Leonardo DRS Inc (DRS) 2006 Q4 法說會逐字稿

Good morning, everyone, and welcome to DRS Technologies' conference call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. (OPERATOR INSTRUCTIONS). As a reminder, ladies and gentlemen, this conference call is being recorded.

At this time, for opening remarks and introductions, I will turn the call over to Ms. Patricia Williamson, Vice President of Corporate Communications and Investor Relations for DRS Technologies. Please go ahead, ma'am.

Thank you, Kelly. Good morning and thank you for joining us on today's conference call to review DRS Technologies' financial results for the fiscal 2006 fourth quarter and year ended March 31, which we reported earlier this morning.

Hosting today's call are Mark Newman, Chairman, President and Chief Executive Officer of DRS; and Richard 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 today on our web site.

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's financial results, please refer to today's earnings release and our filings with the Securities and Exchange Commission, available on our web site.

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 SEC filings available on our web site at drs.com.

The Company 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. Mark?

Thanks, Pat, and good morning, everyone. Thank you for joining us on today's call to discuss the results of fiscal 2006 and the fourth quarter. As you saw in our news release this morning, fiscal 2006 was a great year for DRS. We capped off our record fiscal year with a very strong fourth quarter and reported substantial increases in key metrics for both periods. I will spend a few moments touching on some of the highlights.

Revenues for the fiscal year of $1.74 billion were 33% above last year, with organic growth accounting for 13% of the increase. Our new S3 Group, formed out of our acquisition of Engineered Support Systems, contributed $168 million to our revenue base for the two months we owned this operation in fiscal 2006.

Full-year operating income was 35% higher than last year and represented an 11.1% operating margin. 34% higher net earnings resulted in diluted earnings per share of $2.67 on average shares outstanding that were 10% more than fiscal 2005. And our cash flow was strong at $113 million, up 12% from a year earlier.

We captured $2.2 billion in new contract awards during the fiscal year, 52% higher than last year, providing a book-to-bill ratio of 1.3 to 1. At March 31, we posted funded backlog of $2.4 billion, 82% above backlog at the same time last year.

Chief among our fiscal '06 accomplishments, aside from the exceptional financial results, were our completion of the Engineered Support acquisition on January 31, coupled with our offering of $945 million in new debt securities; completion of two smaller acquisitions earlier in the year that have contributed to our competitive profile in intelligence gathering and digital battlefield computer systems; our selection for Standard & Poor's MidCap 400 Index; and our declaration of quarterly cash dividends for our stockholders, which began in June 2005.

Earlier today, we were pleased once again to announce the Company will pay a $0.03 quarterly cash dividend for stockholders of record as of June 15, which will be payable on June 30.

Results for our fourth quarter were excellent. Taking a brief look, we posted record revenues that were 79% higher than a year ago, with 29% due to organic growth. Operating income rose 79% on an 11.5% margin, and net earnings were up 76%, or $0.79 per diluted share, on 30% more shares outstanding than last year's fourth quarter.

Free cash flow was 95% above last year's fourth quarter, providing us with the opportunity to pay down some $150 million in debt following the close of the Engineered Support acquisition. Bookings in the fourth quarter also were strong, providing a 1.2-to-1 book-to-bill ratio.

There were a number of important milestones achieved in the fourth quarter, and I think they're worth mentioning. Starting with our C4I Group, we delivered all of the contracted power systems hardware to the shipyard for the first Littoral Combat Ship being built by Lockheed Martin. C4I shipped more than 3,000 tactical computers, bringing the total of DRS-produced computers delivered on the Army's FBCB2 program to now over 24,000. And the Group was awarded a $142 million production contract on the SIRIUS Long Range Infrared Search and Track systems program to support the Canadian and Royal Netherlands Navy. The SIRIUS system will enhance a ship’s self-defense capabilities by automatically detecting and tracking anti-ship missiles and aircraft.

Our Surveillance & Reconnaissance Group had a very strong bookings quarter, securing over $100 million in contract awards for cooled and uncooled ground vehicle electro-optical systems, $40 million in orders for Thermal Weapon Sights, and some key orders in other core product lines, including vehicle diagnostic and test equipment, UAVs and air combat training systems. The Group also completed some key initiatives relating to advancements in our Focal Plane Array technology.

During the quarter, we successfully produced the first 12-micron mid-wave and 15-micron long-wave Integrated Dewar Cooler Assemblies, as well as third-generation, two-color infrared detectors. These advancements place DRS in the forefront as the industry's leader for next-generation FLIR systems, which will offer greater performance in a smaller, lower-weight and lower-cost system than any other available today.

During our S3 Group's two months of operation with DRS, this segment was awarded a two-year Army contract with a ceiling of $222 million to provide an integrated, open-standards command and control information technology infrastructure for the Multi-National Forces in Iraq as part of the United States' ongoing reconstruction program. S3 has an extensive track record in the design and operation of military communications systems, network management and support, which will contribute to providing the vital stabilization rebuilding needed for Iraq's governmental infrastructure.

Thanks to efforts of our S3 Group, the Elizabeth City Coast Guard air station hangar we built in North Carolina is now fully operational, with two C-130 aircraft currently being inspected for repair and maintenance. This successful effort is expected to open up new opportunities for DRS to capture additional business in aircraft repair and overhaul services, while also providing an opportunity to expand our Coast Guard relationship.

During the quarter, S3 also delivered a new SATCOM network to the Special Operations Command, marking its entry into this new customer community with global satellite communications technology. Since forming the S3 Group, we've made some significant progress in our efforts to integrate this business with DRS. And on May 1, we consolidated certain operating units that have similar product lines, business services and customers within each of the two strategic business units that comprise S3.

This initiative furthered a vision that originated with Engineered Support Systems' management over a year ago. It was implemented to ensure a stronger competitive industry profile over the long-term, increase operational efficiency, align our focus with customer priorities and improve customer interface. We also continue to implement strategies to improve efficiencies and encourage coordinated common pursuits within the C4I and Surveillance & Reconnaissance Groups.

These efforts are part of our ongoing initiative, as we have mentioned in the past, to remain highly competitive, adaptable and responsive to our customers, and to assure our operations continue to be aligned with customer priorities.

As you saw in our earnings release this morning, we raised our EPS guidance for fiscal 2007, reflecting confidence in our expectations for significant year-over-year increases to our top and bottom line. We reiterated earlier guidance for fiscal '07 revenues of $2.9 billion, which represents about a 67% increase over fiscal '06 sales.

Our new diluted EPS estimate of $3.05 to $3.10 is about 17% higher than EPS the year before and includes about a $0.10 to $0.12 impact from our adoption of FAS 123(R) for expensing stock options. We expect our operating margin to continue to remain strong at more than 11%, and free cash flow for the year to be $100 million to $125 million.

As you saw in today's release, we also issued guidance for the first time on the three months that will end June 30. Anticipated first-quarter revenues of $600 million to $625 million represent an 85% increase over the fiscal '06 first quarter. The $0.49 to $0.51 in diluted EPS we are estimating for the first quarter of fiscal '07 includes a $0.02 impact from the adoption of FAS 123(R) and a 43% increase in average shares outstanding.

Before I turn the call over to questions, let me just add that we are very excited about moving forward in fiscal 2007, invigorated with the addition of our S3 Group's new business lines, customers and employees, in addition to the opportunities that lie ahead of us. As reflected in our funded backlog at year-end and our updated guidance, the addition of Engineered Support Systems will contribute a significant base of systems, products and services that will positively impact fiscal '07 and beyond.

Our Company is now a leading total solutions supplier with deep capabilities in providing defense products, systems, services and subsystems integration. These expanded capabilities position DRS as a major supplier in Armed Forces modernization, personnel mobility, and operations and maintenance support, while providing new opportunities for growth in the intelligence and Homeland Security markets.

Going forward in fiscal '07. we intend to fully leverage our combined strength and continue to execute well on our strategy. I would now like to open the call for questions

(OPERATOR INSTRUCTIONS). Peter Arment, JSA Research.

Peter Arment

Good morning, Mark. Nice results. Just a question on S3. I know this is the first quarter, so maybe I was just completely off on a modeling aspect. But is it the margins running a little lower than previously or is it just due to the accounting and other things that are flowing through this quarter? Maybe you could just give us a little color on that.

Let me turn that over to Rich.

Margins were actually right in line with where we expected them to be for the two-month period. For the full year next year, we do expect the margins to be a little bit north of 10%, probably mid 10% range.

You have to remember for the two-month period, the mix between the services side and the product side has a big impact on the margins because the services margins are lower historically. So, we are very comfortable with the margins where they are.

Great. Thanks. That's all I had.

Ferat Ongoren.

Could you help us with the sequential margins on the Engineered Support business, because there was some period that they didn't report the numbers? Could you basically walk us through the last reported margin,, which was about 14.5% and probably benefited from a high margin on the DPGDS program to 9% margins, which probably includes higher G&A?

Okay. Their margins for their fiscal 2005 were reported at 13.9%. The write-offs in the intangibles, as required through the purchase accounting, is about $22.5 million a year. So, figure that is about somewhere between 180 - 200 basis points, depending on what the revenue number is, as that amortization takes place.

Additionally, remember that their two biggest margin programs, the Tunner and the MSTAR, concluded during the year. And they were just doing some sort of sustainment work on those programs. So, those margins were coming down as the year was progressing, due to lower revenues from those two programs.

Additionally, they have new programs starting up -- their two biggest ones, the Fuel Farm and the RIFTS, which are going to be nice revenue producers for us and already started, are going to be low-margin programs in the beginning, and the margins will improve as the year goes on.

And also remember Spacelink that they acquired in January, which is on the services side and is lower-margined, just because of the nature of their business. They only had nine months of operations with Spacelink in their '05 numbers.

So, when you put all that together, the margins, depending on the mix of the business, is going to be 9%, maybe could get high as 11%, depending on mix in some quarters; but it is going to be in the mid-10s.

Synergies that you're going to get from this business going forward, is that going to accrue to other segments or to this segment?

Yes. That's a good point. And there are a lot of synergies that are anticipated. Some we have already started to realize. We got a late start in the integration process because we closed on this transaction later than we originally anticipated. But we have started to catch up as to where we thought we would be. And those synergies will spread across all of DRS.

So, you will see -- if you look at the separate pieces, you will see that the DRS pieces will be more profitable as a result of this integration. And the margins that we forecasted back in September, when we announced this transaction, are still very much in line with what we expect.

And then in terms of the revenues that you're guiding for, what percent of the revenues for fiscal '07 is in the backlog right now?

Also a good question. That number -- historically, we have talked about a lot of the backlog represents the revenues going forward. You know that in the backlog number, the next quarter's revenues are already all in backlog. That number is going to change a bit now. On the product side, that is still true.

But on the services side now, the backlog is going to be less a percentage of the services revenue because a lot of that is booked on a monthly basis. So, I can't give you a specific number now. We're trying to figure out, actually, how to come up with that number on an accurate basis.

If you had to take a guess, it would probably be something like 65 or 70% of the backlog that exists right now. But that is something we're going to work our way through.

But then the core businesses will add a coverage of maybe 80% or so from the backlog? The two other businesses that you already had, excluding Engineered Support.

No change on that. In fact, it is probably a little stronger today than it has been.

(OPERATOR INSTRUCTIONS) Mike French, Kaufman Brothers.

A question on the cash flow, and can you provide any particular guidance for the first quarter? You have a year number in the press release. I was wondering if you could break it down, at least for the first quarter.

No Mike. I'm not going to get into the habit of trying to forecast cash flow by quarter. I can tell you historically the first quarter has always been the weakest of the four quarters from a cash flow standpoint, and I would expect that to continue. But that is really as far as I can go.

And then a follow-up to the question about your guidance and what is in it. What is the assumption right now for a supplemental? You guys provided that in the past. Is it roughly the same as it was last quarter?

Well, the supplemental is really a bookings question, right?

Yes.

So the majority of what we book tends to come from the regular budget. We probably would have a tough time guessing, because some of our things could come from supplemental dollars or it could be in the regular budget; it just depends how they are going to dole it out.

So, I would say that is a very tough question. Last year, we probably booked over $500 million from the supplemental. There are going to be two that we know of. There is the current supplemental; there will be a bridge supplemental from what we understand.

There won't be much that comes in there that really affects fiscal '07, however. Most of the business that we will book out of the supplemental will affect fiscal '08, because we have most of what we need in backlog now.

So, it would be a very difficult thing to just pick a number out. What we have as a total forecast that our guys have put together for where they think their bookings are going to be for the year, which are very strong. We just haven't asked them to break it out between regular and supplemental.

Thank you.

Stephen Levenson, Ryan Beck.

Can you tell us a little bit about the integration of Engineered Support? And you mentioned that Command and Control unit. Are they using a lot of other DRS -- older DRS equipment in that? And have you set something up in between the divisions to enable you to use more of your own stuff?

I don't -- I can answer the integration is going very well. In fact, it is probably going faster than we even anticipated when we closed the deal. The interaction with all the people is excellent. We have been realigning the businesses. We are seeing good interaction between old DRS and new DRS, as we call them. So, I think that is very positive.

I don't think -- I don't think I follow the other part of your question. Are you talking about --?

Capturing more of the margin by using equipment produced by the C4I and S&R divisions?

Are you talking about this big program through -- Iraq?

Any of them. The one that you mentioned in particular.

Are you talking about -- or the quick reaction programs?

Yes.

Mark Newman

Okay. We haven't analyzed that at this point. But I think certainly in the long run, there is going to be a benefit from that. You know, there is no question. But I don't have an analysis of that. I though you were talking about the main integration of the business.

Oh, no.

That is going very, very well.

Okay. Thank you. And one for Richard. What is the threshold? Is there an earnings threshold where you to see an impact from the convertible bonds on the shares outstanding?

The strike price is $59.60. So, if the stock price -- or I should say as the stock price gets to about $59.60, there would be an impact. I don't think it will be that significant, certainly, for this year. But if the strong earnings continue, there will be an impact, and we will factor that into our forecast.

So, it is based just on the stock price, not on an earnings level at DRS?

That’s correct.

Howard Rubel, Jefferies & Company.

Thank you very much. A couple of things. One, could you give us a sense of the mix with respect to S3, Mark? It seems that if we do annualize what you have done so far, the revenues in the first quarter might be a little bit more skewed towards the old core C4I and Surveillance business, and the new EASI a little bit lower than what we might have thought.

I think if you look overall for the year, if we do about $2.9 billion, we are still sticking with $1.2 billion coming from Engineered Support acquisition and the balance coming from DRS. So, it still looks like 1.2 and 1.7. That hasn't changed much.

In my head right now, I don't have the breakout for the quarter, but I think we are pleased with what they are doing in the first quarter. I don't think that is an issue -- do you?

No. And obviously, I do have it in my head, but we have always resisted trying to forecast by segment by quarter, and I'm going to continue that resistance.

You mean we can't entice you?

No.

Your head -- it's not in my head.

Well, we just have to get inside your head, Rich. But in all seriousness, there has always been seasonality at DRS, but usually we would see a more impressive year-over-year improvement in results than what we are likely to see in this first quarter.

Is there anything in here that would -- I mean, could you elaborate a little bit on what is holding it back? I mean, obviously borrowing costs and some of those factors, but those should already be incorporated into what we are thinking about.

Let me answer this the best way, which is really we had a very, very strong fourth quarter. Which means that -- and whatever we do is really aligned with what the needs are of the customers in any quarter. So, in meeting the requirements that we had for the quarter, stuff that may have ended up in the first quarter of this year ended up in the fourth quarter of last year. So, I think that helped account for the very, very strong fourth quarter.

And we are getting off to, I think, a very good start in the first quarter, but there may be a few cents that could have gone from one into the other. Either way, I think we are looking very strong.

The other thing you have to remember is we are ramping up a lot of new programs right now. So, historically, I don't think we are out of line with where we have been in the past.

I guess -- you know, I don't agree with your premise, Howard. The earnings are up 50% over last year, and that includes an additional charge for the FAS 123(R). So I am very happy with the quarter the way we're starting out.

Okay. That's fair. Two last things. One is have you finished what you think your intangibles will be with respect to EASI? Or how far along are you in the process, would be a better way to ask that.

I would say we are 95% of the way there. We have got a preliminary appraisal report that I expect to turn into the final. If it does, we are talking about annual amortization of the intangibles related to S3 of $22.5 million.

And then finally, it looked to me like you've started out the quarter very strongly in the way of bookings, Mark. There were a couple of fairly large orders that did fall in S3's book out of the box. For the year, do you see kind of mid-teens sort of bookings growth?

We are going to have very solid bookings growth. And generally what we strive for is a 1-to-1. So, what we would like to do is certainly book as much as we are going to ship for the year. So you do the math.

Thank you very much.

Steve Binder, Bear, Stearns.

Good morning. Good quarter. A couple of different things. One, Mark, you said up front about the supplemental bookings for fiscal year '06 -- I think ahead of $500 million. But I'm just looking at the notes from the last quarter, and it looked like you were a little over $300 million. Was the IBAS contract -- is that what you're factoring in?

That was probably the biggest part of it.

So if you look for fiscal year '07 just in total from a booking standpoint, do you have a sense on where your plan is book-to-bill?

Are you talking supplemental now or are you talking --?

Just total – I’ll make it easy for you.

That's why I am saying total book-to-bill for the year should be about 1-to-1.

And your assumption on supplemental bookings was what then for --?

What I said before was I don't have the visibility, just sitting here right now, as to what is going to come from the supplemental. But all I have is the forecast for the bookings for the year. As you pointed out, we got off to a very good start in the first quarter.

And then as far as -- let's handle Howard's question a little differently. Just distribution-wise, you look at the last seven years, you have been averaging 18 -- your first-quarter earnings have been 18 to 19% of the full-year level. And granted, acquisitions can skew that. But it's been pretty, pretty steady. And this year's first quarter, you are suggesting 16%.

So I don't know, Rich, did you want to tackle that a different way or any thoughts on that or is it just conservatism or does it get back to what Mark said about the front-end loading to the fourth quarter?

No it pretty much -- if you look at it, the earnings are about 16%, the revenues are a little higher, based on the forecast that we are giving. And remember now the ratio is a little skewed because of the stock option expense all of a sudden is being factored in. And I think as the year goes on, interest expense will come down as we continue with a strong cash flow, so you'll see interest expense less as a percentage. And also, as you know, our margins do tend to go up as the year goes on. So, all that together will show the earnings number where we expect it to be.

All right. Mark, you talked about some of the contract wins and they've had some good bookings over at Engineering Support. A couple of losses, though -- the chem bio shelter system, at FDECU as well. Can you maybe just touch on what you think happened there?

Well, I think you can look at them two different ways. The chem-bio I think was just a bummer. We would have liked to have won that. We are the incumbent, and we got beat. And it's hard to comment on that, except to say that now that we are a part of that business, we are getting our arms around it, we are getting our costs in line, and we are going to take whatever steps we can to make sure it doesn't happen again.

The other one, I don't think we are totally out of the picture yet there. We are still working with the company that actually won the program. And there may be an opportunity for us on that one. And that is, of course, minor.

But the other was -- it was a disappointment. There is no other way to say it. But we are going to work around because we're having a lot of positive wins also from them, including this up-armor contract that we have gotten. So, I think everything is overall going to be pretty solid, and that's why we're still forecasting $1.2 billion for the year out of that segment.

And finally, Rich, can you just -- you had exceptional working capital performance in the quarter. Can you just touch on the high points there, as far as the contributors to the working capital reduction?

Sure, Steve. For the quarter, the working capital declined about $46 million. The biggest pieces, receivables actually were up $51 million; inventories were up $3 million; prepaid expenses, other assets were down $20 million; accounts payable were up $24 million; customer advances for the quarter were up $56 million -- I'm sorry not customer advances -- accrued expenses were up $56 million. Customer advances were actually down $4 million. And then there's a whole bunch of little things that net to the rest of it.

David Gremmels, Thomas Weisel Partners.

On the S3 consolidation initiative that you talked about, can you just give a little more detail on what was consolidated and is it complete and how much cost savings do you expect that to generate?

We are still working on what the total cost savings will be. But essentially, for example, we are going to take the entire Services group and turn it into one DRS technical services company and consolidate all of the overhead operations, G&A operations into one entity now.

On the Sustainment Systems side, we are going to do similar things, which we have already set in motion, by the way, on both sides to combine operations where we can. And even without closing facilities, which we don't have plans to do, we can still operate from one facility instead of two from the point of view of overhead and G&A.

So, it is a huge initiative; it involves lots of people. We have also taken out cost across the board. We have taken out a lot of corporate cost that doesn't fit anymore because they are no longer an independent public entity. So, I would say we have implemented cuts across the board. We have implemented these consolidations. And at the end, it is going to be a far stronger business.

I will say that the bulk of what we are doing was already in their planning cycle when they were an independent company. So, it was kind of put on hold while they were going through the divestiture or the sale process. Then we picked up their plans and then them, together with some of the key people from our corporate organization, and have now implemented the program.

So, I think it is going to be a very positive thing for us. It is going to have some impact in '07, of course, and I think you'll see the biggest impact in '08 and beyond.

At the time when you announced the acquisition of EASI, you talked about a target of $15 million in synergies. Is that still the target or could you maybe be doing a little better there?

Let me just say that is the base now. That's the base target.

And doing the math on the organic growth that is implied in your '07 guidance, I am getting 5 or 6% organic growth, which seems to be a disconnect with the very strong new order bookings for the year. So, I guess first of all, is my math right there? Or if not, what organic growth rate are you expecting in '07? And if you just touch on what might account for the disconnect.

The implied organic growth is 8.2%. You can give me a call and we can figure out where your math is different than mine, but in our model it is 8.2%.

Okay. But then even assuming 8.2%, when you look at the book-to-bill of 1.25 for the year, it seems like there is a bit of a disconnect. Is that maybe a longer duration of the services revenue or is there something in there that might account for that?

Well, don't forget that some of the contracts you get are multiyear contracts. So even though they are funded, you are not going to actually recognize the sales in one year. Sometimes it slips into a future period.

Fair enough. And then just a couple housekeeping questions. What depreciation and amortization expense is assumed in your '07 guidance?

Depreciation expense is from $45 million to $48 million. Amortization, $30 million to $32 million.

And what tax rate are you assuming?

If you use 40%, you will be in the ballpark.

Myles Walton, CIBC World Markets.

Just to clarify, I just wanted to clarify one point. Did you say that the current supplemental being talked about in Congress and being passed through Congress is going to be an FY '08 impact and likely de minimis on FY '07?

No, no. What I meant to say was where you will see the sales revenue -- the revenue side. The bookings will come in fiscal '07 as part of the bookings that we will have. But in round numbers, if we said 1-to-1, that would imply that we're going to book $2.9 billion for the year.

So remember, we're going to be starting the year out with a $2.4 billion backlog. We are going to book $2.9 million and we're going to sell $2.9 billion. So, we're going to end up with $2.4 billion in backlog if those numbers hold. So that means the $2.4 billion in backlog that we are going to have at this time next year isn't going to be the same composition, obviously, as the $2.4 billion we have got right now.

So, when I talk about the impact of the new supplemental, those are revenues that will actually get recognized in '08 and beyond. That is all I meant. But from a bookings standpoint, obviously it will have a positive impact.

(indiscernible) I was actually asking about the revenue side. In fiscal year '06, did you realize much revenue from the fiscal year '05 supplemental?

There is probably -- if you go back to '05, there is probably some, so maybe half.

Half of (multiple speakers)?

I am just guessing.

Yes. So about $250 million of the $500 million?

Right. Keep in mind the beauty of this business is the visibility that you have into the future. So you book these things and then you put them into the production mix, and then they go out as it is called for contractually. Then you have programs like FBCB2, which stretches out over many years. And even though we look at it as one total number that we're going after, we get it in pieces. So, it just depends on the program that we book. But no matter how you slice it, it is positive.

Yes, I know. I think I am just getting at that it looks -- it appears that -- I guess off of David's last comment and the fact that the supplementals will likely have some effect, at least in the fourth quarter of FY '07, that maybe there is some room on the top line to head upwards a little bit.

And just to clarify, Rich, tax rate for '07?

Around 40% -- maybe a little higher, maybe a little lower.

That's good for me. Thanks.

(OPERATOR INSTRUCTIONS). Gary Liebowitz, Wachovia Securities.

I guess in the third quarter, you had some losses on the DD(X) propulsion engineering. Did those continue into the fourth quarter, and where does that program stand as we go into '07?

Actually, most of the work has been completed on that motor and we did get some additional funding that came through recently, which is going to help that. And then we expect to see funding next year as well. And I think that -- I believe the Navy is going to continue to support the program. So, we are hoping to see money come in this next budget -- it may be in the supplemental even -- to continue to work there. So, I think the bulk of what we saw written off has been concluded.

Also, were there non-recurring finance charges or early debt retirement expenses that flowed through the fourth quarter, Rich?

Yes, there was. In total -- well, I will give it to by the pieces. There were three pieces. Two were expenses and one offset some of that. We wrote off the deferred financing fees on the old term loans, which was about $2.6 million. We had a commitment fee that we paid on the bridge loan for the financing of the ESSI deal, which was about $2.4 million. And then we had an offset of a little over $1.5 million related to a gain on some interest swaps that were related to the term loans that we retired.

And is that in your Other Income line?

No, all that is part of interest expense.

And maybe I missed it, but what was the cash balance at the end of year?

The cash balance was low -- it was a couple of million dollars, a little less than a couple million dollars. Everything -- all the spare cash that I have is being used to pay down the revolver.

Greg Agnew, Friedman, Billings, Ramsey.

In the past, you have mentioned that within the legacy DRS business, there's sort of a multiplier of about four times on your backlog in terms of options and ceiling value. I was wondering if you could characterize how many years that typically encompasses? Just essentially trying to figure out how much future business could come from what is attached to your current backlog on a per-year basis?

I think because we know the kinds of programs we are on and we use that number four times, it says if you didn't go out and win lots of new things, you would end up with a good $2.5 billion to $3 billion business a year, which would be a no-growth business, but a very solid business. So, I think that four times probably still is a good number going over the long term.

What we try to do is to forecast, when we do our own internal planning, we forecast a modest organic growth rate, and we don't build in acquisitions. And sitting here today, I think if we looked out five years, aside from fiscal '07, which obviously will be a big jump because of the Engineered Support acquisition -- but I think if you go to '08, over the next four years, based on the kinds of things that we're involved with, we still see a nice organic growth. And we have always pegged that at around 5 to 8%.

So, I think that the kind of mix we have in the backlog, the programs that we have, would say that, aside from '07, which is going to be a huge jump up, barring any other acquisitions, we'd still have a business that could grow at that level, based on the kind of business and the mix that we already have. So, I think the number is probably still a good number for you to use.

And then with respect to organic growth, just two quick ones. What are you basing your first quarter's revenue outlook on in terms of organic growth? And then also, if I could get the organic growth by segment for the fourth quarter.

I will give it to you by segment. I actually thought we had it in the press release. But for the quarter you want?

Yes. Thanks.

C4I was 20.1% and S&R was 38.8%. ESSI obviously is not part of the organic calculation.

Okay. And then just what organic growth level you have baked into the first quarter. Just overall.

Actually, I think I prefer not to disclose that. It is very difficult. We've said organic growth is very lumpy by quarter, and I have a whole range of organic growth, depending on different scenarios.

The other thing it is a function of what happens to go out the door that particular quarter. Because we don't manage the quarters to organics; we manage it to contract requirements.

Okay. Thank you very much.

Alok Chopra, Oppenheimer Capital.

Nice quarter. Just a quick question on the ESSI or EASI guidance.

S3.

ESSI, okay.

S3, we call it now.

S3.

S3.

I stand corrected. Your mid-10% sort of EBIT margin guidance had presumed factors in the synergies, or are those on top of that for '07?

It factors in the synergies that under generally accepted accounting principles will be applied to them. Then there are additional synergies that will get attributed to the rest of the DRS businesses.

Okay. So Rich, when we looked at this before, I think you had once commented that there were like 14 different operating units within S3 and that there was some cost cutting that could be done, etc. And so two months after the closing of the -- or three months after closing the deal now, if the $15 million is a base, how much higher can it go? Are you willing to comment? Can it be double that because of the synergies?

The real way you have to look at this is it is not so much the number as what periods the number will fall into. Because remember that there is a backlog that exists already that is bid one way. And then there is new business that we're going to book in the future that will now be bid a different way, because of the difference in the cost structure.

So, it is a very tough thing to give absolute numbers because we don't want you to then factor that number into one fiscal year. So, if you use the $15 million, you say, gee how does that $15 million fit into the year. Does mean we can add $15 million on top of the earnings that we are already giving guidance to? So, what we're trying to do is to build in, in any fiscal period, meaning year or quarter, what the impacts are for that particular quarter.

It is like up until now, we didn't know what the real impact would be on FAS 123, for example. And now we have completed our fiscal year, we have done the calculations, so we were in a position now to forecast what that would be. We wanted to give all of you an opportunity now to see what that number is so that you can hone up the forecast that you already had.

So, what we are trying to say is, we are doing a great job on the consolidation front and on the cost savings front. And then as soon as we know how those numbers are going to affect quarters or full years, we will let you know that as part of our guidance.

Okay. That's fair. Just one other question on the balance sheet. Do you have any -- care to give any guidance on your target debt-to-cap, the way you want to wind up at the end of '07? I mean, I presume all the free cash flow will be used to pay down debt here. But can we get, I guess, more debt pay down or are you looking at acquisitions as well?

You know, in the two months, we reduced the debt down significantly more than we had in our original projections. As you know, from the peak of the debt, we reduced the debt about $150 million, $160 million. Our goal is still to bring that debt down as quickly as we can. We want to get that debt-to-capitalization close to 50%, and I think we will certainly be a lot closer at the end of the year than we are today.

Thank you very much.

David Gremmels, Thomas Weisel Partners.

Just a couple of quick follow-ups. On your intelligence businesses, some competitors have been talking about some order delays in that intelligence area. Just wondering if you have experienced any similar delays and if you have witnessed any changes in the competitive landscape.

We haven't seen big changes in the competitive landscape that I am aware of. We probably have had a few delays. On the other hand, we had a tremendous win on the JTT, which had been protested and finally the protest got lifted and that was all over, so we are getting that underway now. That is the Joint Tactical Terminal. That is a huge program for our intelligence business, and is more than enough to fill in for some of the slight delays that we have seen on other parts. But we haven't seen the kinds of delays that some of these other companies are talking about.

And then just a quick one on the model. Given that you have paid down debt a little faster than expected, I think for interest expense in '07, originally you talked about $124 million. Should we look for that number to come in a bit lower now?

Yes.

Can you give a number?

I am using a range in the model of between $118 million and $120 million.

All right. No more yes/no questions in the future. Thanks a lot.

[Sanjay Ramakrishna], ING Clarion Capital.

What was the -- thanks for taking my call -- what was the debt balance on the revolver at the end of the quarter?

$40 million.

And how much was available to draw?

The revolving balance is $400 million. There was $40 million that was in use and roughly $40 million that was allocated for letters of credit. So that would leave $320 [million].

So, you are saying through this year, you look to be paying down that $40 million?

Correct.

[Anna Moore] of [JLS Asset Management].

I just wanted to get some clarification on the one-time charges, the $2.4 million and the $2.6 million and the offsetting $1.5 million gains that you mentioned. Were those in the current quarter or in the full year?

No, that was in the current quarter.

Okay. Was that included in the prior '06 guidance or were those unexpected items that occurred intra-quarter that were not in prior guidance for '06, prior to reporting?

No, that was in there. If you go back and look at the script, you will see that we talked about that.

At this time, there are no further questions. I'd like to turn the call back over to our speakers for any additional or closing remarks.

Well, thank you for joining us on today's call, and I look forward to speaking with you again in August on our next earnings call. Have a good weekend.

That does conclude today's teleconference. Once again, we would like to thank you for your participation and you may now disconnect.