Edgar Filing: CPI INTERNATIONAL, INC.

cpii_10ka-fy10.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-K/A

Amendment No. 1

(Mark One)

x	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended October 1, 2010

¨	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)
Securities registered pursuant to Section 12(b) of the Act:

	Title of each Class		Name of Each Exchange on Which Registered
	Common Stock, par value $0.01 per share		The Nasdaq Stock Market LLC
Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.				Yes ¨ No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.				Yes ¨ No x
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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.				x
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 the definitions of “large accelerated filer,” “accelerated filer” and “small 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 Act).				Yes ¨ No x
The aggregate market value of common stock held by non-affiliates of the registrant as of April 1, 2010 (the last business day of the registrant’s most recently completed second fiscal quarter) was approximately $96 million, based on the closing sale price of $13.09 per share of common stock as reported on the Nasdaq Stock Market.
Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date: 16,820,741 shares of the registrant’s common stock, par value $0.01 per share, were outstanding at December 1, 2010.

DOCUMENTS INCORPORATED BY REFERENCE:

Portions of the registrant’s definitive 2011 proxy statement, anticipated to be filed with the Securities and Exchange Commission within 120 days after the close of the registrant’s fiscal year, are incorporated by reference into Part III of this Form 10-K.

EXPLANATORY NOTE

We are filing this Amendment No. 1 on Form 10-K/A ("Amendment") to correct a typographical error in our Annual Report on Form 10-K for the fiscal year ended October 1, 2010, which was filed with the Securities and Exchange Commission on December 10, 2010 (the “Original Filing”).

In the Original Filing, the Report of Independent Registered Public Accounting Firm issued by KPMG LLP ("Accountant's Report") was erroneously shown as December 9, 2010. The correct date should have been December 10, 2010, the date of the Original Filing.

This Amendment contains our financial statements (Part IV, Item 15 (a) (1)), with the correct date on the Accountant's Report. Except for changing the date of the Accountant's Report from December 9, 2010 to December 10, 2010, no other changes have been made to the Original Filing.

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PART IV

Item 15. Exhibits, Financial Statement Schedules

(a) (1) Financial Statements:

The following consolidated financial statements and schedules are filed as a part of this report:

·	Report of Independent Registered Public Accounting Firm

·	Consolidated Balance Sheets

·	Consolidated Statements of Income

·	Consolidated Statements of Stockholders’ Equity and Comprehensive Income

·	Consolidated Statements of Cash Flows

·	Notes to Consolidated Financial Statements

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Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders

CPI International, Inc.:

We have audited the accompanying consolidated balance sheets of CPI International, Inc. and subsidiaries (the Company) as of October 1, 2010 and October 2, 2009, and the related consolidated statements of income, stockholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended October 1, 2010. We also have audited the Company’s internal control over financial reporting as of October 1, 2010, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting (Item 9A). Our responsibility is to express an opinion on these consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

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In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of CPI International, Inc. and subsidiaries as of October 1, 2010 and October 2, 2009, and the results of its operations and its cash flows for each of the years in the three-year period ended October 1, 2010, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of October 1, 2010, based on criteria established in Internal Control – Integrated Framework issued by the COSO.

Mountain View, California

December 10, 2010

/s/ KPMG LLP

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CPI INTERNATIONAL, INC.

and subsidiaries

CONSOLIDATED BALANCE SHEETS

(in thousands, except per share data)

	October 1,			October 2,
	2010			2009
Assets
Current Assets:
Cash and cash equivalents	$	42,829		$	26,152
Restricted cash		1,804			1,561
Accounts receivable, net		45,707			45,145
Inventories		75,208			66,996
Deferred tax assets		11,030			8,652
Prepaid and other current assets		6,459			6,700
Total current assets		183,037			155,206
Property, plant, and equipment, net		54,259			57,912
Deferred debt issue costs, net		1,604			3,609
Intangible assets, net		72,474			75,430
Goodwill		162,225			162,225
Other long-term assets		4,677			3,872
Total assets	$	478,276		$	458,254

Liabilities and stockholders’ equity
Current Liabilities:
Current portion of long-term debt	$	66,000		$	-
Accounts payable		24,290			22,665
Accrued expenses		23,653			19,015
Product warranty		5,101			3,845
Income taxes payable		5,022			4,305
Advance payments from customers		14,218			12,996
Total current liabilities		138,284			62,826
Deferred income taxes		21,707			24,726
Long-term debt, less current portion		128,934			194,922
Other long-term liabilities		5,411			2,227
Total liabilities		294,336			284,701
Commitments and contingencies
Stockholders’ equity
Preferred stock ($0.01 par value; 10,000 shares authorized and none issued and outstanding)		-			-
Common stock ($0.01 par value, 90,000 shares authorized; 17,020 and 16,807 shares issued; 16,813 and 16,601 shares outstanding		170			168
Additional paid-in capital		80,015			75,630
Accumulated other comprehensive (loss) income		(141	)		598
Retained earnings		106,696			99,957
Treasury stock, at cost (206 shares)		(2,800	)		(2,800	)
Total stockholders’ equity		183,940			173,553
Total liabilities and stockholders' equity	$	478,276		$	458,254

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

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CPI INTERNATIONAL, INC.

and subsidiaries

CONSOLIDATED STATEMENTS OF INCOME

(in thousands, except per share data)

	Year Ended
	October 1, 2010		October 2, 2009			October 3, 2008
Sales	$	360,434	$	332,876		$	370,014
Cost of sales		251,987		239,385			261,086
Gross profit		108,447		93,491			108,928
Operating costs and expenses:
Research and development		12,429		10,520			10,789
Selling and marketing		20,794		19,466			21,144
General and administrative		24,988		20,757			22,951
Amortization of acquisition-related intangible assets		2,749		2,769			3,103
Strategic alternative transaction expenses		19,913		-			-
Total operating costs and expenses		80,873		53,512			57,987
Operating income		27,574		39,979			50,941
Interest expense, net		15,213		16,979			19,055
(Gain) loss on debt extinguishment		-		(248	)		633
Income before income taxes		12,361		23,248			31,253
Income tax expense (benefit)		5,622		(218	)		10,804
Net income	$	6,739	$	23,466		$	20,449

Earnings per common share - Basic	$	0.40	$	1.42		$	1.24
Earnings per common share - Diluted	$	0.37	$	1.33		$	1.15

Shares used to compute earnings per common share - Basic		16,571		16,343			16,356
Shares used to compute earnings per common share - Diluted		17,837		17,443			17,684

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

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CPI INTERNATIONAL, INC.

and subsidiaries

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

AND COMPREHENSIVE INCOME

								Accumulated
						Additional		Other
	Common Stock					Paid-in		Comprehensive			Retained		Treasury Stock
	Shares			Amount		Capital		Income (Loss)			Earnings		Shares			Amount			Total
Balances, September 28, 2007		16,370		$	164	$	68,763	$	937		$	56,042		-		$	-		$	125,906
Comprehensive income:
Net income		-			-		-		-			20,449		-			-			20,449
Unrealized loss on cash flow hedges, net of tax benefit of $1,652		-			-		-		(2,697	)		-		-			-			(2,697	)
Unrealized actuarial loss and prior service credit for pension liability, net of tax benefit of $30		-			-		-		(49	)		-		-			-			(49	)
Total comprehensive income																				17,703
Stock-based compensation cost		-			-		2,160		-			-		-			-			2,160
Exercise of stock options		9			-		38		-			-		-			-			38
Tax benefit related to stock option exercises		-			-		5		-			-		-			-			5
Issuance of common stock under employee stock purchase plan		72			1		852		-			-		-			-			853
Issuance of restricted stock awards		89			-		-		-			-		-			-			-
Forfeiture of restricted stock awards		(2	)		-		-		-			-		-			-			-
Purchase of treasury stock		-			-		-		-			-		(206	)		(2,800	)		(2,800	)
Balances, October 3, 2008		16,538			165		71,818		(1,809	)		76,491		(206	)		(2,800	)		143,865
Comprehensive income:
Net income		-			-		-		-			23,466		-			-			23,466
Unrealized gain on cash flow hedges, net of tax expense of $1,471		-			-		-		2,415			-		-			-			2,415
Unrealized actuarial loss and prior service credit for pension liability, net of tax expense of $52		-			-		-		(8	)		-		-			-			(8	)
Total comprehensive income																				25,873
Stock-based compensation cost		-			-		2,729		-			-		-			-			2,729
Exercise of stock options		57			1		83		-			-		-			-			84
Tax benefit related to stock option exercises		-			-		48		-			-		-			-			48
Issuance of common stock under employee stock purchase plan		111			1		952		-			-		-			-			953
Issuance of restricted stock awards		106			1				-			-		-			-			1
Forfeiture of restricted stock awards		(5	)		-		-		-			-		-			-			-
Balances, October 2, 2009		16,807			168		75,630		598			99,957		(206	)		(2,800	)		173,553
Comprehensive income:
Net income		-			-		-		-			6,739		-			-			6,739
Unrealized loss on cash flow hedges, net of tax benefit of $496		-			-		-		(653	)		-		-			-			(653	)
Unrealized actuarial loss and prior service credit for pension liability, net of tax benefit of $22		-			-		-		(86	)		-		-			-			(86	)
Total comprehensive income																				6,000
Stock-based compensation cost		-			-		3,051		-			-		-			-			3,051
Exercise of stock options		126			1		229		-			-		-			-			230
Tax benefit related to stock option exercises		-			-		526		-			-		-			-			526
Issuance of common stock under employee stock purchase plan		49			1		579		-			-		-			-			580
Issuance of restricted stock awards		38			-		-		-			-		-			-			-
Balances, October 1, 2010		17,020		$	170	$	80,015	$	(141	)	$	106,696		(206	)	$	(2,800	)	$	183,940

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

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CPI INTERNATIONAL, INC.

and subsidiaries

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

	Year Ended
	October 1,			October 2,			October 3,
	2010			2009			2008
Cash flows from operating activities
Net income	$	6,739		$	23,466		$	20,449

Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		8,076			7,773			7,607
Amortization of intangible assets		2,996			3,021			3,356
Write-off of patent application fees		-			83			-
Amortization of deferred debt issue costs		1,353			1,241			1,197
Amortization of discount on floating rate senior notes		12			12			15
Non-cash loss on debt extinguishment		-			144			420
Discount on repayment of debt		-			(392	)		-
Non-cash defined benefit pension expense		31			39			55
Stock-based compensation expense		3,040			2,679			2,135
Allowance for doubtful accounts		17			6			-
Deferred income taxes		(5,159	)		(1,000	)		(1,360	)
Net loss on the disposition of assets		82			130			205
Net loss (gain) on derivative contracts		374			343			(838	)
Tax benefit from stock option exercises		806			212			50
Excess tax benefit on stock option exercises		(593	)		(54	)		(18	)

Changes in operating assets and liabilities, net of acquired assets and assumed liabilities:
Restricted cash		(243	)		(785	)		1,479
Accounts receivable		(579	)		2,197			5,241
Inventories		(8,200	)		(1,495	)		1,986
Prepaid and other current assets		(726	)		426			(246	)
Other long-term assets		(775	)		67			(208	)
Accounts payable		1,625			1,556			(685	)
Accrued expenses		5,588			(4,107	)		(4,953	)
Product warranty		1,256			(314	)		(1,419	)
Income tax payable, net		2,516			(5,974	)		(1,003	)
Advance payments from customers		1,222			661			203
Other long-term liabilities		350			179			213
Net cash provided by operating activities		19,808			30,114			33,881

Cash flows from investing activities
Capital expenditures		(4,492	)		(3,365	)		(4,262	)
Acquisitions, net of cash acquired		-			-			1,615
Payment of patent application fees		(41	)		-			(147	)
Net cash used in investing activities		(4,533	)		(3,365	)		(2,794	)

Cash flows from financing activities
Proceeds from stock purchase plan and exercises of stock options		809			1,037			891
Repayments of debt		-			(30,358	)		(21,000	)
Purchase of treasury stock		-			-			(2,800	)
Excess tax benefit on stock option exercises		593			54			18
Net cash provided by (used in) financing activities		1,402			(29,267	)		(22,891	)


Net increase (decrease) in cash and cash equivalents		16,677			(2,518	)		8,196
Cash and cash equivalents at beginning of year		26,152			28,670			20,474
Cash and cash equivalents at end of year	$	42,829		$	26,152		$	28,670

Supplemental cash flow disclosures
Cash paid for interest	$	13,917		$	16,081		$	18,720
Cash paid for income taxes, net of refunds	$	8,437		$	6,539		$	13,099

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

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CPI INTERNATIONAL, INC.

and subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(All tabular amounts in thousands except share and per share amounts)

1. Organization and Summary of Significant Accounting Policies

Organization and Basis of Presentation: 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.

The consolidated financial statements include those of the Company and its subsidiaries. Significant intercompany balances, transactions, and stockholdings have been eliminated in consolidation. Certain prior year amounts have been reclassified to conform to current year presentation.

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 comprised the 52-week periods ending October 1, 2010 and October 2, 2009, respectively. Fiscal year 2008 comprised the 53-week period ended October 3, 2008. All period references are to the Company’s fiscal periods unless otherwise indicated.

Liquidity: The Company’s cash and cash equivalents as of October 1, 2010 of approximately $42.8 million is not sufficient to repay certain long-term debt totaling $66.0 million currently scheduled to mature in August 2011. The Company intends to obtain replacement financing to repay the respective loan within fiscal year 2011 prior to its scheduled maturity date. The Company has historically financed, and intends to continue to finance, its capital and working capital requirements including debt service and internal growth, through a combination of cash flows from its operations and borrowings under its senior credit facilities.

While the Company believes that, based on its cash flow from operations and its past history, it will be successful in obtaining the replacement financing with reasonable terms to repay its maturing debt, there are no assurances that such additional refinancing will be successful. If the Company is unable to refinance its debt facility, the Company may need to implement other alternatives such as issuing common stock or securities convertible into common stock to repay its indebtedness. If implemented, these actions could negatively impact its business or dilute its existing stockholders.

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CPI INTERNATIONAL, INC.

and subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular amounts in thousands except share and per share amounts)

Foreign Currency Translation: The functional currency of the Company’s foreign subsidiaries is the U.S. dollar. Gains or losses resulting from the translation into U.S. dollars of amounts denominated in foreign currencies are included in the determination of net income or loss. Foreign currency translation gains and losses are generally reported on a net basis in the caption “general and administrative” in the consolidated statements of income, except for translation gains or losses on income tax-related assets and liabilities, which are reported in “income tax expense” in the consolidated statements of income.

Use of Estimates: 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.

Revenue Recognition: Sales are recognized when persuasive evidence of an arrangement exists, delivery has occurred, the price is fixed or determinable, and collectibility is reasonably assured. The Company’s products are generally subject to warranties, and the Company provides for the estimated future costs of repair, replacement or customer accommodation in cost of sales.

Revenues from contracts that contain multiple elements are accounted for in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic FASB ASC 605-25 “Revenue Recognition — Multiple Element Arrangements.” Through October 1, 2010, revenue from these contracts was allocated to each respective element or unit of accounting, based on each element’s relative fair value using vendor-specific objective evidence (“VSOE”) or third-party evidence (“TPE”), if determinable, and was recognized when the respective revenue recognition criteria for each element was met. Effective October 2, 2010, the Company is required to adopt the provisions of FASB Accounting Standards Update (“ASU”) 2009-13, “Revenue Recognition (Topic 605): Multiple Deliverable Revenue Arrangements – A Consensus of the FASB Emerging Issues Task Force,” which, among other things, requires revenue to be allocated to each element based on the relative selling price method in the absence of VSOE or TPE. See Note 2.

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CPI INTERNATIONAL, INC.

and subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular amounts in thousands except share and per share amounts)

The Company has commercial and U.S. Government fixed-price contracts that are accounted for under FASB ASC 605, “Revenue Recognition,” Subtopic 35, “Construction-Type and Production-Type Contracts.” These contracts have represented not more than 4% of the Company’s sales during fiscal years 2010, 2009 and 2008, and are for contracts that generally are greater than one year in duration and that include a significant amount of product development. The Company uses the percentage-of-completion method when reasonably dependable estimates of the extent of progress toward completion, contract revenues and contract costs can be made. The portion of revenue earned or the amount of gross profit earned for a period is determined by measuring the extent of progress toward completion using total cost incurred to date and estimated costs at contract completion.

Sales under cost-reimbursement contracts, which are primarily for research and development, are recorded as costs are incurred and include estimated earned fees in the proportion that costs incurred to date bear to total estimated costs. The fees under certain commercial and U.S. Government contracts may be increased or decreased in accordance with cost or performance incentive provisions that measure actual performance against established targets or other criteria. Such incentive fee awards or penalties are included in revenue at the time the amounts can be reasonably determined.

Revenue is recorded net of taxes collected from customers that are remitted to governmental authorities, with the collected taxes recorded as current liabilities until remitted to the relevant government authority.

Cash and Cash Equivalents: The Company considers all highly liquid short-term investments with original maturities of three months or less, readily convertible to known amounts of cash to be cash equivalents.

Restricted Cash: Restricted cash consists primarily of bank guarantees from customer advance payments to the Company’s international subsidiaries. The bank guarantees become unrestricted cash when performance under the sales or supply contract is complete.

Inventories: Inventories are stated at the lower of average cost or market value, primarily using the average cost method. Costs include labor, material and overhead costs. Overhead costs are based on indirect costs allocated among cost of sales, work-in-process inventory and finished goods inventory. Inventories also include costs and earnings in excess of progress billings for contracts using the percentage-of-completion method of accounting. Progress billings in excess of costs and earnings for contracts using the percentage-of-completion method of accounting are reported in Advance Payments from Customers.

The Company assesses the valuation of inventory and periodically writes down the value for estimated excess and obsolete inventory based upon actual usage and estimates about future demand. The excess balance determined by this analysis becomes the basis for the Company’s excess inventory charge. Management personnel play a key role in the excess inventory review process by providing updated sales forecasts, managing product rollovers and working with manufacturing to maximize recovery of excess inventory. If actual market conditions are less favorable than those projected by management, additional write-downs may be required. If actual market conditions are more favorable than anticipated, inventory previously written down may be sold, resulting in lower cost of sales and higher income from operations than expected in that period.

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CPI INTERNATIONAL, INC.

and subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular amounts in thousands except share and per share amounts)

Management also reviews the carrying value of inventory for lower of cost or market on an individual product or contract basis. A loss is charged to cost of sales when known if estimated product or contract cost at completion is in excess of net realizable value (selling price less estimated cost of disposal). If actual product or contract cost at completion is different than originally estimated, then a loss or gain provision adjustment is recorded that would have an impact on the Company’s operating results.

Property, Plant and Equipment: Property, plant and equipment are stated at cost. Major improvements are capitalized, while maintenance and repairs are expensed as incurred. Plant and equipment are depreciated over their estimated useful lives using the straight-line method. Building, land improvements and process equipment are depreciated generally over 25, 20 and 12 years, respectively. Machinery and equipment are depreciated generally over 7 to 12 years. Office furniture and equipment are depreciated generally over 5 to 10 years. Leasehold improvements are amortized using the straight-line method over their estimated useful lives, or the remaining term of the lease, whichever is shorter.

Goodwill and Other Intangible Assets: The Company accounts for business combinations using the purchase method of accounting in which intangible assets acquired are recognized and reported apart from goodwill.

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

The Company accounts for goodwill and other intangible assets in accordance with FASB ASC 350, “Intangibles-Goodwill and Other.” ASC 350 requires that goodwill and identifiable intangible assets with indefinite useful lives be tested for impairment at least annually. ASC 350 also requires that intangible assets subject to amortization be amortized over their respective estimated useful lives and reviewed for impairment. Identifiable intangible assets are amortized on a straight-line basis over their useful lives of up to 50 years. The Company tests goodwill for impairment annually or more frequently if events and circumstances warrant. The Company’s annual testing resulted in no impairment of goodwill in fiscal years 2010, 2009 and 2008.

Long-Lived Assets: The Company accounts for long-lived assets in accordance with FASB ASC 360, “Property, Plant and Equipment,” and ASC 350, which requires that long-lived and finite-lived intangible assets, including property, equipment and leasehold improvements, be evaluated for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. An impairment loss would be recognized when the sum of the undiscounted future net cash flows expected to result from the use of the asset and its eventual disposition is less than its carrying amount. Such impairment loss would be measured as the difference between the carrying amount of the asset and its fair value.

There were no triggering events identified that would indicate a need to review for impairment of long-lived assets during fiscal years 2010, 2009 and 2008.

- 13 -

CPI INTERNATIONAL, INC.

and subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular amounts in thousands except share and per share amounts)

Deferred Debt Issue Costs: Costs incurred related to the issuance of the Company’s long-term debt and other credit facilities are capitalized and amortized over the estimated time the obligations are expected to be outstanding using the effective interest method. Deferred debt issue costs for CPI’s revolving credit facility and term loan, CPI’s 8% Senior Subordinated Notes due 2012 and CPI International’s Floating Rate Senior Notes due 2015 are amortized over the term to maturity of the respective debt of four years, eight years and ten years, respectively. As a result of the Company’s debt repurchase or prepayment as discussed in Note 5, $0.2 million and $0.3 million of unamortized deferred debt issue costs were written off and charged to (gain) loss on debt extinguishment in the consolidated statement of income for fiscal years 2009 and 2008, respectively. As the outstanding balance of CPI’s term loan is expected to be repaid within the next 12 months, the Company has classified $0.7 million of the related unamortized deferred debt issue costs as current (prepaid and other current assets) in the consolidated balance sheet as of October 1, 2010. As of October 1, 2010, and October 2, 2009, gross long-term deferred debt issue costs were $6.4 million and $7.9 million and related accumulated amortization was $4.8 million and $4.3 million, respectively.

Product Warranty: The Company’s products typically carry warranty periods of one to three years or warranties over a predetermined product usage life. The Company estimates the costs that may be incurred under its warranty plans and records a liability in the amount of such estimated costs at the time revenue is recognized. The determination of product warranty reserves requires the Company to make estimates of product return rates and expected cost to repair or replace the products under warranty. The Company assesses the adequacy of its preexisting warranty liabilities and adjusts the balance based on actual experience and changes in future expectations.

Business Risks and Credit Concentrations: Defense-related applications, such as certain radar, electronic countermeasures and military communications applications, constitute a significant portion of the Company’s sales. Companies engaged in supplying defense-related equipment and services to government agencies are subject to certain business risks unique to that industry. Sales to the government may be affected by changes in procurement policies, budget considerations, changing concepts of national defense, political developments abroad and other factors.

Research and Development: Company-sponsored research and development costs related to both present and future products are expensed as incurred. Customer-sponsored research and development costs are charged to cost of sales to match revenue recognized. Total expenditures incurred by the Company on research and development are summarized as follows:

	Year Ended
	October 1,		October 2,		October 3,
	2010		2009		2008
CPI Sponsored	$	12,429	$	10,520	$	10,789
Customer Sponsored		16,106		17,526		12,028
	$	28,535	$	28,046	$	22,817

Advertising Expenses: Costs related to advertising are recognized in selling and marketing expenses as incurred. Advertising expenses were not material in any of the periods presented.

- 14 -

CPI INTERNATIONAL, INC.

and subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular amounts in thousands except share and per share amounts)

Income Taxes: The Company records income taxes using the asset and liability method. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

In addition, the calculation of the Company’s tax liabilities involves dealing with uncertainties in the application of complex tax regulations. In accordance with FASB ASC 740, “Income Taxes,” the Company recognizes liabilities for uncertain tax positions based on the two-step process. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step requires the Company to estimate and measure the tax benefit as the largest amount that is more than 50% likely of being realized upon ultimate settlement. It is inherently difficult and subjective to estimate such amounts, as this requires the Company to determine the probability of various possible outcomes. The Company reevaluates these uncertain tax positions on a quarterly basis. This evaluation is based on factors including, but not limited to, changes in facts or circumstances, changes in tax law, effectively settled issues under audit and new audit activity. Such a change in recognition or measurement would result in the recognition of a tax benefit or an additional charge to the tax provision.

Income tax-related interest expense and income tax-related penalties are reported as a component of the provision for income taxes in the consolidated statement of income.

See Note 11 for further discussion on income taxes.

Comprehensive Income: The Company follows the accounting treatment prescribed by FASB ASC 220, “Comprehensive Income.” Comprehensive income is defined as a change in equity of a company during a period from transactions and other events and circumstances, excluding transactions resulting from investments by owners and distributions to owners. The difference between net income and comprehensive income for the Company arises from unrealized gains and losses on cash flow hedge contracts, net of tax, and unrealized actuarial loss and prior service credit for pension liability, net of tax.

2. Recently Issued Accounting Standards

In the first quarter of fiscal year 2010, the Company adopted provisions of FASB ASC 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.

- 15 -

CPI INTERNATIONAL, INC.

and subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular amounts in thousands except share and per share amounts)

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 12 to the consolidated financial statements. The adoption of this guidance did not have a material impact on the Company’s computation of earnings per share.

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.

- 16 -

CPI INTERNATIONAL, INC.

and subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular amounts in thousands except share and per share amounts)

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 VSOE, if available, TPE if VSOE is not available, or estimated selling price if neither VSOE or TPE 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 will adopt the provisions of this update under ASU 2009-13 effective October 2, 2010. The Company does not expect ASU 2009-13 to have a material impact on its consolidated results of operations, financial position or cash flows.

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 will adopt the provisions of this update under ASU 2009-14 effective October 2, 2010. The Company does not expect ASU 2009-14 to have a material impact on its consolidated results of operations, financial position or cash flows.

In December 2009, the FASB issued ASU 2009-17, “Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities,” as a further clarification to 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. The Company will adopt the provisions of this update under ASU 2009-17 effective October 2, 2010. 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.

- 17 -

CPI INTERNATIONAL, INC.

and subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular amounts in thousands except share and per share amounts)

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 was 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 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 will adopt the provisions of this update under ASU 2010-17 effective October 2, 2010. The Company does not expect ASU 2010-17 to have a material impact on its consolidated results of operations, financial position or cash flows.

3. Supplemental Balance Sheet Information

Accounts Receivable: Accounts receivable are stated net of allowances for doubtful accounts as follows:

	October 1,			October 2,
	2010			2009
Accounts receivable	$	45,819		$	45,240
Less: Allowance for doubtful accounts		(112	)		(95	)
Accounts receivable, net	$	45,707		$	45,145

- 18 -

CPI INTERNATIONAL, INC.

and subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular amounts in thousands except share and per share amounts)

The following table sets forth the changes in allowance for doubtful account during fiscal years 2010, 2009 and 2008:

	Year Ended
	October 1,			October 2,			October 3,
	2010			2009			2008
Balance at beginning of period	$	95		$	89		$	89
Provision for doubtful accounts charged to general and administrative expense		54			17			19
Write-offs against allowance		(37	)		(11	)		(19	)
Balance at end of period	$	112		$	95		$	89

Inventories: The following table provides details of inventories:

	October 1,		October 2,
	2010		2009
Raw material and parts	$	42,167	$	38,205
Work in process		24,531		20,542
Finished goods		8,510		8,249
	$	75,208	$	66,996

Reserve for loss contracts: The following table summarizes the activity related to reserves for loss contracts during fiscal years 2010 and 2009:

	Year Ended
	October 1,			October 2,
	2010			2009
Balance at beginning of period	$	4,068		$	1,928
Provision for loss contracts, charged to cost of sales		4,157			4,173
Credit to cost of sales upon revenue recognition		(4,488	)		(2,033	)
Balance at end of period	$	3,737		$	4,068

Reserve for loss contracts are reported in the consolidated balance sheet in the following accounts:

	October 1,		October 2,
	2010		2009
Inventories	$	3,343	$	3,967
Accrued expenses		394		101
	$	3,737	$	4,068

- 19 -

CPI INTERNATIONAL, INC.

and subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular amounts in thousands except share and per share amounts)

Property, Plant and Equipment, Net: The following table provides details of property, plant and equipment, net:

	October 1,			October 2,
	2010			2009
Land	$	2,947		$	2,947
Land improvements		1,861			1,851
Buildings		41,424			40,630
Machinery and equipment		48,610			45,935
Construction in progress		1,023			640
		95,865			92,003
Less: accumulated depreciation and amortization		(41,606	)		(34,091	)
Property, plant and equipment, net	$	54,259		$	57,912

Intangible Assets: The following tables present the details of the Company’s total acquisition-related intangible assets:

	Weighted Average		October 1, 2010							October 2, 2009
	Useful Life (in years)		Cost		Accumulated Amortization			Net		Cost		Accumulated Amortization			Net
VED Core Technology		50	$	30,700	$	(4,115	)	$	26,585	$	30,700	$	(3,501	)	$	27,199
VED Application Technology		25		19,800		(5,297	)		14,503		19,800		(4,505	)		15,295
X-ray Generator and Satcom Application Technology		15		8,000		(3,574	)		4,426		8,000		(3,042	)		4,958
Antenna and Telemetry Technology		25		5,300		(665	)		4,635		5,300		(453	)		4,847
Customer backlog		1		580		(580	)		-		580		(580	)		-
Land lease		46		11,810		(1,687	)		10,123		11,810		(1,434	)		10,376
Tradename	20 - Indefinite			7,600		(495	)		7,105		7,600		(275	)		7,325
Customer list and programs		24		6,280		(1,485	)		4,795		6,280		(1,218	)		5,062
Noncompete agreement		5		530		(332	)		198		640		(336	)		304
Patent application fees		-		104		-			104		64		-			64
			$	90,704	$	(18,230	)	$	72,474	$	90,774	$	(15,344	)	$	75,430

Intangible assets, net as of October 1, 2010 and October 2, 2009 include a total of approximately $0.1 million of application costs and associated legal costs incurred to obtain certain patents. Once obtained, these patents will be amortized on a straight-line basis and charged to operations over their estimated useful lives, not to exceed 17 years.

The amortization of intangible assets amounted to $3.0 million, $3.0 million and $3.4 million for fiscal years 2010, 2009 and 2008, respectively.

- 20 -

CPI INTERNATIONAL, INC.

and subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular amounts in thousands except share and per share amounts)

The estimated future amortization expense of intangible assets, excluding the Company’s unamortized tradenames, is as follows:

Fiscal Year	Amount
2011		3,003
2012		3,003
2013		2,883
2014		2,897
2015		2,897
Thereafter		54,591
	$	69,274

Goodwill: The following table sets forth the changes in goodwill by reportable segment during fiscal years 2010 and 2009:

	October 1,		October 2,
	2010		2009
VED	$	132,621	$	132,621
Satcom equipment		13,720		13,720
Other		15,884		15,884
	$	162,225	$	162,225

Accrued Expenses: The following table provides details of accrued expenses:

	October 1,		October 2,
	2010		2009
Payroll and employee benefits	$	14,254	$	11,015
Accrued interest		1,735		1,786
Strategic alternative transaction expenses (Note 10)		1,495		-
Other accruals		6,169		6,214
	$	23,653	$	19,015

- 21 -

CPI INTERNATIONAL, INC.

and subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular amounts in thousands except share and per share amounts)

Product Warranty: The following table summarizes the activity related to product warranty during fiscal years 2010 and 2009:

	Year Ended
	October 1,			October 2,
	2010			2009
Beginning accrued warranty	$	3,845		$	4,159
Actual costs of warranty claims		(5,451	)		(4,524	)
Estimates for product warranty, charged to cost of sales		6,707			4,210
Ending accrued warranty	$	5,101		$	3,845

4. Financial Instruments

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, inventories 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 fiscal year 2010, no fair value adjustments or material fair value measurements were required for the Company’s non-financial assets or liabilities.

- 22 -

CPI INTERNATIONAL, INC.

and subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular amounts in thousands except share and per share amounts)

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 October 1, 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.

The following tables set forth financial instruments carried at fair value within the ASC 825 hierarchy:

			Fair Value Measurements at October 1, 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	$	36,420	$	36,420	$	-	$	-
Mutual funds2		171		171		-		-
Foreign exchange forward derivatives3		437		-		437		-
Total assets at fair value	$	37,028	$	36,591	$	437		-

Liabilities:
Interest rate swap derivative4	$	816	$	-	$	816	$	-
Total liabilities at fair value	$	816	$	-	$	816	$	-

1 The money market and overnight U.S. Government securities are classified as part of cash and cash equivalents and restricted cash in the consolidated balance sheet.
2 The mutual funds are classified as part of other long-term assets in the consolidated balance sheet.
3 The foreign currency derivatives are classified as part of prepaid and other current assets in the consolidated balance sheet.
4 The interest rate swap derivatives are classified as part of accrued expenses in the consolidated balance sheet.

- 23 -

CPI INTERNATIONAL, INC.

and subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular 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 consolidated balance sheet.
2 The mutual funds are classified as part of other long-term assets in the consolidated balance sheet.
3 The foreign currency derivatives are classified as part of prepaid and other current assets in the consolidated balance sheet.
4 The interest rate swap derivatives are classified as part of accrued expenses and other long-term liabilities in the 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, 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.

- 24 -

CPI INTERNATIONAL, INC.

and subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular 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 7 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 was $192.6 million and $188.5 million as of October 1, 2010 and October 2, 2009, respectively. See Note 5 for the carrying value of the long-term debt.

5. Long-Term Debt

Long-term debt comprises the following:

	October 1,		October 2,
	2010		2009
Term loan	$	66,000	$	66,000
8% Senior subordinated notes due 2012		117,000		117,000
Floating rate senior notes due 2015, net of issue discount of $66 and $78		11,934		11,922
		194,934		194,922
Less: Current portion		66,000		-
Long-term portion	$	128,934	$	194,922

Standby letters of credit	$	4,544	$	5,544

- 25 -

CPI INTERNATIONAL, INC.

and subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular amounts in thousands except share and per share amounts)

Senior Credit Facilities: CPI’s senior credit facilities (“Senior Credit Facilities”) provide for borrowings of up to an aggregate principal amount of $160 million, consisting of a $100 million term loan facility (“Term Loan”) and a $60 million revolving credit facility (“Revolver”), with a sub-facility of $15 million for letters of credit and $5 million for swing line loans. Upon certain specified conditions, including maintaining a senior secured leverage ratio of 3.75:1 or less on a pro forma basis, CPI may seek commitments for a new class of term loans, not to exceed $125 million in the aggregate. The Senior Credit Facilities are guaranteed by CPI International and all of CPI’s domestic subsidiaries and are secured by substantially all of the assets of CPI International, CPI and CPI’s domestic subsidiaries.

Both the Term Loan and the Revolver will mature on August 1, 2011 if, prior to August 1, 2011, CPI has not repaid or refinanced its 8% Senior Subordinated Notes due 2012. If CPI repays or refinances its 8% Senior Subordinated Notes due 2012 prior to August 1, 2011, then the Term Loan would mature on August 1, 2014 and the Revolver would mature on August 1, 2013.

In August 2007, CPI borrowed $100 million under the Term Loan. Borrowings under the Senior Credit Facilities bear interest at a rate equal to, at CPI’s option, LIBOR or the ABR plus the applicable margin. The ABR is the greater of the (a) the prime rate and (b) the federal funds rate plus 0.50%. For Term Loans, the applicable margin is 2.00% for LIBOR borrowings and 1.00% for ABR borrowings. The applicable margins under the Revolver vary depending on CPI’s leverage ratio, as defined in the Senior Credit Facilities, and range from 1.25% to 2.00% for LIBOR borrowings and from 0.25% to 1.00% for ABR borrowings.

In addition to customary fronting and administrative fees under the Senior Credit Facilities, CPI will pay letter of credit participation fees equal to the applicable LIBOR margin per annum on the average daily amount of the letter of credit exposure and a commitment fee on the average daily unused commitments under the Revolver. The commitment fee varies depending on CPI’s leverage ratio, as defined in the Senior Credit Facilities and ranges from 0.25% to 0.50%.

The Senior Credit Facilities require that CPI repay $250,000 of the Term Loan at the end of each fiscal quarter prior to the maturity date of the Term Loan, with the remainder due on the maturity date. CPI is required to prepay its outstanding loans under the Senior Credit Facilities, subject to certain exceptions and limitations, with net cash proceeds received from certain events, including, without limitation, (1) all such proceeds received from certain asset sales by CPI International, CPI or any of CPI’s subsidiaries, (2) all such proceeds received from issuances of debt (other than certain specified permitted debt) or preferred stock by CPI International, CPI or any of CPI’s subsidiaries, and (3) all such proceeds paid to CPI International, CPI or any of CPI’s subsidiaries from casualty and condemnation events in excess of amounts applied to replace, restore or reinvest in any properties for which proceeds were paid within a specified period.

If CPI’s leverage ratio, as defined in the Senior Credit Facilities, exceeds 3.5:1 at the end of any fiscal year, CPI will also be required to make an annual prepayment within 90 days after the end of such fiscal year equal to 50% of excess cash flow, as defined in the Senior Credit Facilities, less optional prepayments made during the fiscal year. CPI can make optional prepayments on the outstanding loans at any time without premium or penalty, except for customary “breakage” costs with respect to LIBOR loans.

- 26 -

CPI INTERNATIONAL, INC.

and subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular amounts in thousands except share and per share amounts)

The Senior Credit Facilities contain a number of covenants that, among other things, restrict, subject to certain exceptions, the ability of CPI International, CPI or any of CPI’s subsidiaries to: sell assets; engage in mergers and acquisitions; pay dividends and distributions or repurchase their capital stock; incur additional indebtedness or issue equity interests; make investments and loans; create liens or further negative pledges on assets; engage in certain transactions with affiliates; enter into sale and leaseback transactions; amend agreements or make prepayments relating to subordinated indebtedness; and amend or waive provisions of charter documents in a manner materially adverse to the lenders. CPI and its subsidiaries must comply with a maximum capital expenditure limitation and a maximum total secured leverage ratio, each calculated on a consolidated basis for CPI.

CPI made no payments on the Term Loan during fiscal year 2010. During fiscal years 2009 and 2008, CPI made repayments on the Term Loan of $22.8 million and $11.0 million, respectively. As of October 1, 2010, the principal balance of the Term Loan was $66.0 million.

At October 1, 2010, the amount available for borrowing under the Revolver, after taking into account the Company‘s outstanding letters of credit of $4.5 million, was approximately $55.5 million.

8% Senior Subordinated Notes due 2012 of CPI: As of October 1, 2010, CPI had $117.0 million in aggregate principal amount of its 8% Senior Subordinated Notes due 2012 (the “8% Notes”). CPI made no repurchase of any of the outstanding 8% Notes during fiscal year 2010. During fiscal year 2009, CPI repurchased a total of $8.0 million. CPI repurchased $3.0 million aggregate principal amount of the 8% Notes in January 2009 at a discount of 8.5% to par value. CPI paid approximately $2.9 million, including accrued interest of $0.1 million, for the repurchase and realized a net gain of approximately $0.2 million. CPI also repurchased $5.0 million aggregate principal amount of the 8% Notes in June 2009 at a discount of 2.75% to par value. CPI paid approximately $5.0 million, including accrued interest of $0.2 million, for the repurchase and realized a net gain of approximately $0.1 million. The 8% Notes have no sinking fund requirements.

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

At any time or from time to time, CPI, at its option, may redeem the 8% Notes, in whole or in part, at the redemption prices (expressed as percentages of principal amount) thereof, together with accrued and unpaid interest thereon, if any, to the redemption date, if redeemed during the 12-month period beginning on February 1 of any given year. For year 2010 and thereafter, the optional redemption price is 100% of the principal amount of the 8% Notes.

Upon a change of control, CPI may be required to purchase all or any part of the 8% Notes for a cash price equal to 101% of the principal amount, plus accrued and unpaid interest thereon, if any, to the date of purchase.

- 27 -

CPI INTERNATIONAL, INC.

and subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular amounts in thousands except share and per share amounts)

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

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

Floating Rate Senior Notes due 2015 of CPI International: As of October 1, 2010, $12.0 million of aggregate principal amount remained outstanding under CPI International’s Floating Rate Senior Notes due 2015 (the “FR Notes”). CPI International redeemed none of its outstanding FR Notes during fiscal years 2010 and 2009. During fiscal year 2008, CPI International redeemed $10.0 million aggregate principal amount of the FR Notes. The FR Notes were originally issued at a 1% discount and have no sinking fund requirements.

The FR Notes require interest payments at an annual interest rate, reset at the beginning of each semi-annual period, equal to the then six-month LIBOR plus 5.75%, payable semiannually on February 1 and August 1 of each year. The interest rate on the semi-annual interest payment due February 1, 2011 is 6.43% per annum. The FR Notes will mature on February 1, 2015.

The FR Notes are general unsecured obligations of CPI International. The FR Notes are not guaranteed by any of CPI International’s subsidiaries but are structurally subordinated to all existing and future indebtedness and other liabilities of CPI International’s subsidiaries. The FR Notes are senior in right of payment to CPI International’s existing and future indebtedness that is expressly subordinated to the FR Notes.

Because CPI International is a holding company with no operations of its own, CPI International relies on distributions from Communications & Power Industries to satisfy its obligations under the FR Notes. The Senior Credit Facilities and the indenture governing the 8% Notes restrict CPI’s ability to make distributions to CPI International. The Senior Credit Facilities prohibit CPI from making distributions to CPI International unless there is no default under the Senior Credit Facilities and CPI satisfies a senior secured leverage ratio of 3.75:1 and, in the case of distributions to pay amounts other than interest on the FR Notes, the amount of the distribution and all prior such distributions do not exceed a specified amount. The indenture governing the 8% Notes prohibits CPI from making distributions to CPI International unless, among other things, there is no default under the indenture and the amount of the proposed dividend plus all previous Restricted Payments (as defined in the indenture governing the 8% Notes) does not exceed a specified amount.

At any time or from time to time, CPI International, at its option, may redeem the FR Notes, in whole or in part, at the redemption prices (expressed as percentages of principal amount) thereof, together with accrued and unpaid interest thereon, if any, to the redemption date, if redeemed during the 12-month period beginning on February 1 of any given year. For year 2010 and thereafter, the optional redemption price is 100% of the principal amount of the FR Notes.

- 28 -

CPI INTERNATIONAL, INC.

and subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular amounts in thousands except share and per share amounts)

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

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

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

Debt Maturities: As of October 1, 2010, maturities on long-term debt were as follows:

Fiscal Year	Term Loan		8% Senior Subordinated Notes		Floating Rate Senior Notes		Total
2011	$	66,000	$	-	$	-	$	66,000
2012		-		117,000		-		117,000
2013		-		-		-		-
2014		-		-		-		-
2015		-		-		12,000		12,000
	$	66,000	$	117,000	$	12,000	$	195,000

The above table assumes (1) that the respective debt instruments will be outstanding until their scheduled maturity dates, except for the Term Loan under the Senior Credit Facilities, which is assumed to mature on the earlier date of August 1, 2011 as described above under “Senior Credit Facilities,” and (2) a debt level based on mandatory repayments according to the contractual amortization schedule. The above table also excludes any optional prepayments.

As of October 1, 2010, the Company was in compliance with the covenants under the indentures governing the 8% Notes and FR Notes and the agreements governing the Senior Credit Facilities.

(Gain) loss on debt extinguishment: The repurchase of $8.0 million of the 8% Notes during fiscal year 2009, as discussed above, resulted in a gain on debt extinguishment of $0.2 million which was comprised of a discount of $0.4 million, partially offset by a non-cash write-off of $0.2 million deferred debt issue costs. The redemption of $10.0 million of the FR Notes in fiscal year 2008 resulted in a loss on debt extinguishment of approximately $0.6 million, including non-cash write-offs of $0.4 million of unamortized debt issue costs and issue discount costs and $0.2 million in cash payments primarily for call premiums.

- 29 -

CPI INTERNATIONAL, INC.

and subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular amounts in thousands except share and per share amounts)

Interest rate swap agreements: See Note 7 for information on the interest rate swap agreements entered into by the Company to hedge the interest rate exposure associated with the Term Loan.

6. Employee Benefit Plans

Retirement Plans: The Company provides a qualified 401(k) investment plan covering substantially all of its domestic employees and a pension contribution plan covering substantially all of its Canadian employees. Discontinued as of end of fiscal year 2008, a profit sharing plan had also been provided by the Company, covering substantially all of its Econco employees. These plans provided for the Company to contribute an amount based on a percentage of each participant’s base pay. The Company also has a Non-Qualified Deferred Compensation Plan (the “Non-Qualified Plan”) that allows a select group of management and highly compensated employees to defer a portion of their compensation. The Non-Qualified Plan liability recorded by the Company amounted to approximately $0.4 million and $0.3 million as of October 1, 2010 and October 2, 2009, respectively. For all of the Company’s current retirement plans, all participant contributions and Company matching contributions are 100% vested. Total CPI contributions to these retirement plans were $2.7 million, $2.6 million and $3.7 million for fiscal years 2010, 2009 and 2008, respectively. The Company’s contributions were lower in fiscal years 2010 and 2009 as the Company reduced its contributions to the retirement plans as a cost savings measure, which was restored to prior levels during fiscal year 2010.

Defined Benefit Pension Plan: The Company maintains a defined benefit pension plan for its Chief Executive Officer (“CEO”). The plan’s benefits are based on the CEO’s compensation earnings and are limited by statutory requirements of the Canadian Income Tax Act. All costs of the plan are borne by the Company.

At October 1, 2010 and October 2, 2009, the Company recorded a liability of $0.4 million and $0.3 million, respectively, which approximates the excess of the projected benefit obligation over plan assets of $0.9 million and $0.8 million, respectively. Additionally, the Company recorded an unrealized loss of $0.3 million, net of tax of $0.1 million, as of October 1, 2010; an unrealized loss of $0.2 million, net of tax of $0.1 million, as of October 2, 2009; and an unrealized loss of $0.2 million, net of tax of $0.1 million, as of October 3, 2008 to accumulated other comprehensive (loss) income in the consolidated balance sheets..

The Company’s defined benefit pension plan is managed by an insurance company consistent with regulations or market practice in Canada, where the plan assets are invested. Net pension expense was not material for any period. Contributions to the plan are not expected to be significant to the financial position of the Company.

7. Derivative Instruments and Hedging Activities

Foreign Exchange Forward Contracts: Although the majority of the Company’s revenue and expense activities are transacted in U.S. dollars, the Company does transact business in foreign countries. The Company’s primary foreign currency cash flows are in Canada and several European countries. In an effort to reduce its foreign currency exposure to Canadian dollar denominated expenses, the Company enters into Canadian dollar forward contracts to hedge the Canadian dollar denominated costs for its manufacturing operation in Canada. The Company does not engage in currency speculation.

- 30 -

CPI INTERNATIONAL, INC.

and subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular amounts in thousands except share and per share amounts)

The Company’s Canadian dollar forward contracts in effect as of October 1, 2010 have durations of 7 to 11 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 (loss) income in the consolidated balance sheets. At October 1, 2010, the unrealized gain, net of tax of $0.3 million, was $0.7 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 consolidated statements of income. The time value was not material for fiscal years 2010, 2009 and 2008. 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 consolidated statements of income. The gain recognized in general and administrative expenses due to hedge ineffectiveness for fiscal year 2010 was $0.1 million. No ineffective amounts were recognized due to anticipated transactions failing to occur in fiscal years 2009 and 2008.

As of October 1, 2010, the Company had entered into Canadian dollar forward contracts for approximately $14.1 million (Canadian dollars), or approximately 39% of estimated Canadian dollar denominated expenses for October 2010 through June 2011, at an average rate of approximately 0.94 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 the Senior Credit Facilities discussed in Note 5. The notional value of the 2007 Swap was $30.0 million at October 1, 2010 and represented approximately 45% 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 (loss) income in the consolidated balance sheets. At October 1, 2010, the unrealized loss, net of tax of $0.3 million, was $0.5 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 consolidated statements of income.

See Note 4, Financial Instruments, for further information regarding the Company’s derivative instruments.

- 31 -

CPI INTERNATIONAL, INC.

and subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular 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 October 1, 2010 and October 2, 2009:

	Asset Derivatives					Liability Derivatives
		Fair Value					Fair Value
	Balance Sheet Location	October 1, 2010		October 2, 2009		Balance Sheet Location	October 1, 2010		October 2, 2009
Derivatives designated as hedging instruments
Interest rate contracts						Accrued expenses	$	816	$	1,766
Interest rate contracts						Other long-term liabilities		-		557

Forward contracts	Prepaid and other current assets	$	437	$	3,467
Total derivatives designated as hedging instruments		$	437	$	3,467		$	816	$	2,323

As of October 1, 2010 and October 2, 2009, all of the Company’s derivative instruments were classified as hedging instruments under ASC 815.

- 32 -

CPI INTERNATIONAL, INC.

and subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular amounts in thousands except share and per share amounts)

The following table summarizes the effect of derivative instruments on the consolidated statements of income and comprehensive income for fiscal years 2010 and 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 )
	Year Ended							Year Ended							Year Ended
	October 1, 2010			October 2, 2009				October 1, 2010			October 2, 2009				October 1, 2010			October 2, 2009
Interest rate contracts	$	(355	)	$	(2,173	)	Interest expense, net	$	(1,862	)	$	(1,797	)	Interest expense, net	$	(36	)	$	(51	)

Forward contracts		1,236			(315	)	Cost of sales		3,150			(3,963	)	General and administrative(a)		45			(321	)
							Research and development		365			(192	)
							Selling and marketing		158			(106	)
							General and administrative		219			(317	)
Total	$	881		$	(2,488	)		$	2,030		$	(6,375	)		$	9		$	(372	)

(a) The amount of gain recognized in income during fiscal year 2010 represents a $62 gain related to the ineffective portion of the hedging relationships, net of $17 loss related to the amount excluded from the assessment of hedge effectiveness. The amount of loss recognized in income during fiscal year 2009 represents a $323 loss related to the amount excluded from the assessment of hedge effectiveness, net of a $2 gain related to the ineffective portion of the hedging relationships.

- 33 -

CPI INTERNATIONAL, INC.

and subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(All tabular amounts in thousands except share and per share amounts)