Leonardo DRS Inc (DRS) 2005 Q3 法說會逐字稿

Good morning and welcome to the Engineered Support Systems third quarter earnings release. Following today's presentation, there will be a question and answer session. (Operator Instructions). Your host for today's call is Mr. Gerry Potthoff, Vice Chairman and Chief Executive Officer. Sir, you may begin.

Thank you Carly (ph) and good morning everyone. Thank you for joining us. Hopefully you have had a chance to review our earnings release for the third quarter ended July 31, 2005 which we issued early today.

As you can see, we posted an excellent order with revenues of nearly 259 million, a 17% increase above the third quarter of last year and net earnings of a record $0.52 per diluted share, a 6% improvement. As our release stated, both our recent acquisitions and organic sources contributed to the gains in revenues and earnings.

Equally as important, cash flow was also very strong for the third quarter with cash from operations totaling 30 million for the period with operating cash flow of about 59 million for the first nine months of this fiscal year. Our various working capital management initiatives have shown great results. Entered orders and contract backlog levels also in great shape, which should allow us to wrap up fiscal 2005 in fine fashion and to set the stage for a very solid fiscal 2006 as we will discuss in a few moments.

I am occupied on today's call by our CFO, Gary Gerhardt and Dan Rodrigues, the Company's President and Chief Operating Officer. After Gary runs through a detailed discussion of the quarter's financial results, San will then discuss a couple of important topics -- the status of the DPG DS (ph) program now as the reliability testing has been completed as well as where we stand on our former (ph) programs and our expectations for that area of our business going forward. And then I will comment on the dealer budgetary environment and supplemental spending plans and we will provide some insight into several new business opportunities that we're currently pursuing. Later in the call, Gary will discuss our initial 2006 financial guidance and our ongoing acquisition activities. And I will return to wrap up our planned remarks with some thoughts on troop deployments and military transformation initiatives. And as customary, we will then open up the call for a few questions from our participants.

We would like to provide substantial detail in this report. It is a rather lengthy report, so we ask for your patience. Thanks, and with that, we will jump into the financial discussion with Gary.

Thanks, Gerry. Before I begin my remarks, 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.

As we reported earlier today, during the third quarter of 2005 we posted net income from continuing operations of $22.6 million or $0.52 per share on a post-split basis. These earnings were derived from an overall 17% increase in net revenues as compared to the third quarter of last year. While existing operations remained strong, contributions from our three most recent acquisitions -- PCA, Spacelink and MSI -- represented the majority of our revenue growth for the period. New acquisitions accounted for approximately $29 million in additional quarterly revenues and $2.6 million in operating income in the current period.

Organic revenue growth for the third quarter included approximately $23 million in additional (indiscernible) order (ph) work, increased sell (ph) to commit telecommunications support revenues on the PMD cats (ph) and multinational programs as well as higher M-1000 trailer refurbishment work during the period. Similar to the second quarter of this year, these quarterly revenue gains were partially offset by reduced work on the TUNNER (ph) cargo loader which decreased by more than $16 million as the production phase of the program has been completed. And as expected, Instar radar deliveries were also substantially below the level of last year by more than $21 million with the completion of the large Northrop order in 2004.

Due to the stop work order, DP GDS revenues were about $11 million below the comparable quarter in the prior year. As explained in our earnings report for the second quarter, our results for the remainder of fiscal 2005 will continue to be negatively impacted by reduced production work on the DP GDS program until work recommences later this year. Segment operating results largely reflecting impact of the various programmatic (ph) revenue shifts compared to the previous year as I noted previously. Systems revenues and margins have declined from their 2004 levels with the completion of the TUNNER production and reduced Instar work with somewhat lower profit intersegment work, such as uparmor now accounting for greater portion of segment revenues. These margins should stabilize as newer production programs come online and ramp up over time.

However, fueled by solid organic revenue growth and the SpaceLink acquisition, the Services segment has seen sizable increases in both revenues and operating profit in 2005. This has been achieved despite the DP GDS program delays by better leveraging the segment's cost structure and focusing on higher margin business opportunities in past quarters, such as uparmor and telecommunications support work.

Net income from continuing operations totaled $22.6 million, 10% higher than the second quarter of last year. It should be noted that the prior year's results did include a $1.3 million pre-tax loss on the sale of our Sanford facility. Earnings per share rose 6% on a diluted share base that was comparably 3% higher than the prior years primarily due to the impact of exercised and outstanding employee stock options in the current period.

Free cash flow continued to be strong in the third quarter at a robust $28 million for the quarter and $52 million year-to-date, driven by increased earnings and reduced working capital levels. We expect to achieve our $75 million free cash flow target by year's end.

Despite spending approximately $190 million in cash on acquisitions so far this year, our level of net debt at quarter end stood at just $76 million, less than one-half our trailing four quarters EBITDA figure of more than $151 million. Obviously, our leverage is quite low.

In our release, we reaffirmed our earnings forecast for 2005. We continue to expect revenues to come in between $1.02 billion and $1.05 billion, a 15% to 19% increase over 2004. Earnings-per-share should be between $2 and $2.03 for the year. But as you're aware, net income would have been substantially higher had the DP GDS program not encountered the temporary production delays.

Entered orders for the third quarter totaled $264 million, bringing the total to $717 million for the first nine months of the year. Including anticipated orders for the DPGDS program with its production resuming in the fourth quarter, total bookings continue to be targeted at 1.1 billion for 2005, so a very active fourth quarter is expected. Funded backlog advanced slightly above the April quarter while total contract backlog approached nearly $2.3 billion at quarter end, a more than $200 million increase from the previous quarter.

Now I would like to turn the call over to Dan Rodrigues who will discuss the status of the DPGDS program and recent developments in the uparmor area. Dan?

Thanks, Gary. Since mid-July, Ford (ph) DPGDS primary power units, including the systems' eight CAT diesel engines and generator sets, have undergone reliability testing at Eglin Air Force Base in Florida. The reliability audit got a little later start than expected thanks to the impact of Hurricane Dennis. The test involved two units configured in the Air Force A-model configuration and two B-model units in the fifth wheel army configuration. This test setup involving four PPUs was the powerplant configuration which would be used for an 1100-man camp, which requires up to 3 megawatts of power. The PPUs involved in the test included a variety of modifications which had been identified as a result of the comprehensive DPGDS systems analysis undertaken over the last several months.

Without getting too bogged down in the details of the actual testing, I can briefly describe the paces the units were put through. The test followed a diurnal power cycle which means that the power load requirements vary throughout the day as they do in deployed environments. Power needs ranged from a low point of 30% of the requirement in the overnight hours to a maximum of 110% of the power requirements in the mid-afternoon. While the overall powerplant ran continuously for 24 hours a day since the units were operating at varying power loads, only the number of engine generators needed to produce the required load were actually operating at any one point in time.

For example, at 2 in the morning, only three engines were running while at 2 in the afternoon, all eight engines would have been needed. The reliability test calls for 600 hours on each engine or 4800 hours in the aggregate. And following the diurnal power cycle and on average, an engine operated about 17 hours a day requiring roughly 33 days for the test completion.

As a result of all of that, I am pleased to report that ESSI and the Air Force have successfully completed the five-week long reliability audit of the primary power units without any significant system failures. Certainly there were minor performance problems encountered, but nothing that adversely affected the reliability of the units as we experienced over 99% operational availability during tests, well above the system's requirement.

In over 33 days of testing, the powerplant was down for less than two minutes. Obviously, both we and our customer are very pleased with these results. But the important question in everyone's mind remains -- when will we be back in production on the PPUs? The Air Force stop work order on the PPUs was actually extended during the testing period as the existing stop work order was set to expire. The standard length for a stop work order is 90 days and is defined that way in the federal acquisition regulations. This was necessary since reliability testing was ongoing and the reporting of its results had yet to be finalized.

With Hurricane Katrina bearing down on the Florida Panhandle heading into last weekend and the testing having been completed last Thursday, the power units were immediately moved into place to provide the command center at Eglin Air Force Base sufficient power to continue operations in the wake of the storm; clearly, a vote of confidence from our customers.

Per discussion with our Air Force customer, we expect the test report to be formally issued in September with the stop work order removed shortly thereafter. In conjunction with the lifting of the stop work order, we would expect to see new orders released as well. Beyond that, we expect to see additional orders from both the Air Force and the Army in fiscal year '06 through fiscal year '08 time period. And if planned overseas deployments continued, then it is quite likely that the orders would continue even after fiscal year '08.

Once again, I want to express my appreciation to our valued Air Force and Army customers, our partner Caterpillar, our key suppliers and most importantly, our many ESSI employees for their strong support during this entire process of determining the appropriate solutions set to address the performance issues with PPUs.

Now I would like to shift gears a little bit and discuss the status of our uparmor programs. First off, I can tell you that by the end of August, tomorrow, our West Plains (ph) factory will have produced and delivered 1049 FMTV crew protection kids and a total of 355 add-on armor kits for the M-915 tractor under the two contracts received from the Army earlier this year. Total revenues for this work are expected to exceed $70 million. We will also be delivering another 50 M-915 armor kits to the Army later in September. I cannot emphasize enough the efforts of our folks at West Plains who pulled out all of the stops to meet the Army's aggressive schedule for these vital protective systems. Our ability to ramp-up production, maintain high quality and still meet other contractual commitments speaks volumes to the dedication of our staff, not only at West Plains, but throughout the organization. Truly, a job well done.

But our work in this important force protection area is far from over. We're currently working with another defense contractor to armor their fleet of commercial trucks operating in the Southwest Asia Theatre as well as the potential for armoring construction equipment. Both of these initiatives were generated from the innovative design capabilities of our Radiant engineers working closely with the Army's Tank and Automotive Command and will again utilize the manufacturing capabilities of our SEI subsidiary. More information will be forthcoming on these projects over the next few months as the situation develops.

We're often asked -- what is the Army's current thinking on the future of uparmor beyond those vehicles now deployed in Iraq and Afghanistan? And more directly, how will ESSI play a continued role? Well as you may know, the Army recently began to lay out its long-term armor strategy. This will employ a modular concept involving what I will refer to as an A kit and a B kit approach. Our understanding is that some 200,000-plus noncombat vehicles in the Army's inventory will be made armor capable by modifying them with an A kit which will allow an armor protective solution to be easily added with a minimum degree of modification and effort. This work would likely be performed by the OEMs of these vehicles, such as Oshkosh, Stuart Stevenson, AM General and the like. Under this modular strategy, B kit armor solutions will be developed and provided for approximately 40% of this fleet that can be installed as their deployment dictates. Production of B kits and conversion of their design to a detailed technical data package format will be performed by subcontractors to the OEMs.

We understand that these production subcontracts will be competitively awarded beginning in the spring of 2006 and overseen by the Army. The Army's modular strategy to provide crew protection as the mission dictates will allow for use in both peacetime and wartime conditions and help increase fuel economy, payload and reduce wear and tear on the vehicles. This approach will emphasize commonality between vehicle systems, utilize a host of lessons learned from the add-on armor approach currently being employed and will be synchronized to the Army's ongoing modernization strategy for tactical wheeled vehicles.

Assisting the Army's program manager in tactical vehicles and overseeing and managing the design effort will be an engineering services contractor, or ESC. And I am pleased to report that our Radiant subsidiary has very recently been exclusively selected by PM Tactical Vehicles to support its armor strategy with the award of a contract with initial funding of $2.6 million and a value of up to $8 million over its three-year term, including options. This is clearly a reflection of Radian's noted expertise in this area as demonstrated by their past performance and will ensure that ESSI will continue to play a key role in executing the Army's plans in this emerging force protection area.

Under the first phase of this effort, RADIAN will assist OEMs to develop a flexible armor package for a variety of platforms, including the FMTV, the Humvee, the Hemet (ph) platforms, while in the second phase, will include the PLS, the HET (ph), the M-915 and 939 trucks and tentatively, two Marine Corps vehicle platforms. In its role as the engineering services contractor, RADIAN will continue -- will coordinate OEM armor kit designs and ensure design commonality within and between vehicles as much as practicable. We expect to compete for the subcontracts for prediction B kit armor solutions for the OEMs as they come up for bid. A firewall will be established between our armor manufacturing organization and our RADIAN engineering staff such that the ESC RADIAN will remain an honest broker for the PM Tactical Vehicles in fulfilling their important duties.

In consideration of our strong track record of performance in this area, the military's ongoing force protection needs and RADIAN's new role in helping the Army carrying out its armoring strategy, we believe that exceptional business development opportunities exist for ESSI in regards to vehicle armory over the next few years. Now I would like to turn the call back to Gerry Potthoff.

Thanks, Dan. We all appreciate the efforts of you and the team in helping to get the DPGDS program back on line. Also, congratulations to both our RADIAN and SEI teammates for their hard work and all of the uparmor programs. And thanks to our fantastic customers for their support -- excellent examples of teamwork within our company and with our customers.

When we last spoke to you in conjunction with second quarter's earnings release, the $82 billion '05 supplemental bill had just been passed. From that bill, we had expected to receive significant funding for generators, trailers, target acquisition systems and a variety of support equipment; roughly 100 million of procurement dollars in the aggregate. As expected, a good portion of those funds were indeed awarded to us during our third quarter, most notably $76 million for tactical quad (ph) generator sets and funding for night vehicle based target acquisition systems. Additional procurement dollars from the '05 bill will continue to come in over the next several months and it has been widely reported that Congress has also included bridge funding of another 50 billion in the '06 defense budget to help fund the ongoing war (ph) for them to span the gap between '05 and an expected '06 supplemental.

We are already beginning to get some visibility from our customers on the spending components of the anticipated '06 supplemental bill, some speculate maybe as high as 200 billion in overall size. Likely areas of our business of benefit include additional generator sets and reset (ph) activities, more night and (indiscernible) target acquisition upgrades, petroleum and water distribution systems, telecommunications support work, Army buys of DPGDS primary and prior units, HEMAT (ph) and M-1000 trailers and a variety of other business.

Additional insight into the components of and importantly the timing of contract awards in our next year’s supplemental bill will develop as we and the military services receive more visibility.

We have also been extremely busy with new proposal activity across many areas of the Company and I would like to turn this back to Dan to discuss a few of these opportunities. Dan?

Thanks, Gary. Several multiyear production programs are currently out for bid and they include, first, the retrofit of some 195 chemical biological protection sulfur systems which our Engineered Air subsidiary had produced over the last several years to an electronically controlled configuration. This opportunity could be worth as much as $32 million over the next two years. At the same time, a follow-on production contract solicitation for as many as 1000 CVPS (ph) systems in the new electronic configuration is also being vigorously pursued by our product team. This program would be worth several hundred million dollars over the next several years depending upon the actual number of units desired by the Army. We believe that our role as the original provider of the CVPS and the investment we have made in new development work on the program solidly positions us for success. Award decisions on both of these efforts are expected early in fiscal 2006.

We are also finalizing our proposals for several multiyear production programs in the environmental control area. These opportunities, each of which are expected to exceed $100 million in total value, involve the incorporation of next-generation designs into portable heating and cooling units used by the Air Force and the Army. In most cases, one of our ESSI subsidiaries actually designed and manufactured the original equipment which these new systems will replace. Given our company's position as a leading provider of environmental control technology on the battlefield, we expect to be a formidable candidate to win these projects, which will likely be awarded in early 2006.

The FDECU (ph) program, under which we have been providing field deployable environmental control units to the Air Force and the Army since 1998, is coming up for a recompete within the next several months. The current contract under which we have delivered about 18,000 FDECU's to date, was awarded to our KECO subsidiary as a small business set-aside program prior to its acquisition by ESSI and it will also be recompeted as a small business solicitation. As such, we have teamed with a very capable small business in pursuit of the opportunity. Under our arrangement, our partner will provide greater than half of the direct labor content with KECO getting the remainder of the work.

FDECU has been a very successful program for ESSI over the years and it will continue to be going forward. However, due to the work split and our role as the subcontractor, the reported revenues will decrease and margins will decline somewhat from their current levels. We expect this change to impact the program in the latter part portion of fiscal year 2006.

Meanwhile, FDECU's will continue to be delivered out of our funded backlog on our current contract and/or be purchased from the GSA schedule as needed by our various military customers until full rate production levels are achieved on the follow-on contract.

We are also pursuing a multibillion dollar, multiple award telecommunications support contract with the United States Army, entitled the Worldwide Satellite System, WWSS program. Our CamScale (ph) and Spacelink subsidiaries have joined forces and are teamed with an outstanding group of world-class equipment and service providers on this project. We believe that this program provides us with a great opportunity to expand our presence in the growing world of satellite communications support for deployed forces.

And while the government will be bundling various support tasks and equipment purchases through this vehicle, we do not believe that the WWSS will in any way take away from the work we currently perform under the PM DTES (ph) or DSPSG contracts. And as previously noted, we will also actively pursue a variety of uparmor programs from the Army and other contractors. Obviously, many other program opportunities are also being worked at various levels throughout the Company, but time does not allow us to discuss all of them here with you today. I would now like to ask Gary Gerhardt to discuss our preliminary 2006 financial forecast, first provided in this morning's earnings release. Gary?

Thanks, Dan. As Dan noted, we laid out our first pass at 2006 revenues and earnings guidance in our release today. At this point in the year having just completed the third quarter of fiscal 2005, we're only beginning to formulate our expectation for 2006. Per our planning process, the individual budgets for each of our subsidiaries will be refined over the next couple of months and will then be finalized before the end of the fiscal year. Based upon our initial forecasts, we see a strong year shaping up for fiscal 2006.

Revenues are expected to rise between 14 and 23%, advancing to their 1.20 to $1.25 billion level largely due to significant organic business growth across the Company. Conclusion of a full year's results for our 2005 acquisitions of PCA, Spacelink and MSI should account for approximately $50 billion of the year-over-year increase with the remainder from organic sources. The impact of our numerous recent services and systems contract awards, supplemental defense spending, resumption of DPGDS production and overall solid business outlook are expected to provide us with excellent internal revenue growth for 2006.

Earnings growth is also expected to be strong next year. Our initial guidance calls for earnings-per-share of $2.20 to $2.30, our growth up between 8 and 15% above the current year. Due to several contributing factors, our earnings assumptions for 2006 anticipate overall operating margins reflective of the changes in our business mix are exceeding our long-term organic growth targets. These targets include, number one, completion of certain mature highly profitable production contracts such as TUNNER who was complete in the second quarter of 2005 and FDECU, which will transition to a new contract in mid-2006. TUNNER logistical support work continues at substantially lower revenue and profit levels in 2006 while as Dan explained, the current FDECU contract winds down and moves to a reduced revenue, less profitable arrangement later next year.

Secondly -- the commencement of initial production work and development programs, including Minuteman, ECS, Fuel Form (ph) and several other programs. While these are expected to be profitable long-term programs, production revenues and margins are typically much lower than normal during the early stages of a contract and increase over time as unit deliveries and efficiencies improve.

And lastly, a greater portion of services related revenues in 2006. Telecommunications support projects and similar work will compromise a substantially greater portion of the Company's revenue in the coming year. Rapid revenue growth at TAMSCO coupled with a full year's inclusion of Spacelink's business will naturally lower ESSI's overall reported operating margin somewhat. Typical operating margins in most services programs range from 6 to 10% with a predominance of T&M task orders involved.

In light of the above, we believe that the margin expectations inherent in our initial earnings guidance are reasonable and prudent in the circumstances. As we have successfully done in the past, we would hopefully be able to improve contract profitability and a leveraging of our cost base over time.

Free cash flow is expected to remain strong in 2006 with an initial estimate of $90 million for the year. And without additional acquisitions, we would certainly be in a substantial positive cash position by the end of 2006. As is customary, our forward forecast does not reflect the potential impact of any other acquisitions. Frankly with all of the M&A activities and opportunities in the pipeline at the present time, I would be very surprised if we were not successful in adding one or more attractive accreting acquisitions to ESSI within the next six months. Our current targets include larger manufacturing and services firms with revenue well in excess of $50 million individually, as well as a number of somewhat smaller bolt-on acquisitions that extend our product or service offerings to our military and intelligence customers.

With our unlevered balance sheet, we certainly had adequate capital resources at our disposal to take advantage of opportunities in our portion of the defense marketplace, which in our opinion remains a target-rich environment. Now Gerry will wrap up with our remarks.

Thanks Gary. Great report. I too am encouraged to see solid growth in our business space and like you, believe that we will successfully manage our business to achieve improved profitability.

In addition, many of the acquisition candidates being pursued are compelling opportunities. So, we expect a continuation of record performance.

Before we conclude our planned remarks this morning, I would just like to take a couple of minutes to address an issue that continues to be of importance to our shareholders -- the impact of Iraqi Freedom on our (technical difficulty) longer-term business prospects. For the past two years, we've constantly been asked questions, such as -- what happens if all of the troops come home tomorrow, or how does an increase in the number of soldiers in the Army affect your business? And we have consistently responded that while the Iraq situation certainly has positively impacted our business, over the last couple of years, short-term variations in the number of soldiers deployed abroad does not drive our business day-to-day.

In addition any incremental work stemming from this and any extended military deployment is generally awarded and completed in a matter of years rather than months. As you read in the papers in the past week or so, Army leadership has publicly commented on both its more immediate intentions as well as its contingency planning in the event an even more extended deployment in Iraq and Afghanistan is required. Both the administration and military commanders in Iraq appear to be hopeful that a significant troop draw-down could occur within the next 12 months. Their goal as it has always been is to hand over more of the security responsibility to local Iraqi forces both to increase their economy and to help remove the perception that the country is being occupied.

Any planned pull-back is of course dependent on continued political progress in that contrary. At the same time, the Army must position itself for the unfortunate possibility of maintaining well over 100,000 soldiers in-country for as long as four more years as its worst-case scenario should security conditions dictate.

Regardless of when U.S. troops levels diminish in Southwest Asia, the task of returning our forces and equipment readiness to their desired levels is a daunting, multiyear endeavor facing our military leadership. It will require sizable as yet to be requested appropriations. We're talking billions and billion here. And a mobilization of the defense industrial base to complete. In regards our business, while an extended deployment such as we are experiencing in Iraq and Afghanistan certainly continues to provide some unexpected new growth opportunities, it is the ongoing transformation of military support structure, its mission and how it deploys that will impact our business to the greatest degree over the long haul.

The big story here is that the Army is moving towards modularity -- the ability to deploy and perform their missions within smaller units of action that must be lighter, faster and more agile. This transformation is necessary to respond to an adversary who has also changed, who does not necessarily follow the rules of engagement and who then continually adopts to our response. Yet, in order to go to battle in this manner (ph), these brigades must be able to operate and sustain themselves independent of the Army's traditional much larger division-centric footprint, so they will need more support equipment and logistics services from contractors such as ESSI to do their important work.

And these changes won't happen overnight. It will be an ongoing process, incorporating new thinking, new technologies, lessons learned and oftentimes requiring a new approach to meeting the needs of the war fighter.

So at this point, it's difficult to quantify the specific dollar impact that ongoing transformation initiatives may have on our business prospects. But as a preeminent provider of advanced military sustainment solutions and logistics services in many functional areas, including mobile power and environmental control communications, transport, shelter, security and others vital to ongoing military operations, we're extremely well positioned to participate in this transformation in a very meaningful way.

That concludes our planned remarks, folks. Thanks for your patience and allowing us the time to attempt to fully communicate with you, and we will now begin the Q&A portion of the call. Thanks.

(Operator Instructions). Selman Akyol, Stifel Nicolaus.

First of all, a couple of quick questions. Can you --.

Speak up just a little, Selman, if you would, please.

When you guys are giving your guidance for next year, can you talk a little bit about the anticipated revenue split between services and manufacturing?

Percentage wise?

Yes.

Well, we're going to have to look at the numbers here, but it..

While we're looking, would you maybe hit us with another question, Selman, we're thinking 50/50.

Yes, it's a little over 50% for the services side, Selman. Remember that we continued to see increased growth in the service side of the business, and of the acquisitions we added in '05, the largest was Spacelink. Therefore, it kind of made that break over 50%. So it's a little over 50% for services in '06.

Gotcha. And then also, on the FDECU, you said it's going to be recompeted. Do you know when that is going to be awarded?

It will be in '06, but I cannot give you an exact date for an award.

And then lastly if I can, you guys said you expected entered orders of over 1.1 billion. You have been awarded 717 million year-to-date which I guess gives an implication of 383 million coming in the fourth quarter.

Yes.

Can you just briefly go through the major programs you're looking to get awards on?

You're right about that; it's a big fourth quarter. Certainly a big fourth quarter event would be a DPGDS production award for next year. Some of the other programs we'd look at could be some of the additional trailers on the M-1000, that some of our decontamination products that we're selling to the Army. Okay?

Great, thank you.

Guadum Khana (ph), SG Cowen (ph).

Hi, gentlemen, can you hear me? It's (indiscernible). In your fiscal '06 guidance, what were you assuming in terms of supplemental funds from fiscal '06?

I think the last time we got together, we reported that it was our expectation to get something in excess of 100 million for '05 and something in excess of 100 million for '06. And at this point in time, we have somewhere between 75 and 100 booked out of the '05 supplemental and we are still looking for that kind of a range for '06. We continue to get visibility on that each day, but I think that's the input that we began to get here within the last two months and we feel pretty good about that and certainly think that there could be an upside. But our visibility in some of our programs certainly in the services area is limited.

And that would be entered orders. I think maybe you might have asked revenue also.

Right.

The sizable amount of the entered orders from the '05 supplemental have been generators, STTGs (ph), and those revenues start in '06 and actually go into '07 because we have other backlog up at (indiscernible), so forth. So I would have to pull a number out of the air, but probably in that '06 forecast right now somewhere between 50 and 75 million worth of revenues. Any '06 supplementals that we get as Gerry was talking about -- and yes, we do anticipate another 100 million there -- probably won't have any major impact on '06 and it will probably go into '07, just like again we got little revenues in '05 from the '05 supplemental.

Got it. And with regards to the crew protection kits, this year I know you said excluding the additional 50 that you expect to deliver, you're going to be over 70. Are you still comfortable with about 80 million or so this year in fiscal '05 in uparmor sales? What are you assuming in your plan for fiscal '06?

I think the sales --

We're going to be in excess of 70 million.

We're going to be somewhere between 70 and 80 in '05; yes, we're comfortable with that in '05. And I think the '06 forecast has like 40 in it, something like that right now -- 40 to 50. And Dan kind of touched upon that. That arena is changing, but the good news about it, in the changing, we still think we're going to be a major participant and there are several activities going on right now which will lead us then to being able to do 40 to 50 million and there could be some other opportunities out there like we have seen previously that were not in initial forecast that actually could include '06 -- increase '06 numbers. So we feel pretty warm about that 40 to 50 and hopefully there's some upturn in the year in addition to that, but it's not in the forecast.

Last thing, and I will let someone else go. Your services margin I think this quarter were at 7.1%, pretty high. And what explains that and how should we model this going forward? And also, if you could tell us what the DPGDS sales were in terms of spares (ph) or support, whatever, in the quarter, that would be helpful. Thanks.

Let me start with the margin. As we mentioned before, and it's a little hard and I realize as the analysts out there have models that they have to stick it in -- it's a little hard for several reasons. Mainly, what's in there, okay, and let go over that just real quickly. The basic services business is a 6 to 10% OP-type business and there is a considerable amount of that in there. Telecommunications business, a lot of that is higher margins, say low teens and so forth. The DPG GDS business, which is in that sector, that segment, is considerably above that and could be say about 20% worth of OP. The uparmor business, which is in that sector also, is much higher OP margins too, and therefore it has an impact.

Similarly, we purchased Spacelink earlier this year and have added them and they have a little bit higher operating margin than that original 6 to 10 and they are in the low to mid teen operating margin and they will be participating next year at a fairly sizable rate. So what I'm saying is sometimes it's a little tough for us based upon the margin. There's still one other variable out there that we really have little ability to forecast, and that is under what we call the R2 contract. That would be what you might call third-party business. That is business that is brought in by one of TAMSCO's subcontractors and they will get up to usually 6% on some business and pick any major government contractor out there. And he may bring something in that we really don't have a lot to do with, and TAMSCO it's 6%.

So that can have a significant impact on margins at 6% and then it is good business because the risk is nothing we don't participate, but we're going to get 6% on it. So sometimes it's a little tough to predict that margin out there. And again, it will vary considerably a lot by the uparmor and the DPGDS business out there. But there's so many variables, sometimes it's hard to predict. I didn't mean to give you a tough answer, so I think we see long-term that business settling in maybe somewhere presuming we continue to have some amount of uparmor and DPGDS in the low, low, low, low teens, you know; 10% is not a bad number and so forth.

What you also asked was about DPGDS (multiple speakers) what was in the fourth quarter and third quarter.

$2 million worth of revenue in the third quarter.

4 million in the third quarter.

All from secondary equipment.

How much was that? Could you repeat that?

4 million in revenue.

Thanks a lot.

Robert Stallard, Banc of America Securities.

I was wondering if you could first comment on the DPGDS program. When that returns to full rate production, do you see the margins on this business moving back up into the sort of plus 20% level?

Let me answer the second part of that and Dan then can tell you when, but is Gerhardt, Robert. The margins will come back up to the levels that we saw before. Remember when we identified this situation in the second quarter, we basically at that time accounted for the additional costs relative to running the test. We upped our warranty reserve, we did all kinds of things in our normal conservative manner to take that in the second quarter. So the long-term margin will be strong on them as we have seen before. Maybe they're not quite as strong, but they're still going to be the 20 range. And Dan, you want to talk about (multiple speakers)?

From a when (ph) Bo, I would suggest that, as I said, the Air Force was in the process of compiling its results and getting ready to issue its report this month. And with the issuance of that report, I would expect that we would see a lifting of the stop work order allowing us the production. So I still look for it as a fourth quarter event.

You mentioned Gary in passing about the acquisition situation, there's lots of things out there. I was wondering if you could comment on what you think of the multiples that are being asked at the moment and whether these are relatively expensive?

Robert, it kind of varies and we have seen a lot of discussion out there with a lot of people saying that multiples are kind of going up and so forth. There is -- as this environment continues to shrink as the words are, properties are becoming a little harder to obtain. We really have not seen that as much. Multiples are just highly dependent upon very honestly sometime bankers and what they value properties are. Certainly in the services end of the business, they become much more expensive and as they become more off the chain of command or the food tree as far as their sophistication and so forth up in the IT, they get fairly expensive.

The systems side, I will call them the manufacturing businesses and so forth, they are higher than we paid for some of these companies, the initial companies six years ago but we have not seen quite as much fluctuation there.

So in your answer to your thing is, you get some wild variances on the services side, depending on the complexity and that specific company. On the other side, they are still out there and there are still a lot of opportunities. So if it doesn't make sense, we're not going to be out paying 15 times trailing EBITDA or something like that for the business. If somebody has a haltable (ph) like that, they probably better have strong evidence they're going to the growing at 50% per year for the next 10 years or something like that, and then they may be worth 15 trailing. But if it's just a flat growth at 5% a year going forward, 15% multiple on trailing doesn't make sense for anybody over any kind of period of time, other than maybe one or two years.

Finally some minor things. What are your assumptions for a tax rate looking into next year? Have you got any thoughts on the share count either?

The share count number that's in the calculations, 44.6 million, probably a conservative share count. Tax rate is 38%. We look at that very -- in much detail quarterly. We don't have anything right now that would anticipate that that changes, so all forecasts have 38.40 in them right now.

That's great. Thank you.

Chris Donaghey, SunTrust.

Hi, good morning. Gary, first of all, I was wondering if you can reconcile the entered orders versus the total backlog increasing. Your total backlog went up by $200 million I guess sequentially, but you said entered orders for the third quarter were only 264 million. So I guess it sounds like the total backlog number from an order standpoint was higher than the 264?

Yes, it was. Several key programs were one and I'm looking for the list -- I may find them here in a second where they are. But programs with options or ID IQ contracts that have long-term potential on them were significant in the quarter. And quite frequently, you'll get a contract and one of them in there which where one was like $170 million worth of total value. We may have only gotten $10 million worth of initial funding. But the long-term value would be 170, so you'd obviously put 10 in the funded backlog and 160 go into unfunded.

So that is basically what happened in the second quarter. Certainly, that shows strong long-term strength and growth potential and so forth. And the other thing, quick comment, is that sometimes you can look at that funded backlog quarter to quarter as we have obviously always said and so forth, but it will vary just based upon timing of orders as we give you the fourth quarter forecast, it could be, you know, it's the second day of November, we get a bunch of orders and we end up to 1.1 billion, but it's still go to be there long-term and so forth. So again, a bunch of contracts, it's high anticipated contract value over a period of time. They were awarded in third quarter without real high binding necessarily on them. Did that answer the question, Chris?

Yes you did. Also, did you say that in the forward-looking guidance for '06, there were $50 million in acquisition revenue built into that expectation?

No, nothing. We have never put any kind of revenue or any kind of effect on forward-looking forecast for any acquisitions until we close the deals, and then we'll update you at that time for the quarter after that. So the numbers that we gave in the press release and we talked about here have zero acquisitions in them.

I was meaning the contribution from Spacelink, MSI.

I'm sorry. Yes, we would have obviously put them in for the whole year. So as we said, I think we gave some numbers in there relative to the growth and so forth, that some of the growth in '06 versus '05 would be the fact that Spacelink was in roughly for three quarters this year and they're going to be in for four quarters next year.

I guess what I'm trying to do is back into an organic growth projection, which if Spacelink, MSI and the PCA all contributed $50 million in incremental revenue in '06, then that implies organic growth in 2006 of about 11 to 16%

I think the overall number Chris was 14 -- the range of 14 to 23.

Right.

(MULTIPLE SPEAKERS)

I just thought you had said at one point in the conference call, you'd (indiscernible) PCA, Spacelink (MULTIPLE SPEAKERS).

But yes, I hear what you're saying. I think your numbers are close. There's still fairly significant organic growth in -- (multiple speakers). Here is the calculation. Let me see here. Organic growth in dollars for '06 versus '05 is 130 to 150 million. And you can calculate your percentage off of that basically. A total of '06 organic.

Okay, great. Thanks.

Eric Hugel, Stephens Inc.

Good morning, guys. Can you give us sort of I guess in the numbers what the impact if there is any from options expensing for '06 guidance?

Option expensing -- of course, there's nothing in '05. In '06 right now, we have no projection. Our compensation committee is still looking at what is going forward relative to that. We did grant some options from a shareholder approved plan here in the July timeframe. Those of course did not require being expensed and we're going to look closely at what happens in '06. We'll look at a couple of things. We'll look at what other companies do. I would tell you in general, the amount of options unfortunately since we think it's a very positive motivator for employees would probably less outgoing than we have seen historically due to the expensing. So, again, nothing in there right now.

I don't think Eric we would expect any material impact on our income statement in '06 relative to options expenses once we do come up with a plan.

Okay. You discussed the I guess the margins going forward in the services business. Your systems margins though for this quarter stepped down a bit too, like around 16%. Can you sort of talk about what happened during the quarter and what you would expect going forward? And then was there a really a mix shift there also or what's sort of going on and sort of where should those margins go going forward?

I would say that in the remarks that certainly Gary made, you would -- we have seen a mix shift on our systems side. We have seen the TUNNER program come to a conclusion, we will see the existing FDECU contract next year get to a conclusion and what we will see is that the replacement contracts will be new startup programs.

Yes, but I'm talking this quarter let's say versus last quarter. Last quarter, there was a minimal TUNNER revenue I would expect as the program ramped down and you're not saying the FDECU or lot of the other. What's sort of this happening? Let's just go from last quarter to this quarter. Is it all mix, or was there anything sort of significant in there?

(MULTIPLE SPEAKERS). There was some amount of TUNNER in the second quarter, Eric. More obviously quantity wise more in the second quarter than in the third quarter. The TUNNER program came to end, so there was certainly some final letting out of reserves. That always happens as required by all accounting rules in the second quarter versus the third quarter. Other than that, Eric, we would have to go through the details. There's certainly probably there may be a little bit difference in the amount of uparmor in there, some of the other programs that may have some variance.

I guess would you expect then, I guess going for the next couple of quarters until let's say FDECU runs out, you said that sort of the timing of that, it sort of comes out in the back half of next year. Would you expect margins in this sort of let's say 16, 17% range? Is that sort of a good way to look at it?

The systems margins that we saw in third quarter are probably reflective of what we're going to see in the near-term future.

Okay. And then you said that FDECU, the margins -- I guess FDECU and then sort of those new programs ramping up, that would be more of an impact let's say in the back half of next year, so we would see a further step-down in margins from the systems business?

Eric, again, relative to the specific FDECU, yes, okay. That was what one would indicate at the present time. FDECU itself would be dependent upon when that contract is awarded, the next contract, and what the of course the DOD does meanwhile relative to meeting the existing demand since the new contract, we anticipate our winning it, but whoever wins it will have to run a first article. And therefore, the production will be -- under the new contract will take some time. So there could be additional sole-source awards under the existing not contract but new contracts. So that could have an impact. But if you read it just as the facts laid out right now, certainly you would see under the FDECU contract a decrease in OP dollars in the second half of '06 versus the first half of '06. But we need to look at all of the details of all of the programs and we probably need to get offline, Eric, and go through that in a little bit more detail relative to how the quarters run out in '06 based upon all of the programs.

Because there's going to be some programs coming online that will be stronger in the second half of the year which will be profitable, not 30%. They may get there eventually but meanwhile, they're going to be reasonably profitable. But again, they're going to have more revenue maybe in the second half than they do in the first half which will in OP dollars offset that FDECU increase.

Right. You talked about a number of large program opportunities, (indiscernible) Bioshelter (ph) and the environmental control units being awarded some point early in 2006. Would those be sort of initial awards and you have to go through a whole development stage, or once those are awarded, would production of those units start? Would we actually see some revenues in '06 from these contracts?

You're going to see some amount of revenues '06. But yes, back your original statement, that they will go through some amount of development, some amount of first article testing. It varies by program. These are not ground-up developments. The CVPS (ph) program will require some amount of revised qualification testing let's say it because it is an electrical-driven unit now versus -- it was historically a hydraulic unit. But we have made the rest of the unit, so a lot of it won't go through. So there's going to be some amount of development, some amount of qualification, first article, developmental testing and there could still be some production in '06. But it will be a mixture in all of those however. Meanwhile, we will have revenue in those programs based upon that development and we will have some amount of profit. It will certainly not be 30%, but those -- that development (indiscernible) right now is pretty much projected to be somewhat profitable.

But those would really be '07, let's say fiscal '07, fiscal 2008, sort of production ramp-up types of programs?

In general, yes.

My final question before I get back. Your $3 million estimate for DPGDS to sort of I guess retrofit the existing fleet, those sort of do the fix (ph); is that still holding?

Yes it is.

Thanks a lot guys.

Folks, we're running out of time and we'd like to take one more question, please.

David Gremmels, Thomas Weisel Partners.

Thanks, and thanks for all of the detail on the call. I have one bigger picture question and then one more narrow question. So first on the armor opportunities with the Army's new armor strategy, it sounds like there's a lot of moving pieces there but it sounds like there's a lot of opportunity. And is it possible to quantify the ultimate amount of work out there? Is there a point at which this increases and becomes a very major part of your business?

I think today, David, it would be hard to quantify the production side of that. The initial designs are not even on paper yet for the new armor strategy that the Army is evolving. But, you would certainly look at, with a population of some 200,000 vehicles, the population is huge by comparison to what we've accomplished in our past nominally looking at I guess probably, what, 15; 1600 vehicles that's we have -- kit's we've delivered to the Army and the revenues that that has driven for us.

Can you maybe comment on the competitive environment for that type of business? I assume that that would be fairly competitive.

We would expect it to be fairly competitive, and obviously we would also expect the fact that (technical difficulty) obviously has already been (technical difficulty). I believe that's the (indiscernible) performance will be strongly considered when those competitions unfold. One thing I'm real proud of those guys is they are probably the only company that got it on ahead of schedule and under the estimated cost for the United States Army to include the fact that we ultimately refunded some of the contract value to the Army.

So I guess looking big picture, is it possible that this kind of business could stay in the $50 to $100 million range for many years to come for you depending on the outcome of some of these competitions?

I think it is possible.

Is certainly is, David. I would suggest also that -- watch the funding, watch the supplementals. That's what we do to try to determine how much of that can go through the uparmor because as we all know, it's crucial to our war fighters. But it has the potential of real aims (ph) for the future. We will see here in the next I guess six to nine months.

And then lastly on your '06 guidance, I'm just wondering what are you assuming in there for DPGDS? Are you assuming that you recapture the 35 million or so that slipped out of '05?

Yes. It would assume the fact that we have in firm backlog right now somewhere in that range, let's say, okay, new entered orders and then running that on a production schedule out of how much would be produced in '06. I think of the new entered orders in that backlog, it probably actually for right now, it runs into '07 actually.

So you'd be looking at something in the neighborhood of 100 million in DPGDS revenue next year?

I think that's a little right now based upon the current production schedule out there and orders and so forth. It doesn't mean that we can't get that done, but I think it's a little bit less than that.

I think you had said on the previous call, it had been running at about 70 million per year. So are you saying that it will be back at that 70 million in '06, or that it will be something beyond that 70 million?

I think it's in that range.

In the range of 70 million?

Yes.

Thank you.

Thanks, David. And something that David we haven't covered this morning is the recent activity. And we were just getting started on that with our trailers, also with our generator sets. That is something that will also evolve as we continue to get improved visibility. But we're obviously very encouraged with the potential.

And then I might finish up by reinforcing the fact that we expect to continue record performance. As we discussed earlier, revenues next year of 14 to 23%, earnings of 8 to 15 and all of that really will exceed the past and our forward long-term organic growth targets. So we feel pretty dog-gone good about the business and we really appreciate everyone's time this morning and all of the excellent questions. With that, we thank you and good day.

Thank you for participating in today's teleconference and have a great day. You may disconnect at this time.