Leonardo DRS Inc (DRS) 2007 Q3 法說會逐字稿

Good day, 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. Instructions will follow at that time. (OPERATOR INSTRUCTIONS) As a reminder, ladies and gentlemen, this conference is being recorded. Now at this time for opening remarks and introductions, I would like to turn the conference over to Ms. Patricia Williamson, Vice President of Corporate Communications and Investor Relations for DRS Technologies. Please go ahead, ma'am.

Thank you, April. Good morning and thank you for joining us on today's conference call to review DRS Technologies' financial results for the fiscal 2007 third-quarter and nine-month period ended December 31, 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 website.

Today'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 website.

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 our 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 results for the fiscal 2007 third quarter and the nine-month period. As we reported in our news release this morning, we turned in record performance for both periods. Additionally, a quarterly record in new contracts of just over $1.1 billion drove our funded backlog at December 31 to over $3.1 billion for the first time.

These results have placed us in a strong position as we near the end of what we believe will be another outstanding fiscal year, and we have confidence that we will accomplish the goals we set out to achieve. I would like to take a few moments to review some of the financial results and provide some operational highlights. Then Rich and I will be happy to take your questions.

Third-quarter revenues were 75% higher than the same quarter last year. Organic revenue growth was very strong at 12.6% for the quarter, and 14.8% for the nine-month period. DRS continues to post solid organic sales growth rates. Consolidated operating income was 71% higher than the prior year's third quarter and represented an 11.3% operating margin.

EBITDA was also strong, 73% higher than last year's third quarter, and 14% of sales. Net earnings were 78% higher than a year ago. Diluted earnings per share of $0.86 included a $0.02 reduction for stock option expensing. Third-quarter diluted EPS was based on about 41 million diluted shares outstanding compared with approximately 29 million shares for last year's third quarter. It also included a $0.13 discrete tax benefit.

Free cash flow of $18 million was about 28% higher than the third quarter in the prior year. The $1.1 billion in new contract awards during the three-month period, a new quarterly record, was 263% higher than a year ago. That represents a strong book-to-bill ratio of 1.62 to 1. At December 31, funded backlog surpassed the $3 billion mark for the first time, coming in at over $3.1 billion, which was 91% above backlog at the same time last year.

Taking a brief look at the nine-month period, revenues exceeded $2 billion, and they were 86% higher than the same period a year ago. The 14.8% organic sales growth was mostly driven by our infrared and vehicle diagnostics product lines.

Operating income was a nine-month record at 80% above the same year-ago period. Nine-month EBITDA was 82% above reported EBITDA for the same period in fiscal '06. Our EBITDA margin was 13.3%.

Net earnings were also a record for the nine-month period, up 55% to $2.01, including a $0.07 reduction for stock option expensing, compared to last year's diluted EPS of $1.84.

Free cash flow for the nine months was approximately $24 million. We're maintaining our outlook of 90 to $115 million for the full year.

As mentioned in the press release, during the third quarter DRS was selected as one of three companies to provide preliminary designs for the Common Enterprise Display System, or CEDS program. DRS was the only company selected to provide designs for both the remote displays and the display consoles. CEDS is expected to be the display system used on the DDG-1000 Zumwalt Class Multi-mission Surface Combatant, formerly known as the DD(X), as well as other future Navy ships, submarines and aircraft.

I mentioned last quarter that we began shipments ahead of schedule on the new $400 million FBCB2 computer systems contract announced earlier this fiscal year. During the third quarter, we booked an additional $55 million in new orders on this important Army program and $23 million in orders from Harris Corporation to provide Video Display Modules to the FAA. Both of these orders build on our success as a key supplier of flat-panel ruggedized displays. Since you're all very familiar by now with our work on the FBCB2 program, let me talk a little bit about the award from Harris.

The Video Display Modules we're delivering will provide an integral touch screen capability to FAA air traffic controllers. They will be incorporated in the Voice Switching and Control System, which will allow controllers to access to and control of VHF and UHF radio signals for air-to-ground communications, and will provide ground-to-ground intercom, interphone and external circuit communications. This new system was designed to enhance air traffic controller productivity, reduce operator stress and increase air traffic safety. DRS successfully completed the engineering work on this contract, and with this new award moved into full production.

Also during the third quarter, we delivered our Permanent Magnet Motor to the Navy's DDG-1000 Land-based Test Site in Philadelphia, where testing is expected to begin next month. This system, like our other integrated power systems equipment, is expected to provide increased efficiency, reliability and commonality of electric ship architecture. The use of this motor in new electric warships would provide an affordable, technologically advanced capability.

DRS has already been selected by General Dynamics' Bath Iron Works to provide both the Integrated Fight Through Power distribution system and the motor controllers for the new DDG-1000 ships, as well as all of the variable frequency drives and motor controllers. Just this work alone on the integrated power system exceeds $50 million per ship set.

We had an exceptionally strong bookings quarter in our electro-optical systems product lines, receiving over $112 million in orders for the Horizontal Technology Integration program; more than $100 million on the Improved Bradley Acquisition System program; more than $70 million on Thermal Weapon Sights program; and over $50 million on the Driver Vision Enhancers program. With more than $275 million in new contracts received for ground vehicle electro-optic work in the third quarter alone, DRS remains a key provider of critical equipment supporting the Army's recapitalization and modernization efforts for combat vehicles.

During the third quarter, we received a contract performance assessment report from the government on our work supporting command and control and tactical communications for the Multinational Forces in Iraq. This assessment resulted in "purple" ratings, which are the highest possible scores across the board in all categories. These ratings are a real tribute to the hundreds of DRS employees that are in Iraq working alongside our troops. Our people in the field have an extensive track record in design engineering, installation and operation of communication systems and network management supporting vital communications infrastructure.

Last month, we were awarded a milestone $300 million order, with initial funding of $50 million, to provide communications and technical support services for CENTCOM operations in Southwest Asia. This followed an initial $16 million in funding we received in the third quarter from the Defense Information Systems Agency via CENTCOM to support the Defense Information Systems Global Network Satellite Transmission Service program. This program will provide critical satellite bandwidth, communications and transmission services to the Department of Defense.

During the third quarter, we continued to see strong interest in many of our military support and sustainment systems. For example, our new M1200 Armored Knight™ system will now provide combat-proven targeting and fire support on armored wheeled vehicles that protect crew from ballistic threats.

We booked about $25 million in the third quarter on this program and will continue to support the Army's efforts to reset existing Humvee-based Knight systems deployed extensively in Iraq and Afghanistan.

We also captured $76 million in new awards for mobile trailers in the third quarter, mostly relating to the M1000 Heavy Equipment Transporters and Heavy Expanded Mobility Ammunition Trailers. DRS is now the Army's recognized leader for production and life-cycle support of trailers used to move heavy equipment off-road and in expeditionary environments.

Currently, over 80% of the Tactical Quiet Generators procured by the Army are produced by DRS. In the third quarter, we booked another $24 million in orders for this product line and $27 million in 3-kilowatt and next-generation 100- and 200-kilowatt power generators. These mobile power units are a critical source of reliable, essential power in a lightweight, low-noise package that can be used in remote field locations wherever electrical power is needed for training missions, peacekeeping efforts and combat operations.

At the start of the third quarter, we announced our new operating organization, which aligned all of our operating units into four segments on the basis of customer focus, operating synergies and complementary lines of business. The financial results issued today reflect this new organization, which was designed to encourage inter-segment cooperation and the development of joint initiatives to pursue new business opportunities.

Last month, we were very pleased to welcome retired U.S. Army Lieutenant General Jerry Sinn as Senior Vice President Land Warfare Strategic Plans and Programs in our Washington office. Before joining the DRS, General Sinn had a stellar 38-year career with the Army, most recently serving as Military Deputy for Budget. He has been a leader and chief strategist regarding Army budget matters for the past eight years and will enhance our ability to better serve our Army customers.

As you saw in earnings release this morning, we raised our guidance for fiscal 2007 diluted EPS to reflect the impact of the third-quarter discrete tax benefit. We now expect $2.98 to $3.05 per share, which includes a $0.10 to $0.12 impact from stock option expensing. Our sales guidance of 2.7 to $2.75 billion, operating margin of 11% or better, and free cash flow of 90 to $115 million remain unchanged.

As you are aware, this week the President submitted his fiscal 2008 defense baseline and 2007 supplemental budgets to Congress, proposing in total $716.5 billion to fund the Department of Defense. About $481 billion was designated for fiscal '08 baseline operations; $93 billion for '07 combat operations; and about $142 billion to support the Global War on Terror in fiscal '08. The '08 baseline operations budget proposal is more than 11% above the prior year's, more than I think most expected, while the '07 supplemental fell slightly short of the $100 million that was rumored.

It is unclear at this time if an additional '08 supplemental is planned; but in all, the proposal represents a high level of funding for defense. The weapons procurement portion of the '08 budget of about $102 billion represents a significant 25% increase over the '07 budget, with R&D remaining steady at $75 billion. Under the proposed plan, each military service receives higher funding year-over-year, with the Army's share increasing to 27%.

Clearly, equipment reset, readiness and long-term force modernization were a primary focus of this request, which are areas where DRS provides strong support. As we have said, we see opportunities for growth throughout fiscal '08 and well into our fiscal '09. Now I would like to open the call for questions.

(OPERATOR INSTRUCTIONS) Michael French of Kaufman Bros.

Congratulations on a strong performance. I have a question. Can you explain the tax benefit that occurred in this quarter and whether that is likely to recur in future periods?

Sure, Michael. The discrete tax benefit, which was $0.13 to us, the majority of that relates to a benefit we get for our foreign sales, foreign exports. It is not a -- this is a catch-up benefit. The $0.13 is a catch-up benefit. It is not something we would expect to have recur often. We do expect another benefit -- and I don't have it quantified yet -- in the fourth quarter. I want to make it clear that whatever benefit there is in the fourth quarter is not built into the guidance that we have put out there.

Okay. In terms of expanding the margins, do you expect there to be additional expansion in the fourth quarter in order to hit these targets? Especially if what you put out there is before -- you know, because the normal tax rate for you is going to be around 39%, isn't that right? So, your guidance is based on a 39% tax rate?

That's right.

So, I think the margins need to creep up slightly from where they were this quarter in order to hit that target. Is that right?

That is also correct. We will see that margin expansion. If you look historically you'll see that the fourth quarter is always our strongest quarter from a revenue standpoint; and it will be our strongest quarter and has been from a margin standpoint. As we get those higher revenues, the overhead absorption is significant; and the margins are always strongest in Q4.

Okay, thanks. The last question before I turn it back, could you describe the market opportunity for the CEDS program?

Well, that is already pretty large. These kinds of things come in in big chunks, and then they give you an initial award. So, when you look at our backlog, we haven't booked that $300 million. We would have only booked, I believe, it was the $50 million. So, that is a good-sized program, and we could see some expansion there, although now we are really at the front end of it. So, it's a very healthy program for us.

Okay, thank you and good luck.

Steve Binder of Bear Stearns.

I just wanted to touch on C4I. I know with the reorganization the comparisons get muddied a bit. But organic revenues were down year-over-year. I think if you look historically, that group sequentially from the second to third quarter has always seen revenue growth; and we saw revenue decline this year both sequentially and year-over-year. You could touch on that.

I guess what I am getting at is -- was there any execution issues that might have held sales growth back? Any new customers who might have held growth back? And maybe you can also touch on Technical Services, where revenues were down sequentially [both] at 20-plus-%.

Yes, first of all on C4I, they have got some things included there, some pieces that weren't part of their segment before the reorg. That may have accounted for some of that.

I think it is very key for you to understand that in every segment, we have booked more than it sold both in the third quarter and year-to-date. So, everybody is in a very, very healthy position moving forward.

As far as the Services question, one of the reasons that we had the big pickup in sales in the second quarter was because a chunk of business that normally would have happened in the third quarter actually went out in the second quarter. So, the reason it looks like it is down sequentially is really at the very end of the quarter, we got a big chunk of business that normally would have been in the third quarter. So, it really would have been up sequentially. That is all that was.

Were there any accrual adjustments at all, whether in C4I or RSTA at all in the quarter? Profit accrual adjustments or closeout adjustments?

Well, we did -- we had a one-time adjustment on the CEDS program, that we felt that because of the importance of the future of that program, we would go in with a very attractive price; and so we had a one-time shot there. There may have been a couple of other one-time things that we had.

And how big was that, Mark?

It was maybe $1 million, something like that.

All right. Two other things. Just on cash flow for the year, I think it hit the midpoint of your guidance. You need, kind of, almost, you need to beat last year's record or meet last year's record quarter level. Are you comfortable that the fourth quarter will be a record quarter for cash flow?

We are going to see a lot of cash. Rich will address that because there is a lot of cash that has already started coming in at the beginning of the fourth quarter. You want to just address that for a second?

Yes, Steve, the big change in our balance sheet when you see it, and we will be filing our Q later today, is this -- on a year-to-date basis there has been an increase in working capital particularly in inventory and in receivables. I expect both of those numbers to decline in the fourth quarter.

The big increase in receivables is mostly in unbilled receivables; and a big chunk of that broke loose in January, has been billed, and should convert into cash in the next 30 days.

Inventory will come down. Obviously, the key there is that it comes down early in the quarter so that it goes into receivables; and then actually gets collected. That is happening. The question is, will it happen fast enough? We still have another two weeks to get product out the door and collected in this quarter before it starts to become a problem.

So, we have got a roadmap. We have got eight or nine key factors that have to happen, and we are monitoring that. If everything goes our way, absolutely.

Okay, thanks very much.

Gary Liebowitz of Wachovia Securities.

Rich, can you just comment on the Sustainment Systems margins of over 17%? It looks like sequentially that is a big jump versus the last couple of quarters.

Mark, if you can talk a little bit more about SBInet, maybe some milestones that we can look forward to, and how you see that program ramping up. Thank you.

All right, I will address Sustainment Systems. Two factors there, Gary. Number one, I don't want to imply that you'll see 17% as a sustained rate there. Their ongoing rate is not that high; it is more like what they had been running at previously. We did see a benefit in this quarter from the realignment, so there has been an up tick there. But we had very strong product mix there. We had a program that came to an end that we got a benefit; and while it doesn't have a huge impact on the overall margins, it does have an impact when you just look at that piece of business by itself.

By the way, before I talk a little bit about SBInet, along with what Rich is talking about with Sustainment, I think it's very interesting when we took a look at our original plan -- which as you know we had modified during the August call. If you actually take a look at all of our metrics through the first three quarters, you would find that we are ahead of the original plan that we had put in.

What we had discovered was that, based on how we saw the bookings coming, we saw lots of bookings coming in the second half of the year, and so that is why we had adjusted our overall guidance of that 2.7 to $2.75 billion. So, keep in mind that we are well ahead of even the original plan that we had.

The SBInet, you know, is an incredible program. As I have said before, the Department of Homeland Security is doing a very interesting thing there. Rather than let huge contracts, they created something that was called Project 28, which is roughly 28 miles of border down in the Arizona region. They want to get that thing started and working before they start putting more money into the program. So right now, it is a huge opportunity. It is a huge opportunity for us. It's obviously a very huge opportunity for Boeing. And it's a good opportunity for all the other members of the Boeing team.

We are taking it slowly. We want to do a great job for Boeing, and Boeing wants to do a great job for the Department of Homeland Defense on this first piece of the program. I think as that starts to work its way through, you'll start to see that program grow. So we have stood up an office in Washington. We have put some really top-flight people in that office, and we are doing everything we can to support Boeing on that program.

Have you delivered any product towards the first 28 miles yet?

No, but there is a lot of work that has been done. Remember, we are going to do certain things; some of it is studies; some of it is actual product. Then, that all goes to Boeing.

Thank you.

Peter Arment of JSA Research.

Nice quarter. Most of the questions have been asked. But Mark, could you just give us a little rundown on sort of the changes we are hearing about FCS and how that may favorably or negatively impact DRS? I guess some of the funding is being trimmed. But they're also taking another hard look at just how they are going to move things more aggressively into the field, versus on an individual basis.

Well, you know, you're absolutely right, Peter. There is a lot of talk right now on what is going to happen to FCS, and whether FCS will survive, or whether it will survive in another form.

But if you talk to the people who are on the program, one of the key things they are trying to do is to spiral down developments that are coming out of FCS, to get them into the Current Force. There are certain technologies that they are going to do that with. From our perspective, we are involved in a lot of the UAV technologies there and a lot of the EO technologies. A lot of the stuff that we are working on for FCS, I think would have tremendous applicability to the Current Force.

So, we think we're in a good position. Obviously, as FCS slips, there's stuff tied to the Current Force that we are also involved with that could continue to grow. So no matter which way FCS goes, I think it will be good for us. Keeping in mind, of course, that you wouldn't see real production on FCS for over five years, even if it just continued at the rate it is going. So, it is not really a near-term thing.

What it seems like they are doing is trying to borrow from Peter to pay Paul a little bit to handle some of the current needs that they have. But I don't think it's going to go away completely. It may have another name someday, but there is a lot of great technology that is coming out of that program.

Right, okay, so just this stretch out from that standpoint can be interpreted that more current systems are favorable for a company like DRS or the opportunities are?

Right, that seems to be the current feeling.

Okay, thanks, Mark.

Myles Walton of CIBC World Markets.

Mark, obviously very strong bookings continuing here in the quarter. As you start in the fourth quarter, are you expecting another book-to-bill above 1 times?

It is hard to say right now. Obviously, if we booked over -- which we did -- if we booked over $1 billion, $1.1 billion in the quarter, if we were booking $1 billion every quarter we wouldn't be a $3 billion company, we would be a $4 billion company.

So, what is happening is the bookings are coming in a lot faster. In fact, what is interesting, if you took a look at our original bookings plan, (technical difficulty) on our original plan that was put in place last year for this fiscal year, we are exceeding that plan already by about $1 billion.

So, I would say that the bookings, although they will be healthy in the fourth quarter, really should be lower than 1 times, because we are going to obviously have a big sales push in the fourth quarter; and we are already going into the fourth quarter with a huge backlog. So, I think we are going to end the year with a marvelous backlog, which is going to bode well for '08. But I think you can't expect us to be booking $1 billion a quarter.

Rich, a question for you on the cash flow. It looks like implied in your '07 guidance is a working capital investment or growth around $70 million. Historically, DRS has been able to keep that working capital relatively flat. Is there any reason to believe that going forward, post '07, you can't return to that norm?

No, there is no reason not to believe that. In my model, I'm a little lower than that figure that you stated.

Okay, fair enough. Great, thanks.

Ferat Ongoren of Citigroup.

A couple of quick bits. First of all, on Sustainment, Rich, you mentioned that you expected the segment to go back to the usual margin levels, which is about 13%, 13.5%. So, do we assume that there was a $4 million benefit this quarter?

No, no, it wasn't that high. We had an adjustment on one program that was about $1 million in that segment. Then as I said, we had benefits from realignment that we realized. Then there's always mix. It is always going to fluctuate a little bit from quarter-to-quarter.

So, $2, $3 million would be fair to assume?

The sustaining rate there is a little better than our normal 10% to 12%. Maybe 14% on an ongoing basis.

Okay. Then the second question, again another detail on the tax rate. You had guided for 39%, so that gives me a $0.16 benefit. You mentioned a $0.13 benefit. Is that the catch-up part, that $0.03 that is benefiting this quarter?

It is $0.13 in the third quarter, and there was a benefit that was already baked into the 39% in the first half of the year that I had forecasted.

Okay. Then, going back to an earlier question, you changed the segmentation, but is it fair to kind of look back at the prior segmentation and assume that the legacy SR grew about 20% and legacy C4I was kind of flattish to maybe up single digits?

Legacy C4I grew a bit, certainly less than 5%. I didn't do the math on the old S&R Group, but it grew at a good rate.

Okay. Then on Engineered Support, it seems like sequentially it was down $50 million. How is your visibility going into the fourth quarter on that business? It seems like it is moving around quite a bit.

No, we have got great visibility, and the business is doing well if you take the whole business. All we said, and I think it was on Steve's question, Steve Binder's question that I answered, there was a slug of sales about the size of the number you just threw out, maybe a little less, that was supposed to have been in the third quarter; and it actually got pushed into the end of the -- at the end of the second quarter. That is why we had that big spike in the second quarter.

So, I wouldn't read anything into that sequential difference. It was just a timing thing. It came out in the second quarter instead of the third quarter.

I see, okay. Mark, kind of a bigger picture question for you, you know, they have good orders; and as you said, just as the procurement part of the budget is going up, it seems like pretty unusual at this point in the cycle. What is your take on the duration of the orders? Do you see kind of more extended duration as you see these orders, as opposed to kind of faster cycle times before?

Well, the best way I could tell you for ourselves is we are showing growth in next fiscal year and we have not even baked in any new supplemental. So, I think the way you have to look at it is -- remember that there is a lag between the time that money is actually obligated or the budget is passed, and the money is obligated, and the time the money actually gets put under contract. Because it has to go from Congress to DoD; and then DoD has divide it up to all the services; and then eventually it gets down to a contracts officer and a program manager in the government who has to let a contract to a company.

So, there is a lag in time between the time you actually get a budget signed and the time a company actually sees a contract. It is not like they sign the budget and you immediately get all the contracts.

So, what you are seeing is what we have been saying over the last couple of years really, is that you start to book orders, and there is a lag. So, that even if the stuff starts tailing down, you would still see business continuing. So, if you went into the out-years, and all of a sudden you say there's no more supplementals, there will still be a lag in time -- that could be a year and a half -- when that business will still be executed.

So, you have just got to bake that into all of your thinking. Not just for us, but for anybody. You have to bake that into your thinking, especially in the product business. Service business tends to be a little faster turn, and it's very multi-year in nature.

All right, thanks a lot.

David Gremmels of Thomas Weisel.

Mark, I am wondering if you have any initial thoughts on fiscal '08. Given the strong bookings, might we see organic growth accelerate from the '07 levels? Do you have a sense for whether we might see continuing margin improvement next year?

Obviously, we didn't talk about '08, and we will do that when we announce year-end, which will be in May. That aside, we have got a very healthy backlog right now, so that should bode well for our results in '08.

We just are in the process of finalizing all our plans. So, that takes us to April 1 by the time we actually put them in place. I can tell you from what we have seen so far, it should be a very good year.

Okay. With respect to M&A, I think you more or less promised to wait at least a year before ramping the acquisition machine back up after Engineered Support. Now it's been a year, so I am just wondering what your thoughts are there; and what the pipeline looks like; and how active you might be in the coming quarters.

Well, you know, when we first talked about that year to 18 months, we were still a tourist at Engineered Support. Then we became a citizen, and what we found there was that it really was 14 individual companies. So, what we did was we have been working on integrating 14 companies into something a lot more manageable. That is why you have seen all the action that we have taken.

So, we have had our hands full doing that. There are still things coming across our desk that we are looking at, because that is something we are always going to do. We will take a look at anything that makes sense because we essentially have the integration behind us. Now it will become more of a financial picture as to how we could do something efficiently.

Okay, thanks very much.

Greg Alexopoulos of Morgan Stanley.

I would like to focus a little bit more on the C4I and the performance in the third quarter. You guys talked about, during your press release, that sales were down based on intelligence displays in training and control systems. I was wondering if you could touch on each one of those a little bit more.

The Intel is something that a lot of people in that business have noticed, and that has just been a little slow-up in the timing of certain orders in some of the black boxes that we are doing. We are starting to see that thing turn around.

One of the interesting things that we saw, and something that I already pointed out when I was discussing an answer to another question, was that every segment we had booked more than they shipped. So, everyone has got a strong backlog.

Intel is beginning to pick up again in terms of their bookings.

The display business is something we have always expected to see flatten out. You have got huge growth that we saw on the FBCB2 computers; and those are still coming in strong, and we still see a huge growth into the future for that program. But we reached a plateau in terms of production. The next thing is to ramp up to a higher level of production, and that is something we are working on right now. But we have the capacity to do that.

Training and controls has just been off a little bit. Again, most of that is due to timing. Those jobs are starting to come in, as well. So, I would say overall I wouldn't read too much into what happened to that particular segment in the third quarter. You know, we are booking more than we are shipping, and they are looking very good going forward.

Not only more than we are shipping, year-over-year our bookings are up close to 20%. Remember last year they had very strong organic growth; and it's difficult to keep doing that over and over. So, this is kind of a year of kind of consolidating, and then with that big boost in bookings we should see some growth next year.

Yes, very true. Since we are talking about bookings, the bookings were fantastic. Is the majority of the $70 billion supplemental in bookings already, and you're just waiting on the $93 billion now?

The new supplemental we haven't even seen the bookings on.

Right.

The last supplemental. So, what we have gotten the bookings on is the prior supplemental. But I would have to map out the supplementals.

The supplementals bringing money into program offices; and program offices let contracts. But first of all, there is nothing tied to the '08 budget that we have booked a penny on yet. That budget was just signed.

Right. Mark, you talked about a little bit on Sustainment Systems and how that integration is going. But I was hoping you can look at ESSI overall and talk to us about how that integration is going. Are you still on or above plan? How long will it take to fully integrate these 14 companies that you spoke about?

I would say we are 98% of the way there. It is doing very, very well. By the end of the year, we will have the whole thing wrapped up. But we have got that business where we want it right now.

Finally, the last quarter you spoke of seeing higher international activity. Do you continue to see that? Are you focusing more of your business towards that market?

We are working harder on the international front. We have got some joint ventures we have been working on, and we have got some initiatives overseas. That business takes a long time to book, but we are starting to see some results of work that we started years ago. So yes, I think we are feeling pretty good about that business.

Great. Thank you very much.

Steve Levenson of Ryan Beck.

Starting to hear a little noise about bandwidth squeezes across the information grid. Is that something that you think is going to help you with some of your products? Or is that something that could potentially hinder revenues?

Nobody has talked to me yet about that having any impact on what we are doing. I don't think it has a big impact on -- I don't think it has any impact on us right now for the kinds of things we are doing. We are fine.

That includes the UAVs? Which I know are small now, but.

Yes, our UAV business is actually growing. I don't think that is a problem for us. (multiple speakers) for the kinds of things we are doing.

The sort of clandestine stuff, you mean?

I don't mean anything.

Okay. In terms of M&A, are you looking more on electronic sort of systems, or are you looking for things that blend in with Sustainment Systems, now?

We have actually looked at both. We have looked at both. There are different opportunities, and we are there. We are taking a look, but it is not our primary focus as we have been working on the integration of these businesses.

Okay, thanks very much.

Howard Rubel of Jefferies.

A couple things. Mark, just to go back to the EO bookings, they are really phenomenal. If I can kind of track them a little bit back to sort of the BAE Systems' bookings for Bradleys, would you say that you have sort of seen the bulk of the bookings for that line of business for the next six months or so?

No, I think there is still a lot more to come in that area. I don't think we have seen the end. Now we see modest growth -- if you don't include any more supplementals -- we're seeing modest growth in our EO, what we call the RSTA Segment. So, they see growth even without new supplementals. With new supplementals, I think they will see a lot more growth. So, we would have to see what happens with the new budget.

When you mean new supplementals, if I am not mistaken, the recent BAE awards -- which kind of came just around year-end, so you probably got a bunch of the bookings almost simultaneously -- these represent the same bookings that they got just prior to the end of the calendar year, I believe?

Probably. I just in my head I don't have the exact timing of every one of the bookings. But obviously, for ground vehicles we have booked I think it was about almost $250 million (multiple speakers) in the quarter.

It was stunning. It's a very impressive number.

Yes.

But what it looks like to me is the run rate on the Bradleys is kind of running at around 1,700 units a year. So, in terms of refurbs and everything else, it looks like you have kind of got to that level. The next opportunity for you is more one-off things, I would think. Either some foreign military sales opportunities or just the occasional -- gee, this one broke and it is in the field. Is that fair?

Not quite, because we do a lot of other things for that vehicle besides just the EO. We are doing -- we are getting involved in this whole world of Condition Based Maintenance. Our Test and Energy Management business is starting to see more growth than they have ever seen before in the prognostics and diagnostic systems. Don't forget we make cables for Bradleys. So, I don't think we have topped out yet.

No, I wouldn't think so, but I'm just saying from kind of the very visible high-end items, I just wanted to make sure I understood sort of the linkage; and this is very helpful.

The other question I wanted to go back to is Rich's comment on the taxes. I guess this is the [FISC] ETI benefits. Is that correct?

How is it that you have been able to identify this? Most everybody else is actually seeing a runoff in that benefit. What is there that caused you to be able to get these benefits?

Well, you're absolutely correct that there is a runoff. It expires at the end of this year and is replaced by a new provision. This is a catch-up that goes back a few years. Because we have tax years open, we are able to go back and capture benefits that actually apply to fiscal years earlier than this year. That is why I identified it as a discrete benefit and not part of the underlying tax rate.

I totally understand and totally agree with you, I'm just -- I guess you have some good tax accountants that went back and found this additional benefit, because most other people have gone the other way. If we go forward, your tax rate will also be a little bit higher; or will it? Because I think now the domestic manufacturing tax rate -- actually I take that back. It could be a little bit lower, around 32%. How will that affect your future tax rate?

It will help us starting in our fiscal '08. Right now, our modeling is assuming a go-forward rate of 39%. As we get more definition on that, we will adjust it accordingly.

But am I not correct, it is because you sort of didn't have this baked in that -- and with the new rate and the way it works for manufacturing -- if we look kind of apples-to-apples, the new tax rate, Rich, should be lower, not higher?

Apples-to-apples, that would be correct.

All right, thank you very much, gentlemen.

There are no further questions at this time.

I just want to make one correction on something that was said earlier. Somebody had asked the question about the impact of CEDS. I think when Mark responded to it he was actually talking about the CENTCOM contract, when he talked about a $50 million booking and $300 million potential. So, I don't know if you want to -- the question was about CEDS.

I thought it was about CENTCOM.

Yes, I know. That is why I wanted to clarify (multiple speakers).

You're right. I thought he was asking about CENTCOM. You're absolutely right.

Okay, well, thanks, Rich, and thank you all for joining us on today's call. I look forward to speaking with you again next quarter. Take care.

Once again, that does conclude today's teleconference. Thank you all for your participation. You may now disconnect.