CPI International, Inc. F4Q08 (Qtr End 10/03/08) Earnings Call Transcript

| About: CPI International, (CPII)

CPI International, Inc. (CPII) F4Q08 Earnings Call December 16, 2008 11:00 AM ET


Joe Caldarelli - Chief Executive Officer and President

Joel Littman - Chief Financial Officer

Bob Fickett - Chief Operating Officer


Chris Quilty - Raymond James

Gary Liebowitz - Wachovia Capital Markets

Gina Matsuyama – Primedia


Welcome to the CPI International fourth quarter and fiscal year 2008 financial results conference call. (Operator's instructions)

Before we begin, the company has asked me to read the following statement.

Today's presentation includes forward-looking statements within the meaning of the Securities and Exchange Act of 1934. Forward-looking statements provide the company's current expectations, beliefs or forecasts of future events. 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 forward-looking statements.

These factors include, without limitation, competition in the company's end markets; the company's debt levels; significant changes or reductions in the U.S. Defense budget; currency fluctuations; U.S. government contract laws and regulations; changes in technology; the impact of unexpected costs and inability to obtain raw materials and components.

Further information on these risk factors and additional risks and uncertainties are included in the company's filings with the Securities and Exchange Commission. The computations of EBITDA, adjusted EBITDA, adjusted EBITDA margin, free cash flow, free cash flow per share, free cash flow conversions and adjusted free cash flow that will be discussed on today's call are non-GAAP financial measures under Securities and Exchange Commission rules.

A presentation of the most directly comparable GAAP measures and reconciliation of each of these non-GAAP financial measures to the most directly comparable GAAP measures are available in yesterday's press release, which has been posted on the company's website.

Interested parties can access the press release by going to www.CPII.com and opening the press release entitled CPI International Announces Fourth Quarter and Fiscal Year 2008 Financial Results.

I would like to turn the presentation over to your host for today's conference, Mr. Joe Caldarelli, Chief Executive Officer of CPI International.

Joe Caldarelli

Good morning and welcome to CPI’s fourth quarter and fiscal 2008 call. We will focus our comments on today’s call on our results for the fiscal year. Information on our Q4 results can be found on the press release we issued yesterday afternoon.

The agenda for today’s call will be as follows. First I will provide an overview of our fiscal 2008 sales and orders for each of our end markets. Joel Littman, our CFO, will then discuss some of our key financial metrics for the year. He will also discuss our current outstanding debt on our balance sheet as we have received a number of questions on that topic in the last few months. Next, I will discuss some of the trends we are seeing with our customers and their markets and their expectations for fiscal year 2009.

Bob Fickett, our Chief Operating Officer, will join us when we open up the call for your questions. I should mention, by the way, that I am having a little bit of trouble with my voice this morning since I have been on an airplane recently and Bob will be my backup in the event I lose my voice but unfortunately he has also been on an airplane and is losing his voice as well so we will try to struggle through this as best we can.

CPI performed reasonably well in fiscal 2008, notwithstanding the challenging economic environment in which we are operating. In 2008 our sales and order levels both increased in comparison to 2007. We were solidly profitable. We generated significant positive cash flow and we used our cash to de-lever and buy back common stock.

In addition, we invested in our future by increasing both company-funded and customer-funded research and development activities. In terms of our top line our sales increased in four of five of our end markets and orders increased in all of our end markets.

We generated total sales of $370 million in 2008, an increase of 5% from a year ago. We booked $374 million in orders during the year, an increase of 9% from 2007. Our book to bill ratio for the year was positive.

Approximately 45% of our total sales in fiscal 2008 were for spare and repair products. These support recurring programs for CPI and while the timing and size of these programs can fluctuate from year to year they generally provide us with some level of stability and predictability in our revenue stream.

In 2008 45% of our sales were for government end users and 52% were from commercial end use. Historically, government shipments tend to remain reasonably steady from year to year and add another level of stability as well as diversification for our revenue stream. We maintain a large and diverse installed base of products and customers throughout the world with approximately 36% of our sales to international customers.

Another important metric to consider is that we were the sole provider for approximately 58% of our sales in fiscal 2008 compared to approximately 42% of our sales from competitive programs. This ratio has remained relatively stable from year to year and is a good indicator of our strength of our long-term customer relationships and the broad installed base of our products.

I will begin today’s discussion of our 2008 sales and orders by market with our radar and electronic warfare markets which we collectively refer to as our defense market.

Approximately 2/3 of our fiscal 2008 sales for the defense market were for spare and repair products. On previous calls we have discussed the delays that CPI has experienced in the placement of orders in the defense market. In fiscal 2008 it took longer for defense customers to issue RFQ’s and place and finalize orders as has historically been the case. The delays in the finalization of orders meant subsequent delays on the corresponding shipment of products for those programs, negatively impacting our sales of defense products for the year. We expect this trend to continue for the foreseeable future.

We have heard, as undoubtedly you have, that a number of other companies in the defense space are now experiencing similar push outs. Notwithstanding the push outs, our defense orders actually increased 2% to $141.5 million in fiscal 2008. The main drivers of this order growth were orders received for the Hawk missile system which included orders delayed from fiscal 2007 and more than $4 million in orders received in Q4 for radar products to support the APN 45 automatic carrier manning system or ACLS beacon.

The ACLS beacon is used on-board several types of military aircraft and is necessary for automatic landings on a carrier. The program is a new one for CPI and the Q4 order for this program represents a significant one for our Beverly Microwave Division. In a typical year we receive between $3-5 million in Hawk orders. In 2008, however, partly due to our order delays which bunched up the timing of multiple Hawk orders and the corresponding sales therefore into a compressed period of time, we received approximately $9 million in Hawk orders. In order to meet tighter delivery deadlines arising from the delays and displacement of those orders, we expedited the shipping schedules for this program throughout the year which contributed to our enjoying above-average order and sales for the Hawk program in fiscal 2008.

The increase in our defense orders was partially offset by approximately $6 million decrease in demand for radar products to support the Aegis weapons systems. As we have mentioned on previous calls we provide products for new ships that utilize the Aegis system as well as spare and repair products for existing ships within the system. Our participation in new ship builds has elevated our sales and order levels for the Aegis program for several years. However, we have already received all of the expected orders for all of the remaining approved new ships with the Aegis system.

The completion of the new ship build program combined with delays in orders for spare and repair products to support the installed base of currently fielded ships resulted in the approximately $6 million decrease in our Aegis orders in fiscal 2008.

Conversely, our fiscal 2008 Aegis sales remained at elevated levels as we shipped the remaining products to support the new ship builds. Now that we have completed our shipments required to support the remaining new ships, we expect our sales and support of the Aegis system to drop by approximately $10 million or roughly 50% in fiscal 2009.

While there has been recent talk of building several new DVG-51 destroyers incorporating the Aegis system instead of the more expensive DVG-1000 destroyers we have not yet received orders for the proposed new ships. If new ships are built we do expect to place CPI products in those ships, initially providing new equipment and then providing spare and repair products for several decades to come.

In summary, our sales in the defense market increased 5% from last year to $151.8 million in fiscal 2008. The sales growth was primarily due to an increase in sales in support of the various radar systems including the Hawk missile system and the inclusion of the radar systems sold by our CPI Malibu Division which we acquired in mid-Q4 of 2007.

Let’s move on now to our orders and sales to the medical market.

This is a key, profitable end market for CPI and our core medical business continues to grow. However, in fiscal 2008 the growth of our core medical business was masked by the absence of a large Russian medical program in which we had participated in the previous years as well as the timing of a significant customer order for MRI products.

As you will recall, in fiscal 2006 and 2007 in addition to our core medical business we provided x-ray generators for two increments of a large Russian medical infrastructure program. The program did not repeat in fiscal 2008 and the absence of this program had a $6 million negative impact on our orders and a $5.5 million negative impact on our sales in fiscal 2008 as compared to 2007. We believe there will be future increments in coming years but based on the feedback we are currently hearing from our customers we do not believe there will be an increment in fiscal 2009.

Also impacting our comparison to fiscal 2008 was one of our large medical customers ordered an unusually large 3-year supply of MRI products from us in fiscal 2007. Those MRI orders elevated our 2007 medical numbers and correspondingly reduced our 2008 numbers. As a result, our orders and sales of products for MRI applications decreased by $5.3 million and $2.4 million respectively in fiscal 2008 as compared to the prior year. This was purely a timing issue for us and we do expect to continue to receive future orders of our MRI products from this customer but at more typical levels.

In fiscal 2008 our orders for medical products increased 2% from the prior year to $67.7 million. This increase, although dampened by the absence of the Russian program and the timing of the MRI orders reflects increased demand for x-ray generators particularly from our international customers and increased demand for radiation therapy products.

In fiscal 2008 our sales in the medical market were $65.8 million, a 3% decrease from the previous year. As I just mentioned, this decrease was primarily driven by the absence of the Russian program and the unusually strong demand in 2007 for MRI products as a result of the timing and size of that customer’s orders. If we exclude the Russian program and those MRI sales from both fiscal 2007 and 2008, our core medical sales actually increased 12% from $53.4 million to $59.6 million.

Recently we have been seeing evidence that hospitals and other healthcare providers are also being impacted by the current extraordinary economic conditions. Major medical OEM’s have publicly reported softer demand for their products, particularly from U.S. customers. As I am sure you have also heard, we have heard that a number of hospitals are reconsidering or postponing investments into equipment in light of a faltering economy. As a result, in fiscal 2009 we are concerned that our medical orders and sales may be negatively impacted by the weakened economy, especially orders from U.S. customers.

On the other hand, potentially offsetting these challenges, President Elect Obama has recently announced plans for an economic stimulus package that among other things would include plans to upgrade hospital technology. While we don’t yet know the details, timing or magnitude of these proposed stimuli, it could potentially result in increased demand for our products from U.S. customers in the medium term. We continue to monitor this situation closely.

Let’s now move on to our communications market.

In fiscal 2008 our communications orders increased 19% to $127.1 million and our sales increased 5% to $117.8 million. Before we get into the details of our communications sales and orders growth please note that we have recently changed the way we categorize tactical common data link or TCDL products sold by our Malibu division. These are exciting, innovative products for our growing market.

TCDL products support intelligence, surveillance and reconnaissance or ISR applications supporting long-range surveillance for land, air and sea based platforms and provide military commanders with images and data in near real time to enable them to precisely locate and identify any targets.

We previously counted TCDL products in our radar and electronic warfare markets but we believe it is more appropriate to include these products in our communications market. This reclassification is reflected in both our 2007 and 2008 numbers in our press release and in our 10K filing.

The 19% increase in our communications orders in fiscal 2008 was driven by increased orders from our growing military communication market sector including more than $12 million in orders to support the WIN-T mil-comm program as well as telemetry and TCDL orders received by the Malibu Division. The 5% increase in our sales in the communications market in fiscal 2008 was primarily the result of the inclusion of sales for telemetry and TCDL products from our Malibu Division.

As you will recall, we acquired Malibu in August of 2007 and therefore we only reported seven weeks of its results in fiscal 2007. Our fiscal 2008 communications sales growth was also the result of our shipments for [inaudible] information network, tactical or WIN-T military communication program and approximately $50 million 4-year program that CPI won in the fall of 2007.

In fiscal 2007 we participated in the predecessor program to WIN-T called the Joint Network Node or JNN mil-comm program. The JNN program has been successfully completed and therefore our sales to support that program decreased by approximately $4 million in fiscal 2008. That decrease was offset by the $7.3 million increase in sales in fiscal 2008 to support the WIN-T successor program, a program which demonstrated that CPI has become a significant participant in the growing mil-comm market. We began production shipments of the WIN-T in Q2 of 2008 and the program continues to progress smoothly.

Our entry into the mil-comm sector of the satellite communication business is fairly recent and we are encouraged by the success we have enjoyed so far. We expect our participation in military communication programs to continue to grow. In fact, in fiscal 2008 we were also awarded mil-comm business for the pre-production phase of the Navy Multiband Terminal, NMT, programs. If all option years’ production and spares are exercised we expect the total cumulative value of NMT to be in excess of $20 million over approximately four years. The prime contractor on this program is Raytheon.

The commercial communications business was generally stable in fiscal 2008 but our sales and orders for commercial communications programs decreased somewhat mainly due to timing of specific programs. The overall communications business remained surprisingly healthy in fiscal 2008.

Summing up our orders and sales results in our key markets, we did fairly well in fiscal 2008. We had a strong year for certain defense programs such as Hawk, won new business such as the ACLS radar program and the NMT military communications business, our core medical business absent the impact of the Russian tender continued to grow and our military communication business is thriving. However, we continue to see order delays in our defense markets and we are concerned that the current world wide economic crisis may have an increasing impact on our customers and therefore on us in fiscal 2009.

Before I delve too far into fiscal 2009, however, I would like to turn the call over to Joel to discuss our financial highlights for fiscal 2008 and to brief you on our strong balance sheet.

Joel Littman

Thanks Joe. In this morning’s financial discussion I will discuss CPI’s EBITDA, adjusted EBITDA, net income, cash, cash flow, cash flow per share and free cash flow conversion results for fiscal 2008 as well as a summary of our outstanding debt. You can find the definition and reconciliation of our non-GAAP metrics in the financial tables of the press release we issued yesterday.

In fiscal 2008, CPI generated EBITDA totaling $61.3 million or 16.6% of sales which is a decrease from the $64.3 million or 18.3% of sales we generated in fiscal 2007. Our adjusted EBITDA for fiscal 2008 totaled $64 million or 17.3% of sales, a decrease from the $71.3 million or 20.3% of sales in the prior year. The major differences between adjusted EBITDA and EBITDA in both fiscal year’s 2007 and 2008 relate to non-cash stock based compensation expenses and non-recurring expenses related to debt extinguishment.

These differences are fully explained in the financial tables of yesterday’s press release. This decrease in adjusted EBITDA was primarily due to a number of factors related to our increased investment in new products and development programs in fiscal 2008. These factors were as follows: First, during the year a higher percentage of our sales were from products from engineering development programs than in past years. As you know, newer and engineering development products have lower margins than well established, more standard products.

Second, our Malibu division which we acquired in late fiscal 2007, was a significant contributor of new and development products in fiscal 2008. Some of Malibu’s development programs, particularly some legacy programs with contracts that pre-date our acquisition of Malibu, ran into unforeseen challenges resulting in cost overruns.

Third, our company funded research and development efforts increased as well. In fiscal 2008 our total spending on company-funded and customer sponsored research and development increased approximately 40% in comparison to the prior year. We increased company-funded research and development expense by 26% to $10.8 million in fiscal 2008. We remain committed to investing in higher levels of development work as we believe these investments are necessary for CPI’s future and the long-term benefits of this work will outweigh the short-term impact to our profitability.

Our increased investment in development activities is bearing fruit including the aforementioned approximately $4 million in orders received for the ATM 45 automatic carrier landing system, the order for the pre-production phase for the Navy Multiband Terminal and orders for TCDL products at our Malibu Division, all of which are expected to result in good follow-on opportunities.

Additionally, our engineering development activities for the WIN-T program in the first quarter of fiscal 2008 have allowed us to quickly and efficiently ramp up production on this significant, multi-year mil-comm program. In addition to these development related factors, our EBITDA results were negatively impacted by the unfavorable U.S. dollar to Canadian dollar exchange rate in effect for a large part of fiscal 2008.

The negative impact of these factors to EBITDA were partially offset by additional gross profit generated by our 5% increase in total sales in fiscal 2008 as compared to fiscal 2007. In fiscal 2008 we generated $20.4 million in net income or $1.16 per share on a diluted basis. This was a decrease from the $22.5 million or $1.27 per share on a diluted basis generated in the previous fiscal year. The decrease was primarily due to the same factors that affected our EBITDA results in fiscal 2008 and was partially offset by a $1.9 million or 9% decrease in interest expense due to our pay down and retirement of debt in fiscal 2008 and lower interest rates resulting from the refinancing of our credit facilities in late fiscal 2007.

Our effective tax rate for both fiscal year’s 2007 and 2008 was approximately 34.5% with both years benefiting from non-recurring discrete tax benefits. Excluding these discrete tax benefits which are more fully explained in yesterday’s form 10K, our effective tax rate over the past two years has been in the range of 36-37%. Going forward we expect our effective tax rate to be in the same range.

Next I’d like to discuss the changes in our cash and cash flow during the most recent fiscal year. As we have said previously, we consider CPI’s ability to reliably generate positive cash flows on a continuing basis to be a key strength of our business particularly in the current economic environment. We carefully manage our business to maintain positive cash flow and we vigilantly monitor our cash flow as part of our day-to-day operations.

Our over-arching goal as we manage our operations is to build a strong, profitable company that generates positive cash flows and is well positioned to continue to serve our customers for the long run. For the 12-month period ending October 3, 2008 CPI generated $33.9 million in cash flow from operating activities or $1.91 per share on a diluted basis.

During the same period we also generated $29.5 million in free cash flow and adjusted free cash flow of $29.6 million, exceeding our previous expectations for adjusted free cash flow of $20-24 million in fiscal 2008.

Our free cash flow for fiscal year equates to $1.67 per share on a diluted basis.

We used our free cash flow in fiscal 2008 to pay down and retire $21 million of our outstanding debt including repayments of $11 million of our senior term loan and retirement of $10 million of our floating rate notes. We remain committed to continuing to strengthen our balance sheet by paying down and retiring our outstanding debt.

Another use of our cash in fiscal 2008 was our stock buy back program which was approved by our board of directors last May. We used approximately $2.8 million of our free cash flow to repurchase approximately 206,000 shares of CPI common stock in the third and fourth quarters of fiscal 2008. At the end of fiscal 2008 our cash position totaled $28.7 million, an improvement from the $20.5 million cash position as of the end of the previous fiscal year.

In fiscal 2008 our $29.5 million in free cash flow was higher than our $20.4 million in net income for the year. Therefore, our free cash flow conversion, that is the ratio of free cash flow to net income, was greater than 1:1 at 144%. We believe this is an important financial metric and speaks to the strength of our positive cash flow generation capabilities.

In a bit of a break from our normal conference call procedures, I’d like to take this opportunity to discuss how CPI is affected by recent conditions in the credit markets as we have received several questions about this topic in recent months.

We do not have significant financial exposure to Lehman Brothers or other failed banks. We do have an indirect relationship with AIG who provides certain of our insurance policies but we believe that the risk of that relationship to our business is minimal. Most importantly, we believe that our balance sheet is strong and stable, our debt has favorable terms and rates, there will be a few years until our debt matures and we do not anticipate a need to re-enter the capital markets before fiscal 2011.

As you know, CPI operates with debt. We are actively working to repay and retire that debt. As of mid-October we had approximately $225 million in total principle debt outstanding and we had another $55 million of additional borrowings available under our revolver under our 10-year credit facility. Our debt consists of the following:

First we have $125 million in 8% senior subordinated notes which are due in February 2012. Second, we have an $88.75 million term loan which expires in 2014. We repaid $11 million of this term loan in fiscal 2008 and another $1 million in mid-October after the fiscal year ended. Third, we have $12 million remaining in floating rate, senior notes which are due in February 2015. These notes bear interest at a rate of libor plus 5.75% and have historically been our most expensive debt. We retired approximately $10 million of these notes in fiscal 2008.

The term loan is part of our senior credit facility which we amended and restated in August 2007. Our senior credit facilities allow borrowings of up to $160 million consisting of $100 million term loan and a $60 million credit facility which is also used for letters of credit and performance guarantees. We have $55 million of borrowings available under the revolving credit facility. The term loan bears interest at a rate of libor plus 2% and the revolver bears interest at a rate of libor plus 1.25% to 2%.

These senior credit facilities have only one significant financial covenant which requires that we maintain a senior secured leverage ratio 3.75 to 1. Currently the specific ratio is approximately 1 to 1. We are confident we can continue to maintain a senior secured leverage ratio that is well within the ratio required.

With the very large cushion we currently have in this covenant, we expect to remain in compliance with this covenant for the foreseeable future. The term loan will mature in August 2014 and the revolver will mature in August of the preceding year. However, if we have not repaid or refinanced our 8% senior subordinated note by August 2011, both the term loan and revolver will mature in August 2011. Thus, the earliest we would anticipate entering the capital markets to restructure our debt is in fiscal 2011.

In summary, we believe that our debt situation is very stable as a result of our solid balance sheet, our proven ability to generate positive cash flow and our limited exposure to trouble financial institutions we believe that CPI’s debt and liquidity situation is very stable.

Now I’d like to turn the call back over to Joe to discuss fiscal 2009.

Joe Caldarelli

Thanks Joel. As we mentioned in our remarks this morning, CPI performed reasonably well in fiscal 2008. We had some challenges such as the delays in the placement of orders in our defense business, the completion of our participation in certain programs and the absence of the Russian medical tender program in 2008.

Nevertheless, we managed to grow our orders and sales, generate significant positive cash flow, pay down and retire debt and remain solidly profitable.

Now that we are more than two months into fiscal 2009, however, our visibility into this fiscal year is considerably more cloudy. We are in frequent contact with our customers and we remain poised to meet their requirements but the uncertainties they are currently facing due to the state of the economy have made the timing of their programs and their subsequent orders for CPI products much more fluid and indefinite than we have seen in recent years.

This dramatically impacts our visibility into the second half of our fiscal year. Therefore, we feel we do not have enough credible information at the current time to predict with a high degree of confidence and within meaningful ranges how the fiscal year will turn out. As a result, we are not issuing detailed financial projections for the year.

In the last few quarters we have reported delays that we have seen in the placement of orders in the defense markets. These delays are continuing and involve programs for which we provide new products as well as spare and repair products. We have participated in most of these programs for many years and therefore we are not concerned we are losing the business to competitors. We are simply concerned the order timelines for these programs are not materializing in the manner in which they have historically.

Similar patterns are now starting to emerge in our commercial markets which is a change from much of fiscal 2008. Our commercial markets, which include our medical market and our commercial communications markets, have much shorter lead times between the placement of orders and the subsequent sales. These markets therefore have left backlog in our defense market and we typically turn our orders into sales in a matter of days or weeks as compared to the several month lead time typical of our defense market.

As a result, we are accustomed to having less visibility into our commercial market than our defense market. The situation, however, has been exacerbated by the current economic slow down and we are now starting to experience delays in program timing from a cross-section of our commercial customers.

Based on the delays in order placement that we have already seen in the first few months of fiscal 2009 we are predicting that our fiscal financial performance in the first and second quarters of the year will be weaker than it was in the corresponding quarters of fiscal 2008.

We remain committed to managing our business in a prudent and responsible manner to ensure we maintain solid profitability and positive cash generation in both good and challenging market conditions and for both the short and long-term. In keeping with this commitment we are diligently managing our expenses, maintaining constant contact with our customers and we are keeping our factories in an agile state so that we can respond quickly to the changing needs of our customers.

Notwithstanding the current economic slow down and the associated uncertainties and lack of visibility we expect to remain a profitable, positive cash generating company in fiscal 2009 and beyond. As such, we remain confident that despite the various challenges we face we will generate in excess of $20 million of free cash flow in fiscal 2009.

Thank you for your time and attention this morning. Lets begin the question-and-answer portion of today’s call please.

Question-and-Answer Session


(Operator Instructions) The first question comes from the line of Chris Quilty - Raymond James.

Chris Quilty - Raymond James

Can I just get a clarification, when you say weaker results in Q1 does that imply a slower growth rate or negative year-over-year comparisons to the first half?

Joe Caldarelli

Negative year-over-year comparisons on an earnings per share basis for the first half.

Chris Quilty - Raymond James

And on a revenue basis?

Joe Caldarelli

Possibly. That is a little trick here but possibly.

Chris Quilty - Raymond James

Primarily the difference there in the profitability is the higher R&D spending you are experiencing? Or do you think you will have some gross margin expansion? What will drive the negative earnings comps?

Joe Caldarelli

I think it is just the challenging times. All business today is more challenging, somewhat more competitive and the business that is available is not necessarily the best mix. It is really just a combination of all those. One of the things that happens with delays of course is the factories are still running and the stuff isn’t coming in so they end up being inefficient. So certainly in the first part of the quarter we were relatively inefficient in a couple of our factories as we were waiting for an order to come in which was supposed to come in any time and of course they drag out. It is really kind of an inefficient way of running a business.

Chris Quilty - Raymond James

The lack of guidance is maybe a little disappointing. I would argue you guys have better visibility than a lot of companies given the fact you have a lot of sole source and recurring revenue business. I’m just trying to quantify you expect some push outs in the defense business but when you look at your other end markets, which of those has you most worried in terms of visibility or potential growth the year ahead?

Joe Caldarelli

Interestingly, on the defense market we are continuing to see push outs. No question about it. As we have for some time, that is definite. In the other markets it has just become difficult to predict. For example, the medical market we were quite slow in the latter part of October and today are quite busy. So if you ask me today it looks pretty decent and as I look towards the back part of the year our detailed forecast looked pretty reasonable, however everything we read and everything our customers tell us make us cautious and we think it is prudent to share that caution with all of you. It may turn out fine but at this current point there are a number of warning signs that just could be issues.

On the communications market I think as we have said before it remains surprisingly strong through all of 2008 and frankly has remained pretty decent in the first part of 2009. However, the actual order intake in the first couple of months of 2009 has seen some slip outs. No cancellations and no losses but some slip outs. So that tells us when you look at the big picture and you look at what is going on in the economy in the world I would not be surprised if some of these slip outs become programs that just don’t get funded in the long run. So we are taking a cautious approach and kind of bracing for the possibility that those slip outs may turn out to be in the end programs that just don’t happen.

So today we have decent bit of work in the communications business albeit somewhat delayed from what we had originally planned and our forecast for the second half of the year if we believe everything that has been told to us would look fine but I think from a macro economic perspective it would be imprudent of us to assume everything will come back to normal the first half of the year.

So that is the reason why we are having trouble giving guidance because on the face of it right now the first half looks slowish and the second half looks fine but I’m not sure that is really a realistic way of looking at the year when you look at it from a big picture perspective.

Chris Quilty - Raymond James

You hear these stories on the medical side, anybody with exposure to elective surgery a lot of that has fallen off but with regard to the markets you are selling into I don’t think there is a huge amount of elective surgery component that demand. Is it just the capital budgeting process of your customers that would cause a slow down?

Joe Caldarelli

Yes. You may have seen some of the same articles we have seen. We understand the hospitals make very good money on the elective stuff and that has cut back substantially and is being replaced with a lot of non-pay and so that is causing the hospitals to get very concerned about the overall capital budgets and they are taking the same attitude we are. That is to say let’s be cautious. Let’s hold off until we see a better view of things. In the U.S. there is no question that the combination of available credit and the terms of that credit plus now the concern of the number of people that are coming in and paying the premium for surgery and other services is causing the hospitals to become very cautious in the U.S. in particular and to some degree around the world. I think a lot of the people are taking the attitude we have which is look until we know better let’s just be very safe. The result of that is delays on the placement of orders and in some cases the cancellation of programs.

Chris Quilty - Raymond James

In the 10K you mentioned you expect to incur a level of higher R&D spending for the foreseeable future. Is that unchanged? Or is that new information relative to…obviously you have been telling us you have a lot of new R&D Programs but are the spending levels higher than you previously anticipated or is this just on par?

Joel Littman

It is on par. I think for next year the company funded R&D will be roughly at the levels they were in 2008 and we are hoping to get customer funded R&D to remain at comparable levels and there is every indication that will continue. So in aggregate the total development activity in 2009 should be roughly in the ball park of 2008 and we hope to maintain that higher level than traditional going forward for a little while. I think that is the right thing to do in the current time. We need to make sure we are poised with the proper products. It is clearly more competitive. We want to make sure we have good competitive products and good strong products and to the extent our customers want to pay us to do development we are always happy to do that.


The next question comes from Gary Liebowitz - Wachovia Capital Markets.

Gary Liebowitz - Wachovia Capital Markets

Joe you mentioned you haven’t seen any cancellations out of the communications business yet. Is the same true of medical?

Joe Caldarelli

Yes that is true. To be fair, in both medical and communications as I mentioned in my remarks the orders tend to turn around fairly quickly so it is relatively unusual for us to get an order cancellation. What I was referring to, I guess, was the big programs we feed into. The major programs around the world. I can’t think of any major programs that we were tracking that have been cancelled but we certainly have some concerns about some of them.

Gary Liebowitz - Wachovia Capital Markets

For the year, your capital spending came in a bit lower than what you had previously talked about. Were there any specific projects that were pushed out because of market conditions and where do you see capEx going in 2009?

Joe Caldarelli

I don’t think we pushed anything out. We just became a little bit more conservative in cash conservation and the 2009 levels will be comparable within $1 million. Our target capital spending is in the $5 million plus or minus $1 million on either side of that. Given the current conditions I would guess in 2009 we will keep the range on capital spending fairly tight as well.

Gary Liebowitz - Wachovia Capital Markets

If I could get one more clarification on your comments about the first half of 2009 where you said in the financial the EPS performance will be lower, in the first quarter of fiscal 2008 you reported $0.14 of earnings. I guess there was a little bit of a tax headwind there. Are you suggesting that for the December 2008 quarter we could be down in that sort of mid-teens earnings per share or lower?

Joe Caldarelli

I’m suggesting we could be a little bit worse than last year’s first quarter. Last year’s first quarter was not one of our better quarters and this year’s first quarter is shaping up to be comparable to slightly softer.

Gary Liebowitz - Wachovia Capital Markets

As you look into your FY09 plan, do you anticipate making an earn out payment for Malibu or is that part of the market softening? I think it might be a $5 million pay out that might be due. Correct me if I’m wrong there.

Joe Caldarelli

The earn out is a calculation over three years. Year one has already expired and the result of having missed that earn out in year one we recalculated the total exposure for the remaining two years and reduced the amount. I believe we had that in the 10K. It is hard to predict whether we would have an earn out payment generated in 2009 but the aggregate total liability for CPI has already been reduced by virtue of having missed the 2008 earn out.


The next question comes from Gina Matsuyama – Primedia.

Gina Matsuyama – Primedia

In your 10K in 2008 under the contingency section it said you had received notice from a customer complaining terminating contract due to alleged nonperformance. I’m wondering if you could give an extent of the significance of that contract or further details of that.

Joe Caldarelli

I can’t provide a lot of details for obvious reasons. It is a legacy contract that was in place for some time. We have performed the majority of the work under the contract. There were hundreds of thousands of dollars or work left to be done. On the face of it those remaining few hundred thousand dollars could be in jeopardy. We think we have a fairly strong position to demonstrate the work we had done prior to that was appropriate and so we think we are in a good position overall that the exposure we think is nominal and it has been recognized in our financials.

Gina Matsuyama – Primedia

Did you get paid for the portion you did complete then?

Joe Caldarelli


Gina Matsuyama – Primedia

So it is just the remaining hundreds of thousands you haven’t done yet that could be potentially taken away?

Joe Caldarelli

Correct. To be fair, this is very early stages and I don’t want to try and predict the outcome but that is just to kind of give you a calibration basically. The outcome could be a variety of outcomes but we think we are reasonably well covered.

Gina Matsuyama – Primedia

When you say you did a majority of the entire contract can you give a percentage of like 90% or 60%?

Joe Caldarelli

80% plus.


At this time there are no further questions in the queue. This concludes the question-and-answer session. At this time I would like to turn the conference back over to Mr. Littman.

Joe Caldarelli

Thank you very much for joining us. If you have any further questions don’t hesitate to give us a call. We look forward to hopefully having better news for you when we talk next quarter. Thank you.


This concludes today’s conference. We thank you for your participation. At this time you may disconnect.

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