CPI International, Incorporated (CPII)

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F1Q08 Earnings Call

February 7, 2008 11:00 am ET

Executives

O. Joe Caldarelli – Chief Executive Officer & Director

Robert A. Fickett – President & Chief Operating Officer

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

Analysts

Gary Liebowitz – Wachovia Securities

Antonio Antezano – Bear Stearns & Co., LLC

Andrew Berg – Post Advisory Group

Frank Bisk – Pilot Advisors

Gregory [With] – Robeco

Chris McDonald – Kennedy Capital

Presentation

Operator

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

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

The computation of EBITDA, adjusted EBITDA, adjusted EBITDA margin, free cash flow and adjusted free cash flow that will be discussed on today’s call are non-GAAP financial measures. Under Securities & Exchange Commission rules, a presentation of the most direct comparable GAAP measures and reconciliations of each of these non-GAAP financial measures to the most directly comparable GAAP measures, are available in yesterday’s press release which has been posted on the company’s website. Interested parties can access the press release by going to www.cpii.com and opening the press release entitled CPI International announces first quarter 2008 financial results. I would now like to turn the presentation over to today’s host Mr. Joe Caldarelli the Chief Executive Officer of CPI International. Please proceed sir.

O. Joe Caldarelli

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

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

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

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

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

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

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

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