Leonardo DRS Inc (DRS) 2002 Q2 法說會逐字稿

Good afternoon. Thank you all for holding. I'd like to remind all participants that your lines have been placed on a listen-only mode until the question and answer portion of today's call. Also, that the call is being recorded for replay purposes. If you have any objections, you may disconnect at this time. At this time I'd like to turn the call over to your speaker, Michael Shanahan. Sir, you may begin.

Thank you, Tina. Good afternoon, everyone. Thank you for joining us on our call today. You've all seen the earnings release for our second quarter ended April 30, in which we reported net revenues of $91.8 million and earnings from continuing operations of a record 61 cents per diluted share. As noted in the release, we've approved a plan of action to divest our plastics business, and have treated it as a discontinued operation in our financial statements.

We'll comment further on this in just a few minutes.

Our defense business is in very good shape and is poised for continued growth, particularly in the recent - with the recent addition of [Radian], Incorporated to our company, our current backlog at $1.2 billion.

Joining me on the call today are Jerry Potthoff, our president and chief operating officer, Gary Gerhardt, vice chairman and chief financial officer. In addition, we've asked a couple other members of our management team to join us today to update you on a few items that we had previously discussed in our annual meeting, that being Dan [Gair], our vice president of sales, and a most recent addition to our team, Tim Fletcher, the president of [Radian].

Welcome, gentlemen.

And Dan will discuss some of our current business development activity while Tim will provide you some additional insight into a few of the growth areas for [Radian].

First, Gary Gerhardt will recap the second quarter's financial results. Gary?

Thanks, Mike.

As is customary, I will first read our standard disclaimer before I begin.

Statements made during the course of this conference call, which are not historical facts, are considered forward-looking statements within the meaning of Section 27(a) of the Securities Act of 1933 as amended and Section 21(e) of the Securities and Exchange act of 1934 as amended, and are intended to be covered by the safe harbor provisions created thereby.

For the second quarter, we generated record net income from continuing operations of $6.6 million, or 61 cents per share. This is up over 50% from the second quarter of last year, resulting in a 39% increase in earnings per share from continuing operations.

Year-to-date earnings per share from continuing operations of $1.17 cents also were 39% above the prior year. As noted in our release, due to our decision to divest of the plastics business, we have reclassified the segment as a discontinued operation within our financial statements. Accordingly, its revenues and expenses have been captured within the discontinued operations line on our income statement.

During the second quarter, we recorded a noncash $3.1 million, or 29 cents per share charge to reduce the assets of the plastics unit to their estimated net realizable values. This was based upon valuation multiples for similarly sized businesses in the injection molding industry, as well as the range of initial offers we have seen from potential acquirers.

We expect to divest of the plastics unit in whole or in part within the next several months as we continue to market the business.

Including discontinued operations, we reported net income of $3.3 million, or 31 cents per share for the quarter.

The $92 million in second-quarter revenues did come in about 3% below the comparable quarter last year, largely determined by contract production schedules. Year-to-date revenues of $183 million have shown modest growth over the prior year. We anticipate that revenues from existing operations will pick up the pace a bit in the second half of the year.

Operating income from continuing operations for the quarter improved by 28% to $11.5 million, up from $8.9 million last year. Higher contract gross margins, particularly in the light and heavy military segments, were primarily responsible for the growth in profit.

A maturing mix of programs under long-term production led an overall 390 basis point improvement in gross profits.

In addition, the adoption of the provisions of FASB 141 and 142 relating to accounting for intangible assets this year did contribute $800,000 to operating income from continuing operations, as recorded goodwill balances are no longer subject to periodic amortization charges.

Free cash flow generation was outstanding once at $13.5 million for the quarter, and $27 million year-to-date. Similarly, EBITDA totaled $12.8 million, or 13.9% of revenues, compared to 12% of revenues in 2001.

This robust cash flow has allowed us to rapidly deleverage our balance sheet, as our debt-to-total-capitalization ratio dropped to just under 20% at quarter end. Even with the utilization of approximately $27 million in line of credit borrowings to complete the recent [Radian] acquisition, our debt-to-cap ratio of approximately 32% is still below that at the beginning of the fiscal year. Our solid balance sheet provides us significant debt and equity financing capacity in pursuing future plan acquisitions of companies in the defense industry.

Now I'd like to turn the call back to Mike.

Thanks, Gary. Good job.

As Gary just explained, our defense business enjoyed a very solid quarter, although revenues were down somewhat. We fully expect to pick up the pace in this area and finish 2002 quite strong in both revenues and [inaudible] orders. Our defense business is positioned extremely well to capitalize on several favorable trends in the defense industry. First, the breadth of our product lines are significant, as we provide many of the essential types of support equipment needed by our military whenever and wherever they deploy.

Our vast capabilities include loading and transport equipment, mobile electric power, fuel and water distribution systems, environmental control units, battlefield recon and target acquisition systems, test equipment, airborne and ground-based radar systems, and chemical and biological defense systems.

With the addition of [Radian], we now possess tremendous capabilities in logistical support, engineering services, and security systems, three high-growth markets where opportunities abound.

With a portfolio of products and service offerings as diverse and integral to military operations as this, the military literally doesn't leave home without us. And with the expanding war on terrorism, as our military continues to deploy more frequently around the globe, the demand for our equipment and services on the battlefield grows markedly.

As I mentioned to you earlier, Dan [Gair], vice president of sales is with us today to provide some additional insight into various market factors affecting engineering support. As first discussed in our annual meeting in March, Dan will comment on the overall Department of Defense spending plan on current military operations. Dan?

Thank you, Mike.

Taking a look at the defense budget, you'll find the defense spending levels are significant as those during the Reagan administration. The Pentagon projections indicate that U.S. military spending will increase annually in the next five years to a projected level of 451.4 billion in 2007, and that's an approximate $120 billion increase over the next five years. Many believe that Congress will pose little opposition to increase levels of additional defense spending, given current global unrest and the reality of terrorist attacks against America. It's clear the political will of our country is still firmly behind the need for a strong national defense. Operation Enduring Freedom, along with other anticipated actions in our war against terrorism has resulted in positive reaction on many of ESSI's products. ESSI has received orders on an urgency basis for its pumps, heaters, field deployable environment control units, as well as emergency deployment of our chemical/biological protected shelters. DOD's budget growth also addresses the recapitalization of the legacy force, as well as beginning the implementation of its transformation plans. The goal is to maintain today's force while at the same time transforming the military to meet any future conflicts.

If you look at the budget increase from FY '02 to FY '03, you can see that each branch of the service will get an approximately $10 billion increase, with an additional 20 billion for emergency response. This balanced approach will hopefully address the president's major defense priorities to fight and win the war on terrorism, to maintain the morale and readiness of the military, to create a military for the 21st century and to improve DOD's fiscal and management operations.

As the president has said many times, our war on terrorism may take longer than expected. We need to be prepared to stay engaged for an extended period of time if we expect to persevere.

As we pointed out earlier, ESSI is poised to take advantage of the DOD budget growth in FY '03 and beyond. We have in excess of 50 programs currently funded in the out years, all of which support the needs for rapid deployment in the growing war on terrorism.

In addition, the president has also earmarked substantial funding to secure the homeland and strengthen the nation. The immediate aftermath of September 11 was the establishment of a $40 billion emergency response fund, and the creation of a new Office of Homeland Security.

The administration's FY '03 homeland security budget focuses on four major areas: Supporting the first responders, defending against bioterrorism, securing America's borders, and using 21st century technology to secure the homeland, all of which contain opportunity for ESSI.

In addition, the acquisition of [Radian] to the engineering support team should enhance our position in the area of homeland defense, especially in the area of security systems. In all, we believe that ESSI is well positioned once requirements are established for use of the homeland security budget. Mike?

Thank you, Dan. From all indications, the dollars being sought for homeland security are staggering, with the fiscal year '03 spending slated at $38 billion, almost doubling the current year level. But a problem as complex as protecting the American homeland, undoubtedly it will take some time for homeland security initiatives to take place. Funds are being set aside, but tapping into the pipeline of procurement dollars is taking most DOD contractors a bit of time to identify their role.

However, Tim Fletcher and [Radian] will now explain how they have been successful in addressing our country's homeland security for a number of years, particularly with their asset protection business. [Radian] has also capitalized on the increasing trend by the military to outsource logistics support and engineering services to private industry, plus producing a major power generation system for the Air Force and the Army.

Welcome aboard, Tim, and thanks for being here.

Thanks, Mike. We're excited to become part of the ESSI team, and look forward to bringing a unique set of capabilities and products to the table. [Radian] has several areas of rapid growth, most notably our deployable power generation and distribution system, DPGDS, and our asset protection systems business areas.

We recently went into full production on DPGDS, which will be the backbone of the military's deployable power generation architecture.

These deployable systems, which have 920-kilowatt power units, are the largest in the DOD inventory, and will replace a 20-plus-year-old 750KW system.

Our asset protection systems division is very well positioned to respond to the requirements being generated by numerous homeland security initiatives. [Radian] has substantial experience integrating advanced electronic security technologies.

As an example, we were selected to design and integrate all the next-generation electronic security at the Pentagon in conjunction with the renovation effort.

We have also secured nuclear and chemical weapons storage facilities, as well as numerous high-profile government facilities and foreign embassies.

We view the homeland security business area as an important growth opportunity for the future, and have the credibility and proven performance to compete effectively.

Mike, we're glad to be aboard and excited about the future.

Thank you, Tim, and welcome to you and to all of our radiant teammates. We also are very excited about what [Radian] offers our company and its shareholders.

In our earnings release, we already provided revised financial guidance for the remainder of this year, where we increased our earnings per share target by 20 to 25 cents per share, as well as top-level forecasts for 2003.

I'll now ask Gary Gerhardt to comment briefly on this new information.

Thanks, Mike.

I'd like to give our call participants just a bit more insight into our recently updated earnings guidance provided earlier today.

I apologize in advance for the number of moving pieces to our forecast, due to the plastics divestiture, but I'll attempt to sort it out for you.

First of all, we have taken the expected revenues of our plastics business out of our forecasted revenues figure as the accounting rules dictate. Plastics, while off to a slow start in 2002, did generate revenues in excess of $25 million last fiscal year. Essentially, we're replacing these revenues with six months of revenues from the [Radian] acquisition. We're looking for 25 to $30 million in 2002 revenues from [Radian]'s business for the balance of the year.

In summary, our revised revenues are forecasted at between 410 million and 415 million, or 12 to 14% above our core business revenues of $365 million last year.

Right now, we are looking for 2003 revenue growth of between 5 and 6%, to approximately $435 million without any additional acquisitions.

As you know, we have increased our earnings target for 2002 by between 20 and 25 cents to $2.40 to $2.45 per share, based upon expected net income from continuing operations of 26 million to 26-and-a-half million dollars.

We expect operating margins on our existing business to continue their strong pace, and [Radian] will realize EBITDA margins of approximately 10% this first year. All in all, earnings per share from continuing operations for 2002 will be 40% higher than the prior year.

For 2003, we're predicting that we will generate earnings per share from continuing operations of between $2.64 to $2.70 per share, a 10% advancement over the current year.

Now I will turn the meeting back to Mike. Thank you.

Thanks, Gary.

As you've heard, engineered support is on track for another outstanding year, and we expect to have another strong year in 2003. The climate for midsized diversified defense firms such as ours is excellent. We offer solid revenue growth, predictable visibility, and consistent earning results. But clearly, a lot of hard work goes into expanding and running our defense business day-to-day. With that, I'd like to thank our management and employees for all their many contributions in the past and invite them to continue to grow with us along with our new teammates from [Radian]. Business expansion opportunities abound, both internally and through acquisitions, but engineer support will capture on our support for the future. We will now address any questions our call participants may have.

At this time, if you do have a question, please press star 1 on your touch-tone phone.

Again, to ask a question, please press star 1 on your touch-tone phone. To withdraw any questions, you may press star 2.

You will be announced prior to asking your question.

Steve [Wortman], you may ask your question.

Good afternoon.

Regarding the heavy seg- - the heavy support segment, I mean, those margins are north of 16. Were there any, I guess, profit adjustments or is it just, I mean, going forward you expect to generate similar type of margins there?

Steve, we certainly are seeing some increased margins, especially in the heavy military, due to the maturity of some of those product lines. The [Thunder] line still has several years left on it but we are realizing some great efficiencies on that line. I think this quarter itself is a little higher than we're going to see going forward, but we will see higher operating margins than we have seen historically in the heavy military.

The people especially in our West Plains facility have done a great job in working the contracts down there, and as a result, as I say, we've seen some very significant profit increases.

Okay. And I guess on the flip side of the electronics automation, I think that's where a lot of the revenue shortfall was, can you talk specifically what program caused this and why the margins are down there on a sequential basis?

Steve, I don't think we've got that data in front of us. We usually don't talk about it on a contract-by-contract basis. Some of that is a little bit of mix relative to the timing this year, and it's not a long-term situation that we're going to see continually decreased revenue and margins.

Okay.

But, you know, one of the - one of the contracts and we've talked about it before, is the [High Pock].

Uh-huh.

[High Pock], as we - it was booked originally - when we did the SEI acquisition, it was booked at zero profit and we are now seeing some profit but that has some impact on it, as revenues go up and down in that [High Pock].

Okay. Thanks a lot.

Thanks, Steve.

Michael Bray, you may ask your question.

Good afternoon. I wonder if you could lead me through some arithmetic and explain the difference? If I compare [Radian] increment for 2002 versus 2003, it would appear that there's an incremental 40 to 45 million to be gained by owning it for a full year, yet that 40 to $45 million gain does not show in your top-line expectations.

Can you explain what projects drop out or what declines a little bit next year?

Mike, I think I understand your question.

What's in our - let me go back to the start. What's in our forecast for '02 is 25 to 30 million of revenues for [Radian], okay?

What's roughly in the forecast for next year is about $70 million worth of revenue for [Radian]. This year, we're getting five and a half months, next year we're getting 12 months.

In addition to that, in the '03 forecast, you're seeing a little drop-off in heavy military relative to, as we said before, the M-1000 contract is ending, which shows a drop-off, and we've taken a very conservative approach, which we historically have done in respect to providing any kind of guidance and forecast unless the - you know, the program is pretty much locked in and right there, we're not going to give numbers that we're not going to be able to attain.

Okay.

The other thing I think that's important too is [Radian] - [Radian], we closed this deal a little over two weeks ago and we have a lot of knowledge in [Radian] and so forth, but we're still getting some of the numbers kind of in the right order and so forth. They had a different fiscal year than our fiscal year, and in trance posing some of those numbers isn't a thing that gets did you know a hundred percent in two weeks so we took a very conservative approach on [Radian].

All right. At the margin or operating profit level, are there any of the recently-awarded programs that would be experiencing early-stage or ramp-up margins below the target?

Not that I'm aware of. I don't - I don't think so. We will continue to see some variable in operating margin level based upon the individual program, but there's not any new programs of great consequence that are at a lower profit margin, if that's kind of what you're hinting at.

It was. Okay. Thank you.

Thanks, Mike.

Matt [Copsky], you may ask your question.

Matt [Copsky] with Prudential Securities. Congratulations on another great quarter.

Do you see the cancellation of the crusader program as a trend for future cancellations?

Dan, why don't you speak to that?

Yeah. Matt, quite the contrary. We kind of see it as the forerunner of redirecting certain - those military funds to more appropriate programs. That is, rapid deployment areas, smaller, lighter. That transformation is starting to take place. The cancellation of crusader simply indicates more funding for those operations. You know, those are ESSI's products. We see a bigger emphasis in that area right now. And as you may know also, we weren't a teammate on the crusader program, so . . .

Very good. Thank you. Thanks, Matt.

Uh-huh.

Once again, at this time, if you do have a question, please press star 1 on your touch-tone phone.

Our next question comes from [Solmon] [Accrual]. Sir, you may ask your question.

Thank you. First of all, where are you going to include [Radian] on the income statement? Is that going to go up in the light military equipment?

[Solmon], right now, we presume we will, yes.

Okay. Can you talk about upcoming contract awards? Any new business out there that you see that you might be winning?

I think Dan talked about the potential, [Solmon]. I mean, there's a number of them out there in the queue, you know, that we're competing for which we keep in our realm of possibility. But we never really talk about any contract that we - we would never announce it before we'd announce it generally.

Okay. Can you just sort of give me an update on -

But if you're talking about like the potential, again, Dan, I mean one thing that I don't think you mentioned was that with the cancelling of the crusader contract, the military is showing some serious - toward going rapid deployment, but also they're looking at the missile defense systems expenditures, like something that we've had total control since the beginning of the Minuteman. I mean there's some activity out there.

Right. Mike, we've had the Minuteman environmental control system program on our radar for quite some time. That particular - those systems that are still out there - and a lot of people don't - aren't aware of - are growing older. They were put in back in the '60s and they need to be rehabbed, the controls as well as the actual ECS systems themselves. So we were probably - we are the only company that has done that program, the only existing company that has done that program before. And we look to that opportunity to be one of the big, big jobs that we're looking at in the future. Thanks, Dan.

Okay. Is there any update on the postal business, on the contract that got delayed way back when?

There's been no - no change, [Solmon]. They're still really trying to determine some security measures up there at the postal service. I can tell you that we're in contact with them daily and there are some meetings planned in the future to see where we go from here, but I wouldn't say that there's been a major change in their direction now. They're worried more about security than they are speed of their operation right now.

Okay. And I just wanted to get clarified on the electronics and automation system. Someone had asked about growth - or the operating margins coming into 7.2% from the prior quarter of 9.1.

In the comments going forward, we expect that to rebound or does it seem like it's down here and it stays there? I know you said [High Pock] was involved.

Yes, yes, we - we would anticipate that to come up. And again, as the [High Pock] contract continues to become a smaller portion of that, the overall operating margin will increase. [High Pock] is the only contract in that segment that is of lower profit margins and one of the few within the entire company.

All right. Thank you very much.

Thanks, [Solmon].

Our final question comes from Michael Bray. Sir, you may ask your question.

I wonder if you could comment on the acquisition pipeline. I know [Radian] was obviously one of the higher profile opportunities, yet you had indicated, I think, that the pipeline was full. Is it still full? Is there still likelihood of continuing acquisitions?

Mike, we think it is, yes. There's still a lot of activity going on. We still see a lot of new companies. We have several companies right now that we have a lot of interest in. One of which is very serious. As we told you in the last conference call, we would complete two acquisitions this year, and we still plan on doing that, without exception.

So we - we think it's still good out there.

Balance sheet still in a position to repeat something of [Radian] size?

You mean another acquisition of their size? Certainly. We'd love to be able to do one toward the latter part of the year. We have the debt capacity to still do that, and with the level at which we're generating cash, we would, you know, have the ability toward the latter part of this calendar year to even do more than that, if we wanted to, under our current credit facility. So we certainly are looking at a couple of companies of that magnitude that we have some interest in, and the two acquisitions that we told the street before that we would do, one was [Radian], the other was a little smaller company, and those two, one is done and one we would hope to happen soon. And then we will be looking at another, a little larger, towards the latter part of the this year, similar to [Radian]'s size.

Hi, Mike. Mike Shanahan. I will mention that in getting to know Tim Flescher and his people a little better, you know, they were looking at a number of companies in their own initiative and at our suggestion that fit them and they've brought some new information to the table, so the acquisition front, there's still plenty of opportunities out there, in our opinion.

Okay. Thank you.

Thank you, Mike.

And I guess that completes our question period, so thank you all for being on the call, and we look forward to talking to you at the next quarter.

Thank you. That concludes today's call.