Annual Reports

 
Quarterly Reports

  • 10-Q (Feb 9, 2011)
  • 10-Q (Aug 11, 2010)
  • 10-Q (May 12, 2010)
  • 10-Q (Feb 10, 2010)
  • 10-Q (Aug 12, 2009)
  • 10-Q (May 13, 2009)

 
8-K

 
Other

CPI International 10-Q 2010

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. Ex-32.2
  6. Ex-32.2
cpii_10q-3qfy10.htm


UNITED STATES
SECURITIES AND EXCHANGE
 COMMISSION
Washington, DC 20549
 
FORM 10-Q


(Mark One)
 
x
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended July 2, 2010
 
or
 
¨
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ________ to ________
 
 
Commission file number: 000-51928

 
CPI INTERNATIONAL, INC.
(Exact Name of Registrant as Specified in Its Charter)
 
Delaware
(State or Other Jurisdiction of Incorporation or Organization)
75-3142681
(I.R.S. Employer Identification No.)
811 Hansen Way, Palo Alto, California 94303
(Address of Principal Executive Offices and Zip Code)
(650) 846-2900
(Registrant’s telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
 
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.
 
Yes    x    No    ¨
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
 
Yes    ¨    No    ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer
¨
Accelerated filer
x
Non-accelerated filer
¨ (Do not check if a smaller reporting company)
Smaller reporting company
¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes ¨  No  x
 
 
APPLICABLE ONLY TO CORPORATE ISSUERS:
 
Indicate the number of shares outstanding for each of the registrant’s classes of Common Stock, as of the latest practicable date: 16,809,805 shares of Common Stock, $0.01 par value, at August 5, 2010.
 



 
 

 
and Subsidiaries

10-Q REPORT
INDEX
 
 
       Page
 
 
  4
       
 
  4
   
  4
   
  5
   
  6
   
  7
 
37
 
51
 
53
       
54
       
 
54
 
54
 
55
 
55
 
55
 
55
 
56
 
 
 
Cautionary Statements Regarding Forward-Looking Statements
 
This document contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, that relate to future events or our future financial performance. In some cases, readers can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential” or “continue,” the negative of such terms or other comparable terminology. These statements are only predictions. Actual events or results may differ materially.

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of the forward-looking statements. Forward-looking statements are subject to known and unknown risks and uncertainties, which could cause actual results to differ materially from the results projected, expected or implied by the forward-looking statements. These risk factors include, without limitation, risks associated with our pending merger with a subsidiary of Comtech Telecommunications Corp (including but not limited to the risk that the conditions to the consummation of the merger may not be fulfilled), competition in our end markets; the impact of a general slowdown in the global economy; our significant amount of debt; changes or reductions in the United States defense budget; currency fluctuations; goodwill impairment considerations; customer cancellations of sales contracts; U.S. Government contracts laws and regulations; changes in technology; the impact of unexpected costs; the impact of environmental laws and regulations; and inability to obtain raw materials and components. All written and oral forward-looking statements made in connection with this report that are attributable to us or persons acting on our behalf are expressly qualified in their entirety by the foregoing risk factors and other cautionary statements included herein (including under Part II, Item 1A - Risk Factors) and in our other filings with the Securities and Exchange Commission (“SEC”). We are under no duty to update any of the forward-looking statements after the date of this report to conform such statements to actual results or to changes in our expectations.
 
The information in this report is not a complete description of our business or the risks and uncertainties associated with an investment in our securities. You should carefully consider the various risks and uncertainties that impact our business and the other information in this report and in our other filings with the SEC before you decide to invest in our securities or to maintain or increase your investment.
 

CPI INTERNATIONAL, INC.
and Subsidiaries
 
 
 
 
 
(In thousands, except per share data – unaudited)
 
 
   
July 2,
   
October 2,
 
   
2010
   
2009
 
Assets
           
Current Assets:
           
Cash and cash equivalents
  $ 47,183     $ 26,152  
Restricted cash
    1,040       1,561  
Accounts receivable, net
    43,433       45,145  
Inventories
    78,407       66,996  
Deferred tax assets
    10,485       8,652  
Prepaid and other current assets
    4,321       6,700  
Total current assets
    184,869       155,206  
Property, plant, and equipment, net
    54,650       57,912  
Deferred debt issue costs, net
    2,607       3,609  
Intangible assets, net
    73,218       75,430  
Goodwill
    162,225       162,225  
Other long-term assets
    3,786       3,872  
Total assets
  $ 481,355     $ 458,254  
                 
Liabilities and stockholders’ equity
               
Current Liabilities:
               
Accounts payable
  $ 21,164     $ 22,665  
Accrued expenses
    27,955       19,015  
Product warranty
    4,830       3,845  
Income taxes payable
    3,608       4,305  
Deferred income taxes
    328       -  
Advance payments from customers
    12,899       12,996  
Total current liabilities
    70,784       62,826  
Deferred income taxes, non-current
    23,997       24,726  
Long-term debt
    194,931       194,922  
Other long-term liabilities
    2,009       2,227  
Total liabilities
    291,721       284,701  
Commitments and contingencies
               
Stockholders’ equity
               
Common stock ($0.01 par value, 90,000 shares authorized; 17,016 and 16,807 shares issued; 16,810 and 16,601 shares outstanding)
    170       168  
Additional paid-in capital
    79,257       75,630  
Accumulated other comprehensive income
    506       598  
Retained earnings
    112,501       99,957  
Treasury stock, at cost (206 shares)
    (2,800 )     (2,800 )
Total stockholders’ equity
    189,634       173,553  
Total liabilities and stockholders' equity
  $ 481,355     $ 458,254  

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

 
CPI INTERNATIONAL, INC.
and Subsidiaries
 
STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(In thousands, except per share data – unaudited)
 
 
   
Three Months Ended
   
Nine Months Ended
 
   
July 2,
2010
   
July 3,
2009
   
July 2,
2010
   
July 3,
2009
 
 Sales
  $ 93,876     $ 82,520     $ 264,995     $ 241,569  
 Cost of sales
    64,953       58,236       185,910       175,603  
 Gross profit
    28,923       24,284       79,085       65,966  
 Operating costs and expenses:
                               
 Research and development
    3,542       2,731       9,287       8,071  
 Selling and marketing
    5,178       4,762       15,392       14,552  
 General and administrative
    6,373       5,073       18,560       15,537  
 Amortization of acquisition-related intangible assets
    688       691       2,062       2,076  
 Merger expenses
    3,589       -       3,800       -  
 Total operating costs and expenses
    19,370       13,257       49,101       40,236  
 Operating income
    9,553       11,027       29,984       25,730  
 Interest expense, net
    3,780       4,204       11,516       12,965  
 Gain on debt extinguishment
    -       (51 )     -       (248 )
 Income before income taxes
    5,773       6,874       18,468       13,013  
 Income tax expense (benefit)
    1,562       3,004       5,924       (2,201 )
 Net income
  $ 4,211     $ 3,870     $ 12,544     $ 15,214  
                                 
 Other comprehensive income, net of tax
                               
Net unrealized (loss) gain on cash flow hedges and minimum pension liability adjustment
    (1,096 )     3,346       (92 )     84  
Comprehensive income
  $ 3,115     $ 7,216     $ 12,452     $ 15,298  
                                 
 Earnings per common share - Basic
  $ 0.25     $ 0.23     $ 0.75     $ 0.92  
 Earnings per common share - Diluted
  $ 0.23     $ 0.22     $ 0.69     $ 0.86  
                                 
 Shares used to compute earnings per common share - Basic
    16,631       16,362       16,534       16,316  
 Shares used to compute earnings per common share - Diluted
    17,961       17,535       17,787       17,402  


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


CPI INTERNATIONAL, INC.
and Subsidiaries
 
 (In thousands – unaudited)
 
 
   
Nine Months Ended
 
   
July 2,
   
July 3,
 
   
2010
   
2009
 
             
Cash flows from operating activities
           
Net cash provided by operating activities
  $ 22,516     $ 20,308  
                 
Cash flows from investing activities
               
Capital expenditures
    (2,824 )     (2,349 )
Payment of patent application fees
    (36 )     -  
Net cash used in investing activities
    (2,860 )     (2,349 )
                 
Cash flows from financing activities
               
Repayments of debt
    -       (12,358 )
Proceeds from issuance of common stock to employees
    579       781  
Proceeds from exercise of stock options
    214       82  
Excess tax benefit on stock option exercises
    582       51  
Net cash provided by (used in) financing activities
    1,375       (11,444 )
                 
Net increase in cash and cash equivalents
    21,031       6,515  
Cash and cash equivalents at beginning of period
    26,152       28,670  
Cash and cash equivalents at end of period
  $ 47,183     $ 35,185  
                 
Supplemental cash flow disclosures
               
Cash paid for interest
  $ 8,008     $ 9,742  
Cash paid for income taxes, net of refunds
  $ 8,069     $ 2,417  
 
 
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
 

CPI INTERNATIONAL, INC.
and Subsidiaries
 
(All tabular dollar amounts in thousands except share and per share amounts)
 
 
1.  
The Company and a Summary of its Significant Accounting Policies
 
The Company
 
Unless the context otherwise requires, “CPI International” means CPI International, Inc., and “CPI” means Communications & Power Industries, Inc. CPI is a direct subsidiary of CPI International. CPI International is a holding company with no operations of its own. The term “the Company” refers to CPI International and its direct and indirect subsidiaries on a consolidated basis.
 
The accompanying consolidated financial statements represent the consolidated results and financial position of CPI International, which is controlled by affiliates of The Cypress Group L.L.C. (“Cypress”). CPI International, through its wholly owned subsidiary, CPI, develops, manufactures and distributes microwave and power grid Vacuum Electron Devices (“VEDs”), microwave amplifiers, modulators, antenna systems and various other power supply equipment and devices. The Company has two reportable segments: VED and satcom equipment.
 
Basis of Presentation and Consolidation
 
The Company’s fiscal year is the 52- or 53-week period that ends on the Friday nearest September 30. Fiscal years 2010 and 2009 comprise the 52-week periods ending October 1, 2010 and October 2, 2009, respectively. All period references are to the Company’s fiscal periods unless otherwise indicated.
 
The accompanying unaudited condensed consolidated financial statements of the Company as of July 2, 2010 and for the three and nine months ended July 2, 2010 are unaudited and reflect all normal recurring adjustments which are, in the opinion of management, necessary for the fair presentation of such financial statements. These unaudited condensed consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended October 2, 2009. The condensed consolidated balance sheet as of October 2, 2009 has been derived from the audited financial statements at that date. The results of operations and cash flows for the interim period ended July 2, 2010 are not necessarily indicative of results to be expected for the full year.
 
The accompanying unaudited condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances, transactions and stockholdings have been eliminated in consolidation.

 
- 7 -


CPI INTERNATIONAL, INC.
and Subsidiaries
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands except share and per share amounts)
 
 
Use of Estimates and Assumptions
 
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of sales and costs and expenses during the reporting period. On an ongoing basis, the Company evaluates its estimates, including those related to revenue recognition; inventory valuation; provision for product warranty; business combinations; recoverability and valuation of recorded amounts of long-lived assets and identifiable intangible assets, including goodwill; recognition and measurement of share-based compensation; and recognition and measurement of current and deferred income tax assets and liabilities. The Company bases its estimates on various factors and information, which may include, but are not limited to, history and prior experience, experience of other enterprises in the same industry, new related events, current economic conditions and information from third-party professionals that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
 
 
2.  
Recently Issued Accounting Standards
 
In the first quarter of fiscal year 2010, the Company adopted provisions of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 820, “Fair Value Measurements and Disclosures,” that specified the way in which fair value measurements should be made for non-financial assets and non-financial liabilities that are not measured and recorded at fair value on a recurring basis, and specified additional disclosures related to these fair value measurements. The adoption of this new standard did not have an impact on the Company’s consolidated results of operations, financial position or cash flows.
 
In June 2008, the FASB issued an update to ASC 260, “Earnings Per Share,” which addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing earnings per share under the two-class method. The update to ASC 260 requires unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) to be treated as participating securities and to be included in the computation of earnings per share pursuant to the two-class method. This guidance under ASC 260 was effective for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. All prior-period earnings per share data presented shall be adjusted retrospectively. The Company adopted the provisions of this guidance under ASC 260 effective October 3, 2009 and has included the required disclosures in Note 10 to the unaudited condensed consolidated financial statements. The adoption of this guidance did not have a material impact on the Company’s computation of earnings per share.

 
 
- 8 -

 
CPI INTERNATIONAL, INC.
and Subsidiaries
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands except share and per share amounts)

 
In October 2008, the FASB issued guidance codified under ASC 715, “Compensation—Retirement Benefits,” which requires that an employer disclose the following information about the fair value of plan assets: (1) the level within the fair value hierarchy in which fair value measurements of plan assets fall; (2) information about the inputs and valuation techniques used to measure the fair value of plan assets; and (3) a reconciliation of beginning and ending balances for fair value measurements of plan assets using significant unobservable inputs. At initial adoption, application of this guidance would not be required for earlier periods that are presented for comparative purposes. The Company adopted the provisions of this guidance under ASC 715 effective October 3, 2009. The adoption did not have an impact on the Company’s consolidated results of operations, financial position or cash flows.

In April 2009, the FASB released an amendment to ASC 805, “Business Combinations,” which requires an acquirer to recognize at fair value, at the acquisition date, an asset acquired or a liability assumed that arises from a contingency if the acquisition date fair value of that asset or liability can be determined during the measurement period. If the acquisition date fair value cannot be determined during the measurement period, an asset or liability shall be recognized at the acquisition date if (1) information available before the end of the measurement period indicates that it is probable that an asset existed or that a liability had been incurred at the acquisition date, and (2) the amount of the asset or liability can be reasonably estimated. The Company adopted the provisions of the guidance under ASC 805 and its amendment effective October 3, 2009. The impact of the adoption will depend on the nature of acquisitions completed in the future.

In August 2009, the FASB issued ASU 2009-05, “Measuring Liabilities at Fair Value,” an update to ASC 820. This update provides amendments to reduce potential ambiguity in financial reporting when measuring the fair value of liabilities. Among other provisions, this update provides clarification that in circumstances in which a quoted price in an active market for the identical liability is not available, a reporting entity is required to measure fair value using one or more of the valuation techniques described in ASU 2009-05. The Company adopted the provisions of this guidance under ASU 2009-05 effective October 3, 2009. The adoption did not have an impact on the Company’s consolidated results of operations, financial position or cash flows.

In October 2009, the FASB issued ASU 2009-13, “Revenue Recognition (Topic 605): Multiple Deliverable Revenue Arrangements – A Consensus of the FASB Emerging Issues Task Force.” This update provides application guidance on whether multiple deliverables exist, how the deliverables should be separated and how the consideration should be allocated to one or more units of accounting. This update eliminates the residual method of allocation for multiple-deliverable revenue arrangements, and requires that arrangement consideration be allocated at the inception of an arrangement to all deliverables using the relative selling price method. The selling price used for each deliverable will be based on vendor-specific objective evidence, if available, third-party evidence if vendor-specific objective evidence is not available, or estimated selling price if neither vendor-specific or third-party evidence is available. Additionally, ASU 2009-13 expands the disclosure requirements related to a vendor’s multiple-deliverable revenue arrangements. ASU 2009-13 is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010 and early adoption is permitted. The Company is currently evaluating the potential impact that this update may have on its consolidated results of operations, financial position or cash flows but does not expect it will have a material effect.
 
 
- 9 -

 
CPI INTERNATIONAL, INC.
and Subsidiaries
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands except share and per share amounts)

 
In September 2009, the FASB issued ASU 2009-14, “Certain Revenue Arrangements That Include Software Elements,” which is included in the ASC 985, “Software.” ASU 2009-14 amends previous software revenue recognition to exclude (a) non-software components of tangible products and (b) software components of tangible products that are sold, licensed, or leased with tangible products when the software components and non-software components of the tangible product function together to deliver the tangible product’s essential functionality. ASU 2009-14 is effective for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010 and shall be applied on a prospective basis. Earlier application is permitted as of the beginning of an entity’s fiscal year. The Company is currently evaluating the potential impact that this update may have on its consolidated results of operations, financial position or cash flows but does not expect it will have a material effect.

In December 2009, the FASB issued ASU 2009-17, “Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities,” as a further clarification ASC 810-10, “Consolidation of Variable Interest Entities.” ASU 2009-17, upon adoption, requires the use of a qualitative analysis to determine the primary beneficiary of a variable interest entity (“VIE”), amends the guidance for determining if an entity is a VIE and enhances the disclosure requirements regarding an enterprise’s involvement with a VIE. ASU 2009-17 is effective as of the beginning of a company’s first fiscal year beginning after November 15, 2009. Since the Company does not currently have variable interest entities, this update is expected to have no impact on its consolidated results of operations, financial position or cash flows.

In January 2010, the FASB issued ASU 2010-06, “Fair Value Measurements and Disclosures:  Improving Disclosures About Fair Value Measurements.” This update requires reporting entities to make new disclosures about recurring or nonrecurring fair-value measurements including significant transfers into and out of Level 1 and Level 2 fair-value measurements and information on purchases, sales, issuances, and settlements on a gross basis in the reconciliation of Level 3 fair-value measurements. ASU 2010-06 is effective for interim and annual reporting periods beginning after December 15, 2009, except for Level 3 reconciliation disclosures which are effective for annual periods beginning after December 15, 2010. The Company adopted the provisions of this guidance under ASU 2009-06, except for Level 3 reconciliation disclosures, effective January 2, 2010. As this guidance is disclosure-related, it did not have an impact on the Company’s consolidated results of operations, financial position or cash flows.

In February 2010, the FASB issued ASU 2010-08, "Technical Corrections to Various Topics." This update eliminates inconsistencies and outdated provisions in U.S. generally accepted accounting principles (“GAAP”) and provides needed clarification on others. Amendments within ASU 2010-08 that may be applicable to the Company are effective as of the first reporting period beginning after February 2, 2010, the date this ASU was issued. The Company adopted the provisions of this guidance under ASU 2010-08 effective April 3, 2010 with no material impact on its consolidated results of operations, financial position or cash flows.

 
 
In February 2010, the FASB issued ASU 2010-09, “Subsequent Events (Topic 855): Amendments to Certain Recognition and Disclosure Requirements.” This update retracts the requirement to disclose the date through which subsequent events have been evaluated and whether that date is the date the financial statements were issued or were available to be issued. ASU 2010-09 was effective immediately after its issuance and has been adopted by the Company with no material impact on its consolidated results of operations, financial position or cash flows.

In April 2010, the FASB issued ASU 2010-17, “Revenue Recognition—Milestone Method (Topic 605): Milestone Method of Revenue Recognition.” ASU 2010-17 provides guidance on applying the milestone method to milestone payments for achieving specified performance measures when those payments are related to uncertain future events. The scope of ASU 2010-17 is limited to transactions involving research or development. This update further states that the milestone method is not the only acceptable method of revenue recognition for milestone payments. Accordingly, entities can make an accounting policy election to recognize arrangement consideration received for achieving specified performance measures during the period in which the milestones are achieved, provided certain criteria are met. An entity’s policy for recognizing deliverable consideration or unit of accounting consideration contingent upon achievement of a milestone shall be applied consistently to similar deliverables or units of accounting. ASU 2010-17 is effective on a prospective basis for milestones achieved in interim and fiscal years beginning after June 15, 2010. Early adoption is permitted. The Company is currently evaluating the potential impact that this update may have on its consolidated results of operations, financial position or cash flows but does not expect it will have a material effect.
 
 
3.             Supplemental Balance Sheet Information
 
 
   
July 2,
   
October 2,
 
   
2010
   
2009
 
Accounts receivable
  $ 43,522     $ 45,240  
Less: Allowance for doubtful accounts
    (89 )     (95 )
Accounts receivable, net
  $ 43,433     $ 45,145  
 
 
- 11 -

 
CPI INTERNATIONAL, INC.
and Subsidiaries
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands except share and per share amounts)

 
 
   
July 2,
   
October 2,
 
   
2010
   
2009
 
Raw material and parts
  $ 43,933     $ 38,205  
Work in process
    24,855       20,542  
Finished goods
    9,619       8,249  
    $ 78,407     $ 66,996  
 

Reserve for loss contracts:>   The following table summarizes the activity related to reserves for loss contracts:
 
   
Nine Months Ended
 
   
July 2,
   
July 3,
 
   
2010
   
2009
 
Balance at beginning of period
  $ 4,068     $ 1,928  
Provision for loss contracts, charged to cost of sales
    2,886       2,696  
Credit to cost of sales upon revenue recognition
    (3,347 )     (1,522 )
Balance at end of period
  $ 3,607     $ 3,102  

Reserve for loss contracts are reported in the condensed consolidated balance sheet in the following accounts:
 
   
July 2,
   
July 3,
 
   
2010
   
2009
 
Inventories
  $ 3,468     $ 3,092  
Accrued expenses
    139       10  
    $ 3,607     $ 3,102  
 

 
   
Nine Months Ended
 
   
July 2,
   
July 3,
 
   
2010
   
2009
 
Beginning accrued warranty
  $ 3,845     $ 4,159  
Actual costs of warranty claims
    (4,087 )     (3,347 )
Estimates for product warranty, charged to cost of sales
    5,072       2,990  
Ending accrued warranty
  $ 4,830     $ 3,802  
 
 
- 12 -

 
CPI INTERNATIONAL, INC.
and Subsidiaries
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands except share and per share amounts)
 
Accumulated Other Comprehensive Income:>    The following table provides the components of accumulated other comprehensive income in the condensed consolidated balance sheets:
 
   
July 2,
   
October 2,
 
   
2010
   
2009
 
Unrealized gain on cash flow hedges, net of tax
  $ 742     $ 828  
Unrealized actuarial loss and prior service credit for pension liability, net of tax
    (236 )     (230 )
    $ 506     $ 598  
 
 
4.           Definitive Merger Agreement with Comtech
 
On May 10, 2010, the Company announced the signing of a definitive merger agreement with Comtech Telecommunications Corporation (“Comtech”) under which Comtech agreed to acquire the Company in a merger in which Company stockholders would receive a combination of cash and stock in exchange for their Company shares. The ultimate amount of consideration that a Company stockholder will receive for each Company share will be equal to a combination of $9.00 in cash plus a fraction of a share of Comtech common stock equal to $8.10 divided by the average closing price of Comtech common stock over a specified period of time prior to closing, provided that the fraction shall not be greater than 0.2382 nor less than 0.2132. Based on the August 2, 2010 market closing price of Comtech stock of $21.79, the fraction was equal to 0.2382 and was currently valued at $5.19 per share of Company stock.

The transaction is subject to customary closing conditions, including, among others, adoption of the merger agreement by the Company’s stockholders, regulatory approvals, absence of any law or order prohibiting the transaction, effectiveness of the registration statement for the shares of Comtech common stock to be issued in the merger and the listing of such shares on Nasdaq, accuracy of certain representations and warranties and material compliance with covenants, and the absence of any material adverse effect (as defined) with respect to the Company or Comtech. On August 2, 2010, the Company and Comtech received a request for additional information and documents—often referred to as a second request—from the Department of Justice in connection with the proposed merger. The Company and Comtech are working to respond to the second request.

The merger agreement contains certain termination rights for both the Company and Comtech and further provides that, upon termination of the merger agreement, under specified circumstances, the Company will be required to pay Comtech a termination fee of up to $15 million.

For the three and nine months ended July 2, 2010, the Company has incurred transaction costs relating to the proposed merger in the amount of $3.6 million and $3.8 million, respectively. Such non-recurring transaction costs were comprised of fees for investment bankers, attorneys and other professional services rendered in connection with the proposed merger.
 
 
- 13 -

 
CPI INTERNATIONAL, INC.
and Subsidiaries
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands except share and per share amounts)

 
 
FASB ASC 825 establishes a framework for measuring fair value and expands disclosures about fair value measurements by establishing a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The three levels of the fair value hierarchy under ASC 825 are described as follows:
 
Level 1
Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2
Inputs reflect quoted prices for identical assets or liabilities in markets that are not active; quoted prices for similar assets or liabilities in active markets; inputs other than quoted prices that are observable for the asset or the liability; or inputs that are derived principally from or corroborated by observable market data by correlation or other means.
Level 3
Unobservable inputs reflecting the Company’s own assumptions incorporated in valuation techniques used to determine fair value. These assumptions are required to be consistent with market participant assumptions that are reasonably available.
 
Fair value is the price that would be received upon sale of an asset or paid upon transfer of a liability in an orderly transaction between market participants at the measurement date and in the principal or most advantageous market for that asset or liability. The fair value should be calculated based on assumptions that market participants would use in pricing the asset or liability, not on assumptions specific to the entity. In addition, the fair value of liabilities should include consideration of non-performance risk, including the Company’s own credit risk.
 
The Company’s non-financial assets (including goodwill, intangible assets and long-lived assets) and liabilities are measured at fair value on a non-recurring basis; that is, the assets and liabilities are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances such as when they are deemed to be other-than-temporarily impaired. The fair values of these non-financial assets and liabilities are determined based on valuation techniques using the best information available, and may include quoted market prices, market comparables, and discounted cash flow projections. During the three and nine months ended July 2, 2010, no fair value adjustments or material fair value measurements were required for the Company’s non-financial assets or liabilities.
 
The Company measures certain financial assets and liabilities at fair value on a recurring basis, including cash equivalents, restricted cash, available-for-sale securities and derivative instruments. As of July 2, 2010, financial assets utilizing Level 1 inputs included cash equivalents, such as money market and overnight U.S. Government securities and available-for-sale securities, such as mutual funds. Financial assets and liabilities utilizing Level 2 inputs included foreign currency derivatives and interest rate swap derivatives. The Company does not have any financial assets or liabilities requiring the use of Level 3 inputs.
 
 
- 14 -

 
CPI INTERNATIONAL, INC.
and Subsidiaries
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands except share and per share amounts)
 
 
The following tables set forth financial instruments carried at fair value within the ASC 825 hierarchy:
 
         
Fair Value Measurements at July 2, 2010 Using
 
         
Quoted Prices in Active Markets for Identical Assets
   
Significant Other Observable
Inputs
   
Significant Unobservable Inputs
 
   
Total
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
Assets:
                       
Money market and overnight U.S. Government securities1
  $ 41,650     $ 41,650     $ -     $ -  
Mutual funds2
    153       153       -       -  
Foreign exchange forward derivatives3
    659       -       659       -  
Total assets at fair value
  $ 42,462     $ 41,803     $ 659       -  
                                 
Liabilities:
                               
Foreign exchange forward derivatives4
    20               20          
Interest rate swap derivative4
  $ 1,109     $ -     $ 1,109     $ -  
Total liabilities at fair value
  $ 1,129     $ -     $ 1,129     $ -  
 
     
1 The money market and overnight U.S. Government securities are classified as part of cash and cash equivalents and restricted cash in the condensed consolidated balance sheet.
 
2 The mutual funds are classified as part of other long-term assets in the condensed consolidated balance sheet.
 
3 The foreign currency derivatives are classified as part of prepaid and other current assets in the condensed consolidated balance sheet.
 
4 The foreign currency and interest rate swap derivatives are classified as part of accrued expenses in the condensed consolidated balance sheet.
 
 
 
- 15 -

 
CPI INTERNATIONAL, INC.
and Subsidiaries
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands except share and per share amounts)
 
 
         
Fair Value Measurements at October 2, 2009 Using
 
         
Quoted Prices in Active Markets for Identical Assets
   
Significant Other Observable Inputs
   
Significant Unobservable Inputs
 
   
Total
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
Assets:
                       
Money market and overnight U.S. Government securities1
  $ 22,464     $ 22,464     $ -     $ -  
Mutual funds2
    152       152       -       -  
Foreign exchange forward derivatives3
    3,467       -       3,467       -  
Total assets at fair value
  $ 26,083     $ 22,616     $ 3,467       -  
                                 
Liabilities:
                               
Interest rate swap derivative4
  $ 2,323     $ -     $ 2,323     $ -  
Total liabilities at fair value
  $ 2,323     $ -     $ 2,323     $ -  
     
1 The money market and overnight U.S. Government securities are classified as part of cash and cash equivalents and restricted cash in the condensed consolidated balance sheet.
 
2 The mutual funds are classified as part of other long-term assets in the condensed consolidated balance sheet.
 
3 The foreign currency derivatives are classified as part of prepaid and other current assets in the condensed consolidated balance sheet.
 
4 The interest rate swap derivatives are classified as part of accrued expenses and other long-term liabilities in the condensed consolidated balance sheet.
 
 
Investments Other Than Derivatives
 
In general and where applicable, the Company uses quoted prices in active markets for identical assets or liabilities to determine fair value. This pricing methodology applies to the Company’s Level 1 investments, such as money market securities, U.S. Government securities and mutual funds.

If quoted prices in active markets for identical assets or liabilities are not available to determine fair value, then the Company would use quoted prices for similar assets and liabilities or inputs other than the quoted prices that are observable either directly or indirectly. These investments would be included in Level 2.

Derivatives
 
    The Company executes foreign exchange forward contracts to purchase Canadian dollars and holds a pay-fixed receive-variable interest rate swap contract, all executed in the retail market with its relationship banks. To determine the most appropriate value, the Company uses an in-exchange valuation premise which considers the assumptions that market participants would use in pricing the derivatives. The Company has elected to use the income approach and uses observable (Level 2) market expectations at the measurement date and standard valuation techniques to convert future amounts to a single present amount. Level 2 inputs for derivative valuations are midmarket quoted prices for similar assets or liabilities in active markets and inputs other than quoted prices that are observable for the asset or liability.
 
 
- 16 -

 
CPI INTERNATIONAL, INC.
and Subsidiaries
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands except share and per share amounts)
 

Key inputs for currency derivatives are spot rates, forward rates, interest rates and credit derivative rates. The spot rate for the Canadian dollar is the same spot rate used for all balance sheet translations at the measurement date. Forward premiums/discounts and interest rates are interpolated from commonly quoted intervals. Once valued, each forward is identified as either an asset or liability. Assets are further discounted using counterparty annual credit default rates, and liabilities are valued using the Company’s credit as reflected in the spread paid over LIBOR on the term loan under the Company’s senior credit facilities.

Key inputs for valuing the interest rate swap are the cash rates used for the short term (under 3 months), futures rates for up to three years and LIBOR swap rates for periods beyond. These inputs are used to derive variable resets for the swap as well as to discount future fixed and variable cash flows to present value at the measurement date. A credit spread is used to further discount each net cash flow using, for assets, counterparty credit default rates and, for liabilities, the Company’s credit spread over LIBOR on the term loan under the Company’s senior credit facilities.

See Note 6 for further information regarding the Company’s derivative instruments.
 
Other Financial Instruments

The Company’s other financial instruments include cash, restricted cash, accounts receivable, accounts payable and long-term debt. Except for long-term debt, the carrying value of these financial instruments approximates fair values because of their relatively short maturity.

The fair values of the Company’s long-term debt were estimated using quoted market prices where available. For long-term debt not actively traded, fair values were estimated using discounted cash flow analyses, based on the Company’s current estimated incremental borrowing rates for similar types of borrowing arrangements. The estimated fair value of the Company’s long-term debt as of July 2, 2010 and October 2, 2009 was $192.2 million and $188.5 million, respectively, compared to the carrying value of $194.9 million.
 
 
6.    Derivative Instruments and Hedging Activities
 

 
- 17 -

 
CPI INTERNATIONAL, INC.
and Subsidiaries
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands except share and per share amounts)
 
 
The Company’s Canadian dollar forward contracts in effect as of July 2, 2010 have durations of 8 to 15 months. These contracts are designated as cash flow hedges and are considered highly effective, as defined by FASB ASC 815. Unrealized gains and losses from foreign exchange forward contracts are included in accumulated other comprehensive income in the condensed consolidated balance sheets. At July 2, 2010, the unrealized gain, net of tax of $0.7 million, was $1.4 million. The Company anticipates recognizing the entire unrealized gain or loss in operating earnings within the next four fiscal quarters. Changes in the fair value of foreign currency forward contracts due to changes in time value are excluded from the assessment of effectiveness and are immediately recognized in general and administrative expenses in the condensed consolidated statements of income. The time value was not material for the three and nine months ended July 2, 2010 and July 3, 2009. If the transaction being hedged fails to occur, or if a portion of any derivative is ineffective, then the Company immediately recognizes the gain or loss on the associated financial instrument in general and administrative expenses in the condensed consolidated statements of income. The gain recognized in general and administrative expenses due to hedge ineffectiveness for the three and nine months ended July 2, 2010 was zero and $0.1 million, respectively. No ineffective amounts were recognized due to hedge ineffectiveness for the three and nine months ended July 3, 2009.

As of July 2, 2010, the Company had entered into Canadian dollar forward contracts for approximately $19.2 million (Canadian dollars), or approximately 58% of estimated Canadian dollar denominated expenses for July 2010 through March 2011, at an average rate of approximately 0.92 U.S. dollars to Canadian dollars.
 
Interest Rate Contracts:> The Company also uses derivative instruments in order to manage interest costs and risk associated with its long-term debt. During fiscal year 2007, the Company entered into an interest rate swap contract (the “2007 Swap”) to receive three-month USD-LIBOR-BBA (British Bankers’ Association) interest and pay 4.77% fixed rate interest. Net interest positions are settled quarterly. The Company has structured the 2007 Swap with decreasing notional amounts such that it is less than the balance of its term loan under its senior credit facilities. The notional value of the 2007 Swap was $35.0 million at July 2, 2010 and represented approximately 53% of the aggregate term loan balance. The Swap agreement is effective through June 30, 2011. Under the provisions of ASC 815, this arrangement was initially designated and qualified as an effective cash flow hedge of interest rate risk related to the term loan, which permitted recording the fair value of the 2007 Swap and corresponding unrealized gain or loss to accumulated other comprehensive income in the condensed consolidated balance sheets. At July 2, 2010, the unrealized loss, net of tax of $0.4 million, was $0.7 million. The interest rate swap gain or loss is included in the assessment of hedge effectiveness. Gains and losses representing hedge ineffectiveness are immediately recognized in interest expense, net, in the condensed consolidated statements of income.
 
 
- 18 -

 
CPI INTERNATIONAL, INC.
and Subsidiaries
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands except share and per share amounts)
 
 
The following table summarizes the fair value of derivative instruments designated as cash flow hedges at July 2, 2010 and October 2, 2009:
 
 
Asset Derivatives
 
Liability Derivatives
 
 
 
 
Fair Value
 
 
 
Fair Value
 
 
Balance Sheet Location
 
July 2,
2010
   
October 2,
2009
 
Balance Sheet Location
 
July2,
2010
   
October 2,
2009
 
Derivatives designated as hedging instruments
                           
     Interest rate contracts
             
Accrued expenses
  $ (1,109 )   $ (1,766 )
     Interest rate contracts
             
Other long-term liabilities
    -       (557 )
                                 
     Forward contracts
Prepaid and other current assets
  $ 659     $ 3,467  
Accrued expenses
    (20 )        
Total derivatives designated as hedging instruments   $ 659     $ 3,467       $ (1,129 )   $ (2,323 )
 
As of July 2, 2010 and October 2, 2009, all of the Company’s derivative instruments were classified as hedging instruments in accordance with ASC 815.
 
 
- 19 -

 
CPI INTERNATIONAL, INC.
and Subsidiaries
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands except share and per share amounts)
 
 
The following table summarizes the effect of derivative instruments on the condensed consolidated statements of income and comprehensive income for the three and nine months ended July 2, 2010 and July 3, 2009:
 
 
Derivatives in Cash Flow Hedging Relationships
  Amount of
(Loss) Gain Recognized
in OCI on Derivative
(Effective Portion)
  Location of
(Loss) Gain Reclassified from Accumulated
OCI into Income
(Effective Portion)
  Amount of
(Loss) Gain Reclassified from Accumulated OCI into Income
(Effective Portion)
   Location of
(Loss) Gain Recognized in Income on Derivative (Ineffective and Excluded Portion)
   
Amount of (Loss) Gain
Recognized in Income on Derivative
(Ineffective and Excluded Portion )
 
   
Three Months Ended
     
Three Months Ended
     
Three Months Ended
 
   
July 2, 2010
   
July 3, 2009
     
July 2, 2010
   
July 3, 2009
     
July 2, 2010
   
July 3, 2009
 
 Interest rate contracts
  $ (33 )   $ (302 )
 Interest expense, net
  $ (443 )   $ (528 )
 Interest expense, net
  $ (9 )   $ (12 )
                                                     
 Forward contracts
    (667 )     3,591  
 Cost of sales
    149       (62 )
 General and administrative(a)
3       (60 )
                 
 Research and development
  65       (33 )                  
                 
 Selling and marketing
    94       (101 )                  
                 
 General and administrative
  69       (121 )                  
 Total
  $ (700 )   $ 3,289       $ 1,064     $ (2,045 )     $ (6 )   $ (72 )
 
   
 
(a) The amount of gain recognized in income during the three months ended July 2, 2010 represents a $3 loss related to the amount excluded from the assessment of hedge effectiveness. The amount of loss recognized in income during the three months ended July 3, 2009 represents a $64 loss related to the amount excluded from the assessment of hedge effectiveness, net of $4 gain related to the ineffective portion of the hedging relationships.
 
                                                     
   
Nine Months Ended
     
Nine Months Ended
     
Nine Months Ended
 
   
July 2, 2010
   
July 3, 2009
     
July 2, 2010
   
July 3, 2009
     
July 2, 2010
   
July 3, 2009
 
 Interest rate contracts
  $ (281 )   $ (1,889 )
 Interest expense, net
  $ (1,495 )   $ (1,228 )
 Interest expense, net
  $ (28 )   $ (40 )
                                                     
 Forward contracts
    888       (2,791 )
 Cost of sales
    1805       (3,167 )
 General and administrative(b)
51       (285 )
                 
 Research and development
  307       (176 )                  
                 
 Selling and marketing
    134       (96 )                  
                 
 General and administrative
  185       (289 )                  
 Total
  $ 607     $ (4,680 )     $ 936     $ (4,956 )     $ 23     $ (325 )
   
(b) The amount of gain recognized in income during the nine months ended July 2, 2010 represents a $62 gain related to the ineffective portion of the hedging relationships, net of a $11 loss related to the amount excluded from the assessment of hedge effectiveness. The amount of loss recognized in income during the nine months ended July 3, 2009 represents a $286 loss related to the amount excluded from the assessment of hedge effectiveness, net of a $1 gain related to the ineffective portion of the hedging relationships.
 
 
 
- 20 -

 
CPI INTERNATIONAL, INC.
and Subsidiaries
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands except share and per share amounts)
 
 
As a result of the use of derivative instruments, the Company is exposed to the risk that counterparties to derivative contracts will fail to meet their contractual obligations. The Company does not hold collateral or other security from its counterparties supporting its derivative instruments. To mitigate the counterparty credit risk, the Company has a policy of only entering into contracts with carefully selected major financial institutions based upon their credit ratings and other factors. The Company regularly reviews its credit exposure balances as well as the creditworthiness of its counterparties.

When the Company’s derivatives are in a net asset position, such as the case with the majority of the Company’s forward foreign exchange contract derivatives at July 2, 2010, the Company is exposed to credit loss from nonperformance by the counterparty. If the counterparty fails to perform, credit risk with such counterparty is equal to the extent of the fair value gain in the derivative. At July 2, 2010, the Company’s interest rate contract derivative was in a liability position, and the Company, therefore, was not exposed to the interest rate contract counterparty credit risk.
 
 
7.           Commitments and Contingencies
 
 
Fiscal Year
 
Operating Leases
 
2010 (remaining three months)
  $ 482  
2011
    1,324  
2012
    1,125  
2013
    633  
2014
    420  
Thereafter
    2,634  
    $ 6,618  
 
Real estate taxes, insurance, and maintenance are also obligations of the Company. Rental expense under non-cancelable operating leases amounted to $0.6 million and $1.8 million for the three and nine months ended July 2, 2010, respectively, and $0.6 million and $2.0 million for the corresponding periods of fiscal year 2009. Assets subject to capital leases at July 2, 2010 and October 2, 2009 were not material.


 
- 21 -

 
CPI INTERNATIONAL, INC.
and Subsidiaries
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands except share and per share amounts)

 

Fiscal Year
 
Purchase Contracts
 
2010 (remaining nine months)
  $ 20,253  
2011
    9,710  
2012
    166  
2013
    37  
2014
    25  
    $ 30,191  


In addition, the Company could have also been required to pay a discretionary earnout of up to $1.0 million to the former stockholders of Malibu contingent upon achievement of certain succession planning goals by June 30, 2010. However, the Company has determined that such goals were not attained and, as a result, no discretionary earnout was ultimately paid.

Merger Expense Commitment:> For services rendered in connection with the merger agreement with Comtech, the Company has agreed to pay J.P. Morgan Securities, Inc. (“J.P. Morgan” ) a fee estimated to be approximately $5.0 million, of which $1.4 million has been accrued (accrued expenses) and $3.6 million will become payable only if the proposed merger is consummated. The Company has also agreed to reimburse J.P. Morgan for certain expenses incurred in connection with its services, including the fees and disbursements of counsel, and will indemnify J.P. Morgan against certain liabilities, including liabilities arising under the federal securities laws.

 
On July 1, 2010, a putative stockholder class action complaint was filed against the Company, the members of the Company’s board of directors, and Comtech. The lawsuit concerns the proposed merger between the Company and Comtech, and generally asserts claims alleging, among other things, that each member of the Company’s board of directors breached his fiduciary duties by agreeing to the terms of the proposed merger and by failing to provide stockholders with allegedly material information related to the proposed merger, and that Comtech aided and abetted the breaches of fiduciary duty allegedly committed by the members of the Company’s board of directors. The lawsuit seeks, among other things, class action certification and monetary relief. On July 28, 2010, the plaintiff filed an amended complaint, making

 
- 22 -

 
CPI INTERNATIONAL, INC.
and Subsidiaries
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands except share and per share amounts)
 
 
generally the same claims against the same defendants, and seeking the same relief. In addition, the amended complaint generally alleges that the consideration to be paid to the Company’s stockholders under the terms of the proposed merger is inadequate. The Company believes all claims asserted in the lawsuit to be without merit.
 
During fiscal year 2009, the Company received a notice from a customer purporting to terminate a sales contract due to alleged nonperformance. In April 2010, the Company received another notice from the customer claiming additional cost incurred due to the alleged nonperformance. The Company plans to contest this matter vigorously. The Company recorded certain costs in fiscal year 2008 as a result of the termination; however, at this time, the Company cannot estimate the range of any further possible loss or gain with respect to this matter or whether an unfavorable resolution of this matter would have a material adverse effect on the Company's consolidated results of operations and cash flows.
 
 
8.           Stock-based Compensation Plans
 
 
   
Oustanding Options
   
Exercisable Options
 
   
Number of Shares
   
Weighted-Average Exercise Price
   
Weighted-Average Remaining Contractual Term (Years)
   
Aggregate Intrinsic Value
   
Number of Shares
   
Weighted-Average Exercise Price
   
Weighted-Average Remaining Contractual Term (Years)
   
Aggregate Intrinsic Value
 
Balance at October 2, 2009
    3,382,763     $ 6.38       4.95     $ 20,362       2,845,996     $ 4.73       4.43     $ 20,227  
Granted
    108,000       9.66                                                  
Exercised
    (122,795 )     1.75                                                  
Forfeited or cancelled
     (17,125 )     16.42                                                  
Balance at July 2, 2010
     3,350,843     $ 6.60       4.49     $ 30,435      
2,912,134
    $ 5.58       4.00     $ 29,230  
 
The aggregate intrinsic value in the preceding table represents the total intrinsic value, based on the Company’s closing stock price of $15.38 as of July 2, 2010, which would have been received by the option holders had all option holders exercised their options and sold the shares received upon such exercises as of that date. As of July 2, 2010, approximately 2.6 million exercisable options were in-the-money.

During the three and nine months ended July 2, 2010, cash received from option exercises was approximately $0.1 million and $0.2 million, respectively, and the total intrinsic value of options exercised was $0.9 million and $1.5 million, respectively. During the three and nine months ended July 3, 2009, cash received from option exercises was $46,448 and $82,451, respectively, and the total intrinsic value of options exercised was approximately $0.4 million. As of July 2, 2010, there was approximately $2.0 million of total unrecognized compensation costs related to nonvested stock options, which is expected to be recognized over a weighted-average vesting period of 1.3 years.

 

 
- 23 -

 
CPI INTERNATIONAL, INC.
and Subsidiaries
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands except share and per share amounts)
 
 
A summary of the status of the Company’s nonvested restricted stock and restricted stock unit awards as of July 2, 2010 and October 2, 2009 and of changes during the nine months ended July 2, 2010 is presented below:
 

   
Number of
Shares
   
Weighted-Average Grant-Date Fair Value Per Share
 
Nonvested at October 2, 2009
    218,298     $ 11.27  
Granted
    163,307     $ 10.04  
Vested
    (65,914 )   $ 11.87  
Forfeited
    (4,350 )   $ 10.62  
Nonvested at July 2, 2010
    311,341     $ 10.51  
 
During the first quarter of fiscal year 2010, the Company granted 104,800 restricted stock units with time vesting criteria to certain of its non-executive employees and 36,000 restricted stock units with performance vesting criteria to its officers.

During the second quarter of fiscal year 2010, the Company granted certain members of its board of directors a total of 22,507 shares of restricted stock which will vest within the following three years.

Aggregate intrinsic value of the nonvested restricted stock and restricted stock unit awards at July 2, 2010 and October 2, 2009 was $4.8 million and $2.5 million, respectively. As of July 2, 2010, there was $2.6 million of unrecognized compensation costs related to restricted stock and restricted stock unit awards. The unrecognized compensation cost is expected to be recognized over a weighted average period of 1.8 years.

The Company settles stock option exercises, restricted stock awards and restricted stock units with newly issued common shares.
 
Valuation and Expense Information
 
The fair value of the Company’s time-based option awards is estimated on the date of grant using the Black-Scholes model. The fair value of each market performance-based (or combination of market performance- and time-based) option, restricted stock and restricted stock unit awards is estimated on the date of grant using the Monte Carlo simulation technique in a risk-neutral framework.

 
- 24 -

 
CPI INTERNATIONAL, INC.
and Subsidiaries
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands except share and per share amounts)
 
 
Stock Options. Assumptions used in the Black-Scholes model to estimate the fair value of time-based option grants during the nine months ended July 2, 2010 (specifically, the first quarter of fiscal year 2010) are presented below.

Expected term (in years)
    7.79  
Expected volatility
    60.50 %
Risk-free rate
    3.00 %
Dividend yield
    0 %

There were no time-based options granted during the three months ended July 2, 2010 nor during the three and nine months ended July 3, 2009.

Assumptions used in the Monte Carlo simulation model to estimate the fair value of time- and market performance-based options granted during the nine months ended July 3, 2009 (specifically, the first quarter of fiscal year 2009) are presented below.

Contractual term (in years)
    10.00  
Expected volatility
    51.50 %
Risk-free rate
    3.53 %
Dividend yield
    0 %

There were no time- and market performance-based options granted during the three and nine months ended July 2, 2010 nor during the three months ended July 3, 2009.
 
The weighted-average grant-date fair value of all the options granted during the nine months ended July 2, 2010 and July 3, 2009 was $6.25 and $5.61 per share, respectively.
 
Stock Purchase Plan. Based on the 15% discount received by the employees, the weighted-average fair value of shares issued under the 2006 ESPP was $2.31 and $2.08 per share during the three and nine months ended July 2, 2010, respectively, and $1.40 and $1.48 per share for the corresponding periods of fiscal year 2009.

Restricted Stock and Restricted Stock Units. The fair value of each time-based restricted stock and restricted stock unit award and of each performance-based restricted stock unit award is calculated using the market price of the Company’s common stock on the date of grant. The fair value of each performance-based restricted stock unit award assumes that the relevant performance criteria will be met and the target payout level will be achieved. Compensation cost is adjusted for subsequent changes in the outcome of performance-related conditions until the award vests.

Assumptions used in the Monte Carlo simulation model to estimate the fair value of time- and market performance-based restricted stock and restricted stock units granted during the nine months ended July 3, 2009 (specifically, the first quarter of fiscal year 2009) are presented below.

Expected volatility
    51.50 %
Risk-free rate
    3.54 %
Dividend yield
    0 %
 
 
- 25 -

 
CPI INTERNATIONAL, INC.
and Subsidiaries
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands except share and per share amounts)

 
There were no time- and market performance-based restricted stock and restricted stock units granted during the three and nine months ended July 2, 2010 nor during the three months ended July 3, 2009.

The weighted-average estimated fair value of all restricted stock and restricted stock units granted during the nine months ended July 2, 2010 and July 3, 2009 was $10.04 and $8.87, respectively.

As stock-based compensation expense recognized in the condensed consolidated statements of income and comprehensive income for the three and nine months ended July 2, 2010 and for the corresponding periods of fiscal year 2009 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. FASB ASC 718, “Compensation—Stock Compensation,” requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

The following table summarizes stock-based compensation expense for the three and nine months ended July 2, 2010 and July 3, 2009, which was allocated as follows:

   
Three Months Ended
   
Nine Months Ended
 
   
July 2,
2010
   
July 3,
2009
   
July 2,
2010
   
July 3,
2009
 
Share-based compensation cost recognized in the income statement by caption:
                   
Cost of sales
  $ 152     $ 131     $ 432     $ 375  
Research and development
    51       43       161       130  
Selling and marketing
    74       75       214       216  
General and administrative
    505       453       1,493       1,303  
    $ 782     $ 702     $ 2,300     $ 2,024  
                                 
Share-based compensation cost capitalized in inventory
  $ 153     $ 131     $ 444     $ 386  
Share-based compensation cost remaining in inventory at end of period
  $ 98     $ 87     $ 98     $ 87  
                                 
Share-based compensation expense by type of award:
                               
Stock options
  $ 460     $ 455     $ 1,375     $ 1,327  
Restricted stock and units
    286       215       823       599  
Stock purchase plan
    36       32       102       98  
    $ 782     $ 702     $ 2,300     $ 2,024  
 
The tax benefit realized from option exercises and restricted stock vesting totaled approximately $0.4 million and $0.8 million during the three and nine months ended July 2, 2010, respectively. The tax benefit realized from option exercises and restricted stock vesting totaled approximately $0.2 million for the corresponding periods of fiscal year 2009.
 
 
- 26 -

 
CPI INTERNATIONAL, INC.
and Subsidiaries
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands except share and per share amounts)
 

Income tax expense of $5.9 million for the nine months ended July 2, 2010 and income tax benefit of $2.2 million for the nine months ended July 3, 2009 reflect estimated federal, foreign and state taxes. The effective tax rate for the nine months ended July 2, 2010 was 32.1% and diverged from the federal and state statutory rate primarily due to approximately $0.8 million for discrete income tax benefits, including $0.3 million to true-up the fiscal year 2009 tax provision estimate to the filed fiscal year 2009 U.S. income tax return and $0.3 million to adjust deferred tax accounts for a reduction to future Canadian income tax rates.
 
The effective tax rate for the nine months ended July 3, 2009 was a negative 17% and diverged from the federal and state statutory rate primarily due to several significant discrete tax benefits: (1) $5.1 million of unrecognized tax benefit relating to the Company’s position with regard to an outstanding audit by the Canada Revenue Agency (“CRA”), (2) $0.7 million related to certain provisions of the California Budget Act of 2008 signed on February 20, 2009, which will allow a taxpayer to elect an alternative method to attribute taxable income to California for tax years beginning on or after January 1, 2011 and (3) $0.9 million for adjustments to Canadian deferred tax accounts. The $0.9 million adjustment to Canadian deferred tax accounts includes a $0.6 million tax benefit to reflect the reduction to Canadian corporate income tax rates and a $0.3 million tax benefit to correct the computation of certain deferred tax accounts. The $0.6 million adjustment should have been recorded in the first quarter of fiscal year 2008 rather than in the first quarter of fiscal year 2009 and the $0.3 million adjustment should have been recorded in several prior year financial results. These adjustments are deemed immaterial to the Company’s results of operations and financial condition in the affected periods.
 
The effective tax rate for the three months ended July 2, 2010 was 27.1% and diverged from the federal and state statutory rate primarily due to approximately $0.3 million for discrete income tax benefits to true-up the fiscal year 2009 tax provision estimate to the filed fiscal year 2009 US income tax return. The effective tax rate for the three months ended July 3, 2009 was 43.7% and diverged from the federal and state statutory rate primarily due to approximately $0.3 million for several non-recurring discrete income tax expense items and $0.2 million from foreign currency translation losses, primarily from Canadian tax accounts.
 
The Company files U.S. federal income tax returns, as well as income tax returns in California and other U.S. states, Canada and other foreign jurisdictions. Generally, fiscal years 2006 to 2009 remain open to examination by the various taxing jurisdictions. The Company has not been audited for U.S. federal income tax matters. The Company has income tax audits in progress in Canada and in several international jurisdictions in which it operates. The years under examination by the Canadian taxing authorities are fiscal years 2001 and 2002.
 
The total unrecognized tax benefit, which excludes any related interest accruals, was $3.3 million as of July 2, 2010. Of the total unrecognized tax benefit balance, $2.4 million of unrecognized tax benefits would reduce the effective tax rate if recognized as of July 2, 2010. Estimated interest and penalties related to the underpayment of income taxes are classified as a component of tax expense in the condensed consolidated statement of income and comprehensive income and totaled approximately $0.1 million for the nine months ended July 2, 2010. Accrued interest and penalties, net of interest benefits accrued on receivables anticipated as a result of the change in the U.S.-Canada treaty, were approximately $0.7 million as of July 2, 2010. The Company had minimal penalties accrued in income tax expense
 
 
- 27 -

 
CPI INTERNATIONAL, INC.
and Subsidiaries
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands except share and per share amounts)
 
 
The Company believes that it is reasonably possible that, in the next 12 months, the amount of unrecognized tax benefits related to the resolution of federal, state and foreign matters could be reduced by $2.7 million as audits close, statutes expire and tax payments are made. Any prospective adjustments to the Company’s unrecognized tax benefits will be recorded as an increase or decrease to income tax expense and cause a corresponding change to the Company’s effective tax rate. Accordingly, the Company’s effective tax rate could fluctuate materially from period to period.
 
 
 
Earnings per share is computed using the two-class method, which is an earnings allocation method for computing earnings per share that treats a participating security as having rights to earnings that would otherwise have been available to common stockholders. Certain of the Company’s stock-based compensation awards pay nonforfeitable dividends to the participants during the vesting period and, as such, are deemed participating securities. Basic earnings per share are computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding that are increased for additional shares that would be outstanding if potentially dilutive non-participating securities were converted to common shares, pursuant to the treasury stock method.
 
Earnings per share for the respective periods were calculated as follows (amounts and shares in thousands, except per share data):
 
   
Three Months Ended
   
Nine Months Ended
 
   
July 2, 2010
   
July 3, 20091
   
July 2, 2010
   
July 3, 20091
 
Basic Earnings per Share
                       
Net income
  $ 4,211     $ 3,870     $ 12,544     $ 15,214  
Income allocated to participating securities
    (78 )     (52 )     (222 )     (175 )
Net income available to common shareholders
  $ 4,133     $ 3,818     $ 12,322     $ 15,039  
                                 
Basic weighted average common shares outstanding
    16,631       16,362       16,534       16,316  
Net income per common share - Basic
  $ 0.25     $ 0.23     $ 0.75     $ 0.92  
                                 
Diluted Earnings per Share
                               
Net income
  $ 4,211     $ 3,870     $ 12,544     $ 15,214  
Income allocated to participating securities
    (72 )     (49 )     (206 )     (164 )
Net income available to common shareholders
  $ 4,139     $ 3,821     $ 12,338     $ 15,050  
                                 
Basic weighted average common shares outstanding
    16,631       16,362       16,534       16,316  
Effect of dilutive stock options
    1,330       1,173       1,253       1,086  
Diluted weighted average common shares outstanding
    17,961       17,535       17,787       17,402  
Net income per common share - Diluted
  $ 0.23     $ 0.22     $ 0.69     $ 0.86  
   
 
1 Restated in accordance with ASC 260.
       
 
The calculation of diluted net income per share excludes all anti-dilutive shares from stock options. For the three and nine months ended July 2, 2010, the number of anti-dilutive shares, as calculated based on the weighted average price of the Company’s common stock for the periods, was
 
 
- 28 -

 
CPI INTERNATIONAL, INC.
and Subsidiaries
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands except share and per share amounts)
 
 
approximately 0.6 million and 0.8 million shares, respectively. For the three and nine months ended July 3, 2009, the number of anti-dilutive shares, as calculated based on the weighted average price of the Company’s common stock for the periods, was approximately 0.9 million shares.
 
 
11.           Segments, Geographic and Customer Information>
 
The Company’s reportable segments are VED and satcom equipment. The VED segment develops, manufactures and distributes high-power/high-frequency microwave and radio frequency signal components. The satcom equipment segment manufactures and supplies high-power amplifiers and networks for satellite communication uplink and industrial applications. Segment information reported below is consistent with the manner in which it is reviewed and evaluated by the Company’s chief operating decision maker (“CODM”), its chief executive officer, and is based on the nature of the Company’s operations and products offered to customers.

Amounts not reported as VED or satcom equipment are reported as Other. In accordance with quantitative and qualitative guidelines established by FASB ASC 280, “Segment Reporting,” Other includes the activities of the Company’s Malibu division and unallocated corporate expenses, such as business combination-related expenses, share-based compensation expense and certain non-recurring or unusual expenses. The Malibu division is a designer, manufacturer and integrator of advanced antenna systems for radar, radar simulators and telemetry systems, as well as for data links used in ground, airborne, unmanned aerial vehicles (“UAVs”) and shipboard systems.

Summarized financial information concerning the Company’s reportable segments is shown in the following tables:
 
   
Three Months Ended
   
Nine Months Ended
 
   
July 2,
   
July 3,
   
July 2,
   
July 3,
 
   
2010
   
2009
   
2010
   
2009
 
 Sales to external customers
                       
 VED
  $ 66,701     $ 62,572     $ 191,006     $ 180,269  
 Satcom equipment
    21,621       15,704       62,666       49,329  
 Other
    5,554       4,244       11,323       11,971  
    $ 93,876     $ 82,520     $ 264,995     $ 241,569  
 Intersegment product transfers
                               
 VED
  $ 5,853     $ 3,536     $ 18,257     $ 13,323  
 Satcom equipment
    94       -       95       9  
    $ 5,947     $ 3,536     $ 18,352     $ 13,332  
 EBITDA
                               
 VED
  $ 17,744     $ 15,248     $ 47,862     $ 37,449  
 Satcom equipment
    1,737       1,078       6,455       3,123  
 Other
    (7,160 )     (2,545 )     (16,080 )     (6,514 )
    $ 12,321     $ 13,781     $ 38,237     $ 34,058  
 
 
- 29 -

 
CPI INTERNATIONAL, INC.
and Subsidiaries
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands except share and per share amounts)

 
EBITDA is the measure used by the CODM to evaluate segment profit or loss. EBITDA represents earnings before net interest expense, provision for income taxes and depreciation and amortization. The Company believes that EBITDA is a more meaningful representation of segment operating performance for leveraged businesses like its own and therefore uses this metric as its internal measure of profitability. For the reasons listed below, the Company believes EBITDA provides investors better understanding of the Company’s financial performance in connection with their analysis of the Company’s business:
 
 
EBITDA is a component of the measures used by the Company’s board of directors and management team to evaluate the Company’s operating performance;
 
 
the Company’s Senior Credit Facilities contain a covenant that requires the Company to maintain a senior secured leverage ratio that contains EBITDA as a component, and the Company’s management team uses EBITDA to monitor compliance with this covenant;
 
 
EBITDA is a component of the measures used by the Company’s management team to make day-to-day operating decisions;
 
 
EBITDA facilitates comparisons between the Company’s operating results and those of competitors with different capital structures and, therefore, is a component of the measures used by the Company’s management to facilitate internal comparisons to competitors’ results and the Company’s industry in general; and
 
 
the payment of management bonuses is contingent upon, among other things, the satisfaction by the Company of certain targets that contain EBITDA as a component.
 
Other companies may define EBITDA differently and, as a result, the Company’s measure of EBITDA may not be directly comparable to EBITDA of other companies. Although the Company uses EBITDA as a financial measure to assess the performance of its business, the use of EBITDA is limited because it does not include certain material costs, such as interest and taxes, necessary to operate the Company’s business. When analyzing the Company’s performance, EBITDA should be considered in addition to, and not as a substitute for or superior to, operating income, net income, cash flows from operating activities or other statements of income or statements of cash flows data prepared in accordance with U.S. GAAP. Operating income by the Company’s reportable segments was as follows:
 
   
Three Months Ended
   
Nine Months Ended
 
   
July 2,
2010
   
July 3,
2009
   
July 2,
2010
   
July 3,
2009
 
Operating income
                       
VED
  $ 16,232     $ 13,788     $ 43,367     $ 33,128  
Satcom equipment
    1,566       894       5,927       2,568  
Other
    (8,245 )     (3,655 )     (19,310 )     (9,966 )
    $ 9,553     $ 11,027     $ 29,984     $ 25,730  
 
 
- 30 -

 
CPI INTERNATIONAL, INC.
and Subsidiaries
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands except share and per share amounts)
 
 
The following table reconciles net income to EBITDA:
 
   
Three Months Ended
   
Nine Months Ended
 
   
July 2,
2010
   
July 3,
2009
   
July 2,
2010
   
July 3,
2009
 
Net income
  $ 4,211     $ 3,870     $ 12,544     $ 15,214  
Depreciation and amortization
    2,768       2,703       8,253       8,080  
Interest expense, net
    3,780       4,204       11,516       12,965  
Income tax expense (benefit)
    1,562       3,004       5,924       (2,201 )
EBITDA
  $ 12,321     $ 13,781     $ 38,237     $ 34,058  
 

 
Issued on January 23, 2004, CPI’s 8% Senior Subordinated Notes due 2012 (“8% Notes”), the current balance of which is $117.0 million, are guaranteed by CPI International and all of CPI’s domestic subsidiaries. Separate financial statements of the guarantors are not presented because (i) the guarantors are wholly owned and have fully and unconditionally guaranteed the 8% Notes on a joint and several basis and (ii) the Company’s management has determined that such separate financial statements are not material to investors. Instead, presented below are the consolidating financial statements of: (a) the parent, CPI International, (b) the issuer, CPI, (c) the guarantor subsidiaries (all of the domestic subsidiaries), (d) the non-guarantor subsidiaries, (e) the consolidating elimination entries, and (f) the consolidated totals. The accompanying consolidating financial information should be read in connection with the condensed consolidated financial statements of CPI International.
 
Investments in subsidiaries are accounted for based on the equity method. The principal elimination entries eliminate investments in subsidiaries, intercompany balances, intercompany transactions and intercompany sales.
 
 
- 31 -

 
CPI INTERNATIONAL, INC.
and Subsidiaries
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(All tabular dollar amounts in thousands except share and per share amounts)

 
CONDENSED CONSOLIDATING BALANCE SHEET
As of July 2, 2010
 
   
Parent
   
Issuer
   
Guarantor
   
Non-Guarantor
   
Consolidating
   
Consolidated
 
   
(CPI Int'l)
   
(CPI)
   
Subsidiaries
   
Subsidiaries
   
Eliminations
   
Total
 
Assets
                                   
Current assets:
                                   
Cash and cash equivalents
  $ 689     $ 33,092     $ 683     $ 12,719     $ -     $ 47,183  
Restricted cash
    -       -       952       88       -       1,040  
Accounts receivable, net
    -       19,403       9,490       14,540       -       43,433  
Inventories