Leonardo DRS Inc (DRS) 2008 Q1 法說會逐字稿

Good morning, everyone, and welcome to the DRS Technologies conference call. At this time, all participants are in 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 Investor Relations with DRS Technologies. Please go ahead.

Thank you, operator. Good morning, and thank you for joining us on today's conference call to review DRS Technologies' financial results for the fiscal 2008 first quarter ended June 30th, 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 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 on the Company's definition of these metrics and their usefulness in interpreting DRS's financial results, please refer to today's earnings release in our filings with the Securities and Exchange Commission available on our web site.

In accordance with the Safe Harbor provision 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, and good morning, everyone, and thank you for joining us on the call today to discuss our fiscal 2008 first quarter results. As we reported in our news release this morning, we achieved substantial increases in revenues, new orders for products and services and funded backlog for the three-month period.

Detailed in today's release and in a separate release issued July 27th, profitability for the Company was impacted by a $37 million pretax charge on the Thermal Weapon Sights II program, which is being supported by our Reconnaissance, Surveillance & Target Acquisition Segment.

This charge was due primarily to the cost of procuring new materials to support the design modifications we are implementing on this program and to the write-off of certain inventory that can no longer be used. I would like to emphasize that we regret the impact of this program delay on our customers. We are fully committed to the TWS II program, and we remain dedicated to applying all of the necessary resources to it, including our best people who are working seven days a week to get this program on track. We believe we are making progress towards the resolution of any remaining issues, and we expect to resume production deliveries in the current fiscal quarter ending September 30th.

I am sure you understand that for competitive and other reasons, we will not be able to go into further details regarding the specific issues we have experienced.

Getting back to the quarter's financial results, consolidated revenues of $736 million were 17% above last year's first quarter. The rise was attributable entirely to strong organic growth during the period with increases across the board at each of our operating segments.

Consolidated operating income of $31 million reflected an operating margin of 4.3% after giving effect to the $37 million pretax provision on the TWS II program. Without the impact of the charge, we would have reported $68 million in operating income and a 9.3% operating margin, both of which are ahead of our operating plan for the year.

The 9.3% operating margin reflects the revenue mix during the quarter, including a higher portion of revenues generated by our Technical Services businesses, compared with the same period a year earlier. The operating margin also reflects some one-time cost growth, the most significant at our Technical Services and Sustainment Systems Segments related to our engineering logistics and mobile environmental shelters businesses.

Net earnings of $1.7 million included a $23.2 million after-tax impact from the TWS II charge. Diluted earnings per share of $0.04 were reduced by $0.56 as a result of the charge. The Company's adjusted net earnings before giving effect to the charge were $25 million, or 17% higher than the first quarter last year, and our adjusted diluted EPS was $0.60, 15% above the same quarter last year.

Our free cash flow for the first quarter of fiscal 2008 was a negative $13.4 million, compared with a negative $39 million last year. Lower accounts receivable and prepaid expenses contributed to the improvement. Our first-quarter free cash flow is typically negative, as you all know. We expect to generate strong positive free cash flow as the fiscal year progresses.

Bookings were a first quarter record at approximately $940 million, exceeding last year's first quarter by 20%. Fiscal '08 first quarter bookings resulted in a book-to-bill ratio of 1.28 to 1, representing a great start for us in the new fiscal year.

At June 30th, the Company's funded backlog was a very strong $3.3 billion, 27% above the backlog at the same time last year and up 7% from the end of the fourth quarter of fiscal 2007.

On July 27th, we raised our revenue guidance for fiscal '08 and reiterated today that we expect sales between $3.05 and $3.1 billion. We also reiterated diluted EPS guidance of $3.00 to $3.10, which reflects the anticipated benefit from higher revenues, planned operating improvements, a curtailment gain of approximately $11.7 million on one of our benefit plans and a lower effective income tax rate of 37%. The curtailment gain is expected to favorably impact our fiscal second quarter. Fiscal '08 free cash flow should be between $100 million and $120 million. Other details regarding our guidance are included in the news release.

Before turning the call over to questions, I would like to take a few minutes to highlight some of the noteworthy achievements during the quarter. The exceptionally high level of bookings captured during the quarter reflected the continued strong demand for products and services associated with many of our core multiyear programs.

In our C4I Segment, we were awarded $31 million in new contracts to continue to produce UYQ-70 Advanced Display Systems for Navy surface ships, submarines and aircraft. The Q-70 program has been a cornerstone of the Navy's combat system modernization efforts and has been supported by DRS and Lockheed Martin for the past 13 years.

We also received an additional $26 million in new contracts to continue to provide cable assemblies and electronics for the Army's Bradley Fighting Vehicle. The steady demand for these vehicles is resulting in a strong order flow on this program.

We secured $17 million in new contracts during the first quarter for IFTP, or Integrated Fight Through Power - an electrical power distribution system for the Navy's new DDG-1000 Zumwalt-class destroyers. The IFTP, in combination with all of the variable frequency drives and motor controls we are producing for this new class of destroyer, provides us with a major position on the ship's Integrated Power System, equating to more than $50 million of contract work per ship set.

New orders from the U.S. Army of $22 million on the FBCB2 program were also received during the quarter. DRS-produced FBCB2 systems are being installed on hundreds of vehicles, including more than 40 vehicle types, and are also being installed at tactical operations centers and other command post platforms.

Supporting the Army's Blue Force Tracking requirements, they are making a critical difference in the operations in Iraq, contributing to the military's battlefield visualization and network-centric communications efforts. In addition, FBCB2 will be installed on the Mine Resistant Ambush Protected vehicles, known as MRAP.

We experienced exceptionally high demand for our ground vehicle test and diagnostic systems product line during the first quarter of fiscal '08, with $73 million in new orders awarded to DRS. This automated equipment assures that the current generation of Abrams Main Battle Tanks, Bradley Fighting Vehicles and Light Armored Vehicles can be fully sustained around the world.

Utilized throughout the U.S. and deployed internationally, this equipment supports key U.S. Army and Marine Corps modularity requirements, as the force structure evolves from operating divisions to brigade combat teams.

We are also seeing strong demand for DRS-produced Driver Vision Enhancers, booking $60 million in new business on this program across our C4I and RSTA segments. Beyond its application on Abrams, Bradleys and humvees, this system can be installed on any ground vehicle and has been validated for Army and Marine Corps MRAPs. So, we are expecting to see this strong demand continue.

Our RSTA Segment was recognized recently by the management of the U.S. Army Stryker Brigade Combat Team for outstanding support and early delivery of Driver Vision Enhancers for deployment in Iraq. DRS delivered these systems in 10 months in advance of schedule and within 30 days of the Army's initial request.

As part of the recent surge of American troops in Iraq, the Army needs to deploy additional Strykers, all of which require DVEs. Thanks to the dedication and customer focus of the employees at RSTA, our performance in meeting this challenge was well noted.

Order flow for infrared sighting systems at RSTA was exceptional with $47 million in new contracts for the Improved Bradley Acquisition System and $19 million for the Long Range Advanced Scout Surveillance System.

The Mast Mounted Sight for the Kiowa helicopter continues to provide a strong foundation for our efforts in airborne infrared sensors supporting the Army, and we booked over $22 million in awards on this program during the quarter.

At our Sustainment Systems Segment, we delivered the first M1200 Armored Knight Precision Targeting System to the Army, which also occurred 10 months ahead of schedule. The remaining systems funded on the program, which exceed 100, will be shipped on an ongoing basis through July 2009.

Key orders for this segment during the period also included a $27 million award for biohazard detection from an undisclosed customer and $24 million in new contracts from the Army for medium, portable Tactical Quiet Generators.

On the Technical Services side of our business, we were awarded a contract with a ceiling of $110 million that will provide non-DoD federal government agencies with commercial satellite communication. DRS was also selected as the teammate on two of the three winning teams on the Army's Logistic Civil Augmentation Program 4, known as LOGCAP, which at $5 billion in estimated value is expected to be one of the largest IDIQ support services contracts ever awarded.

Established by the U.S. Army to fulfill the DoD's global mission during contingency events, the LOGCAP program is focused on providing a broad range of essential logistics and support services to U.S. and allied forces during combat, peacekeeping, humanitarian and training operations. It was designed to provide troops with additional capabilities to rapidly augment the logistical requirements of deployed forces by using civilian contractors.

Other substantial awards for the Technical Services Segment included $32 million on the DCATS program, $19 million for persistence surveillance, $18 million for global satellite communications networks and $18 million for armoring kits to be used on commercial vehicles operating in Iraq.

In closing, the high level of bookings secured in the first quarter is providing a strong foundation for business growth in fiscal 2008 and beyond. As the government's fiscal '08 defense budget process continues, we are seeing strong support for many of the programs that we are involved in and opportunities to apply our products, service and technology solutions to the challenges facing our nation. We can now open the call to questions.

(OPERATOR INSTRUCTIONS). Patrick McCarthy, FBR Capital Markets.

Hi, good morning, and thanks for taking my call.

Hi, Patrick.

I was wondering if you just -- on the TWS program, I know you're not going to give much detail, but can you tell us whether there are additional technical hurdles that need to be cleared at this point in time or are you principally by that and now you are just getting ready for the production run?

At this time, we are just completing the final testing that has to be done before we can go into full production. As we speak, the testing is ongoing, and we think we are going to get through it in this quarter and hopefully, we are pretty confident we are going to begin deliveries again, by the end of the quarter certainly.

Great. And then on the Sustainment Systems, you mentioned some cost growth on one program. Would it be fair to assume that that is somewhere in the $2 million to maybe $2.5 million of cost growth related to that program?

Yes, probably if you looked at it in total, and we look at it as a one-time event. We have that under control. There was just some cost growth that we saw. That is a routine thing as you go through the estimate to complete exercise at the end of a quarter. So, we have got that under control.

So, you would expect for 2Q margins to kind of go back to the historical norm, if you will?

Yes, yes.

Okay. And then is there anything else you do on an MRAP besides FBCB2?

Yes, as I mentioned, the DVE, the Driver Vision Enhancers, and that is going to be a big opportunity for us on MRAP. In addition, we are getting some contracts to make parts of the system at our Sustainment Systems business because we have an incredible factory that can help with some of the offload on building armor pieces and various types of metal pieces that would go into the vehicle itself. We could even do a whole hull if called upon. So, some of the contractors are talking to us.

I am assuming the FBCB2 is pretty much scoped into each variance of the vehicle. Is the DVE as well?

Yes.

Okay, great. Thank you very much.

David Gremmels, Thomas Weisel.

Thanks, good morning. On the Thermal Weapon Sights contract, I mean, how much do these delays hurt you with the customer, because BAE just announced this morning that they were up to more than 1,000 units per month of Thermal Weapon Sights and Raytheon was added to the contract recently. So, I mean, as you step back and look at that contract, what kind of a market share are you expecting now?

Well, first of all, remember this is going to be a huge program, probably $2.5 billion, $3 billion. So, we are looking at a very, very big program. Raytheon is just getting started on what they call the Bridge contract. So, on the initial contract, it was divided between BAE and ourselves. Everyone has startup problems with a program like this. Ours manifested itself in a different way than BAE's and perhaps manifested itself later.

So, the impact that we have seen thus far is that there was a competition for this Bridge - so-called Bridge contract. BAE got a large order, Raytheon ended up coming in with an order for the minimum quantity I believe, which is still a good order, about 5,000 units, and they kept us in with an order for 1,000 units. So, we were very encouraged by that, and we believe once we get the production runs going, the Army and Marine Corps are going to continue to work with us, and we will see a good portion of this program as we go forward.

We are certainly not happy with the fact that we have had the delays, but my biggest concern is really with the customer, because they need this equipment. So, we are working to get them the equipment, and I think we have so many good features in our product, that once we get into full production, I think you are going to see more orders begin to come in.

Thanks for the color, and then one on the items in the old Engineered Support. In response to Patrick's question, you talked about the item in Sustainment Systems. I think in your prepared remarks, you said that the bigger, the larger item was in Technical Services. I am just wondering if you could maybe talk about what that was, and do you have your arms around it at this point, and what kind of risk might be remaining on the Technical Services side?

No, no. Actually it was in Sustainment Systems. In Technical Services, it was basically on something called the MilParts contract, and it was just a little bit of cost growth that they found in an estimate to complete, and they basically have that under control.

The larger one was in our shelters business that is out in Cincinnati, and the problem there is they have gotten so many orders, way above anything they have ever seen before, that in trying to get some of this equipment out, they have run into some production snags. So, we brought a good team of people in there, very similar to what we did in Fermont when we identified some problems and straightened that operation out. So, we brought some people in who are helping get some good production processes in place so that we can really deliver these things in the quantities that the customer needs. All totaled, there is a few million dollars that is pretty well under control now.

Great. Thanks very much.

Robert Spingarn, Credit Suisse.

Good morning. A couple of questions. First, just to clarify, when you talk about MRAP and you talk about FBCB2, it sounds like you are talking about all of the MRAP vehicles there and then potentially with DVE, as well.

That's correct.

So, effectively you could have 100% share here?

We would certainly like to see that, but you never know. I mean the customer does his thing, but right now, we are the ones that produce this stuff.

And how do you handle the ramp with all the unknowns in the quantities and the speed at which this program is attempting to move?

We have, in the case of FBCB2, created an incredible manufacturing facility down in Florida, and our deliveries for the most part are ahead of schedule. We have truly impressed the customer on this thing. So, that is a huge advantage that we have. Meeting deliveries on FBCB2 is not a problem at all, and on the DVE, we have had incredible success with the DVE program.

Ironically, when we embarked on both DVE and TWS, we thought the problems were going to be with the sensor development and production, especially getting quantities of sensors out the door, and it turns out that was the thing we did the best. So, we can meet the sensor demand and along with the sensor demand, it isn't a problem to meet the production demand that they need for these units. So, we are in very, very good position.

Okay. And then just going back over to TWS, if we look at the size of the charge, it is obviously rather significant, and it would equate to about half your operating profit in the segment last year. Is there anything else in that number separate from TWS?

No. That was just TWS, and the bulk of it -- you have got to remember that I think we were talking in this initial contract of something like 17,000 or 20,000 units. It was a huge number of units, and what happened was we thought we were in production, and they had bought material for about half the units. Remember, it was like a $350 million contract. So, being in production, they wanted to meet the deliveries, and they bought all this equipment.

And then as we started having some problems, we began to redesign elements of it, and in the June/early July timeframe, we realized that some of the equipment that had been purchased wouldn't be able to be used on these systems anymore and that was the bulk of what the write-off was. It's just material now that has changed so substantially that it can no longer be used, and it was custom made, so there is no -- you can't sell it;you can't just send it back.

But at $350 million in contract size, I guess it is a profitless program at this point?

Yes, it is a loss. That is why we wrote off all that money. But the good news is there is a huge market here, and we have got this thing under control now, so that we are going to participate in the future.

It is not a profitless program. This portion of the contract that we have in backlog is profitless. Future orders will be very profitable.

Okay. And just if we back out the charge, and we look at the margin there, it is still a little bit like, I think, relative to our expectations and some of the trends beforehand. Anything else going on in this segment?

Yes. If you take a look at RSTA's performance, the margins were negative 13.6%. If you add back the charge, the margin would be 10.1% compared to last year's first quarter of about 11.1%. So, they are down about 100 basis points even when you add back the charge and the reason for that is their other major program, IBAS, has transitioned to the next contract. The initial contract ended last year. The next contract is at lower margins, or lower prices, and we would hope, as that program progresses just like the first one did, that we will be able to claw back some of the cost savings, as we did the last time, and those margins will go up. But starting off the bat with the new contract, it's lower margin than last year.

Okay, that's very helpful, Rich. And then just finally, when you talked about book to bill in the fourth quarter, it was quite strong, and I think you were asked about the Supplemental [Defense Budget] impact that can come in this quarter. And at the time, you weren't committing to anything. You had very strong book to bill here in June. To what extent has the Supplemental helped?

It has helped a lot. I mean, we still expect strong bookings for the balance of the year, but we definitely saw some of that flow through in the first quarter.

So Q1 could be a peak type of number?

It is hard to say. It is hard to predict bookings by quarter.

I can tell you this. I think we are going to have a good bookings year this year. So, our goal is always to try at least to book what we ship. So, no matter how you slice it, I think we are going to have very healthy bookings.

Obviously, we did take up the revenue guidance from the previous. So we did factor that in.

Great. Thank you very much.

Ferat Ongoren, Citigroup.

Good morning.

Hi, Ferat.

One question on the guidance. To get to your 10% plus margin level, we need to have about 12% margin for the rest of the year. In this IBAS contract, you will probably have $5 million to $6 million headwind. The mix is not going to change. So I am trying to figure how are we going to achieve the 100 basis [point] improvement, compared to last year, in the last nine months of the year. So, if you can give us maybe a sense whether we will see significant sequential improvement in one of the segments or do you expect to have overall improvement going forward?

It's a good question, Ferat. Let me try to give you some clarity, because I do sense that there is some confusion in the analyst community. If you look at the guidance that we put out there, at the low end, it has an implied margin of about 10.3%;at the high end, about 10.4%. Clearly, based on the first-quarter numbers, we are at 9.3% when you add back the $36.8 million charge we took on TWS.

If you look at the four segments, one segment was up year-over-year. That was the C4I Segment. The other three segments were down. I talked a little bit about why RSTA was down, and why we think those margins will come up a bit. If you look at Sustainment Systems for the quarter, their operating margins were about 9.5%, and they had one-time charges, what I call non-routine, one-time charges of about $3.8 million that we don't expect to see going forward on a couple of programs that -- they needed to tweak a bit.

On Technical Services, their operating margins were about 5.9%, 6% for the quarter. They had about $2.5 million of one-time non-routine charges. If you add that back, they were about 7.3%. So, we do expect to see significant improvement in the margins as time goes on.

Also remember, we did tell you about that curtailment gain that is going to come in the second quarter. That also flows through the margins. That is $11.7 million pretax, so that obviously helps, as well.

Okay. And then, Mark, as you sit -- you have all these one-time items this quarter, I mean, was there a comprehensive review of all these issues, and how comfortable you are that you won't see more of this coming?

Separate the two items. Every quarter, we have something that is negative, and we have lots of things that are positive;so that is routine. So the kind of thing you will see -- like we had with Sustainment Systens -- there is always some program that has something. That is why we always tell people if you can do 10% to 12% overall operating margins in this business, you are doing very well.

The TWS was a huge hit, and what was unusual about TWS was that generally you're not in a production mode on something and then going into a redesign. So, it was because we thought that we were in production that we had bought all this material and then found out that we had some difficulties, brought a new team in to investigate the difficulties, and they started making changes.

When they added up all the changes, by the time they started getting the design stabilized well into June, what they discovered was they were going to have to change out some of the parts. Which in and of itself wouldn't have been a big deal, except we had bought half the material for the production. So, that was a very unusual occurrence. It really was a very unusual occurrence.

All these other ones get absorbed one way or another because they are just part of running the business. So, it is not that we are picking on this quarter as all of a sudden we had terrible problems. We had one major problem. The other stuff did impact the margin. Now if RSTA was making 10% on TWS or 12% on TWS, then these other problems and the other segments would have -- we would've said, okay, the margin is a little low this month or this quarter, but we expect them to pick up, as Rich was saying in the outlying quarters.

So really, it's the TWS that was the big wrench this time around and a very, very unusual big wrench. And it's just something that happened, and we had to get our arms around it. But I'll tell you one thing, I think with the organization that we've put in place with the four operating segments, we now have tremendous transparency into the organization, which gives us the opportunity to jump on these things as soon as we become aware of them. So, I think from a management standpoint, we are very pleased that we did that reorg back on October 1.

Okay. And then if you look at the infrared business, I mean, do you see any problems that could be prompted by what is going on in terms of (inaudible). I mean you obviously won the Tactical Range, Thermal Imager and some of these other products. Do you see any issues with those programs right now?

Well, what we see is a market for well over 200,000 Thermal Weapon Sights. So, the Army and Marine Corps haven't even scratched the surface yet on that huge volume that we are looking at. So, our goal right now is we have got to get this TWS into production, regain the confidence from the customer, who has been working with us, I might add, in a very, very helpful way and get these things into the hands of the military. And then once that happens, you will start to see orders begin to flow in on this. So, I think it is going to be a great business for us.

Thank you very much.

Myles Walton, CIBC.

Thanks, good morning. A couple of questions for you that haven't been asked. FBCB2 for a second. Mark, it sounds like you have gotten some level of confirmation that you are pretty darn confident that you will be the only source. I know in late May, the DoD was soliciting inquiries if there was multiple source potential out in the market given what they were looking at as the production ramp on that program, and I know the responses to that were due in early June. Have you received kind of some level of confirmation that you will retain that sole-source basis?

You are never told that you're going to retain a sole-source basis on anything. All I can tell you is that we are doing an incredible job on that program. The customer is very happy. We have the manufacturing capacity, and we have demonstrated it, and we continue to book orders, and I think you are going to see we are going to continue to book orders. So, I think that it's a very, very healthy program for us.

Okay. What was the production rate that you said you could do per year?

Per .

Per year or per month on the system?

God, we are building thousands a month. There is probably maybe 10,000 per month.

Okay, all right. Because I think the requirements for the new contract is 45,000, so that sounds like you can do it and have sized it around $500 million to be awarded in the first quarter of the next fiscal year. Does that sound like what you have heard as well?

Yes, we can meet the demand. That is not a problem.

Okay. And then the CEDS program. I think another larger opportunity on the horizon. The timeline on that. Do you have any update there?

We think within the next couple of months we should know. The official line, I think, is around September. That would be next month, but you never know. These things routinely get pushed off -- these decisions.

Okay and then a couple on TWS. The size of the backlog that you currently have under contract that is 0% margin, can you give us a rough order of magnitude of that, as well as the timeline that that flows out of the RSTA Segment?

Yes, $285 million in backlog, and it is currently scheduled to run out in May of '09. There will be additional orders that will come in that will also be delivered during that time period, but that is what is in backlog today.

$285 million on TWS at 0%?

Yes.

Okay. So that will be a margin headwind for this year-end.

Absolutely. That is factored into the guidance, but you're absolutely right.

Okay. And then finally, the cash versus non-cash breakdown on the charge?

The cash versus non-cash is about 50/50. Not all of the cash gets spent this year.

Okay. But that is the primary reason for the $10 million reduction in free cash flow items.

Exactly.

Myles?

Yes.

I was just thinking about something you had asked about the quantities of FBCB2s. I think I said 10,000 a month. What I meant to say was more than 10,000 a year. So, we are doing like about 2000 a month is what we have been able to turn out. I mean, sometimes we do 2000, sometimes 1000. It depends on the month, but we are more in the 2000-a-month range. But it is still plenty of capacity.

Okay. Yes, I think what they are looking at is 45 over four years -- 45,000.

Yes. So it's not a problem at all.

Okay. Thanks.

Steve Levenson, Stifel Nicolaus.

Thank you. Good morning, Mark and Richard.

Good morning, Steve.

I think in the past, you had talked about content on the MRAP as being about $30,000. With what you have got from Sustainment Systems, does that number go up?

It could, but we believe there will be a DVE and a FBCB2 on every MRAP. We are not going to be working on every MRAP as Sustainment Systems. So, we have begun to get some contracts, but we don't really factor that in because I don't think we are at a run rate kind of level yet.

Okay, thanks. And I think right now the number on order is somewhere around 7,000. Is that what you are using in providing guidance?

We have a projection of DVEs and FBCB2 that are in our plan. I don't know the extent to which they have allocated these units to MRAP. So we sell -- we are not selling to the MRAP producers. We are selling to the Army and Marine Corps. So, they tell us they want so many FBCB2s, we meet the demand and they decide where they are going to put them. So, they may put them on an MRAP, they may put them on a Bradley. So, we haven't factored it in based on MRAP. We have factored it in based on the order flow that we are getting.

Okay. Thanks. And just sort of a general budget question with what is coming up and some of what we are seeing on suppliers smaller than you, are you feeling pressure from above? Are the bigger guys trying to take stuff away from you or are you able to hold your own position there? In addition, do you think you are able to squeeze some of the smaller guys out? I see, in particular, you got some nice orders for signal intelligence gear in the last quarter.

Yes, I mean we are not trying to squeeze anybody out, and we're certainly trying to hold our own with the primes. Generally, when we work with the primes, we are a partner with them. We are usually not just a subcontractor, so we are deeply involved in the program. I don't think in general we have had any indications from primes that they want to squeeze us out of anything. I mean, they generally work with their vendor base. Their supplier base is very important to them because they know that business is going to go up and down, and they don't want to be totally vertically integrated. Everything, I would say, if I had to think about it, has got to be pretty normal.

That was what I was hoping to hear. Thanks a lot.

Steve Binder, Bear Stearns.

Mark, good morning. I know a lot of questions have been asked about margins in the quarter, but, I mean, if you look big picture, I mean, this is -- you have really been a margin improvement story, not just a growth story, but a margin improvement story pretty much up until you acquired Engineered Support Systems, and you have had some bumps along the way last year and this year. I am just wondering if you kind of collectively look at the issues you've had here, how much of it is really the cost issues? How much of it has really been ramp issues because you have had strong volume growth? Is that where you are seeing kind of the disappointing cost performance? Can you kind of weed out or call out what you think the big picture issues have really been or is it really localized issues?

I would say, for the most part, it has been localized. The little pieces of Engineered Support that we have had the problems in that we talked about today, those are fairly small companies that got lots of orders, and I think had some process problems. Nothing major, nothing that couldn't be fixed. We went into that company Fermont that was one of their divisions that makes the Tactical Quiet Generators and, frankly, we walked in, and it was a disaster, and we put a good team of people in and now they are turning out lots of product in a very healthy fashion. So, you always have a couple of bumps in the smaller companies, but I would say overall if you look at Sustainment [Systems], they are doing pretty well.

This thing with TWS wasn't as much a ramp-up problem as, if I had to look in hindsight before buying production material, I would have gone through a complete maybe prototype phase. What was happening was they didn't include prototyping in the contract. So, they were going right from development to production deliveries when the customer needed this stuff. I think we should have taken time out and spent a little more time on doing some real rigorous testing before we gave the signal to start buying material in quantity. So, I think that was an anomaly, and it had nothing to do obviously with Sustainment Systems or ramp-ups. That was an anomaly that I don't believe is going to happen again here.

And then if you look with respect to RSTA, I mea, if you go back to fiscal year '05, it has been a sliding with lower margins here, even if you back out the TWS charge, and we have had very strong volume growth during this period of time.

Yes, but you have got to remember that it wasn't -- it is not all just one contract that you have got five years ago or 10 years ago, and you can just keep producing. As we get better and better at meeting the volume, we are bringing the cost down. So, as you bring the cost down, remember each of these is a negotiated procurement. You are showing them your actual costs, and they are letting you have a profit on top of that. So, that is what goes on in the defense business. You get into heavy production. The later units start to make more money, then it comes time for the next contract. You show them all the improvements that you made, and you are giving that back to the customer in the way of a better price. So, as a taxpayer, you should be real happy.

And then what we have to do is then try to create new efficiencies to improve the margins, and that is why we say if you can do 10% to 12%, you are doing very well in this business even though on some programs you can do 25%. That doesn't last very long. So, the good news is they are getting lots of orders. They are doing a dynamite job, and the customers are coming back to them for more and more product. So, I think that 10% to 12% is still a very good goal to shoot for. We had a couple of things in this quarter. Obviously, we are going to do better than 10% for us to make the guidance, and we are very confident that we can do that.

And lastly, I mean if you look for the full year and you call out the curtailment gain and the TWS charge, do you think '08 will prove to be a low point in margins?

I don't have that number in my head, but I think if you pulled out those two things as if they never happened, I think you would have found '08 would have been the best year in the history of the Company because it is going to be pretty good anyway.

So, you think you are going to be -- you are going to beat -- prior to those two items, do you think you will beat last year's margins?

Those two items when you aggregate them are 82 basis points using a sales base of $3.1 million.

Right. So, I mean --.

Last year, we did 10.9%. You take away the 82 points, we did 10.1%, and we are already guiding -- as I said, the implied guidance is 10.3% to 10.4%. So, if you take away those two items, we are guiding to a little higher in margins.

Right. Thank you.

Howard Rubel, Jefferies.

Thank you very much. Rich, could you first talk for a moment about the pension curtailment? Is it non-cash or is it cash, and what should we expect going forward?

It is non-cash in this year. What it represents is future contributions over the next 4 years that don't get made, so the effect on this year is not significant. What we are doing is we are trying to -- the integration of all our companies is not just on the operating side, but it is also with the benefits and things like that, and we are trying to bring everybody into the 401(k), which tends to be what companies are doing today, and having a match instead of a pension. So over a period of time, we are trying to standardize the benefits across all the DRS companies.

So, you are avoiding a -- I mean, this is the benefit of avoiding future obligation?

Yes.

And then to go back -- not to beat a dead horse on TWS -- just a quick question there, were there any revenues at all in the quarter associated with the program?

No.

Okay. And then the last thing is you have had a number of issues that have cropped up at both Sustainment [Systems] and Technical Services, and if we go back and look at the margins as you have broken them out over the last 15 months or so, there is -- it's hard to get a sense of what they are going to be in any given quarter. Could you give us an indication on those two as sort of what you think -- or -- I mean I realize mix and other factors sort of take this into account, but what do you think would be satisfactory operating results for those two business units?

Let me first say that those units or all of our segments are -- between them all, probably we have 10,000 different contracts. Each of those contracts has their own margin, and so every quarter really is a product of the mix of what is delivered in that quarter, and it can fluctuate sometimes significantly just by what is in there. We are trying to make sure we meet all our customer commitments. We are not trying to obviously manage to a specific margin. I realize you guys have to do your modeling and obviously margins assumptions are a big part of that modeling. So I can understand why you do that, but from a quarter, it is very difficult.

If we go back to the full year, what we reported last year if you just adjusted for the TWS, you adjusted for the curtailment, those are pretty good guidelines. The margins shouldn't fluctuate dramatically because the businesses aren't changing. I mean, if you look at -- for example, this quarter, Technical Services was 25% of our revenues, and you know that they carry a little lower margins. Last year in the first quarter, they were 22% of our total revenues. So that has some impact on the consolidated margins, but when you look at the individual segments, you are not going to see huge fluctuations for the year over year, but in any quarter you might.

I think that's fair. I mean, I understand it. It looks to me like there is always going to be some bumps in the road;otherwise, you are not taking enough risk and I can appreciate that. As we sort of -- as you've sort of seen a few things that haven't quite played out as well as you would have liked, Mark, is there a reason to sort of have what you almost want to call a tiger team that goes into each of the business units and just challenges the managers just to keep them on their toes?

That is exactly what we are doing. What we did was we broke the Company up into four operating segments, and Bob's got just that kind of team. He has got technical and operations and financial experienced people, and they actually go out and visit these different operations and work with them. So, we are doing that exact thing and that is why when we see a problem like in the shelter business, we have people that we can send out right away to get our arms around it, and then what we do is we draw upon a lot of the good people within that operating segment to augment the people that we have sent out and then they stabilize it and get it going and that is part of operating a large company. So we actually are doing that. That is why we are identifying the problems, and we are getting our arms around them as quickly as possible. But no business, as you say, goes without problems, and we have taken risks on programs, which is normal, and overall, we are doing very, very well.

A few years back, we used to strive to get an 8% margin, and we brought the margins up to 10% to 11%, and that is why we have said for years and years, if you're doing 10% to 12% in this business, that is very, very healthy. This particular quarter, because of the few things that happened, it would have been 9.3%. Next quarter, it could be some other number, and when you average it out, we are going to do better than 10% this year. So, I think we are doing everything we need to do to stay on top of the business.

And so obviously, we can't see problems avoided, and I guess that is the challenge that we have to live with and then related to that is the focus continues to be a lot more on, I think, just the pace of business, as opposed to looking outside for acquisitions or anything at the moment that would be -- that you would add to the Company today?

Well, our feeling is that with the organic growth as healthy as it is in this environment, we should be spending time on the operation. That doesn't mean we don't look at acquisitions. We are looking at things, but our major focus is on the businesses that we have because we are getting the level of business that is coming through the door. So, if you look at the marketplace, a lot of things are very overpriced right now, and we have got to let that play out.

We are watching a few things going on in the credit markets today and that is impacting private equity money and everything else. So, I think we stick to our knitting right now, and then we will have some tremendous opportunity going forward as a strategic buyer.

Thank you very much, gentlemen.

You are welcome.

Gary Liebowitz, Wachovia Securities.

Good morning, gentlemen. Mark, I didn't see in the release any mention of orders related to the SBInet program, and I guess there have been some reports of some delays there. Has your thinking changed at all on this program and what are your expectations in terms of revenue or orders?

The major thing on SBInet is we have delivered what we have had to deliver for what they call the P-28 contract, and it has been pretty good. I think we have been one of the good contractors to Boeing on this particular program.

The next step is the government has to sign off on P-28, so that they can then move on to the border program. And that is between Boeing and Homeland Security. So, we are doing what we need to do, and if SBInet goes forward, I believe we are going to still have a pretty good role on it. We work closely with Boeing. We support them in any way we can. They are good people. They have got good people on this thing, and we have got to see where it goes, but I believe it is going to be a good program for us.

And you are still as confident as you were three months ago that the government will go forward with this?

I am as confident as I was three months ago, but that is exactly where I am today. I mean what the government does, nobody knows. We know that the solutions that are coming into being could be good solutions for this particular problem if the government believes that the border is a problem. So, it is really a function of where the government wants to take the program. We are [inaudible] in industry, I would say we are ready to meet the challenge. They have to want to make the challenge. So, I would say I am as confident today as I was three months ago, yes.

Okay. And one for Rich. Rich, I think you said that the curtailment gain in the second quarter will flow through to segments. How should we allocate that -- about evenly or how should we think of that?

What do you mean? Allocated amongst the segments?

Correct.

It is all going to be in the Systems -- Sustainment Systems segment.

Okay. And how is the ERP system investment and upgrade going?

It is going well. It is a significant investment that we are making at several locations, three actually, three different locations right now, and I expect that to continue on plan and to be a part of our ongoing capital expenditure program.

Okay, thank you.

Greg Alexopoulos, Morgan Stanley.

Good morning, Mark and Rich. So, when you guys gave out EPS guidance at year-end, your insights were accurate, because you obviously had a problem on TWS, and you talked about one of the reasons why maybe it was lower -- the EPS guidance was lower than maybe some people expected was some of your other programs transitioning to production. Can you give us a little bit more color on some of these other programs other than TWS that you are looking at?

I am trying to understand the question. What has changed -- when we gave our guidance at the end of the year, it was based on our operating plan and what we believed we could do for the year. What is different is that programs that maybe would have come in later on in the year are starting to come in sooner based on the supplemental, and I think what we talked about in the last call was -- there is just an unknown there with the supplemental. Certainly it was unknown with MRAP and all these other things, which weren't in our plan. So a lot of very positive things have happened in the first quarter that are giving us a brighter outlook on the full fiscal year.

We had no idea at that time that there was this kind of hit on TWS. In fact, I believe we wrote off about $3.5 million at year-end, which was exactly where we thought we were. And it wasn't until the new team that we brought in to work on some of these problems came up, and it was really in June that they came up with a bunch of fixes, and as we started putting the fixes through testing, we started realizing that those were the right fixes and then realized by the beginning of July that there were going to be some changes to the design, which in and of itself wouldn't have been a problem. The problem was that we were already in production, so we had bought all this material. So, that is really an anomaly. That was not anticipated when we gave the guidance.

Same thing with the curtailment gain. We weren't thinking about that at that point either.

Let me rephrase the question. When you gave out guidance, it seemed a little conservative based on two things. One was the supplemental not having been signed yet and the other was just being a little bit more conservative because you had a number of programs transitioning from development to production.

Now with the supplemental being signed and some of that risk being removed out of the equation, the other portion of it was kind of these programs transitioning to production. I didn't mean to imply that you had insight into Thermal Weapon Sights, that that was going to be a problem, but in general that you just felt like you were being a little bit conservative on the EPS because of some of these additional risks in an operational sense. Can you talk about other programs that are currently going into production and maybe give us a little bit of color on that and how they are progressing, some of your major programs?

I would say that the other programs we are working on are doing pretty well. I mean, they are moving nicely and we are not seeing huge problems. I mean, we are getting new contracts on IBAS and HTI, and those have now entered the production phase, and they are doing nicely. There really aren't -- there isn't a whole host of programs that are giving us problems.

What we were talking about was you never know what is going to come up to bite you, so you will have some little problems here and there, and those are the things that impact margin. I would say that we were trying to be realistic is probably a better word than conservative. We took a look at our plan, and this is what we believed we could do. Then we started booking a lot of stuff that we didn't anticipate to book so soon, so the picture is brightening up a little bit.

Great. And if I can turn the focus to Engineered Support a bit, did you have any integration or severance costs in this quarter?

Integration or severance problems?

Severance costs.

Oh, severance costs. No, nothing significant.

Okay. So is the integration of that unit basically complete? I mean you don't expect any additional costs in relation to severance there?

Nothing significant.

Okay. And then finally on Engineering Support, now that you have had it for a year and a half or so, and you are starting to learn the performance of the different pieces of Engineered Support, should we expect some small divestitures in the near future?

From them? Are you talking about from the pieces that we bought at Engineered Support?

Yes.

That is not something that we are thinking about right now.

Okay. That's it. Thank you very much.

Peter Arment, JSA Research.

Good morning, Mark, Rich. A lot of questions have been asked so I'll just ask -- your bookings trend has been a lot higher than previously thought, and so you have quite a bit of visibility in terms of a ramp coming in a lot of key programs. Can you just address sort of the supply-chain issues? Are there any choke points, areas where you are worried about component shortages or are you comfortable that you will be able to ramp up to address those programs?

You are always worried about supplier problems. That is very normal. I believe we have got the bandwidth to ramp up the way we need to ramp up for these programs. We work closely with suppliers. Where possible, we have more than one supplier for various types of components. So I don't think there is anything really out of the ordinary that we are experiencing. So far, you notice from some of my remarks, we have been able to deliver things ahead of schedule.

Right. Okay. So no concerns. There have been some shortages out there in other contractors. You are not seeing that?

We are not seeing heavy problems at this point, so I wouldn't say we have major concerns right now.

Okay, that's great. Thank you.

Patrick McCarthy, FBR Capital Markets.

Good morning. Just a quick follow-up. I know it is early in this, but the House added another Stryker brigade to its mark up, and I was wondering if you could just give us a sense for across the Company how much money or what type of content you think you can get off of an additional brigade? Thank you.

I don't have that in my head, but we are involved in the diagnostic business. We also have FBCB2s, so it could be good business for us, but I don't have a number that I could throw out, Patrick. But it will be positive.

David Gremmels, Thomas Weisel.

Hi. Actually this is Alex in for David now. I just had a question. There has been a lot of orders for GD lately on system enhancement program and other stuff for the Bradleys. What is the lead time on that in terms of when you guys actually see the order flow?

GD would be Abrams.

Sorry, yes. GD got the Abrams work for the SEP, but just on the Bradley on the Abrams, what is the usual lead time?

Usually you can figure within three to six months.

Of when they received the contract?

Yes.

Okay, great. Thank you.

Steve Binder, Bear Stearns.

Rich, can you maybe just touch on the FASB -- the proposed change on cash settled principle bonds and what that impact might be because you have converts outstanding?

Yes, I don't have it quantified yet, Steve. It will certainly have an impact for us. Probably would increase interest expense between $15 million and $18 million a year if it passes as currently proposed, but it is too soon to really say. It will definitely have an impact though, and we will have to take a look at it and see what we can do about that.

And that would start in fiscal year '09, is that it?

The way it is presently proposed, yes. I'm sure there's going to be a lot of controversy about this. I'm sure all the investment bankers are going to have a big issue with it, so we will have to see how it plays out.

And the other question I have is if you look at red programs in the portfolio today, and red being designated by programs with cost growth per se or technical issues or schedule issues, what would you say that represents for the revenue base -- annualized revenue base?

It's not a very big portion. We don't have that many red programs. As Rich said, we are probably working on 10,000 contracts, and we basically laid them out. The major one right now is TWS. Beyond that, everything is pretty well under control.

Okay. Thank you.

Michael French, Morgan Joseph.

Good morning, gentlemen. Congratulations on the strong bookings in the quarter.

Thank you.

I had a question on the vehicle armor side. There are tens of thousands of vehicles out there that are looking at armoring. Should we look at this as sort of the tip of the iceberg or is this really sort of a niche area that you are serving here?

I couldn't hear.

We need you to speak closer to the phone. I don't know if you are on a speaker, but it was hard to hear you.

I'm sorry. On the vehicle armor contract you've announced, there are literally tens of thousands of vehicles that are talking about adding armor to in the truck class. So should we look at the contract you have here as sort of the tip of the iceberg or are is this really just sort of a niche opportunity?

Well, I'd say it is in the niche area, but we have already done well over $50 million on related stuff, so it is like an add-on to contracts we have already had. So, I think it is more of a steady thing than it is tip of the iceberg because they are not -- we are not involved in armoring everything. We have developed a specialty in certain types of vehicles.

Okay, okay. And then another question on sort of the seasonality, if you will. You guys usually ramp up towards the end of your fiscal year, and in the past, you have talked about making moves to try to even that out and smooth out the quarter. So I was wondering if you could update us on the status of that effort? And what we should expect in terms of the seasonal ramp?

We still have the goal to try and linearize, if that is a word, the four quarters. Based on our first-quarter performance and based on our guidance, we are not there yet. The first quarter is not 25% of the guidance, so I don't have any reason to believe that we won't progress this year similar to the way we progressed last year.

Okay. All right. Thank you very much, and good luck.

Thank you.

And this does conclude the question-and-answer session. I will now turn it back to management for closing remarks.

Thank you, and I want to thank everyone for joining us on today's call. Obviously, this was an interesting quarter for us, and we look forward to speaking with you again next quarter. Have a good day.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a good day.