Leonardo DRS Inc (DRS) 2008 Q2 法說會逐字稿

Good morning, everyone, and welcome to the DRS Technologies conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. (OPERATOR INSTRUCTIONS). As a reminder, ladies and gentlemen, this conference 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, J.D. Good morning, and thank you for joining us on today's conference call to review DRS Technologies' financial results for the fiscal 2008 second quarter and six-month period ended September 30, which were reported earlier this morning. Hosting today's call are Mark Newman, Chairman, President and Chief Executive Officer of DRS Technologies, and Rich Schneider, the Company's Executive Vice President and Chief Financial Officer.

Before we begin, I would like to remind everyone that we 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 financials. For more information on the Company's definition of these non-GAAP financials 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 of 1995, please note the risks and uncertainties related to forward-looking statements. 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 like to now turn the call over to Mark Newman.

Thanks, Pat, and good morning, everyone. Thank you for joining us on the call today to discuss our fiscal 2008 second-quarter and first-half results. As we reported in our news release this morning, we achieved record results for the three-month period, with increases across the board in revenues, operating income, net earnings, and earnings per share.

The Company also booked a record $1.1 billion in new orders for products and services, which represents a 1.4-to-1 book-to-bill ratio. Funded backlog for the three-month period was a record high of $3.6 billion. These strong results have provided us with the basis to raise our guidance for fiscal 2008, which I'll touch on later.

We also were pleased to announce that we resumed product shipments under the Army's Thermal Weapon Sights II program during the period. I am proud of the hard work demonstrated by so many of our employees at the RSTA segment on this program.

Second-quarter consolidated revenues of $784 million were 10% above last year's second quarter. The rise was attributable entirely to organic growth. Consolidated operating income of $92 million was 28% higher than last year's second quarter, and reflected an operating margin of 11.8%. Second-quarter operating income included an $11.7 million curtailment gain associated with one of the Company's benefit plans, which we talked about last quarter.

Excluding the gain, operating income was still 12% higher than the year-ago period, and the adjusted margin for fiscal 2008 quarter was 10.3%.

Net earnings of $43 million were 71% above that reported last year, and included approximately $10.4 million in combined after-tax benefits as a result of the gain, and about $3.1 million in discrete tax benefits. The Company's adjusted net earnings excluding these benefits were $32.6 million, representing a 34% increase over adjusted net earnings in the second quarter last year.

Diluted earnings per share of $1.04 were 68% above the same quarter last year and included the positive impact of $0.25 per share in combined discrete benefits. The $0.25 was made up of $0.18 per share for the curtailment gain and $0.07 for the discrete cumulative tax benefits. The Company's adjusted diluted EPS excluding the discrete items was $0.79 or 32% higher than adjusted diluted EPS for the same quarter last year.

Our free cash flow for the second quarter of fiscal 2008 was $42 million. During the quarter we used free cash flow to reduce debt by $25 million and have prepaid $75 million in term-loan borrowings year-to-date. Bookings valued at $1.1 billion were a quarterly record, exceeding last year's second quarter by 21%.

At September 30th, the Company's funded backlog was a record at $3.6 billion, 31% above backlog at the same time last year. Taking a brief look at the first six months of fiscal 2008, sales were $1.5 billion, 13% higher than the first-half last year. Operating income was $123.5 million. If adjusted to exclude the $37 million pretax charge taken in the first quarter on the Thermal Weapon Sights program and to exclude the curtailment gain, the second-quarter operating income was $148.6 million or 9% higher than the year-ago period.

The Company reported a first-half operating margin of 8.1%. Adjusted to exclude the first-quarter charge and the second-quarter gain, the operating margin was 9.8%. Six-month net earnings were $44.7 million. Excluding the discrete events that I've just described, net earnings would have been $57.5 million or 27% above the same period last year.

First-half diluted EPS was $1.08. Excluding the discrete events, first-half diluted EPS would have been $1.39 compared with $1.11 last year. Free cash flow was $28 million for the first six months of fiscal 2008, significantly higher than the $5 million reported last year.

As indicated in this morning's news release, we raised our guidance for fiscal 2008. We now expect revenues to range between $3.1 billion and $3.15 billion. We also increased our diluted EPS estimate to now range between $3.12 and $3.22. $0.07 of the increase is attributable to the discrete tax benefits realized in the second quarter.

Our free cash flow estimate was increased to be in the $105 million to $125 million range. Other details regarding our revised guidance are included in today's news release.

Before turning the call over to questions, I would like to mention a few quarterly highlights. In our C4I Segment, we were awarded a $49 million contract for Driver Vision Enhancer A-Kits for MRAP vehicles, which will be the first systems deployed with an electronic pan-and-tilt capability. The A-Kits are the brackets and housing portion of the Driver Vision Enhancer system. This brings the total value of contracts booked to date for DVE A-Kits supporting MRAPs to $113 million.

We also saw $194 million in new orders for the FBCB2 tactical computers. C4I was also awarded a $26 million contract from the Navy to develop modules for the C-Band Active Array Radar. The new CBAAR will be a shipboard radar targeted to replace the SPS-67 currently in service. CBAAR will equip DDG-51 Aegis destroyers, LHA and LHD amphibious ships, aircraft carriers and other vessels.

The C4I Segment also received a $19 million order for main turbine generator packaging for the first two DDG-1000 Zumwalt class multi-mission destroyers. As many of you saw last week, the Navy announced that DRS was competitively awarded a $63 million IDIQ contract on the CEDS program - the Common Enterprise Display System program. This contract is initially targeted to support the new DDG-1000 class ships and Aegis Class ship modernization.

CEDS is a family of next-generation displays that ultimately will be implemented across Navy surface ships, submarines and aircraft platforms, and will provide a common man-machine interface to the platform open-architecture computing environment. Remote displays produced by DRS will support mission-critical war fighter team situational awareness.

During the second quarter, the RSTA Segment received $73 million in new contract for Driver Vision Enhancer B-Kits, with several thousand units targeted for the MRAP vehicles. The B-Kits include DRS's high-resolution active matrix LCD display panel, uncooled infrared detector and thermal optics.

RSTA shipped the first 10 Phalanx thermal imagers on a contract for 90 systems to be used on the Raytheon Centurion Weapons System. The segment also received a $22 million follow-on contract for additional systems on this program. Centurion is a Land-based Phalanx Weapons System, representing a revolutionary approach to countering insurgent activities by intercepting rockets, artillery and mortar rounds in the air before impact.

During the quarter, RSTA successfully completed two customer reviews for both the small, unmanned ground vehicle and short-range electro-optical system on the Future Combat System program, setting the stage to enter the preliminary design phase for these systems. The short-range electro-optical system program schedule has been accelerated to meet the non-line-of-site cannon First Brigade Combat team schedule.

The Sustainment Systems Segment saw strong demand during the quarter for the 100 and 200-kilowatt tactical power generators under a $17 million contract from the Army. Our Technical Services Segment secured a high level of new orders related to communications, with $52 million in contract on the Multi-National Forces Iraq program, $38 million in bookings on the Defense Communications and Army Transmission Systems program, $26 million from the U.S. Central Command to support Afghan national police communications infrastructure, and $20 million from the Space and Naval Warfare System Center.

The strong operating results in the second quarter, the record demand for DRS's products and services, and the high level of funded backlog at the end of the period have positioned the Company well going into the second half of the fiscal year. We continue to be encouraged by strong customer support for our key programs, and looking ahead, we see a solid pipeline of additional opportunities. All of this is helping to build a solid foundation for continued growth.

We can now open the call to questions.

(OPERATOR INSTRUCTIONS) Pete Skibitski, Credit Suisse.

Mark, I want to ask you, book-to-bill obviously for the first-half is really strong, outperforming what was a pretty strong first-half last year, as well. The third quarter of fiscal '07 was outstanding, so just wanted to get your thoughts on what you see for the second half of this year, whether you think the book-to-bill will remain strong or not.

Well, our goal is to try to do basically a 1-to-1 book-to-bill. Sometimes, we can exceed that a little bit. And as you know, the timing of contracts is kind of out of our hands, so sometimes stuff that we think is going to come in in a subsequent quarter comes in early. So, I would say we're going to see stronger bookings for the rest of the year, and I think in the end we are going to see somewhere over $3 billion in bookings.

I just don't know whether towards the end of the year something is going to come in in March or come in in June. That is something we don't have a lot of control over. But I would say, in general, the bookings flow seems pretty good right now.

Fair enough. I just wanted to ask you about Sustainment. If you X out the curtailment gain, it looks like the margin in Sustainment was down over 100 basis points. Just was wondering if you can give us some color on that, if there are any one-time events going on?

I'll let Rich take a look at that.

Pete, that's a good observation. Last year in the second quarter, Sustainment's margins were about 13.5%. This year, if you back out the curtailment gain, they are a little over 12%. So, you are right on with the 100 basis point reduction. And that really relates to a couple of programs that we talked about actually in the first quarter, where we did a little cleanup, a couple of million dollars. And at their level for a quarter, that is about 100 basis points.

So, you still had some issues with them this quarter, and your expectation I guess is they are finally on track. Is that fair?

That's more than fair, yes.

Okay. Thanks very much, guys.

Gary Liebowitz, Wachovia Securities.

Rich, if my math is right, your guidance supplies something approaching a 12% operating margin in the second half of the year, where in the first-half it was a little under 10%, if you X out the one-time items. Is it more volume, is it mix? Is it just the absence of some of these charges that you're looking forward to?

It's all three, Gary. And if you look historically, we've always had a much stronger second half of the year. As the volume picks up, we get much better absorption on our rates. In last year's third quarter, we were well above 11%, and same thing in the fourth quarter. And the same will be true this year.

Okay, thanks. And one for Mark. Mark, it looks like international sales last year and for recent years have been running under 10%. Are there specific program opportunities or teaming arrangement opportunities that you might consider in order to get your international sales higher?

Yes, we're actually looking at a number of things, and our practice really isn't to talk about programs that we are going after. But there is no question we want to see the international part of our business grow. Right now, it is under 10%. A near-term goal would try to get it to 12% or 15%, maybe ultimately get to 20%, which I've always looked for.

I can tell you that a lot of that work has picked up, and we are chasing numbers of things. So, I think you're right on. We are going to try to improve that.

Without identifying specific programs, are there certain areas that -- opportunities that are available?

Yes, I think things like border security; countries are starting to take a look at U.S. products. You could look at countries like India as a future; not something that is near-term right now. And, we are also pushing the DRS U.K. operation that we've set up. So, I think we are going to see a lot more work coming out of the U.K.

Thank you.

Mr. Myles, your line is open.

Thank you, good morning. You obviously had a good bookings quarter here, and I am just wondering if you think about the portion of the MRAP production requirement that's out there and under contract, can you give us some ballpark about how much you have already under your belt in terms of bookings and how much maybe has more to go? I think you have sized it in the past at maybe a $500 million opportunity overall. I'm just curious how much of that is already in backlog.

That's a good question. I don't have the answer to it, because although we know some -- we can identify some systems that are going directly to MRAP, as you know, most of what we are producing when you look at the DVE program and the FBCB2, those become government-furnished items. So, the government is buying this stuff from us, and we don't always know whether they are targeting MRAP with those products or they are just going into the normal vehicles. So, it is hard for me to answer that.

I can tell you in general, we'll see more MRAPs coming down the road than we've seen so far, so you should see those product lines continue to pick up. It is just very hard for us to pinpoint where they are sending these things.

That's fair. And within the RSTA Segment, Rich, maybe, was there any single charge that was taken on TWS in the quarter? And I guess how much revenue was actually taken on that program in the quarter?

Myles, there was no charge in the quarter. We took a charge in the first quarter, as you know. And their margins were fairly strong in the second quarter at just under 10%. As far as revenue goes, we are not going to really get into giving revenue on specific programs or contracts.

Okay. Then maybe last one, I know you don't provide quarterly revenue guidance, but just as color from last year's second quarter into third quarter, there was obviously a pretty substantial sequential decline in the TS Segment for fiscal year-end effects. Is that something seasonal that we should expect here in this year as well, or is that anomalous to last year?

Actually, that is a good point. Last year, we found at the end of the second quarter that there was a pickup in technical services, because there were a number of very low-margin but high-dollar value programs that came in kind of with sweep-up money, which happened to have given us higher volume.

That is probably turning around a little bit. So, you'll see maybe a little less volume in the second quarter, and we are going to see that start to pick up in the second half.

All right. Thank you.

David Gremmels, Thomas Weisel Partners.

On Thermal Weapon Sights, you resumed shipping. What does the recovery ramp look like at this point? I guess your competitor is talking about getting to 3,000 deliveries per month in '08. Is it possible you could be looking at those kinds of volumes also, or does the redesign delay things?

No, no. I think that like our competitors, once you get into production, you see this start to ramp up fairly quickly. So, the good news is we are into production. And then we are going to adhere to government contract schedules, and then ultimately, we hope to beat those schedules as time goes on. But there is no question that we've got the capability to get to the quantities that they would like to see on a monthly basis.

Okay. Then one on the CEDS and Q-70. It looks like you won half of CEDS, and it sounds like maybe the Q-70 will be with us for a while. How should we think about that business between the two programs? Does the revenue contribution stay around $80 million a year between the two, or how does it change going forward?

You know, it is hard to actually figure that out right now because if you go back in history, when we won the initial UYQ-70, hundreds of millions of dollars continued to pour into the program that we were replacing, to the point where if you looked at the DDG-51 class ships, probably more than half of them have the older equipment that the Q-70 replaced.

So, what happens is Q-70 is the program of record right now, and there is going to be a continued build and a continued life to that program. CEDS is just starting out. It is an IDIQ program. From our perspective, we never had the whole loaf in Q-70, and we are not getting the whole loaf in CEDS, but there is still going to be a lot of business there. And, we are just going to have to see how it plays out.

There are no real schedules right now. It is just a -- it's kind of an infant program. So, I think you are going to see a lot more Q-70s going off into the next year or so, and then maybe you will start to see some ramp in CEDS. But I think we are going to need a couple of quarters to start to understand what this all means.

And then last one for you; obviously, bookings very strong again. How do you reconcile this phenomenal backlog growth with the 10% revenue growth in the quarter and the guidance, which I think implies maybe 10% or 12% growth for the full year? It seems like we should be seeing more on the top line.

Well, that's true, but keep in mind that included in backlog was stuff like TWS, for example, that we had put a hold on shipments for, and now, of course, we are starting to ship. So, there is an element of backlog there that is probably tied to that program that could be a couple of hundred million dollars or so.

So, one could say some of that should have already been shipped. So, I think if you are doing better than 10% organic growth, you are doing pretty well. And we just have to see how the bookings come in in the second half. But I certainly think we are going to close this year strong. That's what we've indicated, obviously, in our guidance.

Thanks very much.

Steve Binder, Bear Stearns.

If you look sequentially, both [Technical] Services and [Sustainment]Systems sales are basically flat, up a tad. And profit pickup before the curtailment gain, you know, 7 to $7.5 million, and you had a lot of trailing issues in Q1. Rich, you touched on some of them up in [Sustainment] Systems, and you had the issues in [Technical] Services. Is a way to look at Q2 that what were the still trailing issues that we would he see in your 10-Q with respect to cost growth? Is there anything there?

Steve, let me -- let's start with the first part where you said that Systems and Services were kind of flat. I mean, Services has been growing rather nicely. If you look at the first six -- the last six quarters, they've been $86 million, $97 million, $97 million, $120 million, $108 million, $108 million.

I'm just referring to sequentially, just from Q1 to Q2. That's all I'm saying. And sales are basically out of those two units flat, up a couple million dollars. That's fine. I'm not criticizing the sales growth. I'm just asking you, there were a lot of legacy trailing issues back in Q1 in both Services and Systems, and I'm just wondering what were the cost issues in Q2? Were there any?

As I mentioned, about 100 basis points on the Systems side, and no, nothing on the Services side. In fact, Services margins were very strong in the quarter.

Okay. Then, Mark, do you want to just comment on TWS as far as -- I mean, you resumed deliveries. Any comments on customer acceptance, any comments on yields that you saw in the initial ramp-up? How did you feel basically about that ramp?

I think from a customer standpoint, they are pretty pleased that we are getting back to shipments. There is no question about that. And I think in terms of being able to build the equipment, the redesigns that we've done are really facilitating the ability to build and test the units. So, I think that is very positive.

So, I come out of the quarter feeling pretty good about the TWS program and where we are heading. And I can tell you there was a monumental effort that was put in by the people at our RSTA segment. They've done an incredible job internally working with the customer, understanding the need to get these things out to the war fighter, and I'm pretty proud of what they've done.

And when you look at the ramps, you are seeing FBCB2, DVE and other programs in both C4I and RSTA. How do you feel about schedule and cost these days, cost performance?

I think we are seeing continued improvement there, and we are meeting the schedules, in some cases even beating the schedules.

And lastly, acquisitions, is there anything in the queue these days, and what kind of size deals are you looking at?

We are always looking, as we've said in the past. There is nothing major that we are looking at right now. But there is certainly a couple of interesting bolt-ons that could help the Company in its future growth, and we continue to look.

Okay, thank you.

Howard Rubel, Jefferies & Co.

Just a couple things. One, to go back on TWS, it is nice to see you've recovered. What have you done with -- you indicated in the [10-]Q there was excess inventory. Have you been able to get that sold and disposed of yet, or are you still working on that?

No, we're actually doing a good job. We've sold units in the -- a good number of units in the second quarter, and we are seeing some nice opportunities going forward. So, I think that is very positive right now.

Have you been able to realize better value than what you first estimated, Mark, with respect to the write-downs?

I am a little confused by the question. What do you mean better value?

Well, I mean sometimes you make an estimate as to what you think you can realize, and lo and behold, it is like any business, you find that you do a little better or you do a little worse. And sounding from your voice, it sounds like you did a little better.

Do you have an idea -- from my perspective, I think it is neutral, but we haven't, as Rich said before, we haven't written any more off, so that is very positive. So wouldn't you say we are heading more in a positive direction?

It's kind of early to -- even if we were seeing improvement, it would be early to reflect that in the numbers. We have a long way to go on that program.

Fair enough. Second, you've been very good at finding tax opportunities, and I know you've got still some open returns. Do you expect any more returns to close, or do you think you will be able to close any returns between now and the end of the year?

I hope so. I mean, that's the issue with the discrete items, is I feel there will be more going forward, but the timing is what is very difficult to pin down. I don't know if it will be third quarter, fourth quarter or some time next year. So, that is why we're very clear in the guidance that we put out there as to what we are assuming in the tax rate, so that if there are any discrete items, positive or negative, they are out there, so you can see them.

Right, I mean FIN 48 should be our guide for what we should be thinking about there, Rich?

100% right.

Thank you. And then just two follow-ups. Actually, one just on your guidance, Mark. Again, kind of going back to what I think everybody else has expressed has been a very surprising level of orders and backlogs, that we are not seeing a higher level of sales in the second half of the year, especially given what appears to be a fairly successful ramp-up on MRAP. Is there any way that you've had people look at sort of what your opportunities still could be if the government stays on track?

First of all, don't forget that very often you book these long-term programs, they are multi-year, so you can't get it all out. We always say if we can do 75% of our backlog in a year, we are doing pretty well. Having good bookings and good backlog is obviously better than not, so that is very positive. I think right now, sitting here at the end of the second quarter, we've put out a nice forecast of where we think we can be in the second half, and we just have to see how production starts to roll off. But no matter how you slice it, as you say, we are in a pretty healthy position right now.

So, if you were to handicap it, we should be thinking the high end is not on -- is probably closer to a reasonable place to be.

That is a conclusion you could draw.

Thank you very much.

Ferat Ongoren, Citigroup.

The first question is on the guidance. You increased the revenues by $50 million when I look at the guidance, and expect the high end of the guidance to be only up by $0.05. If I slip 10% to 12% margins on that higher revenue and $1 million lower interest, I'm (inaudible) off at 10% -- $0.10 higher. So, is that $50 million revenue partially coming from maybe lower margin Thermal Weapons Sights deliveries?

Ferat, your math is 100% correct. We raised the guidance $0.12. We've clearly laid out for everybody that $0.07 is related to the discrete tax items and $0.05 relates to the increase in the revenues. And we are assuming a margin on that incremental revenue of about 6%, as opposed to what you laid out there at 10%. And the reason for that is that when you look at where the increases in the revenues are coming from, a chunk of it is coming from the TWS, which you know has no margin at all, versus what our previous guidance was assuming for TWS revenues.

And then we are getting an increase in the second half of the year on the [Technical] Services side, which as you know, 7% to 8% margins [for them] are very good. And then the rest of it will be at about 10% to 12%. When you put it all together, it averages out about 6%.

Okay. Then let me ask the guidance question a different way. SPAWAR just said that they delivered about 700 MRAPs. And if you kind of -- even if you discount their plans, they will deliver over 4,000 in the next six months. That is probably $100 million or so revenues incremental to you guys, given the 20,000 content per MRAP you guys have.

And then Thermal Weapons Sights is kicking in and you only have 150, 160 million growth in the second half left. I'm just trying to figure is there something else that is coming down or are you just not sure about some of these deliveries timings?

Well, we can only go by what we've booked and what our production schedules are. So, that is how we are running the business. As I said before, to answer one of the other questions, is we are selling FBCB2s, and we are selling DVEs. And the government then takes those and decides where they are going to go.

So, if they decide they want to put more into MRAP for a couple of months, that's what they do. It has nothing to do with what we're shipping to them. We are ramping up to very, very healthy levels on both of those programs. So, it is really up to the government as to how they want to use that equipment.

And if you look at RSTA margin, historically, it was low teens to midteens. Are we going to see that margin? I understand we will have some low-margin deliveries, but when should we see that margin back to normal levels, maybe to 12% or so?

If you adjust the margins for the TWS charge that we took in the first quarter for the first half of the year, the margins are about 10%. Compared to last year, they were 9.9% -- or 9.8% for the same time. Now for the full year last year, they got into the double digits, and we will this year again. I think, again, adjusting for that charge, we will be between 11% and 12%.

Okay, so you are saying we should see the pickup in the third quarter.

Yes, we'll see increased volumes, we'll see better absorption, and you'll see better margins.

Okay, and then in terms of the RSTA revenues, is there any reason why we shouldn't see sequential growth both in third and fourth quarters?

No, you'll see continued improvement.

Okay, good. And finally in Technical Services, 8.5% margin looks pretty strong. Was there a benefit or any sort of unusual gain in the quarter?

No, just mix.

Okay. Thank you very much.

Michael French, Morgan Joseph.

Just wanted to check to see if there was a follow-up on the SBInet program. Has there been any development?

I don't think there are any new developments, although Bob Mehmel and I are going to be going out to the President's Council meeting that Boeing holds. We will be there on Wednesday in Tucson. In fact, I'm going to go get my first demo. So, I'm going to try to see firsthand what is going on with that program, but I think it is making good progress.

Okay, good. And is there any sensitivity in your business to the timing and the passage of the supplemental legislations for the emergency spending?

Not at this moment, but I think if you just look at it in a macro sense, you want to see that get signed certainly very early in next calendar year, or it could have an impact on our troops. So, I think Congress has got to push to get that out. We've got enough backlog right now to carry us to a certain point.

But at some point, if they hold it up, then all these companies throughout the country could end up facing a short dip, in which case people would be theoretically sitting around waiting for production to restart. So, I think that is pretty well recognized in Congress, and I think they're going to do what they need to do and get those budgets signed.

I had one question to clarify on the MRAPs. Do you have the same opportunity on the MRAP II, which is the next generation that they are competing now, that you do on the current generation of MRAP?

Yes, we do.

Okay, and just to double check, cash flow going forward, are you going to continue to pay down debt like you did this quarter?

That's our goal. We've paid down $75 million year-to-date, and we expect to have a strong second half from a free cash flow standpoint, as well.

Very good. Thank you, and good luck.

Steve Levenson, Stifel Nicolaus.

You talked a little bit about SBInet. Can you tell us what is going on, what you think your prospects are in some of the foreign programs like the Saudi contract that I guess is out there for consideration now?

No. You know what I know in terms of what you've read so far, so these programs have to run their course. You never know what is going to get awarded anywhere in some of these programs. So, you just do what you need to do internally, and then see what happens.

Okay. On CEDS, do you see an opportunity to upgrade the DDG-51s? Are they going to skip a generation or do you see Q-70 upgrades in between?

I don't know enough right now to really answer that. I think they threw in the concept of DDG modernization. There's going to be a kickoff meeting in a few weeks with the customer, and also we will get a better handle at that point on what is going on with that program. If I go by history, what we found was they were buying a lot of the older equipment. Because remember, Q-70 is doing an incredible job and has created a big improvement to the fleet.

So, it takes a while to ramp up any new program. Also, they've now said that beyond the forward fits, which is the Zumwalt Class ships, and we don't know how many of those ships they're going to build ultimately, and we don't know how many CG-Xs they're going to build. That DDG modernization is a whole different program, and we just have to see how that shakes out.

You mentioned acquisitions, but is there anything that you're looking at in the DRS portfolio that you'd consider non-core?

Not at this point.

Last, just a little housekeeping thing. Richard, do you have the FAS 123(R) expense for the quarter?

The FAS 123(R) expense for the quarter is built into the numbers. Do you want to know the specific amount?

If you have it.

About $3 million, $2.9 million.

Thank you very much.

(OPERATOR INSTRUCTIONS) Pete Skibitski, Credit Suisse.

Just wanted to follow up on that budget question earlier about the baseline budget, the conferees look like cam to an agreement this week. It's obviously not fully completed, but what were your thoughts on the baseline budget as it stands today? Anything more positive than you expected earlier, or in line?

If I had to measure it in terms of what we are seeing in the budget, it would be more positive for us than negative. So, I think we are pleased with that. I think the next thing is they've got to get this supplemental going.

Right. Yes, there's talk about bridge fund, I guess, which would help. But I imagine when the full supplemental comes through, that's got to be pretty incremental to your expectations, too.

It will be, but don't forget we are sitting with a $3.6 billion backlog. So, this is really for stuff that will start to impact our next fiscal year and beyond. That is what we are really looking at.

All right.

But I think they're going to have to come through. Now whether they break the supplemental into two pieces, like they are talking about, so they are incrementally funding, or they do it all in one, we just don't know. That is Washington.

Exactly. Just one last question; we've touched on this, but anything -- can you guys say anything about the status of -- do you have any red programs out there right now or not?

I don't know if you'd call it red programs. Obviously, we looked at TWS as a red program because it is not making money. But it is -- we are now into production. We had a few difficulties that we talked about in Sustainment, and I think we're getting our arms around that.

We take a look at anything that is in the yellow or red area, and we jump on it and watch those things pretty closely. So, there is nothing of significance that I would throw out, but I could tell you that any time we see something that is a little out of the ordinary, we give it a lot of attention.

Great. Thanks again.

This concludes the Q&A session. I will turn the call back over to management for closing remarks.

Well, I want to thank you all for joining us on today's call, and I certainly look forward to speaking with you again on our third-quarter conference call. Have a good day.

Thank you for your participation in today's conference. This concludes the presentation, and you may now disconnect. Have a great day.