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Executives

O. Joe Caldarelli – Chief Executive Officer & Director

Robert A. Fickett – President & Chief Operating Officer

Joel A. Littman – Chief Financial Officer, Treasurer & Secretary

Analysts

Gary Liebowitz – Wachovia Securities

Antonio Antezano – Bear Stearns & Co., LLC

Andrew Berg – Post Advisory Group

Frank Bisk – Pilot Advisors

Gregory [With] – Robeco

Chris McDonald – Kennedy Capital

CPI International, Inc. (CPII) F1Q08 Earnings Call February 7, 2008 11:00 AM ET

Operator

Welcome to the CPI International first quarter 2008 financial results conference call. My name is Betsy and I’ll be your coordinator for today. At this time all participants are in listen only mode. We will be facilitating a question and answer session towards the end of this conference. (Operator Instructions) As a reminder the conference is being recorded for replay purposes.

Before we begin, the company has asked me to read the following statement. Today’s presentation includes forward-looking statements within the meanings of the Securities Exchange Act of 1934. Forward-looking statements provide the company’s current expectations, beliefs, or forecasts of a future event. Forward-looking statements are subject to known and unknown risks and uncertainties which could cause actual results to differ in material from the results projects, expected or implied by forward-looking statements. These risk factors include without limitations, competition in the company’s end markets, the company’s debt levels, significant changes or reductions in the US defense budget, currency fluctuations, US government contract laws and regulations, changes in technologies, the impact of unexpected cost and inability to obtain raw materials and components. Further information on the risk factors and additional risks and uncertainties are included in the company’s filings with the Securities & Exchange Commission.

The computation of EBITDA, adjusted EBITDA, adjusted EBITDA margin, free cash flow and adjusted free cash flow that will be discussed on today’s call are non-GAAP financial measures. Under Securities & Exchange Commission rules, a presentation of the most direct comparable GAAP measures and reconciliations 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 first quarter 2008 financial results. I would now like to turn the presentation over to today’s host Mr. Joe Caldarelli the Chief Executive Officer of CPI International. Please proceed sir.

O. Joe Caldarelli

Good morning and welcome to CPI’s first quarter 2008 call. We appreciate you taking the time to join us this morning and hope that you have had a chance to review yesterday’s 10Q filing and press release. The agenda for today’s call will be as follows: first I’ll discuss some of the factors that affected our results in the first quarter then I will touch on our sales and orders highlights for the quarter. Next Joel Littman our Chief Financial Officer will discuss some of our key financial metrics. Finally I’ll talk about our expectations for the rest of the year before opening the call up to your questions. Bob Fickett our President and COO will join us for the question and answer session at the end of the call.

Our financial results in the first quarter were disappointing and below our expectations. The impact of delayed sales for certain programs plus our involvement in a large number of development programs had a negative effect on our financial results reducing our net income by $0.12 per share on a diluted basis and our EBITDA by $3.4 million for the quarter. First and foremost approximately $5 million in sales that were expected to ship in Q1 did not reducing our net income by approximately $0.07 per share and our EBITDA by approximately $2 million. These sales were delayed primarily because of delays in the placement of orders, delays in customer inspections of certain finished products and delays in the availability of customer funds for certain programs. For example as we discussed on last quarter’s conference call we expected to receive in Q1 a $3.9 million radar order for the hawk missile system. This order was not received until the first week of Q2. As a result of this delay approximately $1 million in sales that had been expected in December for this program did not materialize during the quarter.

The second factor that negatively affected our Q1 results was the amount of development work that we currently have underway. A number of customers in several markets have recently asked CPI to work with them on numerous development programs putting us in an enviable position from a technology standpoint and reinforcing our position as an industry technology leader. However, the timing of these diverse defense and commercial development contracts has coincided such that we have an unusually high level of development initiatives underway as we continue to develop and deploy innovative new technologies and products. By their very nature development programs carry increased risks of technical issues and cost and schedule overruns and typically have lower margins.

In Q1 the increase of customer funded development programs resulted in sales of products with lower gross margins and increased expenses and in addition our company funded R&D expenses also increased during the quarter. As a result our net income was reduced by approximately $0.05 per share and our EBITDA was reduced by approximately $1.4 million. We expect these higher levels of development work to continue for a while. We’ll discuss in more detail our expectations for Q2 and the rest of fiscal 08 a little later in this mornings call.

Next let’s turn to our sales and order results in Q1. At $85.9 million our Q108 sales were approximately 3% higher than our sales in Q107. Our Q108 orders totaled $89.9 million an increase of approximately 7% from our Q107 orders level. Our new Malibu division which we acquired in Q4 of last year contributed $4.3 million in sales and $8 million in orders in Q108. The Malibu division was not included in our year ago results . Excluding Malibu from our Q108 results our core sales and orders would each have decreased approximately 3% from the same quarter of last year. In the defense market which is the combination of our radar and electronic warfare applications, sales increased 4% to $35.9 million in Q1. This increase was primarily due to the fact that we are now including the Malibu division in our results. Approximately half of the Malibu divisions $4.3 million in Q1sales were in the radar market, the other half were in the communications market. Excluding Malibu from our Q108 sales results our sales in the radar and electronic warfare markets would have been slightly lower than our sales in the combined markets in the same quarter of last year. It is worth noting that the aforementioned delay in the hawk order pushed approximately $1 million in expected radar sales out of Q1.

Our Q1 orders in the combined radar and EW markets decreased 12% to $37.6 million as compared to Q107. There were two main drivers for the orders decrease. First, as I discussed earlier, a $3.9 million order for the hawk to surface to air missile system was expected in Q1, but was not received until the first week of Q2. The delay in this hawk radar order was responsible for approximately 80% of the $5 million decrease in our total defense orders from the same quarter of last year. Second, not unexpectedly demand for radar products to support the ship boards Aegis Weapon System has decreased. For a number of years there has been a high rate of new ship builds for the Aegis Weapon Systems, and we have been providing both new products and spares and repairs for the system. The new ship build is now coming to an end and we have already shipped the majority of our products required to the remaining new ships, so demand for new products for the Aegis System has decreased. We expect to see reduced demand for products for the Aegis System until the recently built ships have commissioned and deployed and start requiring spare and repair products. In the meantime, we will continue to provide a reduced number of products to support spare and repair requirements for the previously deployed Aegis ships.

As we discussed on previous conference calls, delays in orders for defense programs are common, as the timing of defense programs often fluctuates, particularly in the first quarter and fourth quarters of our government’s fiscal year. Around this time every year we take a look at how defense orders are shaping up to try to ascertain if there’s anything unusual going on or if there’s any indication of a general softening in demand. Given the generally fluctuating timing of radar and EW orders and the sheer number of programs in which CPI is involved it’s often challenging to see specific trends in our defense markets until one is well into a particular cycle. At this time we are experiencing a lengthening of order timelines in our defense markets. We are still seeing demand in the systems for these expected products, but we’re experiencing delays in the issuing of RFQs and the subsequent placement of the corresponding orders. Our customers assure us that our defense products are still required and critical to their success but they seem to be taking longer to place their orders, and the order finalization process is taking longer to complete. We don’t yet know what the underlying cost for these delays or even if there is a systemic underlying costs. What we do know is that in Q1 and some degree Q2, so far we have seen an unusually high number of radar and EW orders, as timing has been shifted out to the right. We don’t believe these orders are being lost, there just not being booked as quickly as we would otherwise have expected. Of course delays in order placements and softening sales for these products and programs, shifting to the right. We will continue to closely monitor this situation. We remain confident that the radar and EW markets are fundamentally solid and relatively stable and should continue to grow at low single digit percentages over the long term.

In the medical market our sales decreased 9% to $15.6 million in Q108, in this case we do believe that this is strictly a short term timing issue in part due to our medical sales in the comparable year ago quarter being very strong. We have seen no indication of any changes to the long term fundamentals of our core medical business. In fact, our medical orders increased 7% to $11.7 million in Q1 versus the year ago quarter, and our largest customer for radiation therapy products is reporting renewed growth in this area.

In the communications market our sales increased 3% to $26.9 million and orders increased 8% to $26.3 million in comparison to last years Q1. These increases were primarily due to the inclusion of telemetry products sales and orders as well as increased sales of Starcom products for broadcast applications, and increased sales and orders for international direct to home applications. These increases were partially offset by a decrease in demand for products for certain military communication programs for which we had seen unusually strong demand in the first half of last year. We expect the demand for products for mil com programs will rebound in the coming months as we ramp up our production on increment one of the US Army’s Win-T program, whose award we announced last fall. In the industrial market sales and orders both increased in comparison with Q1 of 07.

Our scientific business is enjoying a period of strong demand and continues to provide us with exciting opportunities to develop innovative new technologies for customers around the world. In Q1 we continued to ship products for the spallation neutron source at Oak Ridge National Lab. In addition, we booked $5.4 million in orders for this program last year, and we will continue to make sales against those orders for the second quarter of 09. In addition, in Q108 we booked another significant multi year scientific order a $5.6 million contract, to provide a foreign scientific institute with [crystrons] to support a new accelerated project for fusion research. We will make shipments on this program through December 2010. This is our first large scientific order from this customer and it’s a very exciting program for CPI.

Now I would like to turn the call over to Joel to discuss some of our key financial highlights for the quarter.

Joel A. Littman

My remarks on CPI’s first quarter of fiscal 2008 will focus on several of our key financial metrics including EBITDA, adjusted EBITDA, net income, cash, and cash flow. In the first quarter of fiscal 2008, CPI generated EBITDA of $11.9 million or approximately 14% of sales. This is a significant decrease from the $17.1 million or 20% of sales generated in the same quarter of the previous year. This decrease is primarily due to sales of less profitable mix of products in the most recent quarter partially as a result of an increase in the number of the customer funded development programs we had underway during the quarter. As you know, development programs typically have lower margins than manufacturing programs. Other factors contributing to the decrease in EBITDA included unfavorable currency effects from the continued weakness in the US dollar and increases in R&D spending, including planned increases as we prepare for the ramp up for the Army’s Win-T program.

During the current quarter EBITDA included approximately $400,000 in stock-based compensation expenses. We believe our first quarter results were unusually low resulting from the lower than expected sales as Joe discussed combined with the unfavorable product mix and development program profitability issues I mentioned a moment ago. And we are maintaining our guidance of average long term adjusted EBITDA margins of approximately 20%.

Let’s take a look at our net income results for the quarter. In the first quarter of fiscal 2008, our net income totaled $2.5 million or $0.14 per share on a diluted basis. It decreased from the $5.8 million or a $0.33 per share generated a year ago, and a short fall of $0. 11 per share from the mid point of our guidance. In comparison to the first quarter of fiscal 2007, our net income was negatively impacted by the same factors that impacted our EBITDA specifically, lower than expected sales, a less profitable mix of products, and the unusually large number of customer funded development programs we currently have underway, plus unfavorable currency effect from the weakness in the US dollar, and increases in R&D spending including planned increases for the Win-T program.

Now, let’s move onto the changes in our cash and cash flow on the last 12 months. Despite the sales and orders short falls and our development program costs during the first quarter we continued to generate solid cash flow. Our cash position as of the end of the first quarter was $27.4 million an increase of $6.9 million during the quarter. During the quarter we generated $7.7 million in free cash flow and repaid $1 million of our term loan. Adjusted free cash flow for the last 12 months was $17.2 million which was slightly below our expectations of over $20 million in adjusted free cash flow. The short fall was due primarily to the sales short fall discussed by Joe and the impact of the sales short fall on working capital and earnings. We remain comfortable that our annual free cash flow for fiscal 2008 will be over $20 million.

I’ll turn the call back over to Joe now to discuss our updated guidance and our expectations for the rest of the year.

O. Joe Caldarelli

As we’ve discussed at length here today we missed our guidance for Q1. We do not anticipate making up this amount as the year progresses. First, the prolonged time lines we saw in Q1 for the placement of certain orders particularly defense orders appears to be continuing to Q2, as a result sales for these programs are expected to be correspondingly delayed. Second, our original guidance had assumed a more favorable relationship between the US dollar and the Canadian dollar. While we have seen some periodic indications that the US dollars strengthening, on average the relative exchange rates have remained disappointing. Our previous guidance had assumed an average effective exchange rate including hedging of $0.95 US to $1.00 Canadian. With hedging currently in place covering almost 90% of our January through June 08 Canadian dollar expenses, our average exchange rate in Q2 and Q3 is approximately $0.98 which is expected to negatively affect our net income by approximately $0.02 per share in each of Q2 and Q3.

Our internal forecast suggests that we could still meet our prior projections for Q2 and Q4 if we were to see an immediate improvement in the issues we’ve discussed today. Therefore, we are maintaining our top end of our original guidance ranges for the year corrected of course for the amount of our Q1 shortfall. However, if we continue to see prolonged order delays and corresponding sales delays and if US dollar continues to weaken our results for the balance of 08 will come in lower than we had originally projected. We are therefore also widening our guidance ranges and hence reducing our lower end of our guidance ranges for the year. For fiscal 08 we are now projecting total sales of between $375 and $385 million, net income of between $22 million and $24 million or $1.23 and $1.34 per share on a diluted basis, adjusted EBITDA of between $68.2 million and $71 million and adjusted free cash flow of between $20 million and $24 million. For Q2 we are projecting net income of between $0.24 and $0.29 per share on a diluted basis. We currently expect that our net income in the third and fourth quarters will be approximately equal to each other.

In summary not withstanding our lower than expected financial performance in Q1, we continue to be excited by our business and our long term prospects. The fundamentals underlying our defense and commercial businesses remain healthy and stable. Over time the short term costs and lower profit margins of the numerous development programs we currently have underway are expected to lead to profitable manufacturing programs that position us well for the future. Our core medical business is posed for continued growth. Our military communications business is slated to grow this year as we ramp up production for the Win-T program. Although it is a relatively small portion of our overall business our scientific business continues to attract customers from around the world interested in developing innovative new technologies with us. Our newly acquired Malibu division booked $8 million in orders in the most recent quarter and is making progress on several important development programs that have good future potential. In addition we continue to generate positive cash flow and pay down our date.

Thank you for your time and attention this morning. Betsy let’s open up the call for questions please.

Question-and-Answer Session

Operator

(Operator Instructions) And your first question comes from Gary Liebowitz from Wachovia Securities. Please proceed.

Gary Liebowitz – Wachovia Securities

You mentioned in the10Q that there were a number of technical problems on development programs and also in a BED product line and it looks like you booked a provision for that. Could you tell us, I’m trying to get a sense of just how pervasive these are and how much $0.06 reduction to second quarter earnings are a result of this? And do you anticipate further provisions having to be taken in the second quarter?

O. Joe Caldarelli

Yeah, there were higher than average in part because we had so many development programs going on and so you know I wouldn’t consider them to be extraordinary except for the fact that the base of development is much higher right now hence the probability, as is always the case in development programs, the probability is higher. So yes there is some possibility as we continue to have a fairly high percentage of development programs on our backlog that there may be needs in the future to take some additional provisions. There are none right now that were aware of but on a probability basis it could very well come up. You know what we’ve done so far is not extraordinary in the sense other than we have a lot more that were dealing with right now.

Gary Liebowitz – Wachovia Securities

So, since December, you have not booked additional provisions, so the material knock down will have to be called out in 10Q like you did this time?

Joel A. Littman

Not yet, in the second quarter, no. We really don’t expect anything that would be material to be honest, Gary.

Gary Liebowitz – Wachovia Securities

Okay. Also if you could clarify, the delays in defense programs, or defense orders that you sighted. Are they all for sole source programs?

Robert A. Fickett

Yeah, the ones that were called out are for sole source programs, we are also seeing even on the competitor’s side, it is strung out a little bit longer, but the majority of the ones called out were sole source.

Gary Liebowitz – Wachovia Securities

One more before I get in the queue again, the R&D for Win-T, I guess you start shifting in the back half of the year, does that start to trail down starting in the second quarters? I think you said $600,000 in Q1.

O. Joe Caldarelli

Yes it does actually the second quarter will have some components still of R&D beyond that will be primarily in production, so it will be primarily production ramp up at that time

Operator

Your next question comes from Antonio Antezano from Bear Stearns. Please proceed

Antonio Antezano – Bear Stearns & Co., LLC

In the defense business beyond order delays do you see any kind of reversion to the mean growth that you estimate to be low single digits, because I think the rate of business was up strongly in 2006, slightly up in 2007, and I’m wondering whether beyond order delay there is also some kind of reversion to the mean there?

O. Joe Caldarelli

Yeah we do. I think, we’ve tried to be fairly candid, but there were a few years there were the growth was clearly above our expectation for the long run and not sustainable in the long run and hence we continue to remind ourselves that the long term growth of this business should be expected to be in the low single digits. The way that manifests itself of course, that we had some fairly large buys in some of the most recent years, for certain product areas but frankly, once their stocked up on those and once the products have billed out, it will take a little while for the products to be fully deployed and out in the field. So yes we do expect to see a reversion to a more normal rate, which will be growth rates lower than we’ve seen in the previous years.

Antonio Antezano – Bear Stearns & Co., LLC

Could you repeat your guidance for the second quarter, EPS guidance? Between 24 and 29, I think you said?

O. Joe Caldarelli

That’s correct.

Antonio Antezano – Bear Stearns & Co., LLC

So, if I add the first quarter plus the middle point of the second quarter, taking your full year guidance, that would imply a very strong second half, or a very strong sequential increase in the second half of the fiscal, what would give you confidence getting to those numbers?

O. Joe Caldarelli

Right now as were looking forward to second half - we’ll, you remember when we started the year we did say that all along we had expected the second half of this year to be stronger than the first half. That hasn’t changed, there are a number of things that are scheduled to generate more sales in the second half, the Win-T Program is one for example. So I think that shape for the year still applies, the concern we have about Q2 in particular is the continued drag out that we’re seeing in the placement of orders. We hope that that will be finished fairly soon, there’s not that much left to be pushed out in terms of some of these orders we’re seeing kind of dragging. There’s one more for example significant Aegis order that has been pushed out but that should be booked in Q3, that wouldn’t expect to generate sales this year until maybe late Q4, early next year, but beyond that were hoping that we seeing most of the drags outs.

Antonio Antezano – Bear Stearns & Co., LLC

Can you comment on the military Sat com business, maybe you can provide more color what your expectations are this year given the problems you have been involved in?

O. Joe Caldarelli

Yeah last year the Mil Sat com was fairly heavy in the first half of the year, and then we completed the work that we had to get done, and we’re a little bit soft in the first half of this year in terms of shipments, we are quiet busy preparing for the Win-T, which will ramp up and is expected to go into full rate production sometime during Q3 and into Q4. So the biggest tangible increase from a specific program perspective is the WIN-T program. There are a number of other programs, the Mil sat com business continues to show a number of opportunities, which may not develop into revenue this year, but certainly bodes well for the future, and we and our competitors are competing intensely for those. But overall the opportunities in Mil sat com are very, very strong, the pipeline is very good and undoubtedly they will drag out to the right a little bit as those things always do, but were pretty encouraged that that is a growing solid business, and our participation in that business these days I think is quiet good

Operator

The next question comes from Andrew Berg from Post Advisory Group, please proceed

Andrew Berg – Post Advisory Group

Going back to your comments on the Aegis program, just refresh my memory, how much of your sales are coming from products coming from Aegis and how much of that is sort of new ship billed related versus reordered?

Robert A. Fickett

It’s a little bit of a complex answer, because the Aegis platform itself has more than just the Aegis specific programs. If you look at the Aegis specific programs we’ve been shipping between $15 to $20 million over the last few years, and of that at least half of that has been for the new ship builds. So, as the new ship builds are winding down that’s the part where we’re seeing drop off. The spares and repairs for the existing ships where there’s many dozens of them out there, that’s still carrying on nicely. What were seeing now is as the number of new ships is dropping down, we’re seeing the new drops but that will come back somewhat as these ships get commissioned and move into the spare repair cycle. Would you like more numbers on that?

Andrew Berg – Post Advisory Group

That’s helpful. And your sense in the terms of the timing, from when the ships will start getting commissioned when do you think you start getting those cycling into your spares/repairs?

Robert A. Fickett

Typically it’s two to five years depending on the product, that should hold pretty true for what we’re seeing.

Andrew Berg – Post Advisory Group

And then in terms of capital expenditures for this year, what are we thinking?

O. Joe Caldarelli

$5 or $6 million, fairly routine this year

Operator

The next question comes from Frank Bisk from Pilot Advisors, please proceed

Frank Bisk – Pilot Advisors

Could you give a little bit more color in terms of the revenue coming in the second half? I guess you mentioned this Win-T program, what else should I be thinking of because I guess its going to be a be ramp, is something going on in other divisions as well where we should see some sales?

O. Joe Caldarelli

Yeah, the hawk order for example that we mentioned we just booked, a good deal of that will be able to be shipped in the second half, now that we have the order. There’s a follow on hawk order that was also delayed out of Q1 but were hoping to book late Q2, which should generate additional sales in Q3 and Q4. There’s a whole series like that, just kind of the way its stacked up, one of our units on the east coast has enjoyed very good backlog and they also have developed a number of new products, which as soon as they get them into manufacturing will generate additional sales, so they’re expecting a strong second half. They’ve got very solid backlog and it’s really a question of simply preparing for production and getting them out there. So I think you know in general particularly the defense side has a reasonable bit of demand that has purchased out and should be able to be cleared out in the second half of the year.

Frank Bisk – Pilot Advisors

Okay and then I guess in your press release you talked about there were delays of $5million of sales in this your first quarter, have we gotten those yet? I guess we got $1 million of those, right? You talked about on the Hawk, what about the other $4 million?

O. Joe Caldarelli

I mean they’re basically all going to be done of course and much of that will have gone in Q2, offset in part unfortunately by the orders that should have been booked earlier and shipped in Q2 pushed out as well. So we’re expecting an aggregate Q2 to be somewhat neutral to slight down. But after that I think we start building a bit of a power wave so that’s why we think Q3 and Q4 should be pretty strong.

Operator

(Operator Instructions) And you have a question from Gary Liebowitz from Wachovia Securities. Please proceed.

Gary Liebowitz – Wachovia Securities

Joel on the tax rate I think you said the tax rate guidance remains unchanged but the first quarter number was somewhat higher. Is the rest of the year going to be lower for the tax rate to be back at 37%?

Joel A. Littman

We expect to get back to 38% Gary, and yes the rest of the year will be lower.

Gary Liebowitz – Wachovia Securities

And also what are you’re expectations for Malibu sales this year could you remind us? And also when is the first potential earn out payment there?

Joel A. Littman

I think we haven’t changed our expectation there it’s in the $20 million range and the end of the fiscal year would be the first time we would calculate the first earn out year basically.

Gary Liebowitz – Wachovia Securities

And how are you tracking for that?

O. Joe Caldarelli

It’s too early to tell frankly at this point. I don’t know.

Gary Liebowitz – Wachovia Securities

Okay fine. Also, the medical business was down, I guess you had one of the worse comparisons in a long time. Do you still view that as a double digit growing business?

O. Joe Caldarelli

Yes the core business still looks that way but a little bit like what we talked about in Aegis, what I need to remind is that the medical business has had the periodic Russia shipments in it. And just to remind us all Russia, is a series of one year programs that will be issued periodically and we’ve have two years of the Russia programs in the previous year and last year. It’s less clear this year for example whether there is a significant Russia program as it relates to us. So long as we remember that Russia was not expected to be a change in the core and was perhaps a one-time plus up then we expect the core business to continue to grow at good solid, on average certainly double digits yes.

Gary Liebowitz – Wachovia Securities

Okay and one last one, you’re not breaking out electronic warfare from radar anymore and the EW business was down both in 06 and07, do you see that trend continuing? Or are there emerging opportunities whether it’s counter ID or active denial or some other EW application that gives you confidence that that business can rebound?

O. Joe Caldarelli

Yes the business really is so similar in the products or so similar that the radar that we found that it doesn’t really add much color to break them out and we mentally kind of lump them together. But yes strictly within EW the core of the original the sort of the traditional EW products are probably stable at this point here. You may recall that a fair bit of our EW business was in providing products for expendable decoys for airplanes and the government reasonably well stocked for those so we’re not seeing incremental demands for those beyond the sort of rates we’ve billed in the past but yes the other item in terms of counter ID and active denial are still very much there but pushing to the right as we’ve discussed in the past. In active denial in particular there’s talk about some more tangibles opportunities in the mid-term and we’re pretty hopefully those will happen but we’re not banking on those yet. But long term again, we continue to believe that that’s a solid opportunity for us and Malibu by the way and the contrary D is probably a little bit more longer term still I think that there’s more development to be done on that one.

Operator

And your next question comes from Gregory [With] from Robeco. Please proceed.

Gregory [With] – Robeco

Just real briefly the free cash flow should we assume you’re going to apply most of that towards debt reduction this year?

O. Joe Caldarelli

Well we’re going to continue to do our debt reduction. You know I don’t know.

Joel A. Littman

And the absence of good accretive acquisitions yes we will be paying down debt.

Operator

Your next question comes from Chris McDonald from Kennedy Capital. Please proceed.

Chris McDonald – Kennedy Capital

Could you remind me what the revenue was under the Russian medical program in 07?

Joel A. Littman

It was around $5 million.

Chris McDonald – Kennedy Capital

Okay. And just in talking to your customers on the defense side of the business could you maybe give a little more color on what they’re telling you in regards to these delays? Is there funding delayed? Is it other priorities? Is it lack of contracting officers being available? Just any more detail on what’s driving the delay that you’re seeing?

O. Joe Caldarelli

Well that’s the frustrating part we’re actually not getting useful feedback. What we do know and when we talk to our contacts is that they need the product, they want the product, they’d like to place it but as I said earlier the system seems to be kind of constipated frankly. So we don’t actually have a good explanation nor are our contacts able to shed any light as to whether they have any directives to slow things down or whether in fact just the system is busy with other things. In a way that’s kind of encouraging because we certainly have not, Bob you can jump in in a minute, but I’m not aware of any circumstances where anyone’s come along and said, “I’ve been told to delay the funding or my fundings been cut off and therefore I’m having to drag it out.” Bob can you add any color to that?

Robert A. Fickett

No I think you hit it pretty well. Absolutely they still need the product, the product demand is in the queue. It just seems like the cycle time from when the RFQ comes to us to coming through with an order, we used to take a month to six weeks we’re now seeing taking anywhere from you know two to six months. The demand is still absolutely there.

Chris McDonald – Kennedy Capital

Okay thanks. And then just lastly on your development programs are most of those structures as cost plus type development or could you just talk about contract type a little bit there?

O. Joe Caldarelli

Most of them are some sort of fixed price arrangement but we do have number that are cost plus. Actually it’s a combination of both, the cost plus ones are the ones that of course result in relatively poor profitability but low risk of course. Some of them are more of a fixed price arrangement but of course have the opportunity for making some money on it but also have the downside. So it’s a combination of both. I’m not sure. Bob, Joel do you have a ration or would you venture a guess?

Robert A. Fickett

The majority is some form of fixed price but even the riskier fixed price we do have some you know we are protected somewhat in that we will particularly have milestones structured in there, where they’ve once we reach a certain part where the risk is very low we will get some of the funding in. It’s just those types tend to get a little lower profit margin then the typical higher risk all with everything in line as a fixed price contract. So it’s really three different forms it takes.

Chris McDonald – Kennedy Capital

Okay and the performance or the margin impact that we’re seeing is driven more so purely based on mix then it is in change in your margin performance on those fixed price development contracts. Is that correct?

O. Joe Caldarelli

Well yes mix in the sense of the development contracts inherently all types of development contracts have lower margins. And as we mentioned earlier and a couple of we have had a little bit of a drag out so we’ve spent more money on it than we otherwise thought we might. We continue to be really excited about the opportunities we have with the development so given the choice today accepting or not accepting a development contract even a fixed price we will take it because it’s good for the future. And in some cased we’ll take it fully knowing that we may have to incest a few dollars in it because the end result ultimately will be that will get new products and will be better off in the long run.

Operator

Your next question from Antonio Antezano from Bear Stearns. Please proceed

Antonio Antezano – Bear Stearns & Co., LLC

Just a follow up, this is more a general question, how macro weakness in the US could affect your business?

O. Joe Caldarelli

We actually we think the area for us that are most exposed for economic weakness would be the industrial market and that defied the pattern in Q1 as you saw that we actually had a pretty strong Q1 for industrial. But conceptually at least industrial market would be the most sensitive. The communications market might become somewhat sensitive. The commercial communications if in fact there was a protracted slowdown that affected peoples infrastructure investments on things like broadcasting and so on. We haven’t seen any signs of that yet but conceptually that’s conceivable but so far the communication market both commercial and military seems to be pretty good.

Operator

Your next question comes from Andrew Berg from Post Advisory Group. Please proceed.

Andrew Berg – Post Advisory Group

Just a follow up on the question before with the respect to free cash flow and I think you said the number was $20 million if I wrote it down correctly?

Joel A. Littman

$20 million that we expect the year to be between $20 and $24 million.

Andrew Bird – Post Advisory Board

Gotcha. And as you think about the usage if you can find something that’s a good acquisition that would be used otherwise its debt reduction. What’s your ability currently to repurchase any of the holding company floating rate notes and then I guess the extent that you’ve got limited ability any debt reduction would be at the banking level?

Joel A. Littman

Correct and yes there is capacity. The capacity as you know builds up but approximately half of our net income. But we do have a capacity and we’re right now going through evaluation trying to make e decision what to do in the short run.

Andrew Berg – Post Advisory Group

Okay and as of the end of this quarter roughly what was that capacity?

Joel A. Littman

It was approximately $6 million to $7 million as of the end of the December quarter.

Andrew Berg – Post Advisory Group

Okay so 6 to 7 is what you could acquire of the hold co if you wanted to?

Joel A. Littman

Exactly.

Operator

There are no more questions at this time. I would like to turn the call over to Mr. Caldarelli.

O. Joe Caldarelli

Thank you very much for listening in. As I indicated it was a very disappointing quarter for us. We are highly motivated to insure we do better going forward and hopefully we won’t disappoint you when we speak next time. Thank you very much for listening and we look forward to talking to you again. Bye-bye.

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Source: CPI International F1Q08 (Quarter End 12/31/07) Earnings Call Transcript
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