L3Harris Technologies Inc (LHX) 2005 Q1 法說會逐字稿

Good afternoon, and welcome to Harris Corporation's first quarter fiscal 2005 earnings release conference call. This call is being recorded. Beginning today's meeting is Pamela Padgett, Vice President of Investor Relations. Please go ahead.

Hello everyone, and welcome to Harris's first quarter 2005 fiscal conference call. I'm Pamela Padgett, Vice President Investor Relations, and on the call with me today is Howard Lance, Chairman and CEO, Bryan Roub, Senior Vice President and Chief Financial Officer, and Bob Henry, Senior Vice President and President of the Government Communications Systems Division. Before we get started, I have to say a few words about forward-looking statements. In the course of this teleconference, Howard, Bryan or other management may make forward-looking statements. Forward-looking statements involve assumptions, risks and uncertainties that could cause actual results to differ materially from those statements. For more information and a discussion of such assumptions, risks and uncertainties, please see the press release and filings made by the Company with the SEC. In addition, in the tables of our release and on this teleconference, we will discuss certain ratios and information that are non-GAAP financial measures. A reconciliation and comparable GAAP measures is included in the tables of our release and on the Investor Relations section of our website, www.harris.com. A replay of this call will also be available on the Investor Relations section of our website. And Howard, with those more than a few words, I'll let you get started.

Thanks, Pam. Good afternoon and thanks to all of you for joining us on our first quarter earnings call today. Of course, as usual, we'll be providing additional details on Harris results for the first fiscal quarter and will discuss the updated earnings guidance for fiscal year 2005 that was provided in the press release this afternoon. Bryan is here to give you additional details on our financial performance.

We certainly had another strong quarter. Consolidated revenue was $669 million, an increase of 22%, compared to the prior year quarter of $548 million. Revenue growth was primarily organic. The inclusion of revenue from the recently completed acquisition of Orkand Corporation, which closed on July 6, represented about 4 points of the 22% growth in the quarter.

The first quarter clearly exhibited our continuing success in driving top-line growth. Even more notable, income from continuing operations increased 57% to $40.1 million compared to $25.5 million in the prior year. Earnings per diluted share increased 53%, from 38 cents in the prior-year quarter to 58 cents in this quarter. And all four of our business segments achieved revenue and income growth in the quarter, and contributed to Company profitability.

Of course, we are very encouraged by the progress in the quarter in both of our commercial businesses. Recent results in Microwave and Broadcast support our belief about the full potential of these businesses going forward. Our previous actions to reduce costs are flowing through in bottom line results. We've also strengthened both organizations with additional talent, organized them to be more customer facing and market focused, helped expand management's view of their addressable markets, and provided product development resources to support growth initiatives. Now clearly we believe there's still a lot of work to be done in these two divisions to make our vision of the future a reality, but we are convinced that we we are moving in the right direction and we believe that the results reflect that.

In our two government businesses, the story and results continue to be very positive. But even here, the business is benefiting from the customer facing organization structure that Bob Henry put in place at the Government Communications Systems Division about a year ago. And, with an expanded view of their addressable markets. These changes are paying off with the continued diversification of our government customer base. Both GCSB and RF are continuing to execute well on existing contracts, and we are winning new contracts and orders at a good pace. The bottom line, our strategy is working. We are expanding core markets, investing in new technology and new products, focusing on our cost, delivering outstanding program execution and now implementing strategic acquisitions.

Let's turn to some specific details about each of the businesses. Results in the government communications systems business were outstanding again this quarter. Revenue was $432 million, a 29% increase compared to the prior year quarter, and operating income increased 41%, to $45.1 million. Improved results were driven by revenue and profit growth across all of the government markets served by the segment. In addition, profitability was enhanced in the quarter by award fees and by the successful termination settlement on the Comanche helicopter program.

But equally important for the future, Harris was awarded five new, multi-year contracts that significantly increased our total funded plus unfunded backlog to a record $4.8 billion. Major program contributors to our year-over-year revenue growth in the first quarter included the FAA Telecommunications Infrastructure Program that we call FTI, the Iraqi Media Network Program known as IMN, the Advanced Extremely High Frequency Terminals Program, or AEHF, for the U.S. Navy, the MAF/Tiger Database Modernization Program for the U.S. Census Bureau, and several important classified programs. As I mentioned earlier, the quarter also benefited from the contribution of the Orkand acquisition. Integration is nearly complete and is going quite smoothly and on schedule.

Our government communication system segment had a truly outstanding contract win record during the quarter. Some of you will recall that last quarter I noted several large program opportunities that were on their horizon for fiscal 2005. I also reminded you that our win rate over the past years has been about 60%. Well, during the first quarter, three of those seven target programs were awarded, and Harris was the winner on all three competitions. The largest award was for the Patriot Program. Patriot is a $1 billion 10-year contract with the National Reconnaissance Office, a long-time customer.

Harris technical services provide operations, maintenance and support services for the NRO's global communications and information systems networks at multiple sites. The second important program win was with a new customer, the National Archives and Records Administration. Harris was selected for $10 million one-year design and analysis phase of a program known as the electronic record archives, or ERA for short. Harris is leading one of the two final teams competing for the ultimate 8-year ERA contract for the potential value of $400 million. The program will enable authentic preservation and electronic access to a large data warehouse of archived government records and documents. We believe we're in a good position to win this contract. Harris has proven capabilities in large database systems including archiving, access, and distributed web-based technology. The contract is currently scheduled for award in August 2005.

The third major program win was announced last month. Harris was awarded a $275 million contract by the Federal Aviation Administration that adds mission support services to the scope of the existing FTI program. Including this scope in expansion, total estimated value of the FTI program is now at $2.2 billion, through 2017.

We also won two additional programs during the quarter that were not on last quarter's highlighted list of opportunities. Both contracts are in support of the next generation aerial surveillance platforms. The U.S. Army Common Sensor Aircraft, or ACS. and the Battle Management Command and Control System, known as BMC 2 for the U.S. Air Force B 10 A aircraft. On ACS, Harris was awarded an initial 3-year $75 million communications integration contract with a potential value of $500 million over the life of the program during the next 20 years. For BMC 2, Harris will provide communications equipment and image processing expertise under a multi-year $22 million system design and demonstration phase. In total value, this award could reach $50 million.

In addition, there remains a number of other opportunities still on the horizon. Together, they represent $7 billion in our bid and proposal funnel for the remainder of fiscal 2005. These opportunities include the War Fighter Information Network Tactical, or Win T Program, with a potential value to Harris of $500 million over 15 years. The field automation program for the U.S. Census Bureau, valued at $800 million over 5 years. And the Automated Flight Service Station AFSS Modernization Program for the FAA general aviation market which could be worth $500 million over ten years. In addition, there are several large classified programs. Turning to the RF segment, RF Communications delivered another strong year-over-year quarter with both revenue growth and income improvement as a result of continuing demand for its Falcon 2 family of tactical radios both by U.S. and allied defense forces.

Segment revenue grew 27% in the quarter reaching $113.3 million and operating income increased 26%, to $31.5 million. Demand for Harris's HF and multiband tactical radios remains quite healthy. In addition to strong demand created by troop deployments, the global transformation of defense communications networks is continuing.

In the international markets, the RF Communications Division continues to be very successful. Harris has a strong presence and reputation, a wonderful international distributor network and outstanding in-country technical support. Significant international orders in the quarter included radios for Denmark, Estonia, Sweden, Malawee and Azerbaijan. During the quarter, the Department of Defense announced that it has agreed to sell Harris Falcon II radios to Pakistan to help improve its ability to gather together intelligence and improve border security operations. Sales to Pakistan will be made through the DOD's Foreign Military Sales Program, known as FMS. This sale has been approved by Congress and is now awaiting final approval by the Pakistan government. Harris estimates the total value of the Pakistan order will be $65 million. Only a small portion of the order is expected to be shipped in fiscal year 2005.

The Bowman Program for the U.K. Ministry of Defense is proceeding as planned with sales expected to be about $20 million higher this year than in fiscal 2004. It's also worth noting that we booked our first order outside of the U.K. for the export version of the Bowman radio, and that's the previously mentioned order from Malawee for $6 million. Also during the quarter, a Boeing-led team that included Paris RF Communications Division was awarded a $55 million contract over 15 months for the Joint Tactical Radio System Airborne Maritime and Fixed Station Program. This is cluster AMF. As we've noted before, selection under AMF moves Harris into applications for airborne radios, a new market for us. The initial contract is for pre-system development and demonstration. There will be a future down select with the total program value to the winning team expected to be more than $2 billion.

And finally, we are continuing with our stepped-up investment rate on our Falcon III radio platform for the U.S. government. We expect to be the first to market with this new platform, and yet another next generation software-to-find radio system.

Turning now to the commercial markets, and beginning with Microwave. Revenue in the Microwave Communications segment was $69.4 million in the quarter, compared to $68.4 million in the year-ago quarter. The business was profitable in the quarter at $900,000 compared to $2.3 million operating loss in fiscal 2004. Regional areas of strength included North America, the Middle East, and Africa. We were also pleased to see market improvements in Latin America during the quarter.

In addition to a continuing robust sales funnel in North America's mobile market, the public and private networks remains full of new opportunities. There continue to be many aging private networks that are overdue for upgrades. Because of public safety and inter-operability issues, funding continues to be made available. Including from the Federal Department of Homeland Security. At the March 2004 analyst meeting, we laid out a series of strategies for our Microwave business and I believe those strategies are beginning to deliver results. First of all, cost reduction efforts are showing up in gross market improvement and in reduced operating expenses. Gross margin rates at MCD were higher in the first quarter, both year-over-year and sequentially, and operating expenses were lower in the quarter, again both year-over-year and sequentially.

The transfer of several functions to our new Raleigh, North Carolina Division Headquarters at the end of fiscal 2004, is providing numerous benefits in addition to lowering our costs. With more of the management team in one location, the operation is more cohesive and efficient. You might recall in fiscal 2003, we consolidated our U.S. based R&D resources to Raleigh. This further consolidation in 2004, has added resources from product line management, operations, supply chain management, finance, and administration to this location. We have brought together the entire product development process. I believe this consolidation has already benefited our TRuepoint product line roll-out and it has brought better direction to other product plans that are in the pipeline.

We've also continued to strengthen the MCD management team. Our new Vice President of Product Line Management joined us recently from Ericsson. And we've taken our number two operations executive at the RF Communications Division, and promoted him to Vice President of Operations at Microwave. We've also added an expert in supply chain management with considerable experience at both Dell Computer and Flextronics.

And speaking of procurement, our cooperate-wide procurement initiatives are already starting to pay dividends. And at MCD, that's being seen in lower costs as well as the signing of a new long-term agreement with the global contract manufacturing partner. Our international sales force is also making progress at MCD in prioritizing their markets, focusing on fewer countries, and providing improved localized service teams. And finally, we said at the March meeting that we were going to use TRuepoint, our new radio platform, to change the game for Harris in international markets. We promised a more competitive product line in terms of performance, cost and scalability, with features that specifically meet international customer requirements. I believe we are delivering on that promise.

We have now released TRuepoint in the 6, 7 and 8 gigahertz frequencies, in a wide range of capacities, and varying configurations. We remain on track to release the 13, 15 and 23 gigahertz frequencies by the end of the calendar year, with the remaining frequencies to be released by March, 2005. I'm excited to report that during the first quarter, we booked $9 million in TRuepoint orders. shipping about $3 million. Today we've booked approximately $14 million in orders, and our second quarter opportunity funnel exceeds $10 million. This gives me confidence that we'll be able to reach the $30 million sales target that we established for TRuepoint for the year.

Turning to our Broadcast Communications business, revenue in the quarter increased 15% to $67.4 million, compared to $58.4 million in the prior year. The restructuring in our European operations and reorganization in our North American operations is behind us. Broadcast is now organized into five customer facing, customer focused business units. TV Systems, Radio Systems, Broadcast Systems Europe, Automation Software and Networking, and Government Systems. I am extremely pleased with the changes that have been implemented, and I have confidence in the management team that is in place. I can tell you this team is clearly focused on driving growth and improving profitability going forward.

In the first quarter, revenue increased in the Radio Systems and Networking and Government Systems business units driven largely by sales of HD radio transmitters in the U.S., and by sales of studio equipment, transmitters, and networking equipment for the Iraqi Media Network Program. Operating income rose to $2.3 million, compared to $1.1 million in the prior-year quarter. Profitability was driven by higher revenue with some off-setting negative mix impact from lower automation revenue in the quarter. New digital radio orders included equipment for Cox Communications, and several national public radio member stations. We remain very optimistic about the momentum in the HD radio market, and truly believe it's the most significant change in terrestrial radio broadcasting in a generation.

The success of satellite radio is stoking the competitive fires of terrestrial broadcasters. Some in the industry are saying that Howard Stern's decision to switch to satellite broadcasting may be the first of many wake-up calls to the radio broadcasting industry. To help advance the transition to HD radio, Harris is working with the nation's largest broadcasters, including clear channel communications. To demonstrate the benefits and ease of transition to digital radio technology.

Of course, following the close of the quarter, Harris signed a definitive agree to acquire Encoda System Holdings for $340 million. We still expect the acquisition to close in early November. Encoda Systems is the leading supplier of end-to-end broadcast enterprise software and services solutions, traffic and billing systems, program scheduling, master control, play-to-air automation, and digital asset management. Encoda provides these work-flow solutions to a broad array of global media companies in the television, radio, cable, and satellite broadcast markets as well as to advertising agencies and media rep firms.

Encoda fits together with Harris Broadcast Communications in an ideal way. To provide customers with even broader end-to-end work-flow solutions. Encoda solutions and digital asset management are very complimentary to our own. Encoda's revenue model with most of its traffic and scheduling customers, is based on multiple year agreements and over $200 million in future revenue is currently under contract. Contracts are typically 3-5 years in length. And to remind you Encoda consolidated revenue for the 12 months ending June 30, 2004, was $124 million and earnings before interest, taxes for this period were $24 million. Last week I visited most of Encoda's U.S. based locations, making presentations and holding discussions with employees at each site. The reception that our team received from these employees was very positive. They believe that Harris is a great home for their business, and we feel the same way.

Let me now turn the call over to our Chief Financial Officer, Bryan Roub.

Thank you, Howard. Cash and cash equivalents were $548 million at the end of the quarter, which reflects the $64 million we paid for the Orkand acquisition right at the beginning of the first quarter. That figure compares to the $628 million cash at the end of fiscal 2004, which included the $45 million in proceeds in the sale of our tools and test systems product line during the fourth quarter.

In the second quarter, we expect to pay $340 million for the Encoda Systems acquisition which Howard was talking about, and that will just come out of our cash balance. Our liquidity remains excellent. The earliest maturity of long-term debt is in 2007, and we have more than 300 million of unused credit facilities available to us in additional debt capacity beyond the unused facility where needed. Our total debt to total capital ratio remains at a low 24%, a rate well below our 35-40% debt to total capital ratio comfort zone.

Cash flow from operations was $5 million, well below the prior year quarter of $82 million. This difference was primarily due to the timing of several cash items. Cash flow is reduced by approximately 50 million from payments related to compensation and requirement benefits that occurred in the first quarter this year, where as the same items fell in the second quarter in fiscal 2004. In addition, our operations provided approximately $27 million less, in advance payments and under an income compared to the prior-year quarter.

Our two Government segments contributed another quarter of strong positive cash flow and our Microwave segment also contributed positive cash flow in the quarter. Although the Broadcast segment did not have a particularly good quarter compared to last year, there was progress made in inventories and accounts receivable. I believe improvement opportunities remain on the liability side of the balance sheet in all of our businesses and we are giving that aspect of asset management more of our attention this quarter.

Capital expenditures were $18 million in the quarter compared to $14 in the prior year. The capital spending was concentrated, as you would expect, in our Government segments tied to the growth of these two businesses. Depreciation expense was $13 million, essentially flat from the prior year amount .

Throughout the Company, we continue to focus on asset management. Although several of our metrics declined this quarter compared to the fourth quarter of fiscal 2004, we did show solid improvement compared to the first quarter of last year and expect continued improvement throughout fiscal 2005. In addition to the normal asset management process we already have in place, I am confident that the recent initiatives that inventory and supply chain management which Howard just mentioned, will also begin to bear fruit as we progress through the year with respect to asset management.

Inventory turns in the quarter were 8.7, slightly down from the fourth quarter of 9.8 but up from 8 in the prior year quarter. Number of days sales outstanding in the quarter was 64, an increase from the fourth quarter of 58, but a decrease from the prior year of 69 days. Return on invested capital in the first quarter of this year was a very good 15%, compared to 16% in our fourth quarter 2004. We did not repurchase any shares in the first quarter of this year. Under our program, to remind you, we have remaining authorization of 3.2 million shares and remains our intention to repurchase shares to offset the delusion when shares are actually issued under our stock incentive.

Now my only comment on the cash flow outlook for fiscal 2005. Despite what I describe as a slow start in the first quarter, I expect another strong year with cash flow from operations in the 200 million to 250 million range which is the same range we communicated last quarter. Although the expected increase in earnings will boost cash flow from operations, we expect to use some of the increase to fund the growth those extra earnings reflect. As we indicated before, capital expenditures should be in the 80-90 million range with depreciation between $60-65 billion.

Finally before Howard summarizes the earning guidance for the year, I'd like to explain two matters. First, last week the Financial Accounting Standards Board formally ratified EITF 04-8, which is the Emerging Issues Task Force rule that requires a new dilution calculation on contingent convertible or so-called COCO, for the accountants out there. We have elected to implement the provisions in this rule, effective with our first fiscal quarter where the dilution impact was 2 cents. We have included restatements including this role for the four quarters of fiscal year 2004, as tables 5 and 6 of the earnings release. This new rule means we are required to treat our convertible debt as if it was in our calculations of earnings per share whether or not it is actually convertible. Please recall, however, that our previous guidance assumed this treatment.

Second, another item including guidance is an expected reduction of income tax expense that will result from the conclusion of a tax examination. That will fall in the second quarter, we're certain, and we expect this to be finalized during the quarter and it will reduce income tax expense $3-4 million or about 5 cents a share. Back to you, Howard.

Thanks, Bryan. Let me conclude my remarks by discussing our fiscal 2005 outlook.

All four of our segments are off to a good start for the year, and I now feel confident in raising our earnings guidance from the previous range of $2.25 to $2.35 per diluted share to a range of $2.60 to $2.70 per diluted share. Here are some of the details behind the new guidance.

Revenue for the Company in fiscal 2005 is now expected to grow by up to 15%, compared to fiscal 2004. This compares to previous guidance of about 10% growth. We now expect Government Communications Systems to grow in the 16-17% year-over-year range, as a result of the new program wins. And we expect to be able to achieve a minimum 10% return on sales, due to our recent award fee performance.

We've initially expected growth of 13-15% including the revenue from Orkand at about $95 million. The RF Communication segment has shown tremendous growth in revenue and significant profitability expansion over the last several years. We had initially expected growth of 4-6%, with a stronger first half. We now expect year-over-year growth to be in the range of 7%, and we expect return on sales to be at or above last year's level.

Our outlook for the Microwave and Broadcast segments remains essentially unchanged from previous guidance. However, I must add that our first quarter performance and strong sales funnel gives us greater confidence that we can achieve the targets that we established during our fourth quarter 2004 conference call. The revised guidance that we provided today includes the expected accretion of 12 cents per diluted share from the Encoda acquisition. It does not, however, include non-recurring GAAP charges for the expected in-process R&D write-down and integration cost which we currently estimate at $6-10 million or a range of 6-10 cents per diluted share. As Bryan explained, the revised guidance includes now 8 cents earnings per share dilution resulting from the change in accounting for the contingent convertible debt instruments and, as he said, we've elected to implement the provisions of EITF 04-8 in our first quarter, and that had an impact of 2 cents per share.

And as he also mentioned, our revised guidance includes 5 cents per share tax item expected in the second quarter. So to recap, the 35 cents per diluted share increase in the midpoint of our guidance today compared to at the beginning of the fiscal year is coming about 18 cents in operations including the additional effect of dilution and of course, primarily as a result of stronger than expected revenue and profitability in our two Government segments. 5 cents is coming from the tax item and 12 cents from the Encoda acquisition. With that I'd like to ask the operator to open the line and we'll take your questions.

[OPERATOR INSTRUCTIONS] We'll go first to Mark Jordan of A.G. Edwards.

Could we talk a little bit about the backlog position and Government Communications Systems group. You the stated $4.8 billion, but can we talk a little bit as to what is in there and what not? Specifically if you look at say, your comments on FTI potential of 2.2 billion, NRO a billion, those large pieces if all included would dominate the backlog position. Could you give us an overview of what is in there and what is potential but not in the backlog?

Sure. I'd like to do that. Of the $4.8 billion, there's about $2.2 billion of the FTI in there and about $1.5 billion of FTI is not included in there. If you remember the contract was a contract with a potential value of $3.7 billion over the 15-year period of time. So we've got 2.2 in and 1.5 of potential not in.

On the Patriot contract, we have about $800 million in on the Patriot contract of the $1 billion possible. That contract over a ten-year period of time. As you stated, that is about $3.2 of the $4.8 billion in there. The rest of them are just contracts that we've had over the years. Some $100 million, some $50, that add up to the rest of the number there.

Not included in the $4.8 billion, I've already stated that the FTI $1.5 billion is not included in there. We don't have any of JSF limited rate production or production in there which could be another $1.5 to $2 billion over a 20-year period of time, and we don't have the F 22 production in there of a few hundred million dollars in there. So there's about $3 billion not included in the $4.8 billion. And, of course the other things that are not included in there was any of the $7 billion that Howard had spoke about earlier on programs to be bid, four in the DOD, five in the civil area and three in the national area, which add up to $7 billion of potential business between those.

The ERA design-off that you're involved in, who is the competitor, could you just sort of size up the two teams.

The two teams, of course, are the Harris team and other lead is Lockheed Martin. It's Lockheed Martin versus Harris in that competition.

A final question, could you just quantify the impact that the sort of special items had on the Government Communications Group? You said there was some specific award fees and a cancellation fee of the Comanche that flowed through. Could you quantify the impact on margins there?

Not specifically. As you can see we ran a little above the 10% ROS guideline for the quarter. It really wasn't that much I think if you look at the numbers.

Okay. But you would say sort of a flat 10% is kind of a more normalized run right there?

With the guidance we provided in July, we felt we could achieve 10% ROS on the core GCSD business and 7% on the acquired Orkand business which we sized at $95 million in revenue. We are feeling a little better now about the business profitability overall and so now we are staying at a minimum 10% of total revenue and we've got good some momentum in the first quarter with a couple of nice award fees and the successful termination of the Comanche program. You're never sure how they'll wind up and so we're glad to have that done and we feel pretty good about our ability to continue to expand margins in GCSP even if it's only a tenth or two a year.

Thank you very much.

We'll now go to John Bucher of Harris Nesbitt.

Question on the Falcon sales and looks like you have new customers in Africa that were mentioned. I'm just wondering what we should expect for the ramp there. I know you indicated only a small portion of the Pakistan business expected to go in FY '05. Can you sort of plot a projectory for us on what your anticipation is on the Falcon and NRF in general?

Without being specific by quarter, I think we're not expecting to see a lot of seasonality this year. We knew we were going to start out the year strong and that's happening, but the pipeline of orders we received in the quarter and the pipeline of potential orders that we expect to receive in Q2 and Pakistan on top of that has given us more confidence that we're going to do 2-3% year-over-year higher growth rate than we thought back in July. We are reaching limitations just on physical production, and we've expanded the factory a number of times even during my tenure here in the last close to two years. We've expanded about as far as we're going to for right now. As a result, we think that most of the capacity will be utilized for orders that are already in backlog and expected orders in the next quarter or two from the U.S. Government, and so as a result, the Pakistan orders will probably primarily be fulfilled in our fiscal year '06 which will give us a nice start to that year.

Thank you. One question shifting to broadcast, you didn't change the outlook for the broadcast business. I'm wondering what are you assuming there as far as the growth and HD radio, you indicated you've got some traction here this quarter, what sort of assumptions are you making in that broadcast outlook not being changed?

Primarily if you recall back to our discussion at the beginning of the fiscal year, you might remember that we made the decision to exit a non-profitable segment of business which basically was integrating studios with a lot of non-Harris product content and that was $13-14 million in revenue last year. As a result of losing that from the base, we felt that we would only be able to grow revenue 1-2% for the year. We still think that's a reasonable forecast. We had a pretty good quarter in the first quarter, but clearly the IMN program was part of what drove the revenue growth and that program is scheduled, at least its current contract will end in January of 2005 and at this point, we're not aware of any major extension in that program. So most of the shipments from BCD to IMN are behind us.

The things that are going to drive growth for the rest of the year and offset the decline in that systems integration business are certainly HD radio. I'm not going to size the specific number. It's obviously millions of dollars. But it's not going to be a big contributor. Our point in mentioning it is we are shipping transmitters and there clearly is I think an accelerating level of interest among the customer base. You'll recall that Clear Channel indicated in a press release a couple months ago their plans to roll out HD radio in their top 95 out of their 100 markets. They said they were going to do that in three years. I think it's likely they'll do it faster. At this point we haven't won all of that business but I feel very good about the demonstrations we've been providing to Clear Channel.

We just came back from the National Association of Broadcasters radio trade show in San Diego. Again, we are feeling positive about our leadership position. I think this new technology we've announced, which is split level combining and probably more technical than I can understand. But what's important to me and important to our customers is allows you to upgrade to HD radio, especially in FM at a much lower cost than if you have to put a completely new antenna system in and so we've gotten a lot of very good feedback with customers on that. We think HD radio is going to drive growth this year. We also think that we're going to see some renewed momentum in Europe as a result of our focus with a new general manager on board and a self-contained team in Europe that's now driving that business unit.

The upside in broadcast remains digital TV conversion in the U.S. and the last phase of that. The FCC recently confirmed the dates that we've been talking about now for almost a year. That is that the top 100 markets need to be in full powered transmission by July of '05. The remaining markets by July '06. If they stick to those dates, we will begin as we go later into this year and into next year to see an acceleration in demand for our digital transmitters. I must say though that given the track record over the last five years, we're just not counting on it. And neither, frankly, are some of the broadcast customers. Those that want a delay as late as possible are going to put all the pressure and maneuvering they can with the FCC to the extent they really stand by their guns this time, then I think that would give us an upside. You would likely see that toward the latter half of this year and, in either case, we will see growth. We are confident we'll see growth in FY '06 in digital transmitters and again the magnitude of the growth depends on how firm the FCC stands behind their latest rule making.

Thank you.

Kevin Dede has our next question.

Congratulations on a great quarter.

Thank you.

Would you mind filling me in a little bit on the synergies that you are driving out of Orkand. Who are some of the customers that they are serving? How are you developing those relationships?

The main customers that we have there, one is the postal service and we're doing services work for them under this contract. Looks like they may have a large infrastructure job coming up. We'll now be a known entity with the postal service with the Orkand acquisition, therefore we'll be a much more viable bidder on that job. Also, State Department, we have stuff going on in many of the countries. That's also going to leverage some of our communication skills and getting data back from those embassies back to the United States using some of our newer wireless COM equipment.

So there's two off the top of my head that we're working with. We're also working with the Health & Human Services organization, and looking to do some communications work there. So most of the stuff that we're going to be doing will be staying in what we call our sweet spot and the sweet spot which is needed now which is communications and information processing, database management and enterprise solution type of systems, and that's what the base division brings to the services part of Orkand. And that's you recall, Kevin, from our initial announcement, that's really our strategy with the services acquisition like this, it's a good core business and great people, great customer relationships, but at 7% return on sales, that's kind of what the business offers. But it brings such a wonderful customer intimacy that we can then build with our larger development program skills which we believe can earn higher return on sales. The overall mixing of those in the GCSD return on sales results at around 10%.

Howard, since I have both your ear and Bob's, can you explain to me how you expect to keep margins up in the 28% range as you take the Falcon II and transition into the Falcon III and when might we expect to see that happen?

First of all, I don't know of anything that's going to drive lower margins. We have scaled up and improved margins as a result of scaling our fixed costs. I suppose if you were to see a significant decline in revenue you'd have to work on getting some of those fixed costs out to maintain the margin. This is never, and I will quote this, this is never going to be a 14 or 15% margin business again .

My approach is you're going to go up, not down. The thing that will potentially pressure it probably in the long run are programs that are not commercially based or commercially structured programs, Kevin, like potentially JTRS could fall in that category where it's a development contract, it's a long-term cost plus or fixed pricing structure is different than developing a radio and selling it in a commercial price list and so on. We believe we're going to be able to mitigate those impacts as more and more of our radios go international. While we're doing a good job internationally, we're not doing a great job. There is plenty of market outside of North America for us to penetrate and those markets offer higher than our average North American margins, and sometimes though they require less complicated, slightly lower cost solutions and that's where the Bowman radio comes in because the Bowman project gave us a different platform. While it shares a lot, it's a different platform made in the U.K. and we're already as you heard from our announcement of the $6 million order with Malawee, are now taking an export version of that to the international markets and so we have an additional arrow in our quiver in terms of going after international market share.

And without going into too much detail, we'll hope to talk more about this at our analyst meeting in the Spring. We're also continuing at RF to develop new product capabilities outside of the just the traditional tactical radio business and that's all I'm going to say today. I guarantee you that we have clear focus and a path we believe to continue growing that business and maintaining the kind of margin level that we and our shareholders have become quite accustomed to.

Before I let you go, Howard, can you explain where TRuepoint is selling. You said that your Microwave business was strong in North America, Middle East and Africa. Has TRuepoint been introduced in each of those regions and where are you seeing the greatest demand for it?

We are seeing TRuepoint sales in every region but predominantly in international markets and I would say in Asia and Latin America where we have been in the least favored position in terms of competing with some of the current international competitive products. I think at this point, we've had TRuepoint sales in some amount, Kevin, in every region but clearly our initial focus is predominantly in international market. I would say in Asia and Latin America where we have been in the least favored position in terms of competing with some of the current international competitive products. You'll see TRuepoint go everywhere. We have revenue in the sales funnel in the second quarter from every single region, including some initial customers in North America.

I'm feeling pretty good. We're not getting overconfident but we now have some momentum with the product. Customer feedback has been very positive and I'm again at this point at least we're confident that the $30 million target can be achieved for this year. More importantly, I should add that we're making more dollars in every radio we are shipping and that's part of our strategy in enhancing the margins in the microwave division so we are also pleased that we're hitting good price cost targets for those radios.

Thank you again.

Now we'll hear from Chris Donaghey of Suntrust.

Great quarter, guys. Howard, I was wondering if you could comment a little bit about Falcon II penetration market saturation. I know that you have the Falcon III in development but that's going to end up going head to head with [Inaudible question-background noise] if I'm not mistaken so as cluster 5 progresses, do you get a sense that the market may eventually freeze for Falcon II at least domestically and the bulk of that business will then come from the international market?

Yeah, I don't believe that it's going to freeze in the next year or two, it's going to be out a few years before that may happen and even at that it still may be what I'll call a fairly good business in the Falcon II. I think JDRS just like other programs that the government has with the dollars associated, with everything they are trying to do it's going to slip out a little bit. You've probably heard that other places. And all that's going to do is help us sell more Falcon II radios to fill in the gap that we thought we would have with JDRS so I believe that's going to happen. The other thing I believe that's happening is that the National Guard units, et cetera are getting more radios and getting more funding so we're supplying more to those units as we go forward and also, it looks the demand for the Falcon II, based on a review I did yesterday, the international demand is still very strong for the Falcon II radio but we are going to have what I consider to be a pretty good period of overlap between Falcon II and then our Falcon III i.e., JTRS compatible radio and then those foreign sales, and even the U.S. sales will then be buying Falcon III radios.

I think we saw that with the transition some years ago from Falcon I to Falcon II. The Falcon III, Chris, is focused for the U.S. government and it's really meant to be an offering with this software compliant architecture, as Bob described, and so the Falcon II is going to be selling for a long time in the international market and we've now come in with potentially a two-tier offer with this export version of the Bowman radio internationally so I think we are in a stronger position. We're also continuing to expand the product line with additional hand-held radios which are very popular in international markets. So international is going to give us a lot of runway, and again, we feel very confident that we're going to get to market first with Falcon III, that's it's going to be a very compelling offer to the U.S. customers and the U.S. Government customers that today, by the way, just to remind you, have to get a waiver every single time they buy a Falcon II. because it's not in with the previous program and I believe if we deliver on the opportunity we have with the Falcon III with the U.S. Government customers, they are going to be standing in line getting waivers for that as well, because when they need radios, they need radios that perform. Having a concept down the road is not going to satisfy those needs.

Okay, so then the plan for Falcon III is to get that developed before the Cluster 5 radio and sort of do an end around on the GDT.

I'd say very similar to what we did with the Falcon II and ITT.

Okay, one more quick question on the backlog, Bob you were mentioning $4.8 billion. Is the NRO contract included in that $4.8 billion?

Yeah, if I remember correctly, it's about $800 million of the $1billion is included in there.

Okay. And then the last thing on the integration of Encoda, you said it's going to be about a $6-$10 million integration cost there or 6 to 10 cents per share. Is that going to be broken out separately going forward or is it going to baked or distributed into the broadcast operating costs?

We will certainly disclose it because we expect these to be one-time costs. They will occur in a relatively first few months associated with the acquisition once we close. About $3.5 million is the in-process R&D write-down that'll happen essentially day one, and then we have a range of 2.5 million then to 6.5 million for potential integration costs relating to the standardization of processes and programs and I personally think it's going to be toward the lower end of that range, Chris, but I wanted to provide a range just in case it goes a little bit higher. So from my standpoint, we will call that out separately, as a non-GAAP adjustment, show a reconciliation so we don't lose sight of the real ongoing profitability of the broadcast business including Encoda.

Okay, and then the last question on that. Do you expect there to be an amortizable intangible asset associated with the acquisition?

Yes, and we've taken that into consideration when calculating our accretion. Our accretion on a cash-basis before the amortization of intangible assets would be higher than the 12 cents this year and we have included that because obviously that's a real P&L cost and a real GAAP P&L cost even though it's a non-cash item.

Okay, great.

If that number gets large enough, we will probably even disclose and talk about in this call our quarterly amortization so that you get a sense of what the cash earnings are compared to non-cash earnings.

Okay. Great quarter.

We'll now go to Ted Wheeler of Buckingham Research.

Good evening. Great quarter. Just on the incentive, the comment that you made, it sounded like there will be expectations of continuing incentive awards and would you deem them to be pretty much in line with the first quarter experience or would that comment just sort of reflecting what already happened in the first quarter?

Yeah, my comment was really reflecting what had already happened, Ted, from the standpoint that our experience over the last several quarters has given me a little higher confidence in our ability to sustain a 10% return on sales or higher performance on an ongoing basis. We did 10.4% in the first quarter, that is slightly higher than last year. It's probably half a point higher than the initial guidance that we provided and so we're off to a good start and we now view , I view, 10.0% return on sales as kind of a floor of the business. Doesn't mean in one quarter that might not happen, if there's an item with timing in the quarter, but we've got quite a good track record going here. Our average award fees are at or above the 90% level, have been the whole time that I've been here. Bob and his team have done a great job in improving those over his tenure in running the business, and we certainly believe they are sustainable.

Okay. Terrific. The other question I had was on TRuepoint. You talked about a $30 million estimate for the year in revenues and yet it sounds like you're going to do $10 million in the second quarter. It would seem that maybe you're ramping up to do a little better than that. Would that be your expectation?

It's always possible. We've gotten 14 million orders in so far and we've only shipped 3 so we've got 11 million backlog. We've got 10 million in the funnel--when I said the sales funnel, I really should have said the order funnel because that's what I meant-- we have the opportunity to get a chunk of those orders in the second quarter, so if we 9 or 10 million in orders a quarter, then we probably will beat 30 million, but at this point, if we do 30 million, that'll be on our plan and that should allow us to exit the year with the level of profitability that we have talked about and targeted, and more importantly, put us on the trajectory then to get to the FY '06 level of profitability that we're shooting for. So good progress, one quarter doesn't make a year, but I did want to talk about the order funnel because it's strong and there's a lot of enthusiasm out there.

Outside of TRuepoint, is there still very strong activity in the U.S. for sort of the cellular industries capacity increasing and bandwidth broadening, et cetera, is that still a pretty good driver?

Yes, I think we're seeing about the same level of activity right now that we saw throughout last year in both the mobile provider market as well as the public and private networks market. The introduction of our higher capacity constellation radio last year was a big hit, we're still getting follow-on orders for that, that's what we call the 4-by DS3 capacity. Where we're able to do that is basically the same radio that we were doing a 3-by DS3 before. So that's proving to be helpful, and the funding at the local state and federal level for upgrading older public networks continues. There's a good market opportunity out there for us. We had a good year in North America last year, as you know, in orders and we believe that we will meet or exceed that this year, and continue to build backlog in North America, and then hopefully couple that with the international business pickup that will come profitably as a result of TRuepoint contacts.

That's great. Thank you.

Now from Oppenheimer, we'll hear from Larry Harris.

Oppenheimer & Company. Thank you and congratulations on the quarter. Just a question with respect to Microwave, are you seeing any sort of benefits from the deployment of three G type networks, either in the U.S. or in Europe? Are you seeing any indication that that might drive demand going forward?

Well, I think it will but I don't see a lot in the immediate term. We're not seeing a great correlation between our order activity, Larry, and the base station infrastructure guide. We're not like out of the phase, but it's just not a perfect correlation. We'll have an up quarter, they'll have a down quarter, and vice versa. I don't know if that's a function of the customer base that we have and what we're dealing with, or not, but we're still building on the areas where we've made investments over the last couple years regionally. The Middle East and Africa continue to be good markets for us and I believe you are going to see more strong orders out of a major customer base that we're developing and nurturing in that part of the world. We continue to see opportunities in Eastern Europe, and maybe Latin America may be starting to come back. I often hear it referred to as the ever-receiving bonanza because of it's ability to go up very quickly and then disappear. But we're seeing the resurgence, additional investments being made in Microwave and are well positioned, I think, with our new product to participate in those. But the market isn't overheated, certainly, but I think now we've seen for a good six months or so a good funnel of opportunities internationally, but I don't always see them correlating specifically with a 3G rollout or a 2.5G rollout in a given country.

Great. Alright. Congratulations on the quarter.

The operator will take one more question please.

Thank you. Our last question comes from Chris Quilty of Raymond James & Associates.

What do you know, I made it in under the wire. Just one question for you on the Win T program, I'm sorry I missed the very front end of the discussion, if you discussed since they combined the two prime contractors on the program, have you, by this point, figured out where you fall out among the competings of contracts or on the previously competing team in terms of what sort of context they have in the program.

I guess the short answer to that is no. The longer answer is, both ourselves and BAE have been in front of General Dynamic and Lockheed Martin with two prime contractors on the Win T before the combined team was put together. We've both gone in separately and gone over our architectures and our system solution, and all four will be players on the team going forward and we're looking forward to that. It's going to be at least another 90 days or so before we know exactly what the detailed roles are going to be and, by the way, General Dynamics and Lockheed have to go back in with this best of breed architecture yet and have that approved by the government, so we're waiting on the Army to approve that, and I'm sorry, I don't remember if it's this week or next week that they go back in, but I know by the end of next week they'll have gone back into the Army with what I'm calling the best of breed architecture and I'm pretty sure that they're going to get approval to go ahead at that point in time.

Right. Right now, Chris, we're still sizing our potential value of about $500 million over 15 years. Could be a little smaller, could be a little larger, depends on how it works out but I feel very good about Bob's team approach to solving the challenge and problem and we'll certainly have a role in the program. No question about that in my mind.

And on that side, we have talked about backlog before and there is nothing in there for Win T because we're still waiting on the outcome.

Well you ought to just put a backlog chart in your press release, save yourself some time.

We'll take that under advisement.

Thank you everyone for joining us today.

That does complete today's conference. We thank you for your participation. You may now disconnect.