Leonardo DRS Inc (DRS) 2004 Q2 法說會逐字稿

Good morning and welcome to the Engineered Support Systems second quarter earnings release. At this time, all participants are in a listen only mode. After the presentation, we will conduct a question and answer session.

To ask a question at that time, you may press star one. Today's conference is being recorded. If you have any objections, you may disconnect at this time. Your host for today's call is Mr. Michael Shanahan, Chairman. Sir, you may begin.

Thank you, Pat, and good morning, everyone. Thank you for joining us on the call today. Hopefully you have all reviewed our earnings release for the first quarter of fiscal 2004 which was issued early this morning. We hit another milestone this quarter exceeding the $200 million dollar mark in quarterly revenues for the first time in our history which is some 68 percent above the second quarter of last year.

Likewise, earnings from continuing operations of a record 66 cents per diluted share doubled our earnings for this same period last year. The inclusion of our most recent acquisitions, combined with an unprecedented level of organic revenue growth, contributed to the sharp increase in quarterly revenues and profit. This performance has once again given us an opportunity to raise our financial expectations for the current year. We will discuss this upward guidance as well as some of the fundamental forces that shape our Company's prospects in today's call. As customary, joining me on the call today are Jerry Daniels, Vice Chairman and CEO; Jerry Potthoff, our President and Chief Operating Officer; Ron Davis, President, Business Development; and Gary Gerhardt, Engineering Supports Officer, who will now recap the quarter's financial results. Gary.

Thanks, Mike. Before I begin, I'll go ahead and read our standard disclaimer. Statements made during the course of this conference call which are not historical facts are considered forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 as amended and Section 21E 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 of 2004 we generated record net income from continuing operations of $18.3 million or 66 cents per share, compared to 33 cents per share for the same period last year. This was due to a 68 percent increase in quarterly revenues with TAMSCO adding approximately $59 million prior to the elimination of intercompany revenues for this period. Plus very strong internal growth on existing defense programs such as Enstar (ph) Videcu (ph) and other support equipment and electronics programs.

Organically, net revenues advanced by $21.1 million or nearly 17 percent during the quarter, primarily on the strength of our increased manufacturing volume.

While an increased revenue base certainly is a large part of the story, we also saw our brought gross margins improve significantly as well this quarter. We posted a gross margin of 25.4 percent to the second quarter compared to 23.8 percent for the same period last year. This improvement has resulted from increased production volumes programs such as Videcu and generator sets in addition to the favorable impact of the Enstar program with Northrop.

And as production volume has gone up the benefits from our facility rationalization program, Project Leverage, and the ongoing impact of our lean manufacturing initiatives really become apparent in the numbers. Obviously, we're quite pleased with these results but will continue to pursue additional efficiency in cost savings initiatives as we move forward.

Higher gross profit contributions led to markedly increased earnings from continuing operations as SG&A expenses as a percent of revenues were held fairly flat.

It should be noted, however, that we took a non-cash pretax charge of $2.2 million during the quarter, related to the amortization of identifiable intangible assets acquired in the TAMSCO transaction last year. In their analysis our independent valuation experts determined that customer or contractual related intangible assets totaling $29.9 million, which we had previously included as a component of goodwill, existed at the opening balance sheet date for TAMSCO.

These intangibles primarily related future business expected under its various GSA schedule items for telecommunication services and similar work. As such, we recorded a charge to properly reflect the remaining unamortized value of these contracts as of our current April 30, 2004 balance within the excepted 1 year post acquisition window for such items.

So we've worked a catch up entry this quarter to properly reflect the balance sheet at April 30th. Previously, we did not anticipate any such amortization to be required, based upon our interpretation of existing accounting rules. Going forward this non-cash charge will amount to approximately $500,000, 300,000 after-tax on a quarterly basis that will be included as a component of SG&A expenses within the services segment over each of the next 15 years.

As we expected, cash flow from operations turned around nicely in the second quarter, totaling approximately $43 million for the period, bringing year-to-date operating cash flow to nearly $21 million. Due to the temporary investment in working capital experienced in our first quarter operating cash flow had been negative for the first few months of the year.

However, as accounts receivable and progress payments have been collected and certain contractual product deliveries have been made, we've seen positive cash flow results.

Absent any cash being used to fund acquisitions, we expect to have fully repaid our bank indebtedness by year's end.

With a solid track record of excellent financial results and a very positive outlook for the Company, we possess ample flexibility to avail ourselves of adequate capital resources necessary to support future acquisitions or internal investment initiatives, several of which we are currently exploring.

Now I'd like to turn the call over to our CEO, Jerry Daniels.

Thanks, Gary, great job.

Well, another outstanding quarter is in the books, and the rest of the management team and I are obviously pleased by all the positives that we are seeing around the Company.

So as we look to grow this firm well beyond the $1 billion revenue mark, we're certainly not intending to slow the pace at which we've been running for the past several years. With our focus clearly on sustained growth, we've just completed our annual long-range planning process -- our planning conference as we referred to it, internally, for each of our business units.

During the sessions our corporate and divisional management teams collectively reviewed the strategic plans of each of our operating companies over the near- and long-term horizons. This year's theme, Sustaining Growth 2005 and Beyond, centered on developing strategies to capture and retain leading share positions in our existing markets while seeking out complementary areas where we can broaden our addressable market space.

We are working to leverage our solid base of recurring business that forms the foundations for sustained internal revenue growth throughout our systems and services business units.

During the planning conferences, we also challenged our operating units to develop strategies for pursuing suitable bolt on acquisition candidates in both product and service areas that could be incorporated into their existing organizations. These targets of opportunity may involve emerging technologies, lease manufacturing products, or unique service areas that will supplement our capabilities and address an access to markets throughout the organization.

Synergistic acquisitions have been a large part of our success and that will not diminish going forward.

Shifting gears a bit, we understand that both the Senate and House Arm Services Committees have recently completed their respective markups of the President's $400 billion plus 2005 DOD budget request.

While few of our programs comprise actual budget line items, we have seen significant suggested plus ups in many areas that will directly affect the funding from many of our products and services. It's no surprise that the uparmoring of military vehicles has received strong support by Congress and as a result we expect to see additional orders for our FMTV uparmoring program in 2005.

The Air Force bear based expeditionary forces and the Army Force provider activities will certainly be well funded with the ongoing hostilities in Iraq and Afghanistan. This will of course positively impact many of our environmental control, power generation, and fuel and water distribution programs.

Today much of our business is derived from O&M funding for logistics services, engineering, spare parts, communications, and the like. Obviously this type of spending is difficult to pin down, but we believe that overriding factors such as government outsourcing and high military operating tempo (ph) will continue to drive O&M spending increases for the foreseeable future.

However, the President's baselined 2005 DOD budget excludes any supplemental funding required for more operations. A supplemental spending bill will undoubtedly be enacted by the end of the year. Already a request for $25 billion has been submitted to Congress which many believe may just represent the beginning of what will be necessary to support the war cost.

We suspect that much of the support equipment of reset (ph) activities will end up getting funded through the supplemental spending bills although, due to their nature, we currently lack the visibility into the timing or amount of these requirements to include them in any revenue forecast.

Against this backdrop, we remain confident that moderate organic growth is a valid, achievable, and sustainable goal for our Company. Without question, we are in a period of heightened military activities with ongoing operations in Iraq and Afghanistan. And we may very likely be engaged in these conflicts for an extended period.

Although there is still much uncertainty surrounding the length and extent of these particular missions, we believe that America's leading position in the continuing war on terror, how that (indiscernible) in the ongoing level of U.S. military presence involved once new governments are installed, will have been an enduring impact on the Company and its prospects for sustained organic growth.

Further, the ongoing changes in military basing location throughout Europe present additional growth avenues products for ESSI products and services as well. Along these lines Jerry Potthoff will now discuss a few of the more significant current anticipated program opportunities that we are currently involved with. Jerry.

Thanks, Jerry, and good morning, folks. Once again we booked a record level of entered orders, totaling nearly 284 million. This figure is roughly equivalent to the orders we saw in the January quarter and brings entered orders for the first half of the year to 567 million.

We now believe the orders will easily surpass the $800 million dollar level for 2004. We have of course seen additional business, resulting from the current military deployments in Afghanistan and Iraq and we expect this trend to persist for some time.

How long will these spending levels last?

Obviously that is very difficult to surmise but, with the Pentagon committed to maintaining a force in excess of 100,000 troops in Iraq through at least 2006, we anticipate robust demand for our support equipment and logistics services as we aid these operations. However, we should point out that the overall success of Engineered Support Systems business model and strategic direction does not hinge upon extended deployments involving tens of thousands of troops, such as in Iraq. The underlying companies comprising the ESSI family today were all doing quite well long before Operation Iraqi Freedom commenced last year.

Military transformation initiatives, the doctrine of rapid deployment and our solid positioning and niche defense markets are the hallmarks of our success. Although major deployment such as Iraq certainly boosts our numbers from time to time, as equipment is consumed in battle and operational tempo increases, they are not necessary for ESSI to be successful long term. We are a well-positioned, capabilities-driven organization that will endure and be successful over the long haul.

Along these lines, I'd like to now provide a brief update of some of the developing new opportunities that we spoke about during last quarter's earnings call that may have both an immediate and a long-term impact on our business.

In February, we noted that there were -- that we were pursuing a major opportunity involving the up-armoring of U.S. Army vehicles for use in Iraq. In what has truly been a major breakthrough into a new market opportunity for the Company our Radian subsidiary has received funding in excess of 30 million so far to provide 773 bolt on up-armor kits for the Army's Family of Medium Tactical Vehicles. Just in the last few months these Radian-designed armor kits have already proven their worth in two separate Incidents, wherein up-armored FMTVs were hit with explosive devices used by insurgents in Iraq but the crew members emerged unharmed.

Needless to say we're quite proud of helping to save those soldiers' lives.

The overall requirement for this application as we understand it involves some 1100 vehicles. A sizable upside possibility. We are hopeful of securing funding for a portion or all of the remainder of these kits over the next year or so. Our SEI West Plains MO operation has been manufacturing the armor kits and obtaining the ballistics steel components earlier this month.

We are excited about our involvement in this important project and hope to leverage our expertise and experiences here to gain additional related opportunities down the road.

We continue to refurbish M1000 trailers, under the $11 million trailer reset contract received back in January as trailers returned from their extended deployment in Iraq. Work will accelerate as additional trailers become available and are returned stateside. Our initial work involves 72 trailers but there are well over 1000 of these units deployed overseas, receiving very heavy usage.

So we expect significant follow-on opportunities. We continue to pursue various equipment reset opportunities for environment control units, fuel and water systems and generator sets that could lead to new work exceeding 100 million and potential contract values over the near- to intermediate term as units are recycled in and out of theater.

We've seen sizable increases in our spare and replacement parts business for these types of systems and, as additional supplemental spending bills are approved by Congress, we expect to see other requirements emerge. Typically for these types of projects you don't see much momentum until funds become available to spend.

TAMSCO's satellite telecommunications support work is going full speed with significantly expanded activity, related to Army operations in Iraq and Afghanistan. Opportunities in this area continue to grow as we're helping to provide much-needed bandwidth to the Army logistics community in support of combat operations. Their work with the coalition provisional authority in Baghdad and various U.S. allies in the region show great promise.

We have recently submitted our proposal for the Amps (ph) program with the U.S. Army. This competitive solicitation involves the development and manufacture of next generation of mobile power systems for the military. This estimated $500 million plus program calls for development activities to occur over at least a two-year period with multi-year production to follow.

Our Fermont subsidiary in Connecticut is taking the lead on this effort and is being assisted by our most recent acquisitions, Pivotal Power, which is leveraging its experience in power conversion technology. We're quite hopeful of receiving an initial development contract on Amps later this year when (indiscernible) announced.

We're working these and many more opportunities throughout the Company as we strengthen our leading positions in the market we serve by also also seeking to expand our product and service offerings to additional government customers.

Now back to Jerry who will wrap up our remarks.

Thanks, Jerry. I'd like to conclude our remarks by commenting on our revised earnings forecast that is included in our release earlier this morning. We're very pleased to be able to once again raise our revenue and earnings expectations for 2004.

Obviously, our business is growing at a rapid pace fueled by U.S. military activity and our leading market position, providing logistics and support equipment. What we offer directly matches with today's military needs.

And as our fortunes increasingly transform themselves to a more mobile, deployable, and sustainable fighting force, Engineered Supports business prospects will only strengthen as we move forward.

Last quarter we increased revenue and earnings guidance on the strength of recorded results and a solid outlook for the remaining quarters. As you can see from the results recorded today, we far outpaced those expectations that are once again in the enviable position of guiding upwards for the year.

With over $400 million in revenue reported for the first six months, with two more solid quarters anticipated, we now expect revenues to approximate $840 million for the full year. This is up some $90 million to $100 million from what we first forecast for 2004 back in December.

True, some of our services' revenue growth has been at comparatively lower margins as in the case of additional buildings on TAMSCO's R2 and telecommunications contracts so the business mix is adversely affected reported operating margins to a small degree. Despite the slight vertibation (ph), we are also raising our 2004 earnings guidance by 15 cents per diluted share to the $2.65 to $2.70 level.

Clearly, 2004 will be an outstanding year for Engineered Support Systems. And with such accelerated growth and great performance presents our team with a challenge to continue to deliver these exceptional results, year after year. With the many emerging business opportunities that we noted above, another six months of entered orders activity remaining in the year and supplemental spending bills looming on the horizon, we believe that it would be premature to provide revenue and earnings guidance for the upcoming year at this time.

There is just too much uncertainty, albeit predominantly positive in our view to lay out such a forecast with any degree of reliability. We will likely announce our first cut at a 2005 forecast in conjunction with our third quarter earnings release in August, which is consistent with the timing we'd used in previous years.

What I can affirm to our shareholders at this time, however, is our sincere commitment to deliver on their expectations that we will meet our long-term goal to deliver annual net income growth of 20 percent per year.

Now we would be glad to entertain any questions that our call participants may have.

(OPERATOR INSTRUCTIONS)

David Gremmels, Thomas Weisel Partners.

My question's on Enstar. Wondering if you can tell us how much revenue was contributed by Enstar in the quarter and year ago and just in general how is that Air Force production contract progressing?

Hold on, David, we're scrambling through pages.

Second quarter, David, 22.9 million in revenue. Year-to-date 38.5 and year -- did you mention last year there would have been -- in what's in last year -- I'm not sure we've got that number of front of us here. It would be less than that obviously, let's see, hold on here.

David I don't think we've got that number in here as far as last year of that was part of your question.

We can get that for you after the call David if you want to give Dan a ring.

Sure and just how the Air Force production contract is progressing in general?

Very successful, David. We're on a schedule delivering to all requirements so we think it's a continued great success.

And I think that that current Enstar contract with the Air Force completes in the current fiscal year. Can you comment on prospects for additional Enstar opportunities behind that?

I don't think we can put lit at this juncture specific numbers to them, David, but we have a significant number of opportunities whether they be domestic our international. We talked a little bit about that last quarter and there continues to be extended and expanded interest in that product because it's fits so many different applications based on all the technology upgrades that we provided over the last two years. So don't have numbers. We will have that in a little better focus, looking forward, as we get together with you a quarter from now. But we're very enthusiastic about the potential.

Okay, great and on TAMSCO -- you gave TAMSCO revenue for the quarter of 59 million. In the past, you've given operating income of breakout for TAMSCO as well -- can you give us the TAMSCO operating income contribution either with or without the charge for the quarter?

Yeah, David, just a suggestion maybe in some of these detail questions we might get on a separate conversation, going through the individual items on the income statement I think is probably not the real purpose here. I'm not sure we've got it here broken out very easily, David. Why don't we give you a callback in a minute and give you all the details of that.

Okay, well, just asking a different question. If you, excluding the charge with TAMSCO, margins have been up or down from previous quarters.

Kind of in the range, we've done a lot of analysis relative to that, obviously, there was a $2.2 million onetime charge. That charge will continue at a lower rate going forward which had a significant impact not only in profitability of the Systems group but also in TAMSCO itself. So you take that out they're in the range of what they've done historically and there's -- some of that is varied a little bit by virtue of TAMSCO. The amount of business that's run through the R2 and the FAS (ph) contracts in some of that lower margin business and that has a positive impact on revenue and on profitability. But it is not a real high profit there and we will therefore have some amount of dilution and percentage but will increase the dollars in total.

So given that the services margins seem to be somewhat correlated with the amount of pass through revenue on the R2 and the FAS (ph) contracts. I guess my question is, what is your new guidance assuming? Do we see services margins return to the 8 to 9 percent range? Or are they kind of going to stay down towards the mid single digit range?

They will be in the mid single digit range going forward, yes, mid to upper single digit range going forward, yes.

Seth Tutis with Sidoti.

Just given the guidances increase for fiscal '04 on revenue and EPS is, I think in the past you've mentioned about a $75 million target for free cash flow for the year. Is that also going to increase, do you suspect?

Free cash flow will probably be north of 80 for '04.

Okay. Just a quick housekeeping item on -- what was CapEx for Q2? It might have been in the release and I missed it.

Held on just a second here. (MULTIPLE SPEAKERS) wasn't in the release (MULTIPLE SPEAKERS) we got all the numbers here.

But there's no significant change in our CapEx from what we discussed earlier. We're sticking to the same general plan.

I think it's -- max, it's probably under 3.

Okay that's fine. And when you look at the new orders of 283 million in change, you've mentioned services in the release have been strong, a large component of that but where else are you seeing strength, specifically, what units whether it be environmental control? Can you just talk to that a bit?

Sure. I think, Seth, that if you think of our business from East to West I don't know there is an exception relative to where we really haven't seen in strength. We really don't have any omissions. Our generation equipment, for example, as you can appreciate is seeing a big surge in spares requirements, as well as requirements for new generation sets. Our environment control systems. Our air-conditioning systems. Really just across the board. Obviously, our communications equipment, as I discussed with you earlier in our comments, is seeing a lot of interest and that will pick up. When you think about the fact that we're just getting launched with a coalition provisional authority with significant partners like Raytheon and SAIC (ph), we obviously are encouraged with that. Where we've been talking over the last few years about things that are going to be with us for the long term and Ron Davis and I were just discussing that this morning something, Seth, that we talked about three years ago is just now starting to see funding, that's the Minute Man program. Where we're doing the next generation of environment control. We are beginning to see new activity on the next generation of our chemical and biological protective system because it's a lot of activity in theater. And so we're going to see some increased activity there in new orders. We're looking at in our SEI division, finally getting to the point where we will get funding to do a next generation of our night system which is the target acquisition and surveillance system where we are going to bring them the man down into the vehicle from the mount, consistent with the threat that they're now experiencing. We're seeing expanded opportunities for our depot level work.

As you know we launched ESSIbuy.com a few years ago and it's just beginning to see, really, some of its initial hits to support the various depots that the military has.

We're partnering with those people in such a way that we're taking significant time and money out of their supply chain management system. We just recently provided a proposal for what they refer to as a load handling modular fuel farm which is $100 to $200 million program. So --

I could ramble on and on. We really have a lot of opportunity in all of our business segments and, obviously, we're very enthusiastic about that.

Okay great. And just one last thing and I will get back in queue. It seems like if you back out Enstar as that ramps down later by the end of the year, are we seeing just a higher sustainable run rate in terms of revenue? Or is this -- it seems like that. Can you confirm that or maybe talk about how much of a surge we've seen just from the military deployment?

I'll take a shot at it and then Gary and Jerry and Ron Davis, who is a master at understanding the marketplace can join in, Seth. But relative to a run rate and a surge requirement as I said in our comments earlier, we are not dependent upon surge and/or those activities associated directly with what is going on today in Iraq and Afghanistan.

As those conflicts wind down, which they inevitably will, there's a tremendous need for all the equipment to be reset and replenished. Concurrent with that, our military is now establishing new beachheads around the world that they haven't had previously. We will be involved in that. We will provide all the sustainment and infrastructure kinds of things that they need for that.

So, whereas, there is certainly a certain amount of surge associated with our current business, for the foreseeable future, we really anticipate a continuation.

(indiscernible) Jerry let me just take a cut at it. It's getting harder and harder to separate what is quote "a surge from this conflict" and what is a longer sustainable business. Because the whole temple of defense spending has remained high and even if this conflict were to end tomorrow and the troops come home don't forget there's going to be a tail on the end of this thing to get the military back to the readiness conditions that they need, that will have an impact. So it's getting harder and harder. I think we clearly know even if the troops were to leave tomorrow, my belief is we will see two years at least of increased spending.

One of the reasons why it's hard for us as we said in the release we typically are not a separate line item in anybody's budget. We are -- about a third of our thing is in operation and maintenance or O&M money, about two-thirds of procurement but we're buried in broad lines.

So it's hard to nail down. They're spending on what they need and we're not trying to avoid it, it is just hard to measure. But I think, overall, the business we got some great people out there that are just doing a great job of going out and winning business for us.

Hey Seth, are you still there?

Yes.

Just as a final to you, we don't have it by quarter but the first six months CapEx is 4.1 million. Okay?

All right. Thank you.

And for David -- this is Jerry Potthoff. For David's question, the input that we have for Enstar looking forward as a forecast in '05 of 25 plus million. Yes and that as I said earlier, we have really a lot of interest particularly some in international markets.

Herb Tinger with Advest.

Jerry, you committed briefly on the M1000 trailer refurbishment that's ongoing now? Could you maybe tell us a little bit about how far along those first units are in the process?

Actually if I recall we generated revenue of approximately 3 million plus for the past quarter, Herb. So we're really just getting started on that and the supply system if you will of those units it needs some time to get put in place so that the military can get those units out of the theater and back to us. And so we're just really getting into the early stages of that activity and I know the guys are talking as we speak today with our customers about add-ons to that particular activity.

Okay and I know a month or so ago, you guys had talked about you were doing some early work on assessing what might need to be done to a number of heaters that were brought back from overseas and bring them back up to sort of an original condition. (MULTIPLE SPEAKERS) (indiscernible) how that program (MULTIPLE SPEAKERS)

Excuse me, Herb, we've been in the process of doing that from last few months very successfully. Matter of fact, we're doing some of that work as part of our ESSI (ph) operation; we're doing some of that work as part of our Keco operation. So yes we're in the middle of that right now, doing some of that refurbishment.

Okay and last question regarding the Amps pending contract award. Is that something that might be awarded late this fiscal year or late in the calendar year?

The customers' commitment is that that would be defined and the award made by the end of our fiscal year. And the reason for that is that if they don't in the military business they could potentially lose some of the funding. So we really expect even though they suggest now, August, that it may not be August but we certainly expect to hear by the end of our fiscal year which is at the end of September being the end of the military's fiscal year. So --

Jerry, you might explain, though, the long-term and the phased nature of that program.

It is a long-term program depending upon how you look at certainly our T2G (ph), our current series of generators started out as being applied to seven-year program. And they may line up to be a 10- to 15-year program. And the Amps which really is next generation, the development phase would be two years; and then you get into a phase production. And at this juncture I think they're talking about it being a 10-year tenure program. But if we look at, historically, what's happened, that 10 year could be a 15- to 20-year program.

But we've really -- I think our production revenues somebody correct me if I'm wrong here, I don't think we see production revenues on that program before '08? Is that the right number?

So, Herb, the period between now and then is in competitive development. There will be two or three winners and then they will down select into a sort of full development program and then, finally, a production program. So real production is about '08.

Thanks for the additional color. Nice job, guys.

Eric Hugel with Stephens Inc.

Great quarter. My first question. You're raising your guidance by about $60 million on your revenue side, just sort of rough order of magnitude here, I was -- you beat my number by about 15 million. So let's just say for the back half of the year you're raising revenue by about 45 million. I guess what I am trying to figure out is, is this just sort of your win rate is coming in faster than you expected? Are there additional orders that you hadn't factored in or is there one large order you've gotten that sort of accounts for a chunk of that?

There's -- it's some of all of the above. The up-armor business is was that type of victory win that we got that brings revenue right now and that's included in there but as I think Jerry Potthoff, Eric, said earlier it's really across every one of our units. They are just -- they're doing a great job of getting out there and winning business. So it's spread all over the place but, probably, if you wanted to pick out a single piece it's the up-armor that is driving it.

Okay. Can we delve a little more? I think Dave tried to allude to it but looking at the services margin, even if you add back the $2.2 million write off, it looks like operating margins in that business were about 4 1/2 percent. I mean, my thought on sort of the pass-through type of work that TAMSCO does, that's about a 6 percent margin business. So I'm trying to figure out why margins were so low in the quarter?

Well, remember that in the services end of the business there's TAMSCO, there's Radian and then there's ESSIbuy. A change as far as the second quarter that was significant was a decrease in revenues on the DPGDS program, remember the large generator set. They were off by about $10 million from the first quarter, off about $10 million from what we anticipate being the run rate for the remaining portion of the year at least. And that's a very profitable program and, therefore, had a significant impact on lowering the overall margins within that sector.

The average margins that we've always talked about in that group have been, yes, in the low to or in the mid single digits, yeah, 7 percent somewhere in that range is a good number going forward. It will vary considerably by virtue of ignoring the one-time amortization which certainly had a significant impact but throwing that out it will vary quarter to quarter based upon DPGDS business as that is a very high profit thing which can bring that up to actually to touch into two digits. And the amount of business that goes through the FAS contract and the R2 contracts, which are marginal as far as they're low and as far as margins. And they do again impact revenue. And they impact profits. It's positive. It's good business. But that can have a fairly significant delta on those each quarter and, therefore, lower that percentage.

I don't mean to make a long story on it sometimes it's a little hard to get a good projection on that profit percentage going on based upon that impact in the R2 and the FAS contract. And, again, driven very heavily by the DPGDS.

Rest of the business is fairly constant and fairly consistent, relative to margins across the board.

Is that not a good way to sort of think about it, sort of like the pass through stuff that TAMSCO does? Like they get an order for a radar or something like that and they go to Raytheon? Is that not like a 6 percent business?

It varies -- (MULTIPLE SPEAKERS)

It can be all over.

Eric I think -- this is Jerry. If you drop that and just look at the macro view of this thing, I mean, in general, those services business are going to stick to the same margins we've always discussed there. We are -- what we're really seeing is of the great growth that we've had, we're getting more growth in the services side than we are on the systems side. And as Gary mentioned, we had revenue down a little bit below our expectations on DPGDS, which is in the services side. But brings hardware type margins. But if you look -- jump to the end of the year, we're still going to be right around that 9 percent net income margins.

It will jump back up because, again, there's going to be a significant amount of DPGDS revenues in the third and fourth quarter.

(MULTIPLE SPEAKERS)

Yes so we will pick up those two at the end.

Remember we told the story before out there relative to it's a little bit of a sequence, DPGDS, we get the orders as you saw in February, March. So then the revenue and the billing of the units and the revenue then happens toward the end of the third quarter, heavily into the first quarter and it inflows, some of it a little bit into the first quarter of the following year. So there's not a lot of activities. Second quarter's the worst quarter for DPGDS just because of the order flow year in year out.

Eric, one other thought on that. Let's not forget that that whereas that pass-through business is low margin, much of it is passed through to our other divisions. They build product from those contracts. And they achieved excellent margins.

So if you were to provide those contributions back to the services business, I think you'd see a much better picture. And net net for us strategically very important -- those past two contracts are some of those contracts that we have to work with around the corporation. And for that matter, within our customer base.

I guess my final question regards the cash flow. Great cash flow during the quarter. Was there -- just in the quarter was there an acceleration out of sort of the back half of the year? Were you able to pull things forward because for my understanding the fourth quarter was going to be this blow out quarter as you got paid for most of Enstar and stuff like that. Just only to do 80 million. Looks like 80 million would be pretty conservative if you sort of keep that thought going.

Well I'm not allowed to use the term conservative on the telephone here so setting that aside, Eric, we will have strong third and fourth quarters. Not too much was really quote unquote "pulled up". It's just a turnaround of the working capital investment in the first quarter a lot of Enstar, some other programs that didn't have progress payments that turned around as far as deliveries happening and, therefore, kind of cashing in on the things and so forth. So you'll still see strong third and fourth quarters and there's a lot of Enstar business. I think so far we've done in the first two quarters about $32 million worth of revenue on Enstar so there's another $30 million out there yet to come. And that to the cash flow is probably 30 days behind the revenue. But other than that it's linear. So you can see there's still some significant numbers out there.

Chris Donaghey with SunTrust Robertson Humphrey.

Great quarter. Question for you on the Iraq reset opportunity. I know in the past you had talked about that being potentially a $200 million type of opportunity. And two questions related to that where do you think that stands right now? And how much would you say have you recognized against into the operations in Iraq and Afghanistan?

I think the opportunity continues to exist but probably dependent upon what timeframe you want to define, Chris, probably greater. What we have learned, though, is that the military is so busy in addressing the immediate needs of our folks in theater that they delayed some of the reset activity that we might have expected. It's just below a little more difficult to transplant. It's a little bit like the M1000 trailer. It requires that full cycle of getting that product out of theater and getting in a position where you can do the reset.

But as we said in the past, if we frame that as a $200 million opportunity, I think we believe, potentially, it's greater than that now.

Okay and then, how much have you -- do you think you've recognized as a result of -- ?

Well they actually recognized very little but as we said, so far as I mentioned, we did somewhere between $3 and $4 million worth of reset activity on the M1000 trailer in our past quarter. Beyond that, if you want to call spares some of our spares business certainly is reset in the widest of definition. Maybe add a few million dollars to that.

Right now, Chris, that's probably the limit of the real revenue activity we've had with reset.

Okay and second question. From an acquisition standpoint, with the organic growth being so strong in fiscal 2004, does that make you more careful at looking at acquisition opportunities? Does it slow things down? Has your mindset changed given the strength in the organic business?

No, not at all, Chris. We're still very active looking at acquisition opportunities. We're -- no, our mindset hasn't changed one iota. We will make good solid acquisitions as they become available and they set our business.

Selman Akyol with Stifel Nicolaus.

Congratulations on a nice quarter. Couple of questions. First of all if we could just start on the G&A line. If you back out what I'm presuming is where you took the 2.2 million charge would get you down to roughly a run right of 21.1 million. And I'm wondering that looked a little high to me. Is there anything going on there especially up from the prior quarter?

Selman, I can't think of anything off the top of my head as far as that -- there's -- we're continuing to invest in our future through IRAD. That's been a very high initiative over the last say a year or something like that. I would have to look at some of those accounts. That's a tough number to pick out on an individual quarter even down to sometimes as far as the number of days in the quarter will vary a little bit but there's nothing else significant that has impacted out there and so forth.

Okay.

I think, Selman, looking at it as part of a growth business where we have many opportunities to invest I certainly don't think the SG&A is out of line.

Yes I was just pulling the numbers off here. About 20 million 21 million in this second quarter throwing it without the amortization. And could say some amount of growth there just relative to the amount of business that we are doing, that people that are on the payroll to support some of that business that actually end up in SG&A so in general, nothing different. We're still have a strong control over those costs and don't anticipate any kind of significant growth, long term, outside of how revenue grows.

Gotcha. And then, any further color on sort of the satellite telecommunications work that you're during and how long is that expected to stay strong?

Our expert on that is Nick Enterbickler (ph) and David Guston (ph) that run the TAMSCO business. And I think each time we talk to them, they believe that the opportunities are expanding. Maybe you start out -- if you go back three, four years ago when Nick started that, I think they believed that it was somewhat of a niche. Five- to 6-year business. I think more recently when we recognized how effective bandwidth on demand is and the recognition that it does not compete with large networked bandwidth operations, it really has an opportunity to stay around for a long time.

Further, we've taken that technology and began to look at some other semi-military applications, government applications that we think have promise. Not in a position to talk specifics but it's an excellent technology that they've developed. And so, legwise, we think it's here for quite some time and the activity that they've just started recently with Radian and SAIC with the coalition group is probably as we see it 5 to 6 years. The model that those fellas used was a model that they used to support Kosovo. And that program lasted about 8 years.

Matter of fact, I think there's still some support going on there as we speak, of the activity in Kosovo.

Fantastic and then last question. Going back to Amps. Can you just give a little color on sort of the competitive profile you see out there? Who you think you're going to be competing against on that?

Well, we certainly couldn't talk about our competitors. But I can tell you this, that we're very bullish because between our Fermont Company which is taking the lead and really three or four other companies within our group that included as I mentioned (indiscernible), that's in the process of developing the Inverter technology. We think we've got a very, very strong team. Because of the size of the opportunities, certainly, we've got some formidable competition. But I think it would be at this juncture not correct to talk about those folks, Selman. Because we just submitted the proposal.

Yes kind of speculating Selman, but we don't know really how many of them show and really end up bidding.

Okay, thank you. Congratulations again.

Robert Winslow with Harris Partners.

I'd like to revisit the Enstar briefly, if I may. So far indicated delivered on about 38 million year-to-date on the Enstar. Would that put you at about halfway through the Northrop Grumman contract?

Yes, roughly. I think the total contract was about 16 (ph) million so that would mean we're probably a little over halfway through.

Yes, Gary just said there may be some other deliveries in there that are not part of the Northrop contracts, so roughly, halfway through (MULTIPLE SPEAKERS) yeah, about halfway through.

And the 25 or so million forecast for 2005. Would that be extension of the Northrop Grumman or would that be all the other potential -- ?

Primarily. You know, as is our practice, we don't put into our most probable forecast. International opportunities are very difficult to predict. Timing is tough. But we have a lot of interest there. In answer to your question directly, yes, it's primarily follow on for the Northrop program.

Okay and then the final thing, I guess, would be you indicated in late March that the Army was looking at the Enstar for its perimeter intrusion detection system. I was wondering if you could give us an update on how that is progressing. And then further to that, what we might expect, in the length of time, due diligence the Army might undertake before they would pursue potential follow-on business?

Well, it continues to go through review, Robert, and you know, if you track these kinds of things, historically, you're probably talking three to five months just picking a number. That would be required for them to complete their analysis. I think, again, the Army's immediate needs as to really support existing troops that we've got in place and these kinds of considerations where I really believe they're real for the future I don't know that that is the No. 1 priority. Live interest, continued evaluation, probably three to six months before we see anything.

Thank you very much.

Eric Hugel, with Stephens Inc.

Just follow-up questions. With the cost of material mainly steel sort of on the rise, have you guys seen any impact in your business?

Very limited and where we have seen it, we've got professionals that have been working, securing existing price levels.

We use a lot of aluminum in a lot of the products. Number 1. Number 2, the contracts that do use a significant amount of steel are either like Tonner (ph) has a look back provision relative to cost so yeah, you basically don't get hurt there. You share in the savings. So you don't give as much back to the government but at the same time you get your costs covered. The up-armor is negotiated procurement. So that's based upon some pretty good cost data going in and, therefore, we would not be hurt in that. So as of to date, we really have not seen, Eric, any kind of significant impact resulting from the significant steel price increases out there.

I know this is sort of a tough one to answer. But with all the talk of increasing troop levels, I guess they're talking about maybe 30,000 troops in the Army and another 9,000 Marines over the next three years. Have you guys sort of looked at what that would mean in terms of just all the infrastructure support equipment that they would need to support such an additional force and what that could mean for you potentially?

Eric, only in sort of a very broad sense. Because the thing that you just mentioned, the -- actually the restructuring of the -- in the Army and the brigade structure versus the division structure also puts upward pressure on many of the things we make and do. But we, really, we just don't know of any way to quantify that. So we keep looking at these sort of trends. And they're all positive for our business but we honestly don't know how to quantify them. And you're seeing part of that quarter to quarter as we see these trends are forcing things up and partially the surprises are all in the right traction.

We know this, Eric, that they don't leave home without us.

Exactly. Good point.

One last question with regard to expansion of options and all that fun stuff. I guess, sort of accounting rules and all that stuff going forward, sort of, what are your thoughts on the use of options going forward into next year?

Well, let's see, it's been a big part -- we think it's a big part of our success. Has been great for the shareholders and we're waiting until there's something definitive said here. Gary, you wanna?

Right now I think we're scheduled that the impact will be first quarter of '06. Certainly the method that seems to be surfacing, we don't really agree with and I don't think very many people agree with. So we will have to appraise it when it comes out as far as how it has impact on us and whether it makes sense in compensation or not. I think on a note is, an investor out there I think, unfortunately, we're all going and hurting some of the things, the positive things that are happening in the market because we are encouraging companies to not have their key executives involved in the company. We're encouraging them to not be investors themselves and I think that's a sad tone for all of us relative to it.

So, we will continue to look at it and we'll see how it impacts and so forth. We're not going to continue to do things that has a significant negative impact on employees -- and I mean on earnings -- and we have involved a lot of employees down to a lower level with that and that's been part of our success. And we think people have helped us grow by virtue of those existing. So long answer but hate to see it (indiscernible) it's not going to hurt or impact negatively our growth in earnings going forward. We'll continue to do what we told you we would do before and we'll continue to get there.

Okay, just one quick one. Enstar you said you were about halfway through with the Northrop contract. Now, that contract -- the deliveries-- you're pretty much done with deliveries at the end of third quarter, right?

Yes. It's pretty -- it's scheduled right now. There may be a little bit but most of the revenue will be recognized through third quarter. There may be some falling in the fourth quarter. Cash will be -- some of that will fall into fourth quarter.

, Okay, thanks, guys.

Thank you. That does conclude today's question-and-answer session. Now I would like to turn it back over to Michael Shanahan.

Thank you all for being on the call today (technical difficulty). That's not me, folks. I was just walking through here. I just want to say one thing as we wrap up and that's thanks to all of our 3,000 employees, all the guys here in the room, and all the management team for once again producing some great great numbers and we will continue to do it. Thank you.