       | —                    |       | 4,786      |       | 299              |       | 2,217             |       | —            |       | 7,302            |       |
| Amortization of  acquisition-related intangible assets                        |       | —                    |       | 334        |       | 63               |       | 151               |       | —            |       | 548              |       |
| Net loss on  disposition of assets                                            |       | —                    |       | 29         |       | —           |       | 36                |       | —            |       | 65               |       |
| Total operating  costs and expenses                                           |       | —                    |       | 8,158      |       | 1,231            |       | 5,460             |       | —            |       | 14,849           |       |
| Operating income                                                              |       | —                    |       | 5,557      |       | 1,009            |       | 3,879             |       | (86               | )          | 10,359           |       |
| Interest expense  (income), net                                               |       | 2,048                     |       | 4,007      |       | (5               | )          | 14                |       | —            |       | 6,064            |       |
| (Loss) income  before income tax expense and equity in income of subsidiaries |       | (2,048                    | )          | 1,550      |       | 1,014            |       | 3,865             |       | (86               | )          | 4,295            |       |
| Income tax  (benefit) expense                                                 |       | (819                      | )          | 1,240      |       | 306              |       | 1,353             |       | —            |       | 2,080            |       |
| Equity in income  of subsidiaries                                             |       | 3,444                     |       | 3,220      |       | —           |       | —            |       | (6,664            | )          | —           |       |
| Net income                                                                    |       | $                         | 2,215      |       | $          | 3,530            |       | $                 | 708        |              | $          | 2,512            |       | $ | (6,750 | ) | $ | 2,215 |   |

 

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**CONDENSEDCONSOLIDATING STATEMENT OF CASH FLOWSFor the Quarter Ended December 29, 2006**
|                                                      | ** ** | **Parent**                | ** ** | **Issuer** | ** ** | **Guarantor**    | ** ** | **Non-Guarantor** | ** ** | **Consolidating** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------|------------|---------------------------|------------|------------|------------|------------------|------------|-------------------|------------|-------------------|------------|------------------|------------|
| ** **                                           | ** ** | **(CPI Int’l)** | ** ** | **(CPI)**  | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**  | ** ** | **Eliminations**  | ** ** | **Total**        | ** ** |
| **Cash  flows from operating activities**            | ** ** | ** **                | ** ** | ** ** | ** ** | ** **       | ** ** | ** **        | ** ** | ** **        | ** ** | ** **       | ** ** |
| Net cash (used  in) provided by operating activities |       | $                         | (126       | )          | $          | 7,006            |       | $                 | 642        |              | $          | 2,520            |       | $ | — |   | $ | 10,042 |   |
| **Cash  flows from investing activities**            | ** ** | ** **                | ** ** | ** ** | ** ** | ** **       | ** ** | ** **        | ** ** | ** **        | ** ** | ** **       | ** ** |
| Capital  expenditures                                |       | —                    |       | (819       | )          | (2               | )          | (2,050            | )          | —            |       | (2,871           | )          |
| Net cash (used  in) provided by investing activities |       | —                    |       | (819       | )          | (2               | )          | (2,050            | )          | —            |       | (2,871           | )          |
| **Cash  flows from financing activities**            | ** ** | ** **                | ** ** | ** ** | ** ** | ** **       | ** ** | ** **        | ** ** | ** **        | ** ** | ** **       | ** ** |
| Repayments of  debt                                  |       | —                    |       | (5,000     | )          | —           |       | —            |       | —            |       | (5,000           | )          |
| Proceeds from  issuance of common stock to employees |       | 197                       |       | —     |       | —           |       | —            |       | —            |       | 197              |       |
| Proceeds from  exercise of stock options             |       | 66                        |       | —     |       | —           |       | —            |       | —            |       | 66               |       |
| Excess tax  benefit on stock option exercises        |       | —                    |       | 42         |       | —           |       | —            |       | —            |       | 42               |       |
| Net cash  provided by (used in) financing activities |       | 263                       |       | (4,958     | )          | —           |       | —            |       | —            |       | (4,695           | )          |
| **Net  increase in cash and cash equivalents**       |       | 137                       |       | 1,229      |       | 640              |       | 470               |       | —            |       | 2,476            |       |
| Cash and cash  equivalents at beginning of period    |       | 139                       |       | 28,299     |       | 290              |       | 1,425             |       | —            |       | 30,153           |       |
| Cash and cash  equivalents at end of period          |       | $                         | 276        |       | $          | 29,528           |       | $                 | 930        |              | $          | 1,895            |       | $ | — |   | $ | 32,629 |   |

 

**CONDENSED CONSOLIDATINGSTATEMENT OF CASH FLOWSFor the Quarter Ended December 30, 2005**
|                                                           | ** ** | **Parent**                | ** ** | **Issuer** | ** ** | **Guarantor**    | ** ** | **Non-Guarantor** | ** ** | **Consolidating** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------|------------|---------------------------|------------|------------|------------|------------------|------------|-------------------|------------|-------------------|------------|------------------|------------|
| ** **                                                | ** ** | **(CPI Int’l)** | ** ** | **(CPI)**  | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**  | ** ** | **Eliminations**  | ** ** | **Total**        | ** ** |
| **Cash  flows from operating activities**                 | ** ** | ** **                | ** ** | ** ** | ** ** | ** **       | ** ** | ** **        | ** ** | ** **        | ** ** | ** **       | ** ** |
| Net cash (used  in) provided by operating activities      |       | $                         | (31        | )          | $          | (4,181           | )          | $                 | 217        |              | $          | 4,193            |       | $ | — |   | $ | 198 |   |
| **Cash  flows from investing activities**                 | ** ** | ** **                | ** ** | ** ** | ** ** | ** **       | ** ** | ** **        | ** ** | ** **        | ** ** | ** **       | ** ** |
| Expenses  relating to sale of San Carlos property         |       | —                    |       | (3         | )          | —           |       | —            |       | —            |       | (3               | )          |
| Capital  expenditures                                     |       | —                    |       | (2,780     | )          | (25              | )          | (140              | )          | —            |       | (2,945           | )          |
| Net cash used in  investing activities                    |       | —                    |       | (2,783     | )          | (25              | )          | (140              | )          | —            |       | (2,948           | )          |
| **Cash  flows from financing activities**                 | ** ** | ** **                | ** ** | ** ** | ** ** | ** **       | ** ** | ** **        | ** ** | ** **        | ** ** | ** **       | ** ** |
| Proceeds from  issuance of debt                           |       | —                    |       | 10,000     |       | —           |       | —            |       | —            |       | 10,000           |       |
| Stockholder  distribution payments                        |       | (17,000                   | )          | —     |       | —           |       | —            |       | —            |       | (17,000          | )          |
| Intercompany  dividends                                   |       | 17,000                    |       | (17,000    | )          | —           |       | —            |       | —            |       | —           |       |
| Net cash used in  financing activities                    |       | —                    |       | (7,000     | )          | —           |       | —            |       | —            |       | (7,000           | )          |
| **Net  (decrease) increase in cash and cash equivalents** |       | (31                       | )          | (13,964    | )          | 192              |       | 4,053             |       | —            |       | (9,750           | )          |
| Cash and cash  equivalents at beginning of period         |       | 33                        |       | 25,528     |       | 323              |       | 627               |       | —            |       | 26,511           |       |
| Cash and cash  equivalents at end of period               |       | $                         | 2          |       | $          | 11,564           |       | $                 | 515        |              | $          | 4,680            |       | $ | — |   | $ | 16,761 |   |

 

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

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

**Overview**

CPIInternational, Inc., headquartered in Palo Alto, California, is the parentcompany of Communications & Power Industries, Inc., a leading provider ofmicrowave, radio frequency, power and control solutions for critical defense,communications, medical, scientific and other applications.  Communications & Power Industries, Inc.develops, manufactures and distributes products used to generate, amplify andtransmit high-power/high-frequency microwave and radio frequency signals and/orprovide power and control for various applications.  End-use applications of these systems includethe transmission of radar signals for navigation and location; transmission ofdeception signals for electronic countermeasures; transmission andamplification of voice, data and video signals for broadcasting, Internet andother types of communications; providing power and control for medicaldiagnostic imaging; and generating microwave energy for radiation therapy inthe treatment of cancer and for various industrial and scientific applications.

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

  **Eimac Relocation**

Webegan the relocation of our Eimac operations (“Eimac”) from our former SanCarlos, California facility to our nearby Palo Alto, California and MountainView, California facilities during fiscal year 2005. On June 1, 2006, we madeorganizational changes and consolidated the operating activities of Eimac intoour Microwave Power Products division, which also operates in our Palo Altofacility. The integration of Eimac into our Palo Alto operations wassubstantially complete by December 2006.

Aspart of this relocation, Eimac experienced planned manufacturing disruptions stemmingfrom the decommissioning of our production equipment in San Carlos and therequired reconfiguration, installation and testing of that equipment prior toproduction readiness in Palo Alto. During fiscal year 2005, in anticipation ofthese planned disruptions, customers accelerated the placement of orders withEimac. This order acceleration in fiscal year 2005, and the subsequentacceleration of product shipments, caused a reduction of customers’ demandrequirements from Eimac during the first half of fiscal year 2006, particularlyin our medical, communications and industrial markets.

****The Eimac relocation negativelyimpacted Eimac orders and sales for the first quarter of fiscal year 2006 ascompared to the first quarter of fiscal year 2007.  By the first quarter of fiscal year 2007,orders and sales rates for Eimac had recovered to near their historical levels.During the first quarter of fiscal year 2006, we incurred move related expensesand Eimac experienced unfavorable overhead absorption and manufacturingvariances due to the reduction in sales volume and relocation disruptions.****

**Orders**

Wesell our products into six end markets: radar, electronic warfare, medical,communications, industrial and scientific.

30

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

Ourorders by market for the first quarter of fiscal years 2007 and 2006 aresummarized as follows (dollars in millions):
|                     | ** ** | **Quarter Ended**      | ** ** | ** **                  | ** ** | ** **                   | ** ** |
|---------------------|------------|-----------------------------|------------|-----------------------------|------------|------------------------------|------------|
| ** **          | ** ** | **December 29,  2006** | ** ** | **December 30,  2005** | ** ** | **Increase (Decrease)** | ** ** |
| ** **          | ** ** | ** **                  | ** ** | **% of**               | ** ** | ** **                   | ** ** | **% of** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **          | ** ** | **Amount**                  | ** ** | **Orders**                  | ** ** | **Amount**                   | ** ** | **Orders** | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| Radar               |       | $                           | 40.1       |                        | 48         | %                            | $          | 36.4 |   | 42 | % | $ | 3.7 |   | 10 | % |
| Electronic  Warfare |       | 2.5                         |       | 3                           |       | 4.7                          |       | 5 |   | (2.2 | ) | (47 | ) |
| Medical             |       | 10.9                        |       | 13                          |       | 10.5                         |       | 12 |   | 0.4 |   | 4 |   |
| Communications      |       | 24.3                        |       | 29                          |       | 28.8                         |       | 33 |   | (4.5 | ) | (16 | ) |
| Industrial          |       | 4.3                         |       | 5                           |       | 4.7                          |       | 6 |   | (0.4 | ) | (9 | ) |
| Scientific          |       | 2.2                         |       | 2                           |       | 1.3                          |       | 2 |   | 0.9 |   | 69 |   |
| Total               |       | $                           | 84.3       |                        | 100        | %                            | $          | 86.4 |   | 100 | % | $ | (2.1 | ) | (2 | )% |

 

Explanationsfor the order increase or decrease by market for the first quarter of fiscalyear 2007 compared to the first quarter of fiscal year 2006 are as follows:

·      **Radar and ElectronicWarfare:** Themajority of our sales in the radar and electronic warfare markets are forproducts for domestic and international defense and government end uses.Orders in these markets are characterized by many smaller orders in the $0.5million to $3.0 million range by product or program. On a combined basis,orders for these two markets increased from an aggregate of $41.1 million in thefirst quarter of fiscal year 2006 to an aggregate of $42.6 million in firstquarter fiscal year 2007. This approximate 4% overall increase in orders forthese markets on a combined basis is consistent with our expectations ofoverall low-to-mid-single digit percentage average long-term annual growth inthese markets taken on a combined basis.

·      **Medical: **The increase in medical orders from thefirst quarter of fiscal year 2006 to the first quarter of fiscal year 2007 wasdue to continued increases in orders for our x-ray generators both from U.S.and international customers due to growth in the overall market and our shareof this market.  The first quarter offiscal year 2006 included a quarterly order from Varian Medical Systems, Inc.for x-ray generators, whereas in the first quarter of fiscal year 2007, we didnot book a similar order from this customer, as the customer had placed itsannual order in the prior quarter.

·      **Communications: **The decrease in communications orders wasprimarily attributable to the cyclical nature of orders in this market.  In the first quarter of fiscal year 2006, wereceived orders for amplifiers used in military communications, direct-to-homebroadcast applications and mobile or temporary uplink satelliteapplications.  Orders in the firstquarter of fiscal year 2007 decreased by $4.5 million due to the timing ofthese orders, as orders for these products did not repeat in the first quarterof fiscal 2007. Customers in the direct-to-home broadcast

31

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markethistorically place large orders for satcom amplifiers when they are expandingtheir broadcast facilities and then reduce their orders as those products aredeployed. We expect that orders for direct-to-home products will return tohigher levels within the next year. The overall order decrease in thecommunications market was partially offset by order increases for certain newersatellite communications products that are gaining market acceptance.

·      **Industrial:   **Orders in the industrial market, one of our smallest markets, arecyclical and generally reflect the performance of the overall economy. The decrease in industrial orders wasattributable to the timing of orders for amplifiers used in industrial testsystems for military and commercial customers.

·      **Scientific:**  Orders in the scientific market,our smallest market, are historically one-time projects and can fluctuatesignificantly from period to period. The increase in scientific orders wasprimarily the result of several smaller orders for fusion and other scientificprograms.

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

**Results of Operations**

Wederive our revenue primarily from the sale of microwave and radio frequencyproducts, including high-power microwave amplifiers, satellite communicationsamplifiers, medical x-ray imaging subsystems, and other related products. Ourproducts generally have selling prices ranging from $2,000 to $100,000, withcertain limited products priced up to $1,000,000.

Costof goods sold generally includes costs for raw materials, manufacturing costs,including allocation of overhead and other indirect costs, charges for reservesfor excess and obsolete inventory, warranty claims and losses on fixed pricecontracts. Operating expenses generally consist of research and development,selling and marketing and general and administrative expenses.

32

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The following table sets forth our historical resultsof operations for each of the periods indicated (dollars in millions): 
|                                                  | ** ** | **Quarter Ended**      | ** ** | ** **                  | ** ** | ** **                   | ** ** |
|--------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|------------------------------|------------|
| ** **                                       | ** ** | **December 29,  2006** | ** ** | **December 30,  2005** | ** ** | **Increase (Decrease)** | ** ** |
| ** **                                       | ** ** | ** **                  | ** ** | **% of**               | ** ** | ** **                   | ** ** | **% of** | ** ** | ** ** | ** ** | **% of** | ** ** |
| ** **                                       | ** ** | **Amount**                  | ** ** | **Sales**                   | ** ** | **Amount**                   | ** ** | **Sales** | ** ** | **Amount** | ** ** | **Sales** | ** ** |
| Sales                                            |       | $                           | 83.7       |                        | 100.0      | %                            | $          | 82.4 |   | 100.0 | % | $ | 1.3 |   | — | % |
| Cost of sales  (a)                               |       | 57.1                        |       | 68.2                        |       | 57.2                         |       | 69.4 |   | (0.1 | ) | (1.2 | ) |
| Gross profit                                     |       | 26.6                        |       | 31.8                        |       | 25.2                         |       | 30.6 |   | 1.4 |   | 1.2 |   |
| Research and  development                        |       | 1.9                         |       | 2.3                         |       | 1.9                          |       | 2.3 |   | — |   | (0.0 | ) |
| Selling and  marketing (a)                       |       | 4.8                         |       | 5.7                         |       | 5.0                          |       | 6.1 |   | (0.2 | ) | (0.3 | ) |
| General and  administrative (a)                  |       | 4.4                         |       | 5.3                         |       | 7.3                          |       | 8.9 |   | (2.9 | ) | (3.6 | ) |
| Amortization of  acquisition-related intangibles |       | 0.5                         |       | 0.6                         |       | 0.5                          |       | 0.6 |   | — |   | (0.0 | ) |
| Net loss on  disposition of assets               |       | —                      |       | 0.0                         |       | 0.1                          |       | 0.1 |   | (0.1 | ) | (0.1 | ) |
| Operating income                                 |       | 14.9                        |       | 17.8                        |       | 10.4                         |       | 12.6 |   | 4.5 |   | 5.2 |   |
| Interest  expense, net                           |       | 5.3                         |       | 6.3                         |       | 6.1                          |       | 7.4 |   | (0.8 | ) | (1.1 | ) |
| Income before  taxes                             |       | 9.6                         |       | 11.5                        |       | 4.3                          |       | 5.2 |   | 5.3 |   | 6.3 |   |
| Income tax  expense                              |       | 3.7                         |       | 4.4                         |       | 2.1                          |       | 2.5 |   | 1.6 |   | 1.9 |   |
| Net income                                       |       | $                           | 5.8        |                        | 6.9        | %                            | $          | 2.2 |   | 2.7 | % | $ | 3.6 |   | 4.3 | % |
| Other Data:                                      |       |                        |       |                        |       |                         |       |   |   |   |   |   |   |
| EBITDA (b)                                       |       | $                           | 17.1       |                        | 20.4       | %                            | $          | 12.5 |   | 15.2 | % | $ | 4.6 |   | 5.3 | % |

 

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Note:  Totals may not equal the sum of the componentline items due to independent rounding. Percentages are calculated based onrounded dollar amounts presented.

(a)     The quarterended December 30, 2005 includes a special bonus expense (see “Special Bonus”below) of $3.25 million, allocated as follows: $0.3 million to cost of sales,$0.2 million to selling and marketing and $2.75 million to general andadministrative.

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

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

·       our senior credit facilities contain covenants that requireus to maintain certain interest expense coverage and leverage ratios thatcontain EBITDA as a component, and our management team uses EBITDA to monitorcompliance with such covenants;

·       EBITDA is a component of the measures used by our managementteam to make day-to-day operating decisions;

·       EBITDA facilitates comparisons between our operating resultsand those of competitors with different capital structures and therefore is acomponent of the measures used by the management to facilitate internalcomparisons to competitors’ results and our industry in general; and

·       the payment of management bonuses is contingent upon, amongother things, the satisfaction by us of certain targets that contain EBITDA asa component.

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

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For a reconciliation of EBITDA toNet Income, see Note 9 of the accompanying unaudited condensed consolidatedfinancial statements.

**Sales:**   Our sales by market for the first quarterof fiscal years 2007 and 2006 are summarized as follows (dollars in millions):
|                     | ** ** | **Quarter Ended**      | ** ** | ** **                  | ** ** | ** **                   | ** ** | ** **    | ** ** |
|---------------------|------------|-----------------------------|------------|-----------------------------|------------|------------------------------|------------|---------------|------------|
| ** **          | ** ** | **December 29,  2006** | ** ** | **December 30,  2005** | ** ** | **Increase (Decrease)** | ** ** |
| ** **          | ** ** | ** **                  | ** ** | **% of**               | ** ** | ** **                   | ** ** | **% of** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **          | ** ** | **Amount**                  | ** ** | **Sales**                   | ** ** | **Amount**                   | ** ** | **Sales**     | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| Radar               |       | $                           | 28.1       |                        | 34         | %                            | $          | 27.6          |       | 33 | % | $ | 0.5 |   | 2 | % |
| Electronic  Warfare |       | 5.8                         |       | 7                           |       | 5.8                          |       | 7             |       | — |   | 0 |   |
| Medical             |       | 17.1                        |       | 20                          |       | 13.2                         |       | 16            |       | 3.9 |   | 30 |   |
| Communications      |       | 26.1                        |       | 31                          |       | 30.1                         |       | 37            |       | (4.0 | ) | (13 | ) |
| Industrial          |       | 5.0                         |       | 6                           |       | 4.4                          |       | 5             |       | 0.6 |   | 14 |   |
| Scientific          |       | 1.6                         |       | 2                           |       | 1.3                          |       | 2             |       | 0.3 |   | 23 |   |
| Total               |       | $                           | 83.7       |                        | 100        | %                            | $          | 82.4          |       | 100 | % | $ | 1.3 |   | 2 | % |

 

Salesfor the first quarter of fiscal year 2007 of $83.7 million were $1.3 million,or 2%, higher than sales of $82.4 million for the first quarter of fiscal year2006. Explanations for the sales increase or decrease by market are as follows:

·      **Radar and ElectronicWarfare: **Themajority of our sales in the radar and electronic warfare markets are forproducts for domestic and international defense and government end uses. On acombined basis, sales for these two markets increased from an aggregate of$33.4 million in first quarter of fiscal year 2006 to an aggregate of $33.9million in first quarter of fiscal year 2007. This increase was primarily due to increased shipments of products forvarious U.S. government and foreign military radar programs, including productsthat are used on the TPQ-37 Firefinder Artillery Locating Radar program and theHAWK missile system.

·      **Medical:**  The 30% increase in sales of ourmedical imaging and radiation therapy products was primarily due to increasedsales of our products used in radiation therapy for the treatment of cancer andin x-ray imaging. In the first quarter of fiscal year 2007, sales of x-raygenerators to U.S. and foreign customers increased $2.5 million, or 29%,including a $1.1 million increase in sales of x-ray generators to VarianMedical Systems for its On-Board Imager® device, as compared to the firstquarter of fiscal year 2006. In addition, shipments of medical products fromEimac increased $1.1 million following the completion of the relocation ofthose operations.

·      **Communications: **The decrease in sales in thecommunications market was primarily the result of the cyclicality of thedirect-to-home broadcast applications market. Shipments of our traditional satellite communications amplifiers fordirect-to-home broadcast applications were $6.1 million higher in the firstquarter of fiscal year 2006 than in the first quarter of fiscal year 2007.  In addition, in the first quarter of fiscalyear 2006, we shipped products to a foreign customer for troposcattercommunications applications; sales for this program were not expected to, anddid not, repeat, resulting in a $0.8 million decrease in the first quarter offiscal year 2007.  These decreases werepartially offset by a $3.6 million increase in shipments of our newer satellitecommunications products to U.S. and foreign customers, including a $1.8 millionincrease in sales of

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amplifierstypically used for mobile or temporary satellite uplink applications and a $1.6million increase in shipments of newer types of amplifiers that are also usedin direct-to-home broadcast and other applications.  Shipments of communications products fromEimac also increased by $1.1 million in the first quarter of fiscal year 2007,as compared to the first quarter of fiscal year 2006, following the completionof the relocation of those operations.

·      **Industrial:   **The increase in industrial sales wasprimarily due to increased demand for power supplies for the semiconductormarket.

·      **Scientific: **Sales in the scientific market, oursmallest market, are historically one-time projects and can fluctuatesignificantly from period to period. The primary contributor to the increase inscientific sales was an increase in shipments from Eimac following thecompletion of their relocation.

**Gross Profit**.  Gross profitwas $26.6 million, or 31.8% of sales, for the first quarter of fiscal year 2007as compared to $25.2 million, or 30.6% of sales, in the first quarter of fiscalyear 2006. The first quarter of fiscal year 2006 included non-recurringexpenses of $0.3 million for the special bonus, discussed below, andapproximately $1.5 million of move-related expenses, including unfavorableoverhead absorption and manufacturing variances, for Eimac. The first quarterof fiscal year 2007, as compared to the first quarter of fiscal year 2006, wasunfavorably impacted by approximately $1.1 million due to increases in ourCanadian denominated manufacturing expenses resulting from the impact of theweaker U.S. dollar in the current quarter as compared to the year ago quarter.In addition, the first quarter of fiscal year 2007, as compared to the firstquarter of fiscal year 2006, was favorably impacted by higher sales and afavorable mix of products with higher gross margins.

**Research and Development**. Research and development expenses were $1.9 million, or 2.3% of sales,in both the first quarter of fiscal year 2007 and the first quarter of fiscalyear 2006.

**Selling and Marketing**. Selling and marketing expenses were $4.8 million, or 5.7% of sales, forthe first quarter of fiscal year 2007, a $0.2 million decrease from the $5.0million, or 6.1% of sales, for first quarter of fiscal year 2006.  Selling and marketing expenses for the firstquarter of fiscal year 2006 included $0.2 million of the special bonus,discussed below.

**General and Administrative**. General and administrative expenses were $4.4 million, or 5.3% of sales,for the first quarter of fiscal year 2007, a $2.9 million decrease from the$7.3 million, or 8.9% of sales, for first quarter of fiscal year 2006.  The first quarter of fiscal year 2006included $2.75 million of the special bonus, discussed below, and relocationexpenses of $0.3million for Eimac.

**Special Bonus**.  On December15, 2005, our board of directors approved the payment of $3.25 million inspecial, one-time bonuses to our employees and directors (other than directorswho are employees or affiliates of Cypress) to reward them for the increase incompany value. The special bonus was not paid pursuant to our management incentiveplan, our 2006 Equity and Performance Incentive Plan or any of our other formalcompensation plans. The bonus amount was not determined based on a formula, butwas instead an amount determined by our board of directors to be reasonablecompensation for the increase in company value. The special bonus was chargedto the condensed consolidated statement of operations in the same lines as cashcompensation paid to the same employees and directors, as follows: $2.75million to General and administrative, $0.3 million to Cost of sales, and $0.2million to Selling and marketing.

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**Amortization of Acquisition-Related Intangibles**. Amortization of acquisition-relatedintangibles consists of purchase accounting charges, primarily for customerbacklog, technology and other intangible assets. Amortization of acquisition-relatedintangibles was $0.5 million for both the first quarter of fiscal year 2007 andthe first quarter of fiscal year 2006.

**Interest Expense, net (“Interest Expense”)**. Interest Expense of $5.3 million forfirst quarter of fiscal year 2007 was $0.8 million lower than interest expenseof $6.1 million for the first quarter of fiscal year 2006.  The reduction in interest expense in thefirst quarter of fiscal year 2007 compared to the first quarter of fiscal year2006 was primarily due to the lower debt levels resulting from the $47.5million term loan prepayment in May 2006.

**Income Tax Expense**.  The Company recorded an incometax provision of $3.7 million and $2.1 million for the first quarter of fiscalyears 2007 and 2006, respectively.  The Company’s effective tax rate wasapproximately 39% for the first quarter of fiscal year 2007 as compared toapproximately 48% for the first quarter of fiscal year 2006.

Income tax expense for the first quarter of fiscal year 2006 included$0.3 million of charges attributable to the fourth quarter of fiscal year 2005,consisting of $0.5 million to correct the overstatement of tax benefitsrecorded in the fourth quarter of fiscal year 2005 for stock-based compensationexpense that is not deductible for income tax purposes in a foreign taxjurisdiction, offset by reversal of a $0.2 million tax contingency reserve thatwas no longer required. Without the correction to the overstatement of taxbenefits, the Company’s effective tax rate for the first quarter of fiscal year2006 would have been approximately 41%.

 **Net Income**.  Net income was $5.8 million, or 6.9% ofsales, for the first quarter of fiscal year 2007 as compared to $2.2 million,or 2.7% of sales, in the first quarter of fiscal year 2006. The first quarterof fiscal year 2006 included non-recurring expenses for the special bonus, andmove-related expenses, including unfavorable overhead absorption andmanufacturing variances for Eimac. The first quarter of fiscal year 2007, ascompared to the first quarter of fiscal year 2006, was unfavorably impacted byincreases in our Canadian denominated expenses resulting from the impact of theweaker U.S. dollar in the current quarter as compared to the year agoquarter.  In addition, the first quarterof fiscal year 2007, as compared to the first quarter of fiscal year 2006, wasfavorably impacted by lower interest expense due to lower debt levels, a lowertax rate, and the impact of higher sales and a favorable mix of products withhigher gross margins.

**EBITDA**.  EBITDA was$17.1 million, or 20.4% of sales, for the first quarter of fiscal year 2007 ascompared to $12.5 million, or 15.2% of sales, in the first quarter of fiscalyear 2006. The first quarter of fiscal year 2006 included non-recurringexpenses for the special bonus of $3.25 million, and move-related expenses of$1.8 million, including unfavorable overhead absorption and manufacturingvariances, for Eimac. The first quarter of fiscal year 2007, as compared to thefirst quarter of fiscal year 2006, was unfavorably impacted by approximately$1.3 million due to increases in our Canadian denominated expenses resultingfrom the impact of the weaker U.S. dollar in the current quarter as compared tothe year ago quarter. In addition, the first quarter of fiscal year 2007, ascompared to the first quarter of fiscal year 2006, was favorably impacted byhigher sales and a favorable mix of products with higher gross margins in thecurrent quarter.

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**Liquidity and CapitalResources**

***Overview***

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

Asof December 29, 2006, we had $242.5 million in total principle amount of debtoutstanding, compared to $247.5 million as of September 29, 2006. In addition,as of December 29, 2006, we had borrowing availability of $36.2 million underthe revolver under our senior credit facilities. As of December 29, 2006, wehad cash and equivalents of $32.6 million compared to $30.2 million as of September29, 2006. Cash balances in excess of operating requirements are invested dailyin overnight U.S. Government securities.

Webelieve that we have the financial resources to meet our business requirementsfor the next twelve months, including capital expenditures, working capitalrequirements and to comply with our financial covenants.

**Historical Operating,Investing and Financing Activities**

***OperatingActivities.***

Operatingactivities provided cash of $10.0 million in the first quarter of fiscal year 2007,which was attributable to net income of $5.8 million, depreciation,amortization and other non-cash charges of $2.8 million and $1.4 million fromnet operating assets and liabilities. The primary source of cash from netoperating assets and liabilities in the first quarter of fiscal year 2007 was a$0.8 million net increase in accrued expenses and accounts payable and a $2.5million decrease in accounts receivable, partially offset by a reduction inincome taxes payable of $1.5 million. Operating activities provided cash of approximately $0.2 million in thefirst quarter of fiscal year 2006, which was primarily attributable to netincome of $2.2 million, and depreciation, amortization and other non-cashcharges (excluding deferred taxes) of $2.9 million, mostly offset by reductionsin net deferred tax liabilities of $2.7 million and $2.2 million used by netoperating assets and liabilities.  Theprincipal uses of net operating assets and liabilities in the first quarter offiscal year 2006 was a decrease in advance payments from customers of $3.7million and an increase in accounts receivable of $2.3 million, partiallyoffset by a $1.6 million net increase in accrued expenses and accounts payableand a $2.2 million increase in income tax payable.

***InvestingActivities.***

Netcash used in investing activities was $2.9 million for the first quarter ofboth fiscal year 2007 and 2006; the primary investingactivity was for capital expenditures. Capital expenditures in the first quarter of fiscal year 2007 included$2.0 million for a building expansion project for our Canadian manufacturingfacility.  Capital expenditures for thefirst quarter of fiscal year 2006 included $2.3 million to purchase capital equipment, buildingand land lease improvements, related to the consolidation of Eimac into ourPalo Alto facility.

Our continuing operations typicallydo not have large recurring capital expenditure requirements. Capitalexpenditures are generally made to replace existing assets, increaseproductivity, facilitate cost reductions or meet regulatory requirements.  In fiscal year 2007, ongoing capitalexpenditures, excluding

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expenditures of approximately $4.5 million forcompletion of the Canadian facility expansion, of which $2.0 million was spentin the first quarter of fiscal year 2007, are expected to be approximately $4.5million.

***FinancingActivities.***

Netcash used in financing activities was $4.7 million for the first quarter offiscal year 2007, compared to net cash used in financing activities of $7.0million for the first quarter of fiscal year 2006.  Financing activities for the first quarter offiscal year 2007 consisted primarily of a $5.0 million term loan repayment in December2006 using available operating cash. The $5.0 million term loan repayment includeda $1.7 million required annual excess cash flow prepayment, described below,for fiscal year 2006 and an optional prepayment of $3.3 million.

For the firstquarter of fiscal year 2006, CPI used the $10 million proceeds of the additional term loan borrowingto fund a portion of a special cash dividend of $17 million paid to the holdersof CPI International’s common stock on December 15, 2005. The remainder of thedividend was financed from cash on hand.

Oursenior credit facilities require an annual prepayment to be made within 90 daysafter the end of the fiscal year based on a calculation of excess cash flow, asdefined in the senior credit facilities (“ECF”), multiplied by a factor of 25%,50% or 75% depending on the leverage ratio at the end of the fiscal year, lessany optional prepayments made during the fiscal year. There was no ECF paymentdue for fiscal year 2005, and therefore, no ECF cash payment was made in thefirst quarter of fiscal year 2006.

**Recently ReleasedAccounting Pronouncements**

InJune 2006, the Emerging Issues Task Force reached a consensus, ratified by theFinancial Accounting Standards Board (“FASB”) in June 2006, on Issue No. 06-3, “HowTaxes Collected from Customers and Remitted to Governmental Authorities ShouldBe Presented in the Income Statement (That Is, Gross versus Net Presentation).”The primary focus of this Issue is to require the disclosure of the accountingpolicy for any tax assessed by a government authority that is directly imposedon a revenue producing transaction (i.e., gross or net basis) for each periodfor which an income statement is presented if those amounts are significant. Weare required to adopt the provisions of Issue No. 06-3 beginning in the secondquarter of fiscal 2007, and its adoption is not expected to have a materialimpact on our financial condition or results of operations.

InJuly 2006, the FASB issued Interpretation 48, “Accounting for IncomeTax Uncertainties” (“FIN 48”). FIN 48 defines the threshold for recognizing thebenefits of tax return positions in the financial statements as “more-likely-than-not”to be sustained by the taxing authority. The recently issued literature alsoprovides guidance on the derecognition, measurement and classification ofincome tax uncertainties, along with any related interest and penalties. FIN 48also includes guidance concerning accounting for income tax uncertainties ininterim periods and increases the level of disclosures associated with anyrecorded income tax uncertainties. FIN 48 is effective for fiscal yearsbeginning after December 15, 2006. Any differences between the amountsrecognized in the statements of financial position prior to the adoption of FIN48 and the amounts reported after adoption will be accounted for as acumulative-effect adjustment recorded to the beginning balance of retainedearnings. We are currently in the process of determining the impact, if any, ofadopting the provisions of FIN 48 on our financial position, results ofoperations and liquidity.

In September 2006, the FASB issued Statement ofFinancial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements,”which defines fair value, establishes a framework for measuring fair valueunder other accounting pronouncements that permit or require fair valuemeasurements, changes the methods used to measure fair value and expandsdisclosures about fair value measurements. In particular,

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disclosures are required toprovide information on the extent to which fair value is used to measure assetsand liabilities; the inputs used to develop measurements; and the effect ofcertain of the measurements on earnings (or changes in net assets). SFAS No.157 is effective for fiscal years beginning after November 15, 2007 and interimperiods within those fiscal years. Early adoption, as of the beginning of anentity’s fiscal year is also permitted, provided interim financial statementshave not yet been issued. We are currently evaluating the potential impact, ifany, that the adoption of SFAS No. 157 will have on our consolidated financialstatements.

In September 2006, the FASB issued SFAS No. 158, “Employers’Accounting for Defined Benefit Pension and Other Postretirement Plans—anamendment of FASB Statements No. 87, 88, 106, and 132(R),” which requires anemployer to recognize the overfunded or underfunded status of a defined benefitplan as an asset or liability in its consolidated balance sheet. Under SFAS No.158, actuarial gains and losses and prior service costs or credits that havenot yet been recognized through earnings as net periodic benefit cost will berecognized in other comprehensive income, net of tax, until they are amortizedas a component of net periodic benefit cost. SFAS No. 158 is effective as ofthe end of the fiscal year ending after December 15, 2006 and shall not beapplied retrospectively. We are currently evaluating the impact, if any, thatthe adoption of SFAS No. 158 will have on our consolidated financialstatements.

InSeptember 2006, the Securities and Exchange Commission issued Staff AccountingBulletin No. 108, “Considering the Effects of Prior Year Misstatements whenQuantifying Misstatements in Current Year Financial Statements” (“SAB No. 108”).SAB No. 108 provides guidance on how prior year misstatements should beconsidered when quantifying misstatements in the current year financialstatements. SAB No. 108 requires registrants to quantify misstatements usingboth a balance sheet and an income statement approach and evaluate whethereither approach results in quantifying a misstatement that, when all relevantquantitative and qualitative factors are considered, is material. SAB No. 108does not change the guidance in SAB No. 99, “Materiality,” when evaluating themateriality of misstatements. SAB No. 108 is effective for fiscal years endingafter November 15, 2006. Upon initial application, SAB No. 108 permits aone-time cumulative effect adjustment to beginning retained earnings.  We believe at this time that the adoption ofSAB No. 108 will not have a material impact on our consolidated financialstatements.

**Critical AccountingPolicies and Estimates**

Ourconsolidated financial statements are based on the selection and application ofsignificant accounting policies. The preparation of these financial statementsand application of these policies require management to make estimates andassumptions that affect the reported amounts of assets and liabilities and thedisclosure of contingent assets and liabilities at the date of the financialstatements, as well as the reported amounts of revenues and expenses during thereporting period. Actual results could differ from those estimates. However, weare not currently aware of any reasonably likely events or circumstances thatwould result in materially different results from current estimates.

Webelieve the following critical accounting policies are the most significant tothe presentation of our financial statements and require the most subjectiveand complex judgments. These matters, and the judgments and uncertaintiesaffecting them, are also essential to understanding our reported and futureoperating results.

**Revenue recognition**

Wegenerally recognize revenue upon shipment of product, following receipt ofwritten purchase orders, when the price is fixed or determinable, title hastransferred and collectibility is reasonably

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assured. Approximately 1% of our sales for our fiscalyears 2004 through 2006 are based on the percentage of completion method ofaccounting where the sales value is determined on the basis of costs incurredand estimates of costs at completion, which require management estimates offuture costs. Changes in estimated costs at completion over time could have amaterial impact on our operating results.

**Inventory reserves**

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

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

**Product warranty**

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

**Business combination and Related Goodwill andIntangibles**

Weaccount for business combinations using the purchase method of accountingpursuant to SFAS No. 141, “Business Combinations.” Intangible assets acquiredin a purchase method business combination are recognized and reported apartfrom goodwill, pursuant to the criteria specified by SFAS No. 141.

Asa result of our January 2004 merger, and our acquisition of Econco BroadcastService, Inc. in October 2004, assets acquired and liabilities assumed wereadjusted to reflect fair value, and the excess of the purchase price over the fairvalue was recorded as goodwill. At both December 29, 2006 and September 29,2006, the carrying amount of goodwill as a result of these transactions was$147 million. Accounting for business combinations requires the allocation ofpurchase price to identifiable tangible and intangible assets and liabilitiesbased upon their fair value. The allocation of purchase price is a matter ofjudgment and requires the use of estimates and fair value assumptions. Theallocation of purchase price to finite-lived assets can have a significantimpact on operating results because finite-lived assets are depreciated oramortized over their remaining useful lives.

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

**Recoverability of long-lived assets**

Weaccount for goodwill and other intangible assets in accordance with SFAS No.142, “Goodwill and Other Intangible Assets.” SFAS No. 142 requires thatgoodwill and identifiable intangible assets with indefinite useful lives betested for impairment at least annually. SFAS No. 142 also requires thatintangible assets with estimable useful lives be amortized over theirrespective estimated useful lives and reviewed for impairment in accordancewith SFAS No. 144, “Accounting for the Impairment or Disposal of Long-LivedAssets.” We amortize identifiable intangible assets on a straight-line basisover their useful lives of up to 50 years.

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

AtDecember 29, 2006 and September 29, 2006, the carrying amount of goodwill andother intangible assets, net was $222 million and $223 million, respectively. Asof December 29, 2006, no significant changes in the underlying businessassumptions or circumstances that drive the impairment analysis led us tobelieve that goodwill might have been impaired. We will continue to evaluatethe need for impairment if changes in circumstances or available informationindicate that impairment may have occurred, and at least annually in the fourthquarter.

AtDecember 29, 2006 and September 29, 2006, the carrying amount of property,plant and equipment was $65 million and $64 million, respectively. We assessthe recoverability of property, plant and equipment to be held and used by acomparison of the carrying amount of an asset or group of assets to the futurenet undiscounted cash flows expected to be generated by the asset or group ofassets. If such assets are considered impaired, then the impairment recognizedis measured as the amount by which the carrying amount of the assets exceedsthe fair value of the assets. This process requires the use of cash flow modelsthat utilize estimates of future revenue and expenses. There is inherentuncertainty in these estimates, and changes in these factors over time couldresult in an impairment charge.

Aprolonged general economic downturn and, specifically, a prolonged downturn in thedefense, communications or medical markets, or technological changes, as wellas other market factors could intensify competitive pricing pressure, create animbalance of industry supply and demand, or otherwise diminish volumes orprofits. Such events, combined with changes in interest rates, could adverselyaffect

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our estimates of future net cash flows to be generatedby our long-lived assets. Consequently, it is possible that our futureoperating results could be materially and adversely affected by additionalimpairment charges related to the recoverability of our long-lived assets.

**Accounting for stock-based compensation**

Atthe beginning of fiscal year 2006, we adopted SFAS No. 123 (revised 2004), “Share-BasedPayment” (“SFAS No. 123R”), and Staff Accounting Bulletin No. 107, “Share-BasedPayment,” for our existing stock option plans under the prospective method.Under the prospective method, only new awards (or awards modified, repurchased,or cancelled after the effective date) are accounted for under the provisionsof SFAS No. 123R. Previously, we applied the intrinsic-value method ofaccounting prescribed by Accounting Principles Board Opinion No. 25, “Accountingfor Stock Issued to Employees,” and related interpretations. Under theintrinsic-value method, compensation expense was recorded only if the marketprice of the stock exceeded the stock option exercise price at the measurementdate. We will continue to account for stock option awards outstanding atSeptember 30, 2005 using the intrinsic-value method of measuring equity shareoptions unless such options are modified.

Thefair value of each option award is estimated on the date of grant using theBlack-Scholes model. The Black-Scholes option valuation model was developed foruse in estimating the fair value of traded options that have no vestingrestrictions and are fully transferable and requires the input of subjectiveassumptions, including the expected stock price volatility and estimated optionlife.

Inaccordance with SFAS No. 123R, prior to becoming a public entity in April 2006,we used the minimum value method to determine a calculated value, rather than afair value, of share awards. Under the minimum value method, stock pricevolatility was assumed to be zero. The estimated fair value (or calculatedvalue, as applicable) of our stock-based awards, less expected forfeitures, isamortized over the awards’ vesting period on a straight-line basis for awardsgranted after the adoption of SFAS No. 123R and on a graded vesting basisfor awards granted prior to the adoption of SFAS No. 123R. Since ourcommon stock has not been publicly traded for a sufficient time period, theexpected volatility is based on expected volatilities of similar companies thathave a longer history of being publicly traded. The expected life of optionsgranted is based on the simplified method for plain vanilla options inaccordance with Securities and Exchange Commission Staff Accounting Bulletin107. The risk-free rates are based on the U.S. Treasury yield in effect at thetime of the grant. In the quarter ended December 29, 2006 and December 30,2005, we recognized $0.2 million and zero in stock-based compensation expense,respectively.

**Item 3.  Quantitative and Qualitative DisclosuresAbout Market Risk**

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

***Interest rate risk: ***Our exposure to market risk for changesin interest rates relates primarily to our long-term debt and our investment inovernight government securities.

Wehave variable rate debt that comprises $80.0 million in floating rate seniornotes due in 2015 and a $37.5 million term loan, under our senior creditfacilities, due in 2010. Our variable rate debt is subject to changes in theprime rate and the LIBOR rate. We entered into an interest rate swap contract(the “Swap”) with a notional amount of $80.0 million to effectively convert thefloating rate senior notes to a fixed rate of 9.9% through the Swap maturitydate in January 2008. We also have $125.0 million of fixed rate 8% Notes. AtDecember 29, 2006, the fair value of the unrealized gain on the Swap was $0.6million, net of tax.

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***Foreign currency exchange risk:**** *Although the majority of our revenue and expenseactivities are transacted in U.S. dollars, we do transact business in foreigncountries. Our primary foreign currency cash flows are in Canada and severalEuropean countries. We have limited market risk exposure from foreign currencyfinancial instruments. As of December 29, 2006, we had entered into Canadiandollar forward contracts for approximately $19.4 million (Canadian dollars), or49% of estimated Canadian dollar denominated expenses over the next ninemonths, at an average rate of approximately $0.89 U.S. dollar to Canadiandollar. On January 2, 2007, the company entered into an additional hedge contract,increasing the Canadian dollar forward contracts to approximately 80% ofestimated Canadian dollar denominated expenses over the next nine months, at anaverage rate of approximately $0.88 U.S. dollar to Canadian dollar. We estimatethe impact of a one cent change in the U.S. dollar to Canadian dollar exchangerate to be approximately $0.5 million annually to operating income orapproximately 1.9 cents to basic earnings per share and 1.7 cents to dilutedearnings per share.

Inan effort to reduce our foreign currency exposure to Canadian dollardenominated expenses, we enter into Canadian dollar forward contracts to hedgethe Canadian dollar denominated costs for our manufacturing operation inCanada. Net income in the first quarter of fiscal year 2007 includes arecognized loss from foreign currency forward contracts of $0.1 million.  Net income in the first quarter of fiscalyear 2006 includes a recognized gain from foreign currency forward contracts of$0.4 million.  At December 29, 2006, thefair value of the unrealized loss on Canadian dollar forward contracts was $0.3million, net of tax.

**Item 4.  Controls andProcedures**

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

Therehave been no changes in our internal control over financial reporting thatoccurred during the most recent fiscal quarter that have materially affected,or are reasonably likely to materially affect, our internal control overfinancial reporting.

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**Part II: OTHER INFORMATION**

**Item 1. Legal Proceedings**

None.

**Item 1A. Risk Factors**

**The Company’s Annual Report on Form 10-K for the fiscal year endedSeptember 29, 2006 includes a detailed discussion of our risk factors.**

**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 SecurityHolders**

None.

**Item 5. Other Information**

None.

**Item 6. Exhibits**
| No.    | ** ** | **Description**                                                                                                                                              |
|--------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |       |                                                                                                                                                         |
| 10.1   |       | Employment Agreement, dated as of June 27, 2000, by  and between Communications & Power Industries, Inc. and John R. Beighley                            |
|   |       |                                                                                                                                                         |
| 31.1   |       | Certification of Chief Executive Officer pursuant to  Rule 13a-15(e) and Rule 15d-15(e), promulgated under the Securities Exchange  Act of 1934, as amended. |
|   |       |                                                                                                                                                         |
| 31.2   |       | Certification of Chief Financial Officer pursuant to  Rule 13a-15(e) and Rule 15d-15(e), promulgated under the Securities Exchange  Act of 1934, as amended. |
|   |       |                                                                                                                                                         |
| 32.1   |       | Certifications of Chief Executive Officer, pursuant  to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.       |
|   |       |                                                                                                                                                         |
| 32.2   |       | Certifications of Chief Financial Officer, pursuant  to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.       |

 

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**SIGNATURES**

Pursuant to the requirements of the Securities Exchange Actof 1934, the registrant has duly caused this report to be signed on its behalfby the undersigned, thereunto duly authorized.
|                                |   | CPI INTERNATIONAL, INC.                                                                                         |
|--------------------------------|--------|-----------------------------------------------------------------------------------------------------------------|
|                           |   |                                                                                                            |
|                           |   |                                                                                                            |
| Dated: February 12,  2007 |   | /s/  O. Joe Caldarelli                                                                                |   |
|                           |   | O. Joe Caldarelli  Chief Executive Officer                                                                      |
|                           |   |                                                                                                            |
|                           |   |                                                                                                            |
| Dated: February  12, 2007 |   | /s/ Joel A. Littman                                                                                        |   |
|                           |   | Joel A. Littman  Chief Financial Officer, Treasurer and Secretary  (Principal Financial and Accounting Officer) |
|                                |        |                                                                                                                 |  |  |

 

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