Leonardo DRS Inc (DRS) 2006 Q1 法說會逐字稿

Good morning everyone and welcome to today's DRS Technologies' conference call. (OPERATOR INSTRUCTIONS). As a reminder, ladies and gentlemen, this conference is being recorded. At this time for opening remarks and introductions, I would like to turn the conference over to Patricia Williamson, Vice President of Corporate Communications and Investor Relations for DRS Technologies. Please go ahead, Ms. Williamson.

Good morning, and thank you for joining us on today's conference call to review DRS Technologies' financial results for the fiscal 2006 first quarter, which were reported earlier this morning. With me today are Mark Newman, Chairman, President and Chief Executive Officer of DRS Technologies, and Rich Schneider, the Company's Executive Vice President and Chief Financial Officer.

Before we begin, I would like to remind everyone that we are providing a simultaneous webcast of this call to the public. An archive of this webcast will be available later this morning on our website, and will remain online for approximately 90 days.

Today's remarks may include some forward-looking statements and certain non-GAAP financial metrics. For more information regarding the Company's definition of these metrics and their usefulness in interpreting DRS' financial results, please refer to the Company's fiscal 2006 first quarter earnings release and our filings with the Securities and Exchange Commission.

In accordance with the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995, please note the risks and uncertainties related to forward-looking statements, which are more fully described in the news release and in the Company's filings with the SEC.

DRS does not undertake any obligation to update any forward-looking statements whether as a result of new information, future events or otherwise. I would now like to turn the call over to Mark Newman.

Good morning to everyone. I am pleased you could join us on today's call to discuss the results of our fiscal 2006 first quarter which ended June 30. I'm going to keep my remarks fairly brief this morning, as our annual meeting is following today's call, and I want to leave enough time for your questions.

DRS continues to benefit from its work on digitizing the battlefield, powering the Navy's fleet, fostering intelligence collection, detecting and acquiring targets, and other components of the recapitalization and transformation of the U.S. Armed Forces. Earlier this morning we were pleased to report record results for the first quarter, and we upwardly revised our guidance for the new fiscal year.

As you side in the news release this morning, we're now providing guidance for revenues of 1.47 to $1.51 billion, which represents a 12 to 15% over our fiscal 2005 sales. We continue to target an operating margin of approximately 11%. And we increased our expectations for full year diluted earnings per share to range between 2.39 and $2.47. This is a 14 to 18% increase over fiscal 2005 diluted EPS.

In addition to our first quarter record performance, we booked more business than in any other quarter, $521 million in new contracts. And our funded backlog climbed to an all-time high of almost $1.5 billion. All of our strategic business units turned in excellent performance, both operationally and financially in the first quarter. Organic revenue growth was strong at 9% for the period. Notably, we delivered a higher operating margin of 10.4% for the quarter compared with 9.8% for the same quarter last year.

Free cash flow was negative, as expected, due to higher tax payments, the payout connected with the settlement of litigation discussed in last quarter's conference call, and higher interest expense related to the additional debt offering completed last fiscal year. However, we expect to generate positive free cash flow as the year progresses, and are still estimating at least 40 to $50 million in positive free cash flow for fiscal 2006.

We continue to utilize cash balances to pay down debt during the first quarter, and we pre-paid $10 million on our term loan. We acquired two strategically important businesses in the first quarter, Codem Systems, which we discussed in last quarter's conference call, and WalkAbout Computers, which we announced on June 27. WalkAbout is a leading producer of tablet PC computers, which DRS acquired for both an entree into the ultra rugged industrial computer market, and to meet the military's growing demand for these versatile systems. Now operating as part of DRS Tactical Systems, WalkAbout's tablet computers are an exciting addition to our already strong product line.

The first quarter of fiscal 2006 was our 21st consecutive quarter of improvement on a comparative year over year basis. And we are very proud of that track record. As we mentioned, we had a great quarter for bookings. And you can read about the quarter's new contract awards in the news release. Right now I'd like to take a few minutes to highlight just some of these, along with some operational achievements.

Our C4I Group captured a total of $236 million in new contracts for the quarter, including 36 million in Navy UYQ 70 Advanced Display Systems awards, and 29 million in awards for Army Applique computers supporting the FBCB2 program. Our Power Systems business was competitively awarded a prime contact from Darva (ph), worth up to $30 million to develop a shaftless propulsion system for the Navy's Tango-Bravo program.

For this program DRS is part of a systems integration team with key Navy suppliers, including General Dynamics’ Electric Boat, Antion (ph) and others. This program is focused on dramatically recasting submarine propulsion design, enhancing submarine acoustic performance and power density with cutting-edge technology we will provide, and improving ship affordability. The program centers on implementing innovative technologies such as electric drives for a demonstration submarine that will be half the size and cost of current subs.

DRS completed an important delivery milestone of a remote sensor vehicle and a command and control communications vehicle for the Navy's Distributed Common Ground Station Program Office. These systems will be used to support a number of technology demonstrations for homeland security and anti-terrorist force protection.

The remote sensor vehicle utilizes our Scout Coastal surveillance radar, and electro-optical infrared and daylight cameras mounted in the Scout platform, providing situational awareness and distributed networking capability. The remote vehicle can be wirelessly networked with the C3 vehicle and other Navy assets using various means of connectivity, including SATCOM.

These vehicles have been delivered to the Navy where they will be integrated into Latoro (ph) Surveillance Systems. The C4I segment also completed full qualification testing for the handheld terminal unit. And this unit has been added to the CHS3 program, along with our thin client display, which passed safety of flight testing, including extreme helicopter vibration testing.

Our Surveillance and Reconnaissance Group booked $285 million in new orders during the quarter, led by strong orders for combat vehicle test equipment, long-range scout surveillance systems, driver vision enhancers, total weapons subsystems, and Bradley Fighting Vehicle sighting systems. This segment had a great quarter for new orders of uncooled infrared sighting systems, including $20 million in contracts for driver vision enhancers, $7 million in thermal weapons sight awards, and over 16 million for a variety of other night vision soldier sighting systems. I'm pleased to report that the DRS-produced driver vision enhancers are shipping well ahead our customer's schedule providing faster fielding of this critical war fighter equipment.

Our results for the first quarter support our positive outlook for the next three quarters of fiscal 2006. We believe the Company is well-positioned to continue our participation in growing segments of the defense budget and priority areas of the supplemental. Our business focus is well-balanced, with a leadership role in key technologies for upgrading the military's current assets, supplying an ongoing war, and helping our customers achieve their transformational objectives in our areas of expertise.

This concludes my brief remarks for today. And at this time Rich Schneider and I would be happy to take your questions.

(OPERATOR INSTRUCTIONS). With JSA Research, Peter Arment.

Mark and Rich, nice results. A quick question, Mark, I guess more from a strategic standpoint, you have made a few acquisitions in the ruggedized computer world, and going back to Powervont (ph) and WalkAbout now. And GD made an acquisition last night of a ruggedized player. Could you give us maybe just a little of the strategic outlook of where you see the military going further? And what the growth I guess from that particular sector? It certainly seems like there is a lot of emphasis there.

I think in our market, which is the ultra rugged market, we are seeing tremendous growth. With three major programs right now, CHS3, Applique, and Bowman in the UK. And of course we're partnering with GD on some of those programs. I think that we're going to see healthy growth over the next three to five years. And it is a market that is also finding some acceptance on the industrial side. But again we are only playing in the very ultra side of the market -- ultra rugged side. Itronics, which is also a very good company, is more on the industrial side, much more heavily then the military side. We are focusing our attention more towards the military.

Is your -- the programs are primarily based for the Army. Is there any other service areas that you're targeting or is there other opportunities for growth there?

Yes. We seem opportunities in the Marine Corps and the Air Force. And then beyond that, with some of the ideas that we have in anti-terrorist force protection, we will probably see some use in the Navy.

Just one quick question, Rich. On that growth -- I guess for the way the second quarter is I guess your guidance. You indicated previously that you're going to have a much more, or hopefully trying to spread the distribution a little more evenly throughout the year. Has any additional growth come in to this quarter that was expected to come into the second quarter?

Now, not really. Pretty much on track.

I guess the guidance for the EPS and for the range is relatively similar to the year ago. Is there any -- is there a higher level of development programs flowing through this quarter, or is there -- just your nature of being conservative?

No, the major differences that we still have the increased interest expense, which is deluding us about $0.04 a share. And as we said, as that money gets deployed, obviously that will start to lessen. And there are more shares outstanding. We are forecasting margin improvement.

Right. No, I deduced that. Nice results guys.

With CIBC World Markets, Myles Walton.

Great quarter. On the bookings front, which were clearly impressive, could you sum up about how much of that you saw as upside from supplemental, if any?

I would say probably in the 125 million range.

Great. And so then I know you mentioned on the last call you expected book to bill to be above 1 for the full year. Clearly you're about one-third of the way there already. I guess looking into '07, you have upped your organic growth for '06 to the 6 to 9%. Are you seeing similar trends into '07 on top of that?

I think as a general statement we could say yes. But keep in mind that because we are on a March 31 year end, we are first going into our planning cycle in September for fiscal '07. So we're not ready to obviously go on the record, but we are seeing a very healthy increase in order flow.

And another of the severance inventory write-down in last year's first quarter, were there any unusuals in this quarter, positive or negative?

No, nothing significant.

And then the last one. On the cash flow, I think you had given an indication of an investment in working capital about 15 to 20 million. Is that still kind of within your guidance for the full year?

Yes, 20 to 25 million is in the guidance, but 7.5 million of that relates to Miltope. So if you took that out, it is right about where you saw.

Thanks again. Good quarter.

Steve Binder with Bear Stearns.

Mark, just to follow-up on that question. 125 of bookings from the supplemental, that will be spend out over what period of time, as far as revenue recognition?

We're figuring probably conservatively beginning in the fourth quarter.

Because -- I mean all you do is bumpy organic growth in the high end point. You kept your low end rate. So I'm just wondering, because my understanding -- I thought from the last call you weren't assuming much of the supplemental, just for the year '06, is that correct?

No, we weren't. And we also think, as you know, there is going to be a lot more coming during the fiscal year. The only thing we don't know yet is how quickly you begin to convert that into revenue. How much of it is actually going to come into '06, and how much of it is going to go into '07. And that is what we're going to be working through beginning in September as we start to plan '07.

We have expanded some of our facilities. We have expanded the business in Florida for our optics business. And we have also expanded the rugged computer business in Florida. We're not fully moved into those facilities, but we're putting ourselves in the position to be able to turn out a lot more product.

So you're absolutely right, we are going to see it begin to pick up. And it is just a question of when. And it is going to bode well for the latter part of this year and certainly into next year.

We are a quarter along, and you just booked 125 million. Do you have a better sense now given the supplemental task (ph) in May, and what kind of level of bookings you are going to get out of the supplemental? Are we talking about something that is in the $250 million range?

I think you could see something in that range. But it is like everything, when you book it then you know. But I certainly think there's an opportunity in that range.

Do you have a sense then on one that would be spent out? Would there be residue in fiscal year '08, or are we going to have a short tail to it as far as sales?

You just pushed me into '08. We're still working on '07, because we are in '06. But I think we will see nice improvement into '07. And there should be some or supplementals coming, as you know, so that should bode well for '08.

If you look at your Army business, it looks to me like the bookings this quarter, almost 60% came from the Army. I am just wondering, it is a big shift for you obviously, as you go into to '07. Do you have a sense how big your Army business will be as a percentage of the total pie in '07?

I can tell you that I think the Army backlog right now is about 46% of our backlog. So it is obviously going to be strong going into '07. But remember on the intelligence side, we are in more of a book and bill kind of mode. We don't carry a big backlog there. And there still plenty of Navy work that we're getting. It is just through the acquisitions that we have done and the growth of the Company, we are obviously doing a lot more Army work than ever before as a percentage of our sales. The Navy work is still very healthy. It is just the Army work has grown because of the acquisitions over the years.

Last question. Is there an opportunity, given there is some rich business coming in to backlog here on the supplemental side, some mature business, is there a margin opportunity here where you can kind of -- inching margins along here. You would be getting improvement, but we haven't seen a quantum leap. Is it possible we could see a little bit more of a bump in '07 because of the mix?

You don't know what is going to happen by '07. You don't know what additional development programs we will be involved with. So that is why we don't drastically change the margins. The other thing is just because the government is giving you this business that doesn't mean that they give you a blank check to have the profits you want. We still have to negotiate profits. And we are obviously not trying to gouge the government on any of these contracts. We want to make a fair profit, and we want to give them a good product. So our goal is to make sure they keep giving us the business. And the only way a customer does that is if he feels he is getting a quality product at a fair price.

Do you happen to have any receivable inventory and payable numbers as far as what kind of change we saw in the quarter?

They actually net to about an increase in working capital of a couple of million dollars. Receivables and inventory were up a little bit, and payables were up as well, but not as much. So the net is about a $2 million increase in working capital.

Where does the bump in working capital come from in the quarter? Was that more in accrued expenses?

Yes, same place -- same first quarter paradigm as every year. We have the big interest payments in the first quarter. We had the Miltope payout. We make first -- we make our year end comp payments in the first quarter. So the first quarter always sees a big reduction in accrued expenses.

Chris Quilty with Raymond James and Associates.

Can you give us an update, or can you give us an annualized revenue run rate that you are seeing now on the Kiowa program? And give you your thoughts of where that goes with the migration to the armed reconnaissance helicopter now that that program has been awarded?

From the point of view of the Kiowa helicopter, we are in probably about an plus $80 million range -- that can go up and down given the year -- of basically supporting that program -- a few modifications and enhancements and support. ARH is a different helicopter obviously. Different kinds of sensors. We weren't involved in that program, but that is going to first go into a development cycle. You'll see a couple of years before that is really ready to be fielded -- the earliest.

Remember these things always take a little longer than you expect. And it is our understanding that the Kiowa Warrior will be supported through maybe as late as 2015. I think you'll see decent support levels going forward there.

Also, I didn't hear you do a specific mention on the Army, how aggressive they are maintaining their roll out of the FBCB2 system and their participation. Can you give us an update there?

On how aggressive we are?

I --.

Could you say that again?

In terms of roll outs -- in the past year to 18 months we saw some good contract awards associated with that. And is there any change as they move to the modularly where we should see an increase in the order rate?

All indications tell us that there will be increases in the order rate.

Significant increases?

I don't know what you call significant, but we didn't bring another plant online because we thought the product line was going down.

Fair enough. Just a general question here. Given the fact that some of the multiples have come back on some of the government IT professional services oriented companies in this space, you have a somewhat heavy hardware centric revenue base. Would you be interested in perhaps picking up more of a service component to the overall business?

Sure. We have always been interested in the service side. Even a couple of years ago we went after something. We lost out that we were interested in. And we have some service work, and we would like to enhance that. But like anything, that has to come through acquisitions. And you have to find the right opportunity, and then have the ability to capitalize on it, and acquire the business. Because there will be other people competing for it. But I would say that IT is something we have always been interested in.

Very good. Thank you. Congratulations on a good quarter.

From Jefferies, Howard Rubel.

Nice numbers gentlemen. A couple of things. First sort of could you talk a little bit about headcount, and what you're doing with productivity? Because clearly there are some operating margin that comes with a lot more direct and indirect hires.

The headcount is sitting right now at about 5,800. So it hasn't grown measurably. And I would say we have the workforce essentially that we need to do the business that we have. We are always looking for good people. But I think we've got what it takes to produce a product efficiently.

To talk about M&A pipeline for a moment, could you describe it in some broad terms? And are you still side of looking for modest sized deals?

Yes. Our pipeline is robust. We've done three deals in the last year, and we think there's more to come. We are looking at good add-ons or bolt-ons, as they say, to existing businesses. And we're also looking at businesses that could be very complementary to us. So there's no lack of opportunity.

It is still sort of -- it is still sort of in the modest sized deals as opposed to several hundred million dollars?

You look at things across the board, but you don't want to predict, because you never know what you're going to end up buying. So I would say we look at all kinds of things. They could be larger, smaller. But whatever we will acquire, it is going to be accretive to earnings. And it is going to fit nicely with our existing business and manageable.

And then the last question I have is more of an opportunity type question. While you've got a lot of core business driven by the Army in the near term, it looks like you're also starting to take a little bit of focus and trying to go after more development contracts, whether it is like the Tango-Bravo or in other areas. Could you talk a little bit about that and how you see that? What opportunities you're focused on?

That is one. We have a number of opportunities in the IR area that we're constantly working. One of the programs that we announced recently, which is in the test equipment side in our Huntsville business -- there was a big development associated with some of the bookings that we had. I think they probably booked about plus $70 million this quarter. And there's a nice chunk I would say probably in the 15 million range that had to do with development. So all the businesses are looking at manufacturing and development simultaneously. That is always the way we have approached the business.

It just seems that you've got such a nice, what I would say is, core business that you're spending a little bit more time trying to develop opportunities that are tangential to it, or expand upon it, as opposed to just drive manufacturing.

That is true. And what we're trying to do by going after some development programs simultaneously is to start setting the stage for what we're going to be doing three to five years from now. So you don't lose sight of that just because you got a lot of very strong core production programs. We are working both planes actually. But we have a nice mix right now.

Patrick McCarthy with FBR.

It is Greg Ague (ph) in for Patrick. Actually following up on that question regarding more development type contracts, we have seen that some development dollars are flowing into uncooled infrared sensors to detect IEDs. It seems like that might be a new opportunity for you guys. Is that something that is currently being pursued, or something along those lines?

If there is anything going on with uncooled IR sensors, I can assure you we are part of it, because we get a big chunk of development programs in that area. And we're coming up with some incredible sensor technology. There's nothing that I want to talk about directly related to that problem, but I know we are working on stuff related to it.

And then just one more. Can you go a little deeper into your assumptions for the second quarter guidance? It seems that would with the companies that you've acquired, that the second quarter guidance sort of would imply either a significantly lower organic growth rate than we have seen, or sort of a 40 to 50 basis point decline in margin sequentially. Is there something we should be looking for on the margin line in the second quarter, or is there going to be something that would affect the revenue?

No, if you take a look at the range -- at the high end of the range that we gave, the implied organic growth is about 5%. We expect margins to be at least equal to what they were in the first quarter. There were no anomalies in the first quarter. And base on the mix that we see we would expect at least the same performance, or even a little better going forward.

And the 5% organic growth range for the second quarter then at the high end, is there just some seasonality in some of your programs here that you're seeing that would pull the second quarter down from the 6 to 9% range that you've guided to?

No, as we have said all along we expect -- last year we were focused on trying to smooth out the revenues. This year it just hasn't been possible. We have said that the second half of the year is going to be much stronger than the first half of year.

Thank you very much. Nice quarter.

Steve Levenson with Ryan Beck.

There has been some news recently that the UK is exporting Bowman, I guess initially to the Dutch Marines and to Romania. Do you expect to be involved in export orders, or do you think there's some requirement there that would preclude you from doing that? And as a second part of that question, I guess there is a big decision coming up from the Investment Board in the UK, and I am wondering if you heard anything on that yet, specifically related to Bowman?

The first part of it, we are working on that project. So where they export, we will be a part of that. As far as the second part of the question, sitting here at this moment I am not aware of that personally. I will find out if somebody else is.

Last night Lockheed got some orders for Q70 and Apache. Is there any reason that we should expect you would continue involvement, or any reason that you wouldn't be? And it is infrared on Apache.

Yes, we're doing the guts of the infrared sight for the Apache. So it is for the whole upgrade to the Apache. It is a very big program actually. And we supply a major module to Lockheed Martin on that. And then of course Q70 that is our program, and they are the prime contractor. If they get a contract, we tend to get a contract afterwards.

Do you -- what do you see looking forward in the segent (ph) area, now that you have got Codem -- and added to your previous business there? Is that an area you're looking to expand in or --?

Absolutely. We think it is going to be a strong growth area going forward. And we're putting a lot of effort into it.

Lastly, I know there was an inventory situation at NVEC last quarter. How that all been resolved, and was there any tick up in the current quarter?

They actually -- it was going to affect the first quarter, which it did a little. They actually came at towards the end of the quarter and they booked what they said they were going to book. So I think it is starting to pick up now.

I think we should clarify for everybody -- when you saying inventory situation, we didn't have enough inventory to meet demand. It wasn't an issue with obsolescence or anything like that.

Right. That is what I meant, you were short raw materials, I guess. Now that pipeline is filling again?

It is starting to fill, yes.

Heidi Wood with Morgan Stanley.

This is Greg Alazopolos (ph) sitting in for Heidi. Good quarter. You got your tax rate down to 42.1%. What kind of distribution should we expect for the next three quarters?

I would expect that the second quarter will be lower. I can't give you a number yet. We're in the middle of an IRS exam that is about to conclude. But I would expect that it will be lower. And then third and fourth quarters will be about the same as the first quarter.

Can you give us what your organic growth rate was for the two segments?

Yes. For the C4I segment it was 16.4%. And for the SNR it was 0.3%.

What kind of opportunities should we expect coming up on the horizon that you guys are involved with?

Opportunities on the horizon. Are you talking about in terms of new programs?

New programs, new competitions that you're currently involved with that should be expected to be awarded this fiscal year.

We generally don't talk about competitions that we're going after. So it is not something that we really want to disclose.

Finally, can you just talk briefly about the -- what kind of level we should expect on the new supplemental? What have you guys heard? And when should those funds start to flow, if they do flow at all?

I think if those funds flow, there could be a few hundred million dollars in there for us. And it is just a question of exactly what gets appropriated and what closes down. I think we have already, as we have said, we started booking, and we had a healthy 125 million plus this quarter. So that money is starting to get released.

Great. Thanks. Great quarter guys.

(OPERATOR INSTRUCTIONS). Ferat Ongoren with Citigroup.

Three questions on the margin. Last year, taking out all the one timers, the margin was 11.5%. Is there a reason why we should we decline to 11%, or is it you're being somewhat conservative on the (indiscernible), or are we seeing an increase in the R&D content overall?

Every year it is different for us based on the product mix, based on the level of development versus mature production. And 11% this year is the way we see the year coming out.

And basically if you see more revenues from supplemental, would that be a reason to revise that margin estimate, given the higher margin revenues coming from supplemental?

It could, but sometimes if you are bringing in extra profit there is also opportunity to invest in new areas, so we balance that very carefully.

C4I was quite strong -- surveillance and reconnaissance. When do you expect revenues to start to pick up -- revenue growth, organic revenue growth to start to pick up?

I think when they get into -- you're talking about S&R?

Yes, exactly.

They had a few delays on TWS, which is now getting into production. And they had a few minor things going on with the Apache that delayed them a little bit. And those are two very strong programs that are going to have to get picked up. And then NVC because of the inventory shortage that we had wasn't as robust as we would have liked to have seen in the first quarter. So we're going to see that start to pick up.

On top of that, with all the other business that now that is coming to them through the supplemental, and then of course with their increased deliveries on DVE, I think you'll start to see that group increase their sales.

I see. Does that revenue profile have an impact in your second quarter guidance, i.e., those delays somewhat decreasing your revenue (indiscernible) for the second quarter?

Yes, that is all baked into it.

And, Mark, one question and M&A. Historically you said that you were looking in the (indiscernible) to $50 million range in terms of acquisitions. Is that still the range? I know most of these are onetime deals, so there could be some (indiscernible). Secondly, it in terms of the paying for these deals, are you thinking about cash compensation or will you be considering any stock at this level?

As you know, it is all a function of the deal and who you're buying from. So it could be a combination. The smaller deals that we have looked at, and the ones we have done -- and the last three have all been cash deals. And we still have plenty of cash to continue on that program. If you got into an IA DT (ph) situation where you needed to use stock and cash to make the deal work properly, then we would consider that as well. It is all -- it all depends on the deal.

We have no further questions in our queue at this time. I will turn the conference back over to our panel for any additional or closing remarks.

Thank you. I just want to thank you all for joining us on the call today. And I look forward to speaking with you again on our next call in November. Have a good day.

That does conclude today's conference call. Thank you everyone for your participation.