Leonardo DRS Inc (DRS) 2004 Q3 法說會逐字稿

Thank you for standing by. Today's teleconference is ready to begin. Good morning, good afternoon and thank you for standing by for the third-quarter earnings release teleconference. At this time, all participants are in a listen-only mode. After today's presentation, we will conduct a formal question-and-answer session. (OPERATOR INSTRUCTIONS). Today's conference is being recorded. If you have any objections to being recorded, you may disconnect this time. I would now like to turn the meeting over to today's host, Mr. Michael Shanahan. Sir, you may begin your call.

Thank you, Ed, and good morning, everyone. Thank you for joining us on our call today. Hopefully, you all had a chance to review our earnings release for the third quarter of fiscal 2004, which was issued earlier this morning.

Once again this quarter, we have posted record revenues and earnings and are well on our way to an outstanding 2004. Quarterly revenues of $222 million were 43 percent above the same period last year, while earnings grew to 73 cents per diluted share, or 76 cents per diluted share excluding losses on asset dispositions. Strong organic revenue growth from existing and more recently acquired businesses were largely responsible for our record performance.

Based on the third quarter's result and a bright outlook for the fourth quarter, we expect to achieve our targeted revenue forecast of $840 million for fiscal 2004 and to generate diluted earnings per share, excluding charges related to facilities sales, of $2.65 to $2.70 per share. On the heels of an outstanding 2004, we see that 2005 looks quite positive as well. We expect to have solid, organic revenue growth in 2005 of between 8 and 10 percent. Earnings expectations call for earnings per share of around $3 for next year. We will discuss 2005 in more detail later during today's call.

Before we get into the financials, I'd like to make a brief comment on the management changes we've recently announced at the Company. First off, I'd like to express my sincere appreciation to Gerry Potthoff in his decision to accept the additional responsibilities of being our Chief Executive Officer. Gerry has been a key member of our top management team since we formally (indiscernible) of the Chairman five years ago. As President and Chief Operating Officer, Gerry and his team have managed the Company's day-to-day operations very successfully during a period of rapid growth, and I believe that with his continued guidance our shareholders, customers and employees will be well served.

I do not plan to belabor the factors surrounding Jerry Daniels' recent decision to resign his position and retire. We understand that this development may have created some level of uncertainty among the investment community but as I have stated repeatedly, his departure was in no way related to the state of the Company's financials, operations, or future business prospects. I believe that our strong financial results reported today and our optimism about the future will make this fact obvious. It was simply a personal decision. We wish him well in his future endeavors.

Now, joining me on the call today are Gerry Potthoff and Gary Gerhardt, our Chief Financial Officer, who will now briefly recap the quarter's financial results. Gary?

Thanks, Mike. Before I begin, I will 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 27-A of the Securities Act of 1933 as amended and Section 21-E of the Securities Exchange Act of 1934, as amended, and are intended to be covered by the Safe Harbor provisions created thereby.

For the third quarter of 2004, we generated record net income from continuing operations of $20.5 million, or 73 cents per share, compared to 48 cents per share for the same period last year. Excluding losses realized upon the sale of our idled (indiscernible) and Sanford facilities during the quarter, diluted earnings per share totaled 76 cents.

The current quarter's results benefited from a 43 percent increase in quarterly revenues compared to last year. We saw outstanding organic growth of some 39 percent during the period with both our Systems and Services segments contributing nicely. The quarter included sizable revenue gains on several existing defense programs such as MSTAR, M1000 refurbishment and vehicle uparmor work as well as continued demand for telecommunication services, security projects and various support equipment and electronics programs.

Overall, gross margins improved to 25.6 percent for the third quarter, compared to 24.5 percent for the same period last year. Manufacturing margins continued to be robust for all our support systems operations, due to increased production volumes and the favorable impact of new programs.

Higher gross profit contribution led to markedly increased earnings from continuing operations, as SG&A expenses as a percent of revenues came in below 10 percent, an improvement from last year. Cash flow from operations so far in 2004 of $19 million will improve significantly in the fourth quarter.

Through the first nine months of 2004, we continued to expect a temporary increase in working capital related to our overall business growth, but upon the completion of the $58 million MSTAR program with Northrop this month, we will see a significant amount of cash receipts in the fourth quarter that will end the year on a very high note. We anticipate that working capital levels will diminish to more normal levels by fiscal year end to achieve our cash flow target of approximately $80 million for 2004. Regardless, we continue to expect that, absent any cash being used to fund acquisitions, we expect to have fully repaid our bank indebtedness by year end and have cash on the balance sheet.

With three quarters in the books, we are on target to finish the year with revenues of approximately $840 million, compared to $573 million last year, an increase of 47 percent. Diluted earnings per share for fiscal 2004 of between $2.65 and $2.70 include certain cash and non-cash charges for severance associated with the resignation of our former CEO totaling $3.1 million on an after-tax basis, or 11 cents per diluted share. These non-recurring costs were incurred and recorded in the fourth quarter of 2004. Of this amount, $2.6 million represents a non-cash charge related to the extension of the exercise period of existing nonqualified stock options to their original term. Our stock option plan calls for options to terminate upon employment ceasing unless otherwise indicated by the compensation committee of the Board of Directors. Given that the exercise price was extended upon the option holder's resignation, variable plan accounting was required under the provisions of FIN 44 requiring compensation expense to be recorded for the intrinsic value of the options. However, this change has no economic bearing on the Company or the option holder.

Our initial look at fiscal 2005 calls for revenue growth of 8 to 10 percent to the 910 to $920 million level, above our general organic growth guidelines of 7 percent annually. Strong revenue growth across our business will yield 2005 earnings per share gains of between 9 and 13 percent compared to this year. As I said, this is our initial guidance and it will be refined and finalized over the next few months and be given at the time of our fourth-quarter earnings call.

Before I wrap up my remarks, I'd like to comment on a couple of items included within our recent proxy filing that may have created some confusion amongst our shareholders. Our proxy filed in advance of a special shareholders meeting to occur on September 15, included a proposal asking shareholders to approve or executive incentive performance plan. This proposal is intended to ensure the income tax-deductibility of any qualifying performance-based compensation amounts paid to certain covered senior executives of the Company. It is certainly in the best interest of the Company to maximize the tax-deductibility of executive compensation without compromising the essential framework of the existing total compensation program. Future incentive compensation levels for those senior executives covered under the plan are not expected to be materially different from the historical levels previously paid by the Company.

Secondly, the proxy filing included a proposal amendment to the Company's articles of incorporation to increase the authorized number of common shares from 30 million shares to 85 million shares. This amendment will provide additional flexibility to the Board of Directors in its discretion to issue a reserve additional shares of common stock without the delay or expense of a meeting of shareholders. The Company could, of course, use these shares of common stock for acquisitions, financing activities, employee compensation plans or stock splits. However, I will tell you that the Board of Directors has no current plans to issue additional shares of stock. We would most likely utilize the increased authorized shares to facilitate future stock splits, thereby increasing our outstanding share float without diluting our current shareholders' interests. We've done four stock splits and at (indiscernible) appropriate times within the past six years which have been highly beneficial to our investors.

Although we cannot rule out using equity as part of our overall acquisition strategy, the strong banking market continues to make debt financing extremely attractive. We've recently met with several members of our bank group to discuss our future financing needs and found them quite receptive to providing a significant amount of capital at very favorable terms. We remain confident in our company's ability to generate substantial operating cash flows, thereby making low-interest debt the most obvious, attractive way of financing external growth.

Now, I would like to turn the call over to our CEO, Gerry Potthoff.

Thanks, Gary, and to our listeners, thanks for your support and your patience this morning. My commentary is somewhat lengthy but we have many exciting things to talk about.

As expected, we posted another outstanding quarter and are set to finish up the year with record revenues and earnings.

Before we get into a discussion of our expectations for 2005 and beyond, I would like to take a minute this morning to express my enthusiasm about my new role with the Company, what we've achieved thus far as a cohesive management team and the bright future we see for our business. As CEO, my approach to running the Company will not change to any great degree. Our business will continue to be run by our governing body, the office of the Chairman, comprised of myself, Gary Gerhardt, Ron Davis, who heads up our Business Development, and of course by our Chairman and founder, Mike Shanahan. Supporting the businesses are two group presidents, Dan Rodriguez and Nick Innerbichler, two key, very capable executives responsible for our operating subsidiaries, and we have a dedicated corporate management staff. Having a deep bench comprised of hard-working, talented individuals who all work together cohesively as a team is one of our greatest assets and has played a large part in the many successes we've enjoyed.

Going forward, our team will remain focused on winning new business, flawless execution of the fundamentals, delivering the highest quality products and services, and positioning our firm for sustained growth. We will continue to leverage our vast engineering, production and logistics capabilities to provide value-added solutions to the marketplace. We will continue to seek out synergistic, accretive acquisition candidates that fit with our culture and that emphasize similar ideals. And, we will continue to utilize leading-edge technology.

Gary has already spoken in some detail about the quarter's financial performance and reaffirmed our solid outlook for fiscal 2005. Not much more needs to be said about this year. However, with the significant growth in revenues and earnings in 2004, which has been partially fueled by some opportunities coming out of the war effort and the post 9/11 security environment, some of you have been wondering about the sustainability of our business, going forward. To address those concerns, I will briefly outline our current revenue growth plan for '05 in relation to the current year.

First off, revenues for 2004 are forecasted at the $840 million level. The only two significant pieces of work that are expected to decline in 2005 are production work on the Tunner cargo loader program and the large base perimeter security contract with Northrop. Tunner production will be completed in May or June of next year, causing a decline in that program's revenues of about 30 million. As you are aware, we're currently completing a large subcontract for MSTAR radar systems with Northrop.

We do, however, continue to forecast MSTAR-related revenues of approximately 35 million in 2005 that will come from a variety of domestic and foreign customers. (indiscernible) of that work looks like our real revenue hole (ph) in 2005 versus 2004 is about 55 million.

Now let me tell you how that shortfall is eliminated and what will contribute to our 8 to 10 percent revenue growth next year. First off, based upon the strong results seen so far this year, we are expecting general revenue growth of some 15 percent for our Services segment. Within this segment, our vehicle uparmor-related revenues will be similar to those in '04, about 30 million, and our large generator-production program should be higher by around 10 million. Our Radian folks are working closely with the Army's tank and automotive command on uparmor solutions for several legacy field vehicle platforms in need of ballistic protection on the urban battlefields of today. This is potentially some excellent business for us, going forward, as these critical needs are addressed.

We also are expecting a sizable support duffel (ph) support contract with the U.S. Army that would add 20 to $30 million of business growth in the profitable spare parts area. Several satellite telecommunications programs are in full swing with sizable contributions to revenue in 2005, and we will be ramping up our aircraft upgrade work for the U.S. Coast Guard in the coming months, resulting in increased new business there.

On the systems or the product side of engineering support, we are expecting a significant amount of refurbishment work for the Heavy Equipment Transport trailers over the next several years. So far, we've been awarded an initial $11 million contract to refurbish 70-plus trailers for the Army. But behind that are up to an additional 1100 units in the fleet deployed during the war that are now in need of upgrade and repairs. We anticipate being tasked with additional work in the near future with estimated revenues of an incremental 20 to 35 million in 2005.

We will also receive an additional 10 million in revenues next year for production of the 100 -- 200 KW quite generator. We've just announced a critical milestone in the program last week. Two other significant power-generation programs are in the works as well and upon award will generate around 10 million in development revenues in 2005.

In addition to the MSTAR-related business, an incremental 20 million in perimeter security system projects through SEI are scheduled for 2005, as we continue to penetrate this high-growth area. Production levels on various grand support equipment programs will be higher next year as well. So with a great number of relevant, high priority programs active amongst our 11 separate operating companies, we are extremely well positioned to meet our integrated growth target for 2005 of 910 to 920 million.

Longer-term, we're currently pursuing a variety of multiyear production programs for the next generation military support equipment. These programs, totaling in excess of 2 billion (indiscernible) estimated future revenues span all areas of our business, ranging from power generation to fuel and water distribution, environmental control, Chem/Bio protection, test equipment and etc. While many of these programs are competitive, we believe that our unique market positioning, capabilities and track record will make us a formidable bidder.

That being said, I remind our shareholders to not necessarily view our company as a program-oriented business per se. Certainly, we have dozens of programs and still more individual projects that are in various stages of their lives. Some manufacturing programs are in the development phase, some are in the steady-state multiyear production while others are (indiscernible) level support programs with revenues coming from spare parts and systems upgrades. Services contracts typically run for several years as well with a multitude of shock duration task orders (ph) constantly being captured and completed at pharma base (ph) of recurring business. My point -- the engineered support systems is not a platform or program-driven company. The strength of our business lies in our vast capabilities and our abilities to develop value-added solutions for our customers in the defense intelligence and industrial markets that we serve. This is how we've grown our business, both organically and through strategic acquisitions that are focused on the customer and how we can better meet their needs. This is what endures; that's the key to our future.

Shifting gears a bit, I would like to quickly touch on a couple of topics that have some lasting relevance to our business. Within the past two weeks, President Bush announced a plan whereby the Army's forward-stationed military force will be reorganized and repositioned to better respond to threats faced in the Global War on Terror. This involves a transfer of some 70,000 military personnel stationed in fixed-site bases in places like Germany and South Korea. We will return stateside over the next ten years so they can be reformed into modular combat teams that are highly deployable worldwide. While at first blush, some may have believed this rebasing initiative to be negative, a negative development for engineered support, but we believe that it fits exactly with our strengths, our strategy and our direction, supporting rapidly deployed forces at remote locations around the globe.

SE provides a basic infrastructure to sustain our forces in battle or peacekeeping operations, but particularly those forces stationed in remote areas, away from urban areas and fixed-site locations. We receive little business from forward-stationed military housed in more permanent locations such as those in Western Europe, or larger bases in Southeast Asia. Therefore, the reduction in forces so deployed will not have a negative impact on the Company. Rather, just the opposite is true. The creation of a smaller, modular brigade that must be totally self-sufficient in battle, the need for additional support equipment and logistics services will be on the rise. Once properly trained and outfitted, these new modular brigades will then rotate from the U.S. into forward operating sites in the territories of America's new NATO partners in Eastern Europe and western Asia. Any Army units based in Europe will be rotating out of Afghanistan and Iraq will likely return to a European home base before being redeployed to the U.S. and elsewhere. From new forward bases, our forces will be then able to mobilize more quickly to combat terror threats in nearby countries. These locations will be much less established in their nature, meaning that our soldiers will require a great deal of infrastructure provided (indiscernible) housing, power generation, air-conditioning, heater, water and fuel distribution, security systems, telecommunications and (indiscernible) artistic support services, just the types of things that engineered support has been providing throughout its history. It's then stands to reason that this activity will positively affect our business, going forward.

A near-term matter involves the concept of the reset of readiness levels of our forces in the wake of waging the current military and stabilization campaign in Southwest Asia, Iraq and Afghanistan. Right now, the military has been unable to fully address its equipment reset needs as it continues to focus on the more pressing matters of stamping out insurgents and creating a more stabilized security environment in these two countries. However, it's no secret that our support equipment is being used and undoubtedly consumed every day and its reset or replacement will take place as these military actions continue. A recent report indicated a 14 mile-long convoy of equipment in Kuwait that is awaiting refurbishment. This illustrates the reset requirements that will trail the completion of the war for several years thereafter. This work must be done to return our military to the required readiness levels as soon as possible. Probably some 135,000 military personnel still actively deployed to support stabilization activities, other urgent needs have taken precedence (sic). The reset of troop support systems such as air-conditioning, car and the like have yet to be dealt with. Generally, the Army is simply buying new equipment as it's needed to support equipment that has been damaged or consumed during the conflict. Eventually, the refers refurbishment or replacement of these systems will occur as the security environment stabilizes and the deployed troop levels diminish. That is typically how the military has managed this process in the past, although the operation Iraqi Freedom conflict is certainly the largest action the U.S. has been engaged in during the past three decades. While we cannot currently predict the timing and the magnitude of this reset effort, other than know that it is inevitable and necessary, we do expect it to have a sizable positive impact on engineered support's business for many years to come. As reset activities come to fruition, we will certainly keep everyone posted.

So thank you folks for your patience in listening to my lengthy commentary, which we thought necessary to ensure that you are fully versed on the exciting opportunities available to our company. Now, I'd like to turn the call over to Mike Shanahan.

Thank you, Gerry Potthoff, and thanks Gary Gerhardt; those are great reports and very thorough. Before we conclude our prepared remarks and take your questions, I'd like to address our expected long-term growth targets.

At this juncture, having just completed the third quarter of fiscal 2004, we are beginning to formulate our budget expectations for the next year. These individual subsidiary plans for 2005 will be refined over the next couple of months and will become finalized before the end of the year. So far, we can easily see that the revenues and earnings will grow nicely in 2005, roughly 10 percent each, after a highly successful 2004. This growth is purely organic and does not include the beneficial impact of any of the acquisitions currently being considered.

Our longer-term growth target, however, is a year-over-year increase in reported net income of 20 percent via the combination of organic revenues, acquisitions and cost saving initiatives. As you are aware, over the past five years, we've grown net income in this manner in excess of 50 percent compounded annually. Given the strength of our business, solid defense spending projections and a multitude of internal and external growth avenues, we believe that our 20 percent goal is a realistic and achievable expectation. We remain focused on reaching this objective once again in 2005 and are vigorously seeking synergistic acquisitions at this time. Our targets include larger manufacturing and service firms with revenues in excess of $15 million individually as well as a number of somewhat smaller, bolt-on type acquisitions that extend our product or service offerings to our military and intelligence customers.

As a Gary Gerhardt told you, we certainly have adequate capital resources at our disposal and the defense marketplace remains a target rich environment. Obviously, we do not comment publicly on any specific acquisition prospects due to the sensitive and proprietary nature of such matters, but we would all be disappointed if we are not successful in our acquisition pursuits in 2005.

So with that conclusion of our formal reporting, we will now entertain questions that our participants may have.

Thank you. At this time, we would like to begin the question-and-answer session. (OPERATOR INSTRUCTIONS). Robert Winslow from Harris Partners.

Good morning. If I could please, I'd like to talk about the MSTAR briefly here. If I heard correctly, your new outlook for MSTAR related to the Northrop Grumman contract was about 35 million for '05. Is that correct?

That is correct.

Did I hear correctly? There was a potential outlook of 20 million related to another perimeter contract?

Yes.

Would that be related to the U.S. Army by chance or can you disclose?

Robert, I'm a little concerned about disclosing some of the details for a couple of reasons. One, in some cases, it's competitive and in many other cases, because of the nature of the use of the product, our customers ask that we not provide any details but I can tell you that the overall requirements and expectations that we have for MSTAR are broad. They include perimeter security, border patrol; they include applications for both domestic and foreign governments, so we're pretty excited about the opportunities there, but I would prefer not get into details at this juncture.

Understood. So it looks like initial outlook for '05 would be about 55 million, correct?

It's depends on how you characterize or categorize the various opportunities that we have but I yes, that's correct. You've got to recognize also that our rating (ph) division has very growth-oriented business called asset protection. It's a part or their business and it does a lot of things in concert with some of our division, some of our subsidiaries in support of various terrorist threats.

Okay, so but that 55 million wouldn't necessarily all be out of SEI it sounds like?

Right.

Would there be any disability on the timing of that 55 million? Would that be back-end loaded in '05?

I think it's spread really throughout the fiscal year, Robert. I could talk to you off-line and give you more details, but I think if you look at what's currently on the books and our expectation for orders, I think it's spread throughout the year.

Then the last thing would be, so I'm trying to get my head around the numbers for '04. Where did MSTAR -- what's the expectation for MSTAR in '04? Does that shakeout around 75 million or so -- business?

I think it's somewhere between 55 and 60 million.

Eric Hugel from Stephens.

Good morning, guys. Can you talk about, in terms of your acquisitions, the attractiveness or multiples that you're seeing out there in the market?

Yes, I don't think we're seeing too much. Multiples have varied obviously considerably since 9/11, up, down, and so forth. Services companies certainly are demanding higher multiples in some of the manufacturing concerns, but I don't think we've seen a lot of variance in multiples here recently. It's hard to put numbers on multiples. You know, you've obviously seen our roadshow before; the acquisitions that we've made and the acquisitions that we look at continually, future growth is very important and therefore, we have made acquisitions that the past twelve months' trailing numbers don't make sense but the outgoing numbers make one heck of a lot of sense. So it's a little difficult to put numbers on a lot of these acquisitions unless they are running 4 percent annual growth going forward and if they are, then they have to bring something else to the party probably to be falling into our acquisition mode.

I didn't mean to kind of avoid it but we're not seeing a lot of changes. Certainly, they're down from what they were during some of the post 9/11 or everything was there and still some of the services companies, depending on what their products are, are pretty high and some of the big boys are competing on some of those but that's a little outside of what we would probably be looking at.

Can you also address -- I know it's hard to sort of talk about it in terms of any specifics, but it looks like with the addition of, like I said, the current budget has additional 20,000 troops coming into -- coming into the (indiscernible) structure I gather the next couple of years. I mean what could that potentially mean for you? I would assume that all of these additional troops, unless they're going to stay here in the U.S., which is kind of doubtful, they are going to need your type of equipment.

Again, I think it's consistent with some of my comments. I mean, whether we are talking the 20,000 additional troops or the 70,000 troops that are going to be redeployed over the next 10 years, I mean, that absolutely fit our strengths, our strategy and our direction. We were noting the other day that it fits our company slogan, which is "The Military Doesn't Leave Home Without Us". We see nothing but upside to the current activity. I suspect another editorial sort of question, Eric, would be that we aren't really concerned about which political party is in the White House. I think we recognize that the American people will support a strong military and as long as they do and as long as we are the world's policeman and as long as there is a terrorist threat, which we think will be for quite a few years to come, we feel very good about our business. We think our strategy and all of the products and services that we provide are (indiscernible) position to provide the growth that we have.

I guess the follow-up to the question would be, you have all of these positive trends but I mean, yes, when are we going to start actually seeing the positive impact -- (technical difficulty)? Is it an '05 issue, an '05 event? Is it an '07 event? When do we start seeing the ramp-up in revenues from these positive trends?

(Multiple Speakers) -- I was just going to say that we just had a record year with record growth. I must be missing something here. I think -- (multiple speakers).

I'm not complaining; I'm just trying to sort of put the timing of these definitely positive trends in terms of when we can sort of start to see them hit.

We've been hitting, very frankly -- you know, we were doing quite well before 9/11, so they were hitting before then, subsequent to that and that was the intent of my commentary. We believe for the foreseeable years to come, we will continue to see excellent growth based on the fundamentals. (multiple speakers) -- so to us, if you look at our first pass at '05 and the guidance we are providing this morning, I mean, to us, that is outstanding. We are delighted to have the business base and the opportunities that we have, Eric.

(OPERATOR INSTRUCTIONS). David Gremmels from Thomas Partners.

Thanks. Good morning. First, I wanted to say thanks for all the detail on the upcoming contract opportunities. You've nipped a lot of my questions in the bud, but I did have one more on MSTAR. Obviously that's been a big contributor in '04 and you mentioned a 35 million target in '05. Is there anything in the pipeline over the next couple of years that could be of similar magnitude to that Northrop contract, or are we looking at primarily numerous smaller opportunities?

No, David, the way we do our business, we have what we refer to as (indiscernible) and MPs (ph) are most probable, and that's the establishment of our baseline and our financials as we project, going forward. They are 70 percent probable. So within that 70 percent, we've got the kinds of MSTAR programs that I talked about here just a moment ago but we also have some very large possibles. That would be akin to the one that we're just finishing up on this year with Northrop. So, a lot of potential because it's a very diverse product and it has applications for a lot of different needs.

So the big ones that are floating around out there, I'm just curious -- are those also military-base -- (Multiple Speakers)?

Yes.

(Multiple Speakers) -- commercial opportunities? What's the nature of those opportunities?

The nature of them are much the same as you mentioned, military operations, perimeter support much like the one we are involved with, Northrop, currently. You know, you are talking about the (indiscernible) out of all military branches because they all have military bases to protect.

Great. How would you characterize your forward visibility today versus historically? Your earnings release highlights a very strong trailing book-to-bill of 1.22 but if you look at total backlog instead of funded backlog, that has actually declined over the past year. So do you have more work to do in average to build '05 or are you about where you have been historically at this point?

I'm going to start on that and then I'm going to ask Gary to jump in because he's got some excellent thoughts on the funded and unfunded, particularly relative to our services business. But, if we were to look historically where we were at this point in time in our fiscal year looking forward to our next fiscal year, we have the best visibility we've had in our history because of the fundamentals that we have been talking about this morning, because of the kinds of companies that we've got, because of the kind of customers we've got. So we feel very bullish, and I think that is what's unique. Here we are at the end of August, and we are looking at '05 very confidently. At this time last year, we didn't have as good a visibility as we have now. Again, it has to do with the kind things that David and I talked about earlier. Having said that, if I could turn the unfunded and funded subject over to Gary?

To start with, I agree with Gerry 100 percent. I think, as far as visibility right now, I think we've got as good visibility as we've ever had. I think the first pass at '05 is just extremely positive. We certainly, upon expectations of '04, everybody was so concerned about '05 and we are continuing to exceed our previous promises out there as far as growth, relative to organics, so that's great.

I think the backlog has a couple of comments. Number one is certainly the defense industry has set its own example I guess or whatever you want to call it, relative to backlog and (indiscernible) about it is it's a very subjective thing. I will use my favorite term, as far as being conservative, as far as how we determine that number, but I can tell you there's a lot of other defense contractors who use that quite differently. An example would be our RQ contract, the estimated value of that RQ contract which came with TAMSCO and was awarded to TAMSCO right about when we bought them or a little bit before that is $2.1 billion, $2.1 billion. Most all of our peers have those types of numbers in their unfunded backlog. We have $0 for that contract. Since we have bought TAMSCO, I think just rough number -- and I have the number back in my office -- we have incurred revenue or generated revenue in excess of $200 million off of that contract while holding backlog at 0. So I think you need to look at a lot of things, and sometimes people get hung up on backlogs on a quarterly basis, book to bill and some tax people ask about it on a quarterly basis. You can go take it down to a day basis and I can give you an infinite number on a daily basis. So you've got to look at it long-term and you've got to look at what's in it. We certainly can have some longer discussions on that but I get concerned when people look at it on a very short-term, and then they also will say, well, so and so, another peer, has a big number. Again, different phases if you're supporting those guys with those other bases, and maybe we should change our bases because unfunded would go up probably over 2 billion in the next couple of days.

I didn't mean to make a long answer but it's something that we look at with detail and it's very important to us. But getting tied up on a quarterly basis in numbers has nothing to do with long-term growth of the Company.

Given that you're going to be exiting the year with cash on the balance sheet and assuming strong cash flows in '05, would you consider a share repurchase?

It depends upon the price, obviously. Certainly, subject to -- has been on the table. We've continually said that the best usage of cash is to make acquisitions. The price has certainly dropped into some numbers that may make some sense. It depends on where it goes long-term.

In terms of your -- just a couple of questions on guidance to finish it up. What tax rate is baked into the '05 guidance?

38.5 I think is in there. We look at that quarterly and our auditors make us look at that quarterly now as far as what that real number is.

Just to make sure I'm thinking about this right, you maintained your '04 guidance of 2.65 to 2.70 despite absorbing it looks like 11 cents or so related to the Q4, the CEO payments. So I mean, it sounds like you are effectively raising your operating guidance by about 11 cents or so. Is that fair?

Yes, I don't know if we look at that. We realize that when we put out the previous reconfirming out guidance back a few weeks ago when the market had taken a negative when we put that out, we knew that we were going to have to do that charge relative to the stock option extension of our previous executive. Again, most of it is a non-cash item. It's a very unusual charge if you want to read the regs associated with it. I'd love -- if somebody has a concern about that, I'll tell them what's called the one-minute rule.

What's the one-minute rule?

Any time someone is terminated by either their own decision or whatever it is, you meet in the hall and two people agree that one guy is going to leave; if he or she has not exercised those options prior to making that decision, in a legal sense you have extended the options, even if it's in the same day, and that's a true statement. Therefore, it's a one-minute rule basically that says if you extend the options for one minute, you go under FIN 44, which says it is an accounting issue. (multiple speakers).

Then a question -- your guidance to '05 earnings growth or organic earnings growth of 9 to 13 percent, which of course would be before any acquisitions, but the '04 number absorbs about 19 cents of one-time items, so on an operating basis, it looks like the organic earnings growth is about 3 to 5 percent. I'm just a little bit surprised, given all the opportunities you highlighted. Why aren't we seeing more growth in that next year?

Well, I think one of the answers is this is the fact that again, this is our first pass. We have not done the detailed budgeting. When we do that in the fourth quarter, we will come out with more specific guidance. I'm not saying it's going to go up or go down. I don't think this is the place -- you know, we can sit here and debate 3s and 4s and 5 percents forever and so forth. What we promised the investment community is long-term growth of this company and so on and that's what we've continued to provide for many years, in and out. I would love to have an individual discussion relative to that.

Selman Akyol from Stifel, Nicolaus.

Thank you. Good morning. Most of my questions have been answered, but let me just take two real quickly, if I may? Gary, On Radian, you said they were working on additional uparmoring. I just want to make sure. Was that beyond the 30 million in guidance you've already given?

Yes, there is a gain -- (technical difficulty) -- legacy vehicles out there that certainly need the ballistic protection, and that military is just trying to ascertain which are the priorities and how to fund them but a lot of opportunity.

Great. Then the second question, I know you don't want to talk about any specific acquisitions per se, but if you guys were sort of a bracket in either terms of numbers or maybe total dollars of the pool that you are looking at --?

I will take a shot at that and then I would appreciate Mike's thoughts on it, but what we have targeted for ourselves something not below a $50 million acquisition as a standalone. That's kind of a minimum. What we're very comfortable with is something between 150 to 250 million.

Okay, great! Thanks.

Chris Donaghey from SunTrust.

Good morning. I was wondering, it's a very nice sequential recovery in the operating margin on the services revenue. Can you just talk a little bit about what's happening there? I'm assuming it's less pass-through on the R2 (ph) contracts but just this quarter and then going forward, the services margin?

Yes, the services end can move a lot based upon a lot of things, number one of which is of course the DPDG revenue in there; that's extremely profitable and there was considerably more DPDGS -- I can't even say it right -- revenue in the third quarter than there was in the first two quarters, so that had an impact on it. (indiscernible) is very profitable. That certainly has an impact on it and so on. Again, what runs through that R2 contract that goes to some of our other subsidiaries has a variance and so forth. Then of course in the middle of that which has been very successful recently and we've seen a significant upturn is spares. Spares margins are extremely strong, so there's so many things in there that can effect it from quarter-to-quarter. It's a combination I'm going to say heavily driven by the DPDGS and the uparmor revenues in the third quarter. And we will see that going forward here near term.

Okay. Then on the Support Systems operating margins, similarly I'm assuming that with the spike in contracts in process and inventories, you are expecting to pull a lot of cash out of that in the fourth quarter, so we should see a sequential uptick in operating margin on the Systems business as well.

Yes.

Well, cash we will. I'm not sure -- certainly, there will be some cash. The fourth quarter will be an extremely strong quarter relative to cash. I'm not so sure I understand your analysis in respect to an upturn in margins. The margins are very strong in the Systems side. There's not quite as much variance from quarter-to-quarter because the programs are more consistent and so forth, and there's no programs that are changing significantly so for right now, kind of the ranges of margins we're seeing in the Systems side should be going forward.

Yes, I guess I was just looking at the second quarter was close to 22 percent and I'm assuming a lot of that was driven by MSTAR deliveries, so I was just assuming there's a large MSTAR delivery that occurs in the fourth quarter -- that wouldn't (ph) have an impact to the operating margin on that side.

No. Revenues taken percentage completion on those contracts, so revenue was taken historically, revenue in our contract, that large contract would be recognized based upon labor hours incurred as a percentage versus total anticipated labor hours. But there is -- in the fourth quarter, MSTAR will be strong, there's no question about it, but there's been a significant amount of MSTAR revenues to date which have been at a very good margin.

Okay, I understand.

Chris Adowitz (ph) from the A.G. Edwards.

Gentlemen, good quarter, guys! I wanted to follow up on the margin question. I was going to ask about mix. I think you guys have tackled that. Do you guys have any comments on -- I guess do you guys have target margins, going forward, that you would like to hit in the businesses?

Target margins?

Chris, as far as budgeting, we look at margins and so forth, but it depends upon programs. Certainly, the services side can vary more based upon some of the programs and they will vary considerably from quarter-to-quarter based upon the mix. So, we will look at when we do budgeting and when we do forecasting, we looked at the first pass in '05, we will look at specific program margins and sum those up. But as far as if you put them on a total basis, there's guidelines based upon what we've done historically and what we anticipate, going forward, but it's more of a roll-up of what we anticipate we're going to do and if there's a problem with a specific program or something, (indiscernible) achieving margins that we would want or anticipate we would more likely just go on and attack that.

Do you guys have kind of like a minimum target when you pursue new work?

It varies from program to program. This industry, it depends upon competition; it depends upon the contracting instrument; it depends upon the division; it depends upon whether it is sole-source; it depends upon -- not to make a long story, it depends upon whether it's a negotiated procurement with cost or pricing data; it depends upon your opportunities to reduce costs once you get the contract. Those are just things of operating in this industry over the years that you find out about.

Do you guys feel like you can generate this type of margin again kind of regularly, going forward? I mean, this is a pretty good margin quarter for you guys.

Oh yes, I think the margins -- you're not going to see a lot of long-term variance in the margins. Again, the biggest thing you can see fluctuation-wise is on the services side based upon DPDGS and next year's going to be a strong year for that but it's quarter-oriented. Historically, DPDGS has been more towards the end of the year, there hasn't been as much revenue. This year there was not a lot of revenue in the first couple of quarters on it and therefore that was one of the reasons the margins were down in the services side. That really drives the margin a lot because it can be a significant portion of revenue, number one, and number two, it's a very profitable program.

Fair enough. I appreciate it. Thanks, guys.

That concludes our conference call for this morning. We thank you all for your good questions and for your attendance and participation, and we look forward to speaking with you in the near future. Thank you.

Thank you, folks.

Thank you for attending today's teleconference. This concludes the call. You may disconnect your lines at this time, and have a good day.