Aerojet Rocketdyne Holdings Inc (AJRD) 2006 Q3 法說會逐字稿

Welcome to the GenCorp third quarter earnings conference call. [OPERATOR INSTRUCTIONS] As a reminder this conference is being recorded. I would now like the turn the conference over to our host, Linda Cutler. Please go ahead.

Thank you, operator. Good morning everyone, and welcome to GenCorp's third quarter 2006 conference call. Before we start I would like to remind you that during this conference call GenCorp's management team may make forward-looking statements as defined by the Private Litigation Reform Act of 1995. All statements in this conference call and separate subsequent discussions other than historical information are forward-looking statements. These statements represent management's current judgment on expectation for future operations.

We encourage you to review the cautionary language regarding forward-looking statements and the factors contained in the third quarter 2006 earnings release as well as management's discussions and analysis and elsewhere in our most recent Form 10-K and other filings with the SEC. These statements and factors could cause business conditions and actual results to differ materially from those expected by the Company or expressed in our forward-looking statements. With that I would now like the turn the call over to Terry Hall.

Thank you, Linda and good morning, everyone. The third quarter of this year was a very significant one for the Company, and particularly for Aerojet-General, our propulsion unit. What made it significant was two NASA contract awards that were announced during the quarter. Those awards were the COTs award to Rocketplane Kistler and the Orion, CEV award to Lockheed Martin and its team. The result of those awards is it basically puts Aerojet back in a substantial role in NASA's manned space exploration and in resupplying the shuttle to potentially the COTs program. Ultimately the financial impact of these awards we're still unable to fully discuss simply because we are in negotiations right now with both Lockheed and Rocketplane Kistler. Those negotiations won't be finalized probably until late November, early December. What these awards should do is they should continue to drive growth at Aerojet, particularly in 2007 and 2008, and they should drive revenues, margins, and cash flows for our company going forward. The challenge for Aerojet will be staffing up in order to meet the schedule of these two programs, and the real challenge is how well will Aerojet execute.

On real estate I'll talk about that in detail a little later. We are making progress on the entitlement. However, how slow or glacially slow, we will talk about the Sacramento real estate market, the entitlement status on our various projects, and where we are on a potential joint venture negotiation. Before we do that, I am going to turn the meeting over to Yasmin so she can discuss the financial results of the third quarter. Yasmin.

Thank you, Terry and good morning to everyone. Today the Company reported a third quarter loss of 13.1 million or $0.24 per share compared to a net loss of 28.9 million or $0.53 per share for the third quarter of 2005. The third quarter loss from continuing operations was 14.6 million or $0.26 per share compared to a net loss of 4.4 million or $0.08 per share for the third quarter of 2005. The 14.6 million 2006 loss does include an 8.6 million charge associated with the Company's quarterly review of environmental reserves which I will comment on in a few minutes. Both periods do include retirement benefit plan expense which is mostly non-cash, the amount in 2006 is 10.8 million compared to 11.9 million in 2005.

As I've noted before, most of this expense relates to deferred recognition of the under performance of the pension plan assets in prior years and past discount rate decreases that are used to determine benefit obligations. We will continue to report a similar impact for the remainder of this fiscal year. However, next year we expect the 2007 expense to be reduced by almost half as compared to the 2006 levels driven by increasing discount rates and also improved performance on our pension plan assets. Again, I would like to emphasize that the retirement benefit plan expenses mostly non-cash. Our major pension plans have been and do remain in an over funded position.

I would like to provide some comments on the reserve increase of 8.6 million, the P&L charge associated with that reserve increase. As noted and as previously talked about, each quarter the Company performs a detailed review and analysis of estimated future environmental costs that considers an array of factors including changes in cost estimates as a result of identification of required remedies, changes in these remedies, the scope of these remedies, the timing and the technologies to be used to clean up the Sacramento sites and Aerojet's other legacy sites.

This reexamination in the third quarter of the future costs resulted in the Company increasing its environmental reserves by approximately 40 million and the amount that we expect to recover under our global agreement with the U.S. government by approximately 32 million. A major driver in the increase were estimated costs associated with complying with the various regulated reorders issued by governing environmental agencies that cover a fairly long period of time including providing replacement [Inaudible] and remediation upgrades at our Sacramento site and former sites. The net charge that we took in this quarter is non-cash for the current year, and from a cash perspective will be incurred over a number of years. It is possible that as our environmental site investigations continue and we characterize information better, that future charges over a number of years could be taken. Again, we do recover the majority of these costs in our contract pricing under our global settlement agreement with the U.S. government.

Let's talk about the continuing operations in a little more detail. Looking at Aerojet, sales are doing well this year. We're certainly pleased with the revenue growth. Third quarter sales were 158 million for 2006, up 18% compared to 134 million for 2005. Aerojet's sales were 157 million for the third quarter of 2006 compared to 132 million in 2005. The increase is being driven by our space propulsion programs, the Atlas V program and our defense program and has been offset by sales as we've talked about, lower sales associated with the Titan contract and possibly for Standard Missile program. Aerojet sales through the first nine months of the year were almost 9% higher than the year before. Year-to-date 454 million compared to 418 million in 2005.

Turning next to Aerojet's segment performance for the quarter, if we exclude the environmental charges and the retirement benefits plan expense, secular performance for Aerojet for the quarter was 13.8 million representing an 8.8% return on sales compared to 16.6 million and a 12.6% return on sales for the third quarter of 2005. The comparable return for the nine months for the year excluding these unusual items were 8.8% in 2006 compared to 10.2% in 2005. This difference in returns for 2006 versus 2005 is primarily influenced by the completion of the 2005 launch support activities on the Titan program which is a high margin contract which we substantially completed in 2005, and it is also influenced by the low margin Atlas sales recorded in the first nine months of 2006. And also some other program mix elements contributed to this change in margin.

Margin improvement at Aerojet is a key objective for us. As we go forward we are definitely focused on improving margins and our goal is to get to double-digit margins for Aerojet in the next year or so. Third quarter 2006 performance for our real estate segment was comparable to 2005 with 2 million in revenues in each quarter, and reflects our ongoing leasing activities. We did not have any real estate transactions of any significance in either period.

Commenting briefly on corporate and other expenses for the quarter, corporate and other expenses were 5 million compared to 3.5 million in 2005. The increase in the third quarter is attributable to a $1.7 million charge taken by the Company in connection with the Olin litigation. We had a judgment issued to us in July in the third quarter. A result of that we recorded a charge for our future remediation activities that may takes place, again mostly non cash this year and the charge of cash to be paid out over a number of years.

My comments next are in debt and cash flow. Our debt, net debt position which is total debt less cash at the end of May was 404 million and decreased to 378 million at the end of the August representing net cash generation of 26 million for the quarter. Contributing to the cash generation was an $8 million tax refund which we received in June which helped offset the $14 million payment that we made related to settlement of the Sacramento toxic court cases. If we set these two items aside, the good news is that the Company did generate close to $22 million of cash in the quarter. However, the not so good news is that a significant portion of that generation was timing in nature and is expected to reverse in Q4. However, we are attempting to see what kind of permanent improvements can be generated through this activity as we go forward. We are focused on actions to improve cash generation for the Company and certainly are moving towards making Aerojet a cash generator for the Company versus a cash user which it has been in the past few years, and we are making progress towards that goal.

At the end of August we had cash balances on hand of 85 million of which 65 million was unrestricted. We had no borrowings under the $80 million revolver at the end of August and anticipate no borrowings through the rest of this year. The $20 million of restricted cash is from term loan proceeds that we received during the quarter that are used to cash collateralize the 5.75 notes that are due in April of 2007. We believe that with our unrestricted cash balances our available borrowing capacity under the revolver, we have more than sufficient liquidity going forward as we continue to execute our strategic objectives of entitling and monetizing our substantial real estate assets and strengthening and growing our Aerojet business. With that I would like to turn the call back to Terry.

Thank you, Yasmin. I am going to start off by talking about Aerojet and where we see it going. We achieved a little more clarity in what 2007 is going to look like last week when Congress finally approved the Defense Appropriation bill, and I will say this, we did quite well, and it looks like at least from the DOD point of view our programs will continue to sustain funding and in some cases actually grow. Now, Aerojet's results are driven primarily by DOD funding and NASA funding. When you look at these two government entities, neither one is predicting spectacular increases in funding in 2007. In total it looks like on the top line there about a 3% increase in funding in the areas that we play in. Having said that, our growth going forward looks like it will be a multiple of that in terms of revenue growth anywhere from two to four times that kind of range in '07.

Now, what are the big growth drivers for us? As Yasmin told you a lot of it is NASA programs to replace functions that are currently being served by the shuttle. To us it's always been a goal to get into, a bigger role into manned space with NASA. As most of you probably know our propulsion market in the U.S. is about $2.7 billion a year. Of that, the largest single propulsion program is about $800 million a year, and that's the shuttle. Unfortunately Aerojet's share of the shuttle market revenues was about $5 million a year which if anybody does the calculation, it is about 6 basis points as a percentage of the total. If you exclude the shuttle from the marketplace, Aerojet has a 30% market share in the propulsion market. Obviously for us to grow we needed to be on the program that's replacing the shuttle, and we can now with confidence say that we will be on that program, and it looks to us like it is an increase in revenues somewhere in the range and it's a very large range because we're still in negotiations and there are still more parts of the program to be bid, but it is a range of 10 to 30 times what we currently are on the shuttle.

Now, last couple weeks there was an announcement that the Lockheed Martin team had won what's called the Orion program or what used to be called the Crew Exploration Vehicle. Aerojet was part of that team, and Aerojet will provide the attitude control and jettison motor on the Crew Aboard System which goes on top the capsule. That is an expendable, which means every time there is a launch we will build and sell to NASA new motors. We are also providing all the propulsion on the capsule which is where the astronauts actually are inside in what's actually manned. That is primarily a reusable unit. We will also provide all the propulsion on the service module which attaches below the capsule and to the capsule. That is an expendable which again means every launch we will supply new propulsion for the service module.

Right now where we are is we've entered into a contract that's approximately of two months of duration where we are being paid by the government to negotiate a definitive contract with Lockheed on the Orion program, and what we expect is the next four years will be development work which means, quite frankly for us is it is a lot of engineering, and we will be hiring additional engineers, quite a significant number to work here in Sacramento, some in Washington State, to develop the Orion program as it goes forward.

Now, the second thing that happened was the award of the COTS program. COTS is not as as well known as Orion or CEV. COTS stands for commercial orbiting transport system, and it's really, the mission it to chiefly supply lift for cargo resupply to the space station. What NASA awarded was to a company called Rocketplane Kistler, a funding of $207 million which is contingent upon Rocketplane Kistler in various steps raising additional $300 plus million of outside funding in stages. The reason that it is important to us is this Rocketplane Kistler design is dependent on what we call the Aerojet 26 engine. It was formerly known as the NK 33 engine which Aerojet has written off a number of years ago and is currently in storage here in Sacramento. Again, with COTS, we have entered into a contract and are being paid to negotiate a definitive contract going forward, and this program again assuming that they are able to achieve the funding levels required, will be a sizable contract which will go on for a number of years which is dependent upon former Russian engines which we own and which we have no basis in.

Finally, what's also to come yet on the Orion program and the going back to space initiative of NASA is what's called Ares, or also the Crew Launch Vehicle that we are expecting awards later this year from NASA. The new launch vehicle that the Orion capsule is going to be launched off of is going to be a 309-foot tall launch vehicle with the first stage being a solid rocket motor, and the second stage being a liquid engine that's a derivative of the engine that was used on the Apollo program on the Saturn lift vehicle. There we are bidding components simply because Alliant Tech Systems has been given a sole source contract on the solid first stage, and Rocketdyne Pratt Whitney has been given a sole source contract on the second stage. What we are going after are components, and I might add that this launch vehicle is a significant technical challenge, one because it is so tall, and two, it is because it is so thin. Ultimately things that we are bidding on are the reaction control engines which control attitude through the launch and components of the liquid second-stage engine.

The bottom line on what's happening with Aerojet is it has now achieved a very meaningful role and we'll see exactly how big it gets over the next few months in the NASA manned space program. The last time a NASA manned space program was put out to bid was 30 years ago, so this is likely to be a very long program for the Company, and what we're looking at initially through the design phase is a cost protected cost-plus contract with the potential to make margins up to some level, typically it is maximum of 8 to 10% kind of level and it's usually below that, but for us it means we're in a market that we were almost excluded from before and means we're going to continue to grow and gain market share. So we're feeling very good about Aerojet and about its future right now. It is clear that we're going to gain market share, and it is clear that they are programs that are going to continue to go forward.

On real estate, let's talk about the Sacramento residential real estate market first. Right now what we're seeing is a downturn in the marketplace, new home sales are down about 40% year-over-year. Estimated prices for new lots or new homes are down about we believe about 30%. It is hard to get at an exact number because the builders have a tendency to lower the price some, plus to throw in free options like swimming pools and upgraded kitchens in order to get sales, but we believe that the level's down about 30% in pricing. That means in reality we are back to 2004 pricing levels for new homes in Sacramento. Now, the market has been and continues to be uncertain as to the depth and the length of this downturn. If you would have talked to the large builders in April and May they would say it was going to be a very short duration in downturn. If you talk to them now, they're saying they don't know, but they believe that the downturn will continue through most of 2007, and a lot of them have said they expect an upturn starting in 2008. The ultimate result of the market right now is we have a surplus of inventory in the marketplace. Right now the builders are trying to work off that surplus, appears to us particularly that the publicly traded builders are being very aggressive in trying to reduce their inventory and are actually walking away from properties and walking away from option payments that they had down.

Now, what's the impact of this on GenCorp and on our real estate? Obviously our stock prices traded down almost in concert with the large home builders, but having said that, our real estate is still exactly the same it was a year ago when the prices were high, and we continue to believe that the long-term growth projections for our community, the region of Sacramento, is going to continue to drive demand for new homes in the future, and nothing is fundamentally changed about our long-term outlook as to the attractiveness of our property or the long-term value that's inherent in having 20 square miles of property just outside the city of Sacramento. What it has done, however, is it has made it much more difficult to find a potential partner in a joint venture that would be able to take the amount of risk that we would require and enter into a definitive agreement which puts at risk for them their investment in our property. The market uncertainty and there is still some entitlement risk in our property has basically resulted in we do not believe that we can reach an acceptable economic transaction with the partner at this time.

Now, having said that, and we also have the issue of why should we do a transaction when valuations are low. So we have terminated the discussions on the joint venture that we disclosed to you late last year or early January, and we are continuing to move forward on our entitlement process. At the same time I will say this. Once we get to entitlement and assuming that the market recovers, we would again probably entertain discussions with some of these people that we've been in discussion over the past nine months or so with. Having said that, they can just not get there given the risk that they see this the marketplace at this time.

Now, we're continuing to work through the entitlement process and it is a frustrating and slow process, one in which we have very little control over the timing. Let's talk about the status of our project. Rio Del Oro, which is our first project, which is the zoning authority, which is the city of Rancho Cordova, we had hoped to have the draft EIR/EIS out by now. The city is now telling us they are still in discussion with the Corps of Engineers, and they're again telling us that they expect those things to be resolved in the near future and a draft EIR/EIS may come out yet in October.

Now, given the slippage that's occurred because primarily of Corps of Engineers issues, I thought I would give you a flavor of some of these issues, and let you know that we still believe that these issues are resolvable. Some of those issues, not all of them are in the LEDPA section which is the least environmental damage, most practical alternative section of the EIR, there is a discussion about whether identifying the environmental superior alternative is a state SEQUA only requirement and/or is it also a NEPA, National Environmental Protection Act requirement. Doesn't seem like a very substantial disagreement. It is what it is.

In the biological resources section, the Corps wants the EIR to determine whether the project is consistent with what's called SSHCP which stands for South Sacramento Habitat Conservation Plan. Now, the only problem with determining whether it is consistent is that no plan has been adopted and is unlikely to be adopted any time in the near future. Again, it doesn't seem to be an unsolvable problem. My favorite issue is there is some discussion with the Corps that the use of the word seasonal, intermittent, and ephemeral are applied inconsistently throughout the conclusions for the impacts schedule. So that's the kind of things that we've been waiting on, the city and the Corps to resolve. Do we believe that we're going to get Rio Del Oro in title? Yes, and we're still saying by the end of 2007.

On our other projects, the next one that we expect to get entitlement is the Glenborough project which is about 1400 plus acres. There the zoning authority is the County of Sacramento and the County of Sacramento is telling us they are close to finishing the draft, EIR/EIS, and that could come out yet this year or early 2008. The next project is Westborough. Westborough, again, is the city of Rancho Cordova. The EIR/EIS is currently being processed. We expect again to get entitlement approval from the city in 2008, so we still have a ways to go. However, we are closer to getting entitlement than we have been in time in the past. We expect that entitlement will occur.

At the time that we get entitlement, the issue that we're going to have to deal with is, one, what's the market look like? Does it justify the investment of monies to put in infrastructure, to put in infrastructure it would take about a year, so if we get entitlement late '07, infrastructure goes in in '08, and we actually have product that's to sell finished lots in late '08 or 2009. Ultimately how fast we monetize our property will depend on the residential market in the Sacramento region. Right now our property has -- looks exactly the same it did a year ago. It is still in a prime location, and we still expect that the population projections of growth and demand for housing in the Sacramento region will come to fruition and that our property will grow in value. Ultimately we compare, or the analogy that we've used is we're kind of like the Saudis. We have a commodity sitting in the ground, on the ground in our case that basically was free to us, we have no basis, and we will monetize it when demand is strong and prices are high. If prices are low and real estate obviously has cycles, then we will monetize a much smaller amount.

Right now we're happy with where the Company is, particularly with what we're seeing in Aerojet. They've exceeded our expectations, and we've seen growth, revenue growth I think 2001 when we sold our Azusa space electronics business to Northrop Grumman, we had approximately 206 million of revenues at Aerojet. It is going to be 625 and growing at substantial rates from this year to next year. So we think they've done a splendid, superb job of growing their market share and growing in the market. We still have challenges to get our real estate monetized. However, we think those challenges will be met, and we think that ultimately there is a whole lot of value over a very long period of time here with the real estate. With that, operator, I would open it up for any questions anybody might have.

[OPERATOR INSTRUCTIONS] Our first question comes from the line of Joseph Nadol of JP Morgan. Please go ahead.

Hi. Good morning. A number of questions here. The first is on the environmental reserve changes. It looks like the reserve went up about 20% from where it was last quarter. And just with regard to the reason for it, are there new regulations that have been recently enacted that led you to change your estimates, new interpretations, new cost estimates on your actual remediation work? Are there overruns?

Joe, I will try to answer that for you. The way we do our reserve, our environmental reserve is basically is it is obviously a 15-year estimate, and when we have a range, and it is in accordance with GAAP, we establish a range. We have historically as a practice taken the low end of the range when we have a range where there is a number of potential solutions. We then work with, in most cases the U.S. EPA to determine what particular solution is going to be acceptable to them, and that's a negotiation that occurs, usually over a large number of years, and when we get to a determination, here is the requirement we adjust the reserve to reflect the actual cost estimates for the projects. That is the biggest driver of increasing the reserve. Also I might add that initially when we established a lot of these reserves, we basically, at the lower end of the range the number was driven by cleaning up to a standard -- an industrial standard as opposed to a residential standard, and so the result of negotiating with the EPA on what the projects actually are and the fact that we are clinging to the highest standard that we can, has resulted in an increase, and that's what drove the increase in the estimates of the 15-year estimates that we did.

Yasmin mentioned that there could be more of this in the future. Is that kind of a blanket disclaimer that is just sort of obvious on its face or is there just a large degree of uncertainty here that means that you can't put it into your GAAP statements because you can't estimate it?

No. I think it is the uncertainty that I just mentioned. That's going to continue as you get close to actually putting in the remedy, and really what happens is kind of two things happen, and they counter each other to some degree. In some cases the technology gets cheaper which means it is cheaper to do, but the remedy that the EPA wants and as you know the EPA is only interested in dirty land, not clean land, so for us to get clean land released we accelerate or negotiate what the remedy is on some dirty land, and that's the quid pro quo for us and them. It's possible that it will happen again in the future, we just won't know until we get close to doing the remedies on our property going forward. In some cases we're not starting on some of the sections of our property until post 2012.

Okay. Secondly, on the cash flow you must have a pretty good idea by now what your cash flow is going to be in Q4. You said there is going to be a material reversal because the in-flow is nice in Q3. Are you looking for 20 million outflow? Can you be specific just so I have a reasonable--?

I think, Joe, if you look at it, some of it will be depend on just how much of the benefit that we saw in Q3. Can we hold onto and make as a permanent improvement as we go forward, but Aerojet in Q4 should generate some cash, a little bit of cash, even after the outflow that happened, and then after that you've got to -- and you have to end up covering your interest expense, and your legacy costs, retiring medical costs, and your corporate costs and other costs. The question really is going to be how much of this outflow can you hold onto and you're not probably hopefully not far off the number that you're looking at. It may be a little bit more than that.

Because you were 26 positive in Q3, so it is kind of 20 to 25 negative in Q4?

That's kind of what we're striving for.

Okay. Third, just a question on the new business you're getting, the new NASA business. You mentioned that the engineering you're doing largely in Sacramento and the production is still several years away, but I am sure that it is a gradual ramp-up process. Are you planning to do the production work in Sacramento?

Depends on exactly what pieces that we're talking about. The -- a lot of the smaller maneuvering engines will be done in Redmond, Washington. Some of the solids if we get any, particularly solids may be done under the Crew Abort System may be done in Camden, Arkansas, and a lot of the work obviously will be done here in Sacramento, particularly the engineering.

When we think about this being potentially a 30-year program, and we think about the long-term -- your long-term volume of business in Sacramento versus other sites given the land development that you're working on, I guess I was -- anticipating a lot of that would be done elsewhere.

Well, quite frankly, what we'll have mostly Sacramento is engineering, and engineers need cubicles, not large land masses.

Right. Understood. Two more. On Glenborough, on the EIR process there, is there anything -- is it a similar process to what you've been going through when you walked us through some of the real technicalities you're dealing with on Rio Del Oro, are you going to have the same issues do you think? Or is this the different venue, the different entitlement authority.

Well, it's a different entitlement authority and the county has a long history of doing entitlements as opposed to Rancho Cordova. This is like their first one, so we're hoping it is a little smoother. There is always stuff going on, and there is always issues, but I would say so far what we've experienced with the County is a little smoother than what we've experienced with the City of Rancho Cordova.

Maybe just the skids are a little more greased with regard to their communications with the Corps?

Yes, they have a longer relationship than the city does obviously.

The final one is Terry, you mentioned that you're -- you have this land like the Saudis, and you're going to sell it when the price is right and the time is right. However, there is a tax issue that is getting closer, is the expiration of your capital loss, and I believe that's in '09, and are there other alternative strategies to make sure that doesn't go away if the real estate market stays sour for a couple of years? How are you thinking about that now?

Joe, that is definitely a major focus for us, and as we evaluate what do we do with the real estate and when do we do it, and there are alternatives and structures and possibilities that we are evaluating and will continue to evaluate very closely to make sure we can achieve the Company's goals with the real estate and also achieve our goals as far as the tax is concerned.

Anything more specific you can share or just that you're working on it?

We're working on it.

Okay. All right. Thank you.

Thank you.

Next we'll go to the line of Andrew Sidoti of Markson Intern. Please go ahead.

Good morning, a few questions here. First of all, could you maybe put a little bit of color around the revenue opportunities associated with the Orion and when we can expect that to meaningfully contribute to top line and I know you talked about margins being somewhere if I heard correctly around the 6 to 8% area as you do the engineering work

Yes. I can try to give you some. The Lockheed award for Orion was basically $1 billion a year, I believe, for four years. So it was $4 billion. Our portion of that is going to be dependent particularly in the development stage on how much scope we get given. Are we comfortable saying that Orion itself over the next four years is going to produce X -- say 10 times what we're doing in a year on what we're doing on the shuttle. Yes, we're probably pretty comfortable with that.

The question that we really have is how much upside do we have and ultimately that for the entire manned, NASA manned space program, which we don't think there is any risk of funding and not coming through on, it will depend on what, if anything, we win on the Ares, the launch vehicle that I mentioned, and what the scope is and then the third thing we don't know right now. Is we don't know the exact timing or the time line that NASA has established. is When we put in our proposal to Lockheed, it assumed a 2012 flight, for example. NASA is now saying a 2014 flight. So does that move everything back? At what speed will NASA be willing to fund, we don't know yet. That's really why we're having trouble saying it is $100 million a year, it is $80 million a year, it is $50 million a year, it is $150 million a year. We don't know.

Given the uncertainty though, do you still think that CEV has the potential to become your largest contract within Aerojet in terms of revenue contribution per year?

It has the potential. Whether it will or not, who knows. We have a couple other contracts that are about the $50 million range, so it depends on what happens in the future. Again, we have a fair amount of clarity into '07 on DOD work. We have less clarity, other than it's obviously going up substantially on the NASA work until we finish these negotiations.

Then on the COTS program, you mentioned in your prepared remarks that you're working with Rocketplane Kistler and you mentioned about the Aerojet 26 that basically if I understood correctly Kistler's system is designed around the rocket engine and that you've written these off. So if the Kistler program actually succeeds, is there reason to assume that you're basically talking about 100% margin as you take them off your line and put them on a Kistler vehicle?

We're talking about a high percentage of margins, but it will again depend upon how it is structured. Are they buying the engines or are they buying services and the engines? They will need some of both in order to fly, and there really the challenge of that program is they have funding milestones they have to meet, and I believe the first milestone was they had to raise 40 million of external funds, and they get a certain amount from NASA once they do that. We're told they have successfully done that, so we know the project will start. The next funding deadline or requirement is a much higher number. I think it is over $100 million that they will have to raise of external funds. It is really dependent upon them being able to fund the program going forward.

I see, and if everything -- if the stars all align with the COTS program, can this also have the potential to be the size -- rival the size of the Orion potential?

Yes. It could be that size or bigger.

And when you mention about looking for hiring engineers, when you take the CEV and COTS together, how many engineers are you looking to hire?

Again, I will give you a range because it depends upon the time line, how fast things need to be done. We're talking 200 to 400 extent of the range that we could see. Not all of them would be engineers, but a vast majority of them would.

Okay, and then I just want to touch on one other area, and that is it has been pretty well documented in the press that one of your largest shareholders is dealing with a facing potential or actual redemptions, and I was just wondering does this set up a situation where you could actually buy back their stock?

Well, we would like to be in that position. Right now our credit agreement procludes us from buying back shares.

Okay. Just kind of a follow-on to that, now that I believe if I read the -- understand correctly David Lorber had resigned from this particular fund. What does that mean for his Board seat.

Well, that's a good question and again we don't have the answers other than what we're told was he was elected by the shareholders, and he hasn't resigned, and we'll just have to wait and see what, if anything, David wants to do or whether the Board has strong feelings about it.

My last question is on real estate, and just wondering have you seen, as far as the entitlement process, have you seen any organized efforts at all to kind of opposition to your entitlement efforts?

No, we haven't, and the reason is we just can't find an environmental group that wants to preserve an ex strip mine rocket testing site. We haven't.

Thank you.

Sure.

[OPERATOR INSTRUCTIONS] There are no additional questions. Please continue.

Thank you. With that, thanks to all of you for being on the call. Like I said, we're relatively optimistic about our future, and we will talk to you next quarter at year end. Thank you and good day.

Ladies and gentlemen, this conference will be available for replay after 11:30 a.m. today through Friday October 20, 2006. You may access the AT&T teleconference replay system at any time by dialing 1-800-475-6701 and entering the access code of 843838. International participants dial 320-365-3844. Those numbers again, are 1-800-475-6701 and 320-365-3844 with an access code of 843838. That does conclude our conference for today. Thank you for your participation and for using AT&T executive teleconference. You may now disconnect.