Leonardo DRS Inc (DRS) 2007 Q2 法說會逐字稿

Good morning, everyone. Welcome to the 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 out that time. (OPERATOR INSTRUCTIONS) As a reminder, ladies and gentlemen, this call is being recorded.

At this time for opening remarks and introductions, I would like to 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, Jeff. Good morning and thank you for joining us on today's conference call to review the DRS Technologies' financial results for the fiscal 2007 second quarter and six-month period ended September 30, which were reported earlier this morning.

Hosting today's call are Mark Newman, Chairman, President, and Chief Executive Officer of DRS Technologies; and Rich Schneider, the Company's Executive Vice President and Chief Financial Officer.

Before we begin, I would like to remind everyone that we're providing a simultaneous webcast of this call to the public. An archive of this webcast will be available later today on our web site.

Management's remarks may include some forward-looking statements and certain non-GAAP financial metrics. For more information on 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, please note the risks and uncertainties related to forward-looking statements. These are more fully described in the news release and in the Company's SEC filings. 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. Good morning and thank you for joining us on today's call to discuss our fiscal 2007 second quarter and first-half results. As you saw on our news release this morning, we reported strong performance for both periods, with higher revenues and strong profitability year over year. Organic growth was exceptionally strong, 17% in the quarter and 16% year-to-date. We also set a quarterly record in new orders for products and services, driving funded backlog at September 30 to a record $2.7 billion.

I will take a few moments to touch on some of the financial results, provide some operational highlights, and then Rich and I will take your questions.

Revenues for the quarter were up 97% over the same quarter last year. Strong organic growth, accounting for 17% of the increase as I mentioned, reflected solid performance from our legacy operations. Revenues from our Surveillance & Reconnaissance Group were exceptionally strong, up 34% from last year's second quarter. The S3 Group, formed primarily by our acquisition of Engineered Support Systems in the fourth quarter of fiscal 2006, contributed $291 million of sales, up 20% from the first quarter.

Consolidated operating income was 86% higher than the prior year's second quarter, representing a 10.1% operating margin.

Our operating income includes the impact of a $3.7 million charge for employee severance, which resulted from our realignment of the Company's operations announced on October 2. Without the added profit from the S3 segment, operating income increased 21% over the previous year's second quarter.

EBITDA was 88% higher than the comparable period last year and was 12.7% of sales. Net earnings were 33% higher than a year ago, and last year's net earnings included a $3 million benefit from a favorable tax audit of previous fiscal years.

Diluted earnings per share of $0.62 exceeded the high end of our guidance by $0.08 and included a reduction of $0.03 for FAS 123(R), and $0.05 for the employee severance charge related to the realignment of our operations. Considering diluted EPS last year included a $0.10 per share tax benefit, fiscal 2007's second quarter diluted EPS was quite strong.

Free cash flow was also strong at $44 million and included a $5 million net tax refund in the quarter.

DRS captured a quarterly record of $915 million in new contract awards during the three-month period, 53% higher than a year ago. That is a book-to-bill ratio of 1.29 to 1. At September 30, funded backlog of $2.7 billion was 58% above backlog at the same time last year.

For the six months, revenues were 92% higher than the same period a year earlier and included 16% organic growth. Operating income was a first-half record, 86% higher than the year-ago period. Without the added profit from the S3 Group, operating income was still 18% higher than the same six months last year. Net earnings were also a record for the period, up 41%.

Reported diluted EPS for the first half of $1.14 was reduced by $0.11 -- $0.06 for SFAS 123 and $0.05 for the employee severance charge related to the realignment of operations, as mentioned, in the second quarter. Last year's reported diluted EPS of $1.15 was $1.05 without the $0.10 per share tax benefit from the favorable audit of previous fiscal years.

There were a number of important milestones achieved in the second quarter that I would like to briefly mention.

On September 25, we announced that the Boeing team, which includes DRS as a key member, won the SBInet competition. SBInet is a landmark contract sponsored by the Department of Homeland Security and is part of the Department's Secure Border Initiative. The Boeing team was selected from a field of several industry teams comprised of leading domestic and international companies. The program is expected to be multi-year.

Initial funding to the team for a five-month effort amounted to $67 million to provide border security to 28 miles of the U.S. border with Mexico outside of Tucson. The successful completion of this phase is expected to open up additional funding on this program.

SBInet will employ proven low-risk off-the-shelf technology to provide border patrol agents with the ability to better intercept attempted illegal border penetration. The system is expected to provide a comprehensive border security capability for ultimately controlling about 6,000 miles of the Southern and Northern borders of the U.S. DRS is planning to support this program with products and services from all of our segments.

During the second quarter, our C4I Group began shipments ahead of schedule on the new $396 million FBCB2 computer systems program announced in June. This latest order is an IDIQ production contract for the Army. Our FBCB2 systems are being installed on hundreds of vehicles, including more than 40 vehicle platform types, and are also being installed at tactical operations centers and other command post platforms. Because they support the Army's Blue Force Tracking requirements, they are making a critical difference in operations in Iraq and contributing to the military's battlefield visualization and network-centric communications efforts.

You may recall in the first quarter we announced that we were selected by General Dynamics' Bath Iron Works to provide both the electric power distribution system -- called the Integrated Fight Through Power system -- and the motor controllers for the U.S. Navy's new DDG-1000 Class ships, which were formerly known as the DD(X).

During the second quarter, DRS secured a position to produce all of the variable frequency drives and motor controllers for this new destroyer. This now provides us with a major position on the integrated power system for the DDG-1000, with more than $50 million of contract work per ship set.

During the second quarter, the first Littoral Combat Ship, named the USS Freedom, was launched. For this ship, our C4I segment provided the machinery plant control and monitoring system, motor controls, and power distribution equipment, as well as the gas turbine packaging. In addition, we received orders to provide the same equipment for the follow-on ship.

Our C4I segment also began delivery of our first digital interface tuner to BAE Systems. This intelligence system will be utilized in the payload that will be integrated into DRS's Sentry unmanned aerial vehicle for the U.S. Special Operations Command.

During the quarter, our Surveillance & Reconnaissance Group made a number of strides on the common electronics architecture initiative. Among these was being selected to lead the Army's Condition Based Maintenance Operations initiative; and we began work under an initial $15 million contract. This accelerated brigade-level field demonstration involves more than 200 Bradley and Abrams tanks. It will wirelessly connect vehicle health management systems and logistics information with decision support tools to provide commanders and logistics managers with data to improve equipment reliability, availability and maintainability. This program is getting a lot of interest from our Army customer.

We also won positions on three future combat system sensor programs, which will place our electro-optical equipment on five of the eight planned ground vehicles, as well as the small unmanned ground vehicles and Class I unmanned aerial vehicles.

As a result of the Supplemental Defense budget and the addition of about $17 billion in reset funding, this Group continues to see strong, steady orders for Driver Vision Enhancers, Improved Bradley Acquisition Systems, Long-Range Scout Surveillance Systems, Thermal Weapon Sights, and many more high-demand programs.

At the S3 Group the first Minuteman production unit was completed, representing the start of a five-year U.S. Air Force program valued at more than $100 million. With this program we are providing replacement environmental control systems for the electronic equipment and combat support personnel of the Minuteman III Intercontinental Ballistic Missile Launch and Missile Alert facilities.

Our environmental control systems will provide temperature and humidity controlled filtered air to 500 operational launch facilities; 50 operational missile alert facilities; four test sites at the Hill Air Force Base in Utah; six sites at Vandenberg Air Force Base in California; and 23 trainer facilities. As an element of our nation's strategic deterrent forces, the Minuteman III is a critical component to our nation's peacekeeping efforts and global superpower standing.

In the second quarter, we also delivered Modular Fuel System units to Fort Carson where about 200 vehicles returning from Iraq were fueled using this system. Customer feedback on the operation of this equipment was very positive.

We continue to see strong interest in many other systems from the S3 Group including the MSTAR radar, where we're seeing new orders from two major prime contractors; the Heavy Expanded Mobility Ammunition Trailers; and the water packaging units, where we're working with Kärcher in Germany to meet strong future growth expectations in the U.S. market.

Our past work in support of Homeland Security has resulted in the first C-130 program depot maintenance overhaul of the United States Coast Guard aircraft, which was successfully completed in August at DRS's hangar in Elizabeth City, North Carolina. For a long time, the Coast Guard has wanted to conduct these efforts in conjunction with their other overhaul capabilities at this East Coast facility. DRS is helping to make this possible, providing the Coast Guard with hangar space to facilitate these overhauls and the personnel to work with the Coast Guard management. We currently provide 180 engineers, technicians, and certified aircraft mechanics to support this effort as part of the Coast Guard's mission for Homeland Security.

As we mentioned last quarter, we made significant progress in our efforts to integrate the S3 Group business, and in the second quarter we continued to consolidate several operating units that had similar product lines, business services and customers.

As announced on October 2, we furthered this initiative by realigning all of our operations into four operating segments. The new DRS organization brings together operations with similar customers and complementary lines of business; sharpens our customer focus to better serve the Company's diverse customer base; leverages operating efficiencies to improve cost competitiveness; and enhances long-term growth and profitability. The new structure, which reduces the number of strategic business units, also creates greater transparency by streamlining the organization and reducing operational management infrastructure.

In this action, we created two segments from the former S3 Group, which are now called the Sustainment Systems Segment and Technical Services Segment. We also transferred the non-EO businesses of the former Surveillance & Reconnaissance Group to strategic business units within the C4I Segment. The electro-optical businesses of the former Surveillance & Reconnaissance Group now comprise the new Reconnaissance, Surveillance & Target Acquisition, or RSTA, Segment.

We believe this new organization will help us meet current and future defense challenges; focus our capabilities to address Homeland Security growth opportunities; and drive operational efficiencies. The implementation of this new organization was part of our strategy to encourage coordinated, common pursuits between all of our operating segments and to leverage the full strength of the Corporation by applying integrated systems and services solutions to customer challenges.

As you saw in our earnings release this morning, our sales guidance for fiscal 2007 is unchanged, and we continue to expect record revenues of $2.7 to $2.75 billion and an operating margin above 11%. We narrowed the range on full-year diluted EPS, increasing the low end of our guidance to $2.83 and maintaining the high end of the range at $2.90. Our fiscal EPS estimate includes a $0.12 impact for expensing stock options. We anticipate $90 to $115 million in free cash flow for the full year.

Before I turn the call over to questions, I would like to mention that the fiscal 2007 Defense budget signed into law last month, in conjunction with the appropriations funded in the Bridge Supplemental, strongly supports many programs of interest to us across all of our businesses. Besides funding for power programs supporting the DDG-1000 and Littoral Combat Ships, the budgets continue to provide strong support for FBCB2 computers, radar systems, intelligence equipment, sighting systems for Stryker Brigades, Abrams and Bradley tanks, LRAS3, and Thermal Weapon Sights, just to name a few key line items.

For DRS, the Defense budgets portend opportunities for growth well into the next fiscal year. Now, I would like to open the call up for questions.

(OPERATOR INSTRUCTIONS) Alok Chopra from Oppenheimer Capital.

Wow, that was quick. Good morning. Just a question on ESSI, or S3. Your margins looked a little light this quarter. I'm trying to figure out what you're guiding to for this business for second half of this fiscal year. Also, could you give us revenue and EBIT in the year-ago quarter for this business?

I will let Rich take that.

Alok, the margins were not really light. There are two factors that you have to incorporate into your analysis. The first is the charge in the quarter of about $2 million related to the realignment. Secondly, there was a heavy weighting towards the Technical Services part of their business, which will carry lower margins.

When you look at the two businesses separately, which we will start to provide to you going forward to give you more transparency, you'll see that the margins were strong on both sides of that business.

As far as quarter comparisons a year ago, I'm not going to provide that. They were run differently, their quarters broke down differently; it really wouldn't make sense.

So what should we look for in terms of margin for full-year fiscal '07 for S3? You have previously given the range, I think, of 10.5 to 11%.

We said 10 to 11% is where we would expect them to be; and we're not changing that.

Okay, great. Thank you.

Howard Rubel from Jefferies & Company.

I have a couple things. Rich, just to talk about the segments for a moment, so you will provide us in an 8-K or something the revised historic data, so that we can get at comparables before you report the next quarter?

Yes, I understand for modeling purposes you guys are going to need that. We're trying to figure out the best way to provide that data.

Could you just talk for a moment, I mean, about this business mix in S3. It does look like a chunk of it was telecom services-related. Is that just -- it was a big number, $214 million in bookings. Is that sort of what we should look for going forward? Or is this just a one-off event?

It is going to be very lumpy. It is very hard to project certainly, even 60 days out, because of the type of business that they have. But the first half of the year, it has been very strong. It is slightly ahead of our plan. In our internal projections, we think it might even be a little lower this quarter. But like I said, it is hard to get clarity on that, because of the type of business.

Then just as a follow-up, talking about clarity and sort of visibility a little bit, it does look like it is a little harder to predict what happens. I think in your press release of a quarter ago, you sort of indicated earnings would be in the $0.55 range, I think. Here you did quite a bit better, and yet you're sort of looking for the year to be sort of where you started.

Can you kind of reconcile the two of those, and why we shouldn't think things should be better? Why is it that this quarter is better than all others?

That is getting very religious now. Why is this night different than all other nights?

Yes, Mark, I know.

I think you have got a situation here where we took a look at the fiscal year, and we saw that the year was a little back-end loaded. So we have been working real hard to try to bring some of that forward, and I think you see that.

You shouldn't negate the other part of the Engineered Support business, which is the Sustainment business, which we're starting to see some strength in going forward. So that is still a good business. A lot of things that they had in the pipeline are now going through testing and all. We are going to see that materialize into good business over the next 12 months – some sooner, some later.

As far as the Technical Services business goes, we are seeing a lot of strength in that business. They are booking a lot of very interesting contracts.

So we did get a shot in the arm on part of the business for the quarter. There is no question about that. But we also see that as a very strong business going forward. So Engineering Support is turning out to be a good acquisition.

Thank you.

Steve Binder from Bear Stearns.

Good quarter. Just to follow up on Howard's question, you have hit 16% organic growth for the first half; and your plan was 8.2% -- if I am not mistaken from the last conference call -- for fiscal year '07. So, obviously, you don't have to be too bright to do the math for the second half of the year, you know.

Then you look at S3 alone, based on your guidance for the full year, it looks like the second half would be down from the first half, which seems unlikely. So I gather this is just conservatism on your part.

I think, you know, we have said before that it's very hard to measure organic growth on a quarterly basis. But sometimes you get a lot; sometimes it will be lower. I think we would be hard pressed sitting here today to say it would be less than 10% for the year. But we really have to see how it's going to fall out.

All I can tell you right now is the businesses are all looking pretty strong. Obviously, the bookings are way up there. So, we expect to continue to see good bookings throughout the rest of this fiscal year. So we will just have to see where it falls out.

All right. Mark, can you maybe just talk about the CEDS program, the competition there? Maybe just give us some sense of the competition, the timing of that award. What does that all mean for the Q-70, the life of the Q-70?

I don't know anything about the timing of the award or the competition. The initial program, you know, on its surface does not look like it would be a very large program right out of the box. But we will have to see what happens.

Right now, it is earmarked first for what is now the DDG-1000. But where it goes from there, I don't know. I think the Q-70 will continue to be strong for the next few years. I don't see that program going away. We are in the middle of a competition, so I can't really give you much detail about it.

Speaking of the DDG-1000, you had a couple of contracts during the most recent quarter, and you just touched on CEDS. How big -- ? You know, at one time it was an electric drive story; but how big will that program turn out to be for DRS, do you think? If you look at just content per boat or annual revenues, do you have a sense?

Obviously, everything outside of the motor is in the $50-plus-million a ship range. That is without the displays. That is just the power distribution and control piece of the system. So, we are already at about $50-million-plus of content. Hopefully, we will be the guy that starts building displays for those ships. So, that will add additional.

On the electric motor right now, there was $11 million in the current budget. The motor, as we speak, is being loaded on a barge and being shipped to the land-based test site in Philadelphia, where it is going to undergo testing.

So, even if it is too late to hit the first couple of DD(X)s, we certainly have a lot of hope for it for its future. We will just have to wait and see. Remember, there are going to be cruisers that are going to be built as well. So, even the electric motor is alive and well. So we are going to be a big part of shipbuilding going forward.

All right. Last, Rich, if you can just touch on working capital in the quarter. I am just guessing [that] you backed out the tax benefit you got; looks like -- I am guessing -- working capital is maybe up a little bit. Were there any big puts and takes? Because obviously the first quarter was a tough quarter for receivables in particular, as well as some of the other working capital accounts?

Steve, working capital actually declined by about $4 million. There's a lot of puts and takes in this quarter. Obviously, receivables were way up with the big increase in revenues; receivables were up about $51 million.

Then there were offsets to that, with our prepaid expenses in Accounts Payables coming down -- I'm sorry, coming up on the payables and coming down on the prepaid assets. Payables were 28.2; prepaid assets came down 27.8, most of that relates to the tax benefit. Accrued expenses, came down $13.4 million. Advances were up $15 million; and then there is a lot of little stuff.

Okay, thanks very much.

David Gremmels from Thomas Weisel Partners.

Can you just touch on the restructuring? How much progress have you made there, thus far? What is left? Can you tell us what the expected cost savings will be?

I can tell you that obviously we have made tons of progress. Except for a few minor tweaks that we will make going forward, we have essentially completed the restructuring of the business.

We call it reorganizing of the business; because I wouldn't look at it as a restructuring. It is really a reorganizing, realignment of the business. I think that is a better terminology.

We have now created a relatively transparent organization, so from a management standpoint, it is going to be easier to manage. From a customer standpoint I think we have a lot more customer focus right now. From a cost standpoint, we have taken a lot of costs out of the business.

We are going to have to quantify that as time goes on. But I think the good news is that we did it all effective October 1, and that we were able to write off in a very strong quarter, the second quarter, the costs associated with any realignment that we did. So, I think we are in a very, very good position going forward.

Great. As a follow-up, the spending delays that you talked about last quarter, is that resolved now? What has been the impact of that Bridge Supplemental? Has that translated into orders yet, or at least helped to loosen up Army spending more generally?

I think what you're going to find is obviously Army spending is going to be excellent, because not only did you have the Bridge, but they added to the Bridge an additional $17 billion for the Army and the Marine Corps.

None of that really has been seen yet, because they just signed the budget. So it takes time for contracts officers to get those dollars allocated. That is why I think we will continue to see strong bookings in the second half.

Thanks very much.

Myles Walton from CIBC World Markets.

Good quarter. A couple questions for you. First on the international market, we have seen some pretty nice pickups; and we can trace some of the larger contractors. But obviously we don't have the granularity to get down to some of the supply chain.

Can you just give us a picture, from where you sit in the supply chain, how the international market is faring for you?

Well, obviously, it is not a huge part of our business, less than 10%. But we are seeing a lot more activity than we have seen in the past. So, I can tell you just in a macro sense the international work is beginning to pick up. We are pretty excited about a lot of the opportunities we have got there -- some things we have booked, other things that we are going after.

Okay, then as a follow-up if I could, the Army as a percent of your backlog, do you continue to see that increase as a percentage? What is that currently?

Right now, it has been increasing; and it is probably, I think -- we will be talking about it. We are going out to AeA on -- we will be presenting I think on Monday out at the AeA Classic Conference. Right now, Army is about 58% of our backlog. So, it is the largest it has been.

But of course, it is 58% of the largest backlog that we have ever had, which was over $2.7 billion. So, there is no question – Army has been very, very strong for us; but the other services are doing pretty well, also.

Okay, great. Then last one if I could, within C4I, if you can just give us a little clarity on the different SBUs in there, the relative growth rates. Because I think this year, you're looking for about flat organically. I'm just wondering which way the puts and takes are going within the business.

We are not going to get into trying to provide separate growth rates by an SBU or by a product line, it just gets --.

Any color you can give?

Not at this point.

Okay, thanks and good quarter.

Patrick McCarthy from FBR.

Just a couple of housekeeping ones to start. Could you give us the organic growth rates for each segment in the quarter?

Sure. I will let Rich give you that.

Thank you.

C4I for the quarter grew at a 3% rate. S&R grew at 34.4%. S3 we don't calculate an organic growth rate until we own them for a year.

Great. Could you also say, did you pay any debt in the quarter? Just update your expectations for debt paydown in the full year.

Yes, debt came down a little over $40 million for the quarter. Most of the free cash flow that we generated went to pay down debt; and we will continue to do that. So, we gave you a forecast of $90 to $115 million of free cash flow. We will take that free cash flow and continue to pay down debt.

Okay, great. Then two programs that you guys mentioned today, I was wondering if you could just maybe size the opportunity. The first one was the Sentry UAV program. Do you have a production contract there? And maybe just a revenue profile if you do.

I can't really talk about the Sentry in terms of its size; we are just not allowed to.

Okay. Then on SBInet maybe just a similar question. How much do you think from that program could be your overall take over the next couple of years?

SBInet, when it was announced by Secretary Chertoff, was purposely put at a very low number. Because -- and I think the Department of Homeland Security is very wise to do this -- they would like to see the Boeing team construct 28 miles of border security, and they want to see how that goes before they start pouring more money into it.

The program can be so large in the long run that you would almost be delirious talking about it. So, I think I would rather just take it a step at a time, and let's see how everything goes with this initial tranche. Then let's see them continue to put money in. But SBInet can be very, very large.

Okay. Then one more question, I apologize. On the C4 business, obviously tremendous backlog growth and orders in the quarter. Organic growth a little bit lower, I guess, than the rest of your business. Lumpy. Any sense as to the revenue profile for the remainder of the year?

You want to take that?

Yes, we would expect that for the year, the 6 to 8% organic growth that we talk about on a sustained basis should come into fruition.

Great, thank you very much.

Citigroup, Ferat Ongoren.

First question, on the guidance in the results. In August, you had decreased the annual guidance by about $200 million. We now see that you beat your own guidance for this quarter by about $60 million, $50 to $60 million. What caused that out performance in the two months of the quarter?

Well, first of all, we took the guidance down by $150 million, not $200 million. What we said at that time is we could not quantify exactly when certain contracts would come in.

So, we were still looking, as we said, at a record year, but we just wanted to err on the side of conservatism, based on the fact that some of these things had slipped out. So, we didn't look at that as a terrible move at the end of the first quarter. Did you want to add anything to that?

No.

But, you know, just looking at the quarter, it seems like the last two months were extremely strong. Was it the telecommunications side helping you? What was the pickup there?

We got a nice pickup on the services side. There is no question about that.

And you're seeing that in the margin, too. The margins were a little lower than we originally anticipated with the higher revenues because of the mix.

Now that is kind of the other question I have. If I go with the high end of your revenue guidance to get to the low end of your EPS guidance, you figure you need to get close to 12.5% margins in the second half. Do you think that is feasible?

Yes, I will break it down into a couple of pieces that I think are -- make it easier for you to swallow.

The first is -- remember the first half of the year has the $3.7 million realignment charge that we recorded. At the same time, as I said, we were heavily weighted on the services side, which has lower margins. I think the mix of services revenues will be less in the second half of the year; so the margin improvement will come from there.

We are expecting a much better mix from a margin standpoint, in some of our product lines on the intelligence side and other places.

Then we do -- we did this whole realignment. We expect to see a benefit to that which will come into play in the second half of the year. You know, if you look historically, we always show margin improvement quarter-over-quarter. Then when you factor these things in, I think you will come to the same conclusion that we have, that it's very achievable.

So, basically what you're saying is if you have higher revenues than what you're guiding now, there could be upside to EPS as well?

That would be correct.

Okay. A couple of quick ones. The other income, about $1.3 million. What was that? You broke that down into segment breakdown.

Yes, that relates to a note receivable that we collected that we did not expect to collect.

Okay. The tax rate for the year?

My model is assuming about a 39% tax rate for the year.

Okay. A final question. If you go back and kind of tell us what kind of leadership changes have happened at Engineered Support; and whether we are done with those changes going forward; whether we should kind of basically not expect any further charges in that business going forward.

Basically, what we did was we looked at whole organization. We realize there were two pieces to it. There was the sustainment and there was the services part. We have an executive by the name of Mitch Rambler, who was running services; and Tom Cornwell who was running sustainment, both doing a good job.

Then we took a look at the group structure that was around that, which was essentially the holdover from the corporate structure that existed when Engineered Support was an independent company. We said, if we break them into two segments reporting directly into corporate, then we could eliminate some of that group structure. Or in that case, public company structure.

So, we eliminated a big chunk of the overhead that existed at the original Engineered Support. Now we have nice visibility into that operation.

We did a similar thing on the Surveillance & Reconnaissance side because the core of that business was what we call RSTA. That already had a manager running it and its own infrastructure. Then there were other pieces that we determined really fit better with parts of our C4I organization. So, when we moved that out, what we ended up having was essentially a corporate office left at S&R that could be pared down, and we did that. So, we ended up with a situation now where we have been able to carve a lot of costs out of the business, giving us much better visibility into the operation, and also it is giving us better customer focus.

So, I think transparency and customer focus is what it is all about. I think that is what we have achieved now.

Okay, very helpful. One final quick question. If you could just update us on the upcoming recompetes, thanks.

The upcoming recompete on what?

Major upcoming recompetes that you're going to basically have to win to get to your guidance or potentially exceed that. Do you have any major upcoming recompetes?

Oh no, no, no. I see what you're saying. To achieve our guidance, do we have any upcoming recompetes? No, no, nothing.

All right, thank you very much.

Greg Alexopoulos from Morgan Stanley.

Good quarter. If you look at the C4I and S&R bookings, roughly $518 million this quarter, they were somewhat weak year-over-year. Can you give us a little bit of color there?

You know, you can't look at a booking -- this is not an ongoing continuing business year-over-year. It is programs. Programs are lumpy. They were very strong last year; they are very strong this year. I mean, our book-to-bill has been unbelievable in both years.

So, we are very happy with the bookings. We expect strong bookings going forward. So you know, I don't see any issues at all.

Okay. Then last quarter you mentioned there was a slowdown in the Intel bookings. Have you seen that pick up this quarter?

It is picking up, not as quickly as we would like to see, but their bookings this quarter were higher then last quarter.

Significantly higher.

Yes. So, we are starting to see that come back. It will take a little time, though.

Typically what agencies are you seeing that come from?

We don't really like to talk about agencies.

Okay. Then back on S3 business, with the Supplemental being signed in '07, and obviously the '06 supplemental signed since the last time you reported, should we expect a less favorable mix in that business? Is more going to come from the services side or the products side in terms of Supplemental?

I thank you will see it in both. But what one really thinks about in Supplementals is the kind of work that is being done to support the troops overseas. But certainly part of that could be services business.

So, I think we have got a lot in the main budget. I think we are going to see a lot coming out of the supplemental. You can see the bookings are really starting to come in, and we haven't even touched the new budget yet.

Right. Finally on the homeland defense, you talked about how the reorganization is going to help you do that. Can you give us a sense as to how you are perceiving that to work now with the new reorg? Also the amount of Homeland Security orders that you received in 2Q.

I don't have in my head Homeland Security orders that we received. But obviously SBInet is the biggest Homeland Security initiative that is taking place right now. We're going to play a key role with Boeing on that program. I think given the reorg that we did, a lot of the support for that is going to be based here in Washington.

However, we are also doing a bang-up job, as I mentioned, done in Elizabeth City with the Coast Guard. That is part of Homeland Security, as well. I think a lot of the products that we manufacture throughout the whole Company now are starting to have homes in that Homeland Security arena.

At some point, I think Homeland Security will be a wedge as we start to show the pie chart of our business. You know maybe at some point we will take a look at breaking that out as a separate wedge, just to give you an idea of where it is.

But I would rather we start booking meaningful stuff. I mean, right now, we are probably in the $50 million range; but I would like to wait until we get to something a little more meaningful before we start breaking it out as something separate. But we definitely are beginning to stand up as an organization to deal with Homeland Security.

So, it would be safe to say that you're seeing growth from Homeland Security in terms of orders in general?

Yes.

Okay, thanks, guys.

JSA Research, Peter Arment.

Good quarter. Question regarding -- and this, you have already addressed a lot of this in your guidance comments. But I just wanted to ask you more from a higher level. Just, you know, you have always been able to provide, you know, I guess a look into the upcoming quarter in terms of whether it is a range on the top or bottom line. That is through all the several acquisitions you have been able to do over the years.

Is the S3 business, you know, at least -- the visibility that much more difficult or unpredictable that you are stopping that practice? Or maybe if you could just give us a little more discussion on that.

Well, I think the S3 business is a good business. I think the rest of our business is a good business. I think what we have demonstrated in the first half is that we are doing very well, and we expect to do very well in the second half. That is what we are trying to focus in on.

We have even taken a look at some of our governance policies. We have come to the conclusion that there is really no value-added in trying to break out and provide all this quarterly guidance. What we're wanting to do is we are going to continue to provide annual guidance at the end of each quarter. You shouldn't take that as a negative. We look at it as a positive.

No, I appreciate that. Thank you very much.

Steve Levenson from Ryan Beck.

Could you give us some additional details on SBInet and how much latitude you're going to have to pick your own products? Or are you going to be bound by relationships that Boeing has with its other team members?

Let me just say in general, Boeing is the prime contractor. We feel fortunate and excited to be working with them on this program. So, I think that is number one.

Number two, don't take this the wrong way, and nobody listening should take it the wrong way, but I am a believer in the mission. So whatever the right product is to meet the mission is the product that should go into the system. If we have the right products, and we have the right pricing, then our products will be there. If other people have the right products, those products will go in.

But I have confidence in Boeing that at the end of the day, they're going to put together the best possible system to safeguard our borders. I think that is how you have to look at a program like this.

Okay, thanks very much.

(OPERATOR INSTRUCTIONS) Howard Rubel, Jefferies & Company.

Mark, just to go back to the cost take out, if it costs you $3.5 million or a little bit more to take out these people and do some things, and it looks like it's under 100 people, one would think that that could be $8 to $10 million worth of annual savings. Is that sort of the right ballpark to think about this?

Obviously, you are doing the math, so we can't argue with the math. The only thing we always have to filter in is you know that sometimes you save money in the defense business; and you've got cost-type contracts, that goes back to the government. Some of it you keep. Some of it filters into this year, next year. Some of it will end up in inventory for profitability following year.

So, it's just a question of how it divides. That is what we have to see as the business begins to unfold.

But obviously, we're going to save a lot of money based on what we have done. We are also going to have a much better structure going forward for managing the business. I think that is very key.

The structure is very clear. Just finish this on Surveillance & Reconnaissance. The numbers are absolutely fabulous. If we think about the way that business is run today -- I mean, I know there is always a little bit of seasonality in it; and the fourth quarter can always be a little bit weaker because there's fewer business days.

But why shouldn't we see this as sort of the run rate for this business for a while? Or was there something in there that caused it to be unusually strong in the September quarter?

Howard, you are talking about --? I guess you are trying to back into organic growth discussion?

However you want to do it, either run rate going forward or organic growth, Rich. However you want to play it, but it is a big number.

Yes, and we are not saying and we're not even trying to imply that that run rate is going to slow down. What does happen -- remember last year in the second half of the year, the organic growth rate for that business was over 19%. So that business has been very strong and will continue to be strong. But now we are comparing a very strong second half of this year to a very strong second half of last year.

Yes, I understand that. But $225 million on a run rate is -- other than the fourth quarter of last year -- is the best you have done. Why wouldn't we think that, given the number of days and the demand in the budget for the products, and things like that, that at a minimum that is kind of the run rate we would be thinking for subsequent quarters?

If everything goes right, we are going to see significant business there. There is no question about it.

So you don't want to quantify it?

I don't want to quantify it today, because it is obviously coming in very well.

By the way, we have also, and this is important, in some of the uncooled infrared products that we're doing -- you know, Thermal Weapon Sights, and things of that nature -- we're starting to really pick up the production on that. So we are improving.

There were areas last year where it got off to a slow start, and now the manufacturability of a lot of the products that we're making in that segment is starting to take off. So, it is not just a bookings story; it is also a good production story as well.

Thank you.

Alok Chopra from Oppenheimer Capital.

If you touched on this earlier, I am sorry, I didn't catch it. But were there a lot of award fees in year ago in S&R that resulted in the negative margin comparison? Or is it just a mix issue? Then I have another question.

There are two factors. One is that there is a realignment charge in that group of $2.0 million; and then it is mix. That organic growth, a lot of that is on new programs that start out at lower margins. That organic growth has a price to it.

Okay, separate question for Mark, maybe. The Army's request for fiscal '08 was recently rejected by -- or the OMB came back with a much lower number than what the Army had requested. I know it is maybe very early in the process to discuss this, but what are you seeing in terms of potential additional funding for reset? Do you think the Army does get their full $20-odd-billion that they want? Is it just going to take time?

Or is this going to be -- you know, if the costs of the war in Iraq stay high, are we going to run into the same sort of situation next year as we did earlier this year, where the Army runs out of money for anything that is nonessential?

Well, what you're faced with right now, first of all, is Congress just finished the '07 budget. So, they got that done. Now they are taking a breather before they get into the '08 budget. You know, you start with OMB; then there are negotiations; then they have to look at requirements; they have got to look at what is going on in the world.

So, I think there is going to be a lot of give and take before we end up with next year's budget. Like a whole year. So, if you recall this past year, there were -- everyone had ups and downs, and this was going to happen, that was going to happen. Then there was the QDR and all this other stuff.

Finally, when the budget comes out, the budget comes out, and that is what it is. So, I think that in the long run, the Executive branch and the Legislative branch are going to the right thing by the troops. I think that is how you have to focus.

Okay, okay. Thank you.

At this time, we have one final question remaining in the queue. Bear Stearns, Steve Binder.

Yes, Mark or Rich, I just wanted to hear your view on acquisitions; and is there much of a pipeline right now? You're slowly improving the health of your balance sheet. So, first is, do you see any attractive opportunities, smaller size opportunities? Two, maybe just kind of talk about your attitude on doing a share issuance.

Right now, and we have said this, when we bought Engineered Support -- and we only closed last January, or really January 31 -- we bought 14 companies. So, we have been in the process of digesting 14 companies. I think we are doing a great job doing it.

You know, we always look into the pipeline. We know that acquisitions will be part of our future, so we're not giving up on acquisitions. But right now, I think the prudent thing to do is, as you say, work on the balance sheet and digest what we have.

We have got very solid organic growth, obviously. You know, I think that is where we should be putting our efforts and that is where we are putting them.

As far as any type of equity issues, should we assume that won't happen? Or is that under consideration? Or maybe just touch on that.

We're not thinking about it. Obviously, if we were going to do one, we would announce it.

All right, thanks very much.

At this time, there are no further questions. I would like to turn the call back over to you, Mr. Newman, for any additional or closing remarks.

Thank you. I thank you all for joining us on the call. We look forward to speaking with you next quarter. I hope, as you see, DRS is alive and well. Take care.

Thank you, everyone, for your participation. That does conclude today's conference. Have a great day.