L3Harris Technologies Inc (LHX) 2005 Q3 法說會逐字稿

Good afternoon and welcome to Harris Corporation's third quarter fiscal 2005 earnings release conference call. [OPERATOR INSTRUCTIONS] Beginning today's meeting is Pamela Padgett, Vice President of Investor Relations. Please go ahead.

Good afternoon everyone and welcome to Harris Corporations third quarter fiscal 2005 conference call. I'm Pamela Padgett, Vice President, Investor Relations. On the call with me today is Howard Lance, Chairman, President, and CEO, Brian 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 let me say a few words about forward-looking statements.

In the course of this teleconference Howard, Brian, 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 press release and on this teleconference we will discuss certain ratios and information that are nonGAAP financial measures. A reconciliation to the comparable GAAP measures is included in the tables of our release and on the Investor Relations section of our website which is www.harris.com. A replay of this call will also be available on the Investor Relations section of our website. Howard with that I will turn it over to you.

Thanks, Pam, and thanks to all of you once again, for joining us for our earnings call. Today we will provide additional details on our results for the third fiscal quarter for each of our business segments. Brian will give you additional details on our financial performance and cash flow and as always we are all here to answer your questions at the end of the call.

We had another very solid quarter with strong revenue growth. Consolidated revenue was $772 million, an increase of 18% compared to the prior year quarter of 654 million. Year-over-year organic growth was about 10% excluding acquisitions. Complementing our revenue growth was even stronger growth and profitability. Net income in quarter three increased by 57% compared to the prior year to $56 million. And all four of our business segments delivered year-over-year increases in operating income. Earnings were $0.40 per diluted share compared to $0.26 in the prior year quarter. Per share results of course reflect the 2 for 1 stock split that was completed on March 30.

I'm very pleased to say that both of our recent acquisitions, Orkand and Encoda Systems, contributed positively to our results. The integration of these two businesses into Harris has essentially been completed and both businesses are on plan and performing consistent with our expectations.

Now let's turn to some specific comments about each of the business segments. The Government Communications Systems segment had another outstanding quarter. Revenue increased by 18% compared to last year, to $464 million. Operating income increased 22% to $52 million driven by continued excellent program execution. Operating income in the quarter did benefit by $3 million from the anticipated settlement of fiscal year 2002 overhead rates with the U.S. Government. You will recall that we settled fiscal year 2001 overhead rates during the first and second quarter's of the year. And received a benefit to income from the reversal of unnecessary reserves for unallowable costs.

The year-to-date income associated with the release of these reserves for both years now stands at approximately $11 million, and an additional $3 million is expected in the fourth quarter. The magnitude of these adjustments of course from our reserve accounts is unprecedented for us in any one year. And we do not expect income from this source in fiscal year 2006. As most of you are aware our revenue in Government Communications Systems spans a broad mix of government customer agencies and departments. We've been particularly successful in recent years in expanding our program and customer base within the civil and technical services segments of the market. This expansion of addressable markets combined with strong customer relationships and superior program execution in our core defense and National Security Programs business units has allowed us to consistently outperform market growth rates and our peer companies. Our success in new program wins in fiscal year 2005 suggests that we will continue this level of relative performance going forward.

Revenue growth during the quarter was driven by many programs across a number of government customers. The largest sources of year-over-year revenue growth in the quarter were from the FAA telecommunications infrastructure program, the recently completed Iraqi media network program, the recently won $1 billion Patriot operations and maintenance program for the national reconnaissance office, and the technical services contracts that came along with the Orkand acquisition. Recent program wins in the third quarter will help to drive continuing revenue growth going forward. These included a three-year $77 million contract to provide application, integration, and deployment, training, and logistic support for newly developed software at the National Security Agency. This new software will be used by NSA to improve and expedite decision making.

And also we won a three-year, $37 million system design and development contract to provide unfurlable space born antennas for the Mobile User Objective System program. This narrow band tactical satellite communication system will be used by U.S. war fighters for in theater operations. Harris large reflector antennas will enable real time multi-media content distribution to troops on the move.

On top of this following the close of the quarter Harris won several additional programs to help drive future revenue growth. In the Department of Defense programs business unit Harris was awarded a potential $350 million, ten-year contract by the U.S. Navy. This is for production of a new common data link system called Hawk Link, for use on its Night Hawk helicopters. Harris will provide high-speed, air to ship, hardware and software that transmit video, radar, acoustic and other sensor data from these Lamps helicopters to their host surface ships at distances greater than 100 nautical miles and at data rates exceeding 21 megabytes per second.

In the civil programs business unit, Harris won a 54 month, $57 million follow on contract with the FAA for maintenance and sustainment of the agency's weather and radar processor system, also known as WARP. Harris will provide the FAA with complete hardware and software support for the life of this program which by the way we've supported continuously since our initial contract award in 1996. WARP allows air traffic controllers to view real time weather data in graphic form right at their controller positions. And finally Harris was awarded a $9.4 million contract by the U.S. Navy to provide digital video map computers and related hardware supporting a variety of different naval aircraft including the F 18 Hornet and Super Hornet and the Night Hawk helicopter.

I'm pleased to report that we recently completed our contract work on the Iraqi media network or IMN and that our program management and contract team has returned home safely from Iraq. We are all very proud of the work this team has accomplished through both our original twelve-month contract and the three-month follow-on contract. Together they totaled $119 million in revenue. Our team working with local partners built a truly world class public television, radio, and satellite network.

A number of large program opportunities are still in the pipeline. And we expect them to be awarded some time during the next 12 months or so. These include a $500 million opportunity with the Army for the war fighter information network tactical or WINT, a next-generation battlefield communication system. A potential $800 million contract to provide network architecture and infrastructure to support the Department of Defense, transformation communication satellite, also known as TSAT this would be the ground segment.

Then there's Phase I of the potential $300 million cryptologic mission management, CMM Objective system, which is a worldwide enterprise management system for the National Security Agency. Also a potential $500 million program for the GOESR. environmental satellite. Harris will provide the National oceanic and atmospheric administration with ground data processing and command and control infrastructure under that program. We also have Phase II a $400 million expected contract for the electronic records archive, or ERA for short. This is a program award to organize millions of electronic records for the national archives and records administration.

A $330 million advanced weather interactive processing system, AWIPS, for the National Weather Service. And a potential $250 million contract as part of the integrated wireless network program for Department of Homeland Security and Justice Department where Harris is a member of the Motorola team. Two final programs that are expected to be awarded again in about 12 months or so, the $1.2 billion down select opportunity with the U.S. Navy for its advanced extra high-frequency satellite communications terminals, and the $800 million U.S. Census Bureau field data collection automation program.

That's a long list. It totals over $5 billion in opportunities. We believe our opportunity pipeline remains very robust in our sweet spot, providing government communications and information technology networks and support. Of course we are actively pursuing these contracts as well as many others.

Let me turn now to the RF Communications division. RF had another outstanding quarter. Revenue in the segment was $144 million which is a 24% increase compared to the year ago quarter. Our ability to rapidly respond to near term customer requirements and our clear technology leadership and product reliability have helped to solidify our position as the leading global supplier of secure, high-frequency and multi-band tactical radio systems. Segment operating income was $50 million in the quarter. That's a 50% increase from last years third quarter. This was a record in terms of both operating income amount and operating margin. About $8 million in income in the quarter resulted from cost reductions from supplier negotiations on the Bowman tactical radio program in the U.K. Since Bowman is on percent of completion accounting this represents a savings on the portion of the contract already shipped to the customer.

As previously I had discussed in these calls we have accelerated engineering R&D in fiscal 2005 at the RF division towards the development of our next-generation Falcon III radio. We believe the Harris Falcon III will be the first radio on the market using the new software communications architecture, or SCA, making it compliant with the joint tactical radio system or JTRS standards. We remain on target to introduce the Falcon III hand held multi-band model in June.

Turning to orders at RF, orders during the quarter were a record $215 million. That's more than double from last year. Adding further strength to our backlog position. Orders were evenly split between domestic and international markets. We believe that reflects strong global demand for our tactical radios. Based on this order rate and the order pipeline we continue to believe that demand for Harris tactical radios will remain very strong throughout our fiscal year 2006.

The opportunity pipeline remains very robust reflecting additional requirements to be funded by the supplemental Department of Defense budget request which is now expected to be approved in May. The Department of Defense remains very committed to communications transformation. Including implementation of the U.S. Army Modularity program. These requirements and their anticipated funding combined with strong international demand we believe bode well for continuing double-digit growth in the RF segment.

Orders during the quarter included $33 million from the U.S. Army for high-frequency radios including $16 million allocated to the Modularity program. This program is the most monumental change in force structure in the Army since World War II. Creating more independent and capable units of action, each with greater command, control, and communications capabilities. Also during the quarter the U.S. Marine Corps awarded Harris an indefinite delivery, indefinite quantity contract valued up to $75 million for HF radios, spares and training. Its worth noting that the ANPRC 150 from Harris is the only HF radio with embedded communications encryption that has been certified for the transmission of classified information on the battlefield.

Harris was also selected by the government of Pakistan to provide HF radios for their defense forces. This $68 million contract includes manpack and vehicular radios along with base station systems and radio frequency remote control systems. This advanced technology is expected to enhance the capability of Pakistan forces to provide real time intelligence information between their patrols and headquarters operations. Pakistan is an important U.S. partner in the fight against terrorist cells operating in this region. As we noted last quarter to meet this increased demand, manufacturing capacity has been added. We are not constrained in our ability to turn orders into revenue and to meet our customer delivery expectations. We believe we are very well-positioned to support the expected orders growth.

Turning to the microwave segment, revenue in microwave communications was $74 million in the quarter; a decline compared to the prior year quarter. An increase in revenue in North America was offset by lower international revenue. However, international orders in quarter three rebounded nicely, providing good backlog and an expectation of higher sequential revenues in Q4. It's important to note that the second half of this fiscal year had some very difficult comparisons with last year for our international microwave revenue. You might recall that last year included $45 million in microwave shipments for the MTN Nigeria microwave backbone project in the second half of the year. While follow-on microwave shipments to MTN Nigeria are continuing this year revenue has been no more than $10 million in any quarter.

In North America the revenue mix between mobile and private networks in the quarter continued to be weighted towards upgrades in private networks for state, county, and local governments. Continuing to be fueled by Homeland Security funding and post 911 interoperability concerns. However, recently several wireless service providers have announced plans to deploy next-generation 3G systems. And we expect this deployment will drive additional microwave system requirements to support mobile networks in future quarters. Operating income in the quarter was $1.1 million compared to a loss of $2.2 million in the prior year quarter. And we achieved this result on much lower revenue.

Product gross margins increased reflecting both the richer mix of our new TRuepoint microwave radios and the shift away from low margin international projects. This trend is expected to continue as TRuepoint sales volume continues to rise. Demand for TRuepoint in the quarter actually exceeded our manufacturing capacity and we've now turned our attention from market acceptance to providing adequate production lead times and adding capacity to our San Antonio, Texas, manufacturing facility. Production capacity available in quarter four should be adequate to meet our demand. Year-to-date orders for TRuepoint now stand at about $30 million. So we expect to exceed our $30 million TRuepoint revenue target that we established at the beginning of the year.

While actively managing low margin business will continue, the lower cost TRuepoint 4000 model, that's just been launched, allows us to pursue PDH access opportunities at much healthier margins than our older, higher cost MicroStar products. Also TRUEPOINT offers the international market a much wider range of frequencies, capacities, and features than MicroStar, thus further increasing our addressable market size.

Stronger third quarter international orders may indicate that international markets are finally improving. We are seeing pockets of strength in the Middle East and Africa and in Latin America, both areas of heavy focus for Harris. New orders received during the quarter included contracts for TRuepoint from V Networks Limited in Nigeria. V Networks formerly called Econet Wireless, is rapidly expanding its footprint in Nigeria to compete with MTN.

We also received a purchase contract from Unmia (ph) Mobile, the newest mobile service provider in Jordan. Unmia chose Harris to support its 3G network backbone and cellular back call expansion. Their project will create the largest single TRuepoint radio network in the Middle East and North Africa at this point. In Latin America Nextel Brazil selected Harris 2.5000 to deliver voice and data services to support their cellular network. And additional Latin American orders during the quarter came from Embratel and Nextel Mexico. And finally a key North America milestone, Harris signed a long-term preferred supplier agreement with Sprint to provide TRuepoint radios for mobile services nationwide.

Turning next to our Broadcast Communications segment. Revenue in the quarter increased 41% from the prior year quarter to $103 million; reflecting the combined results of our core broadcast business as well as Encoda Systems which was acquired by Harris in November. Operating income in the quarter was $7 million compared to only $0.5 million last year. While these results were solid, international market weakness impacted both revenue and gross margins in the core broadcast business and held us back from achieving the stronger results that we had expected.

Revenue in our core broadcast business was essentially flat with Q3 last year. Gains in the U.S. from higher shipments of HD radio transmission equipment were offset by year-over-year declines in international analog radio and television products and by lower revenue in Europe. Demand was particularly soft for European standard DAB radio transmission equipment. Several large international analog transmission projects similar to our very successful project in Romania were also delayed during the quarter. Of course the lower than expected volume resulted in excess manufacturing capacity and higher costs in the quarter.

Gross margins in the core broadcast business actually improved compared to last year. But did decline sequentially. We are reviewing new cost reduction actions at this time that can potentially be implemented in quarter four to counter the effects of the lower volume and rebalance our manufacturing capacity with demand going forward. Also in the quarter core business expenses increased somewhat compared to both last year and sequentially. As a result of specific decisions to add engineering R&D investment and new products and additional sales and marketing costs. I believe these investments will provide excellent returns going forward and will be reflected and seen in fiscal year 2006 revenue growth improvement.

I continue to be very excited about the creation of our new software systems business unit from the combination of the Encoda Systems acquisition and Harris automation. We promised customers that we would accelerate development of new software products as well as integrate the Encoda legacy products to provide them with work flow solutions that meet their productivity requirements. We also promised to introduce next-generation software solutions that would move away from single point products to a complete end to end enterprise system. I'm pleased to announce we are delivering on both of these promises. Many customers who the previous Encoda management believed were at risk prior to our acquisition have decided to stay. Because of the clear benefits of our next-generation solutions and because of the Harris relationship.

At the National Association of Broadcasters trade show last week we introduced the first module in our new family of broadcast software solutions that we call H class. This integrated suite of applications will ultimately span the entire media work flow process from creating content to managing traffic and scheduling to media ingest and Digital Asset Management to play out automation to content distribution and customer billing.

A Beta demonstration of the first H class module which is our new automation software system, was showcased at NAB and will be commercially available later this fall. British Sky Broadcasting has placed the first order for H class to be used to support their new forthcoming high-definition television services. Orders in the third quarter were strong for both domestic HDTV and HD radio. Strength in digital TV orders reflects the measured progress we continue to see in the domestic roll-out. Significant DTV orders in the quarter came from Gray Television, which operates 31, network affiliate stations in the U.S., Liberty Corporation which owns and operates 15 stations, and tri-state Christian Network which operates 6 stations.

The HD radio build out continues to gain traction. All major station groups have now committed to implementing the new standard at more than 2000 radio stations over the next few years. New HD radio orders during the quarter included a contract from NPR affiliate, WJCT F.M. in Jacksonville. They will purchase a complete HD radio transmission package and will be the first station in the Jacksonville market to broadcast in digital. I am very pleased with our progress in this segment of the market. We believe that Harris has become the clear market leader for the HD radio transition with well in excess of 50% market share.

Following the close of the quarter Harris signed a significant agreement with TV Azteca. They are one of the two largest producers of Spanish language programming in the world. TV Azteca will use Harris digital television transmitters and encoding equipment to bring HD television to nine major cities in Mexico by mid 2006.

During my visit to NAB I had an opportunity to see some of our new transmission product offerings as well. I think particularly impressive was our new Power CD UHF transmitter. This has been designed as an HDTV entree for UHF stations combining high output power with lower operating costs. We do this by utilizing a proprietary tube design and liquid cooling to minimize both heat load and the related cooling costs.

Another Harris product making a very big splash at NAB was the new FLEXSTAR digital exciter which is part of our HD radio system. This exciter allows broadcasters to offer additional services that can be included in the digital broadcast stream. This can include additional audio channels or text display information. I think more exciting is that FLEXSTAR was the result of a very intensive five-month development effort by a joint team of engineers from our Broadcast division and our Government Communications Systems division.

At NAB Harris also featured a live end to end DVBH demonstration. The DVBH product allows both domestic and international broadcasters to deliver content to mobile devices including cellular phones or PDAs. You may have seen an announcement from Crown Castle during NAB about the selection of one of our competitors to support some of their early DVBH demonstrations. In meetings with senior management, Crown Castle indicated their full satisfaction with the performance of Harris transmitters on DVBH trials in Australia and in the U.K. In fact later this month we will be installing a transmitter in their Pittsburgh test bed site. We expect to participate actively in their major roll out tender planned for early 2006.

To sum up the broadcast business we continue to believe we are very well-positioned to continue to benefit in the transition from analog to digital broadcasting in both radio and television global markets. With that summary of the business segments let me turn the call over to our Chief Financial Officer, Brian Roub.

Thank you, Howard. Our strong financial position and the high level of liquidity we enjoy continues. Cash and equivalents were 276 million at the end of the quarter after spending more than 400 million for the Encoda and Orkand acquisitions in the first half of the fiscal year. In the quarter we generated 67 million of cash from operations bringing us to a total of 152 million for the first three quarters of the fiscal year. Each of our segments contributed positive cash flow year-to-date which is a very good thing.

Capital expenditures and depreciation and amortization were 18 million each in the quarter, which is slightly greater than the prior year quarter of 15 million and 13 million which reflects the 3 to 4 million of amortization added by the Encoda acquisition. As I had mentioned before capital spending in our company in this year and in last was concentrated in our government segments and is tied to their exceptional growth. Our focus on Asset Management continues and is paying off. We have made solid improvement over the past several years and I expect to have continued improvement in the final quarter of this fiscal year and to continue that improvement through all of fiscal 2006. Sequentially day sales outstanding in the quarter improved to 58 days. That's down from 60 days in the prior quarter.

Inventory turns were even with the prior sequential quarter at 9.3 turns and operating working capital at the end of the quarter was approximately $309 million, which is about 10% of sales and that is also flat as a percent of sales with the prior sequential quarter. Return on invested capital is a very high number for us given our history over the past few years in this quarter was 15% which is a repeat of what we did in the second quarter, a strong performance.

During the quarter we didn't buy back any stock because in effect the pending stock split that was going to occur early and at the end of the quarter. Under our existing repurchase program we have already sales remaining to repurchase approximately 5.3 million shares and we expect to continue to repurchase shares in the open market to offset the dilutive effect of the shares we issue under our stock incentive and retirement plans.

On March 31, we entered into a $500 million five-year senior unsecured revolving credit agreement with a syndicate of our lenders. This replaced our previous $300 million facility and on more favorable terms. As I noted earlier our liquidity remains outstanding, the earliest maturity of any of our long-term debt is in 2007 and the 500 million credit facility I just mentioned is all available to us. We also have debt capacity beyond the unused facility were it needed. The Company's total debt to total capital ratio remains very low at 22% and our credit ratings of BBB plus from S&P and BAA2 from Moody's were both confirmed during the quarter.

As far as our outlook for cash flow for fiscal 2005 I am sure we can deliver on what we have communicated before. We've had three quarters of solid performance and I expect Q4 to be strong as well. I expect cash flow from operations to be in the 200 million to $250 million range as previously communicated. That range may seem too large to some of you given there's only one quarter to go but the upper end includes a $25 million IRS refund we've been promised to receive from the IRS for many, many months. Hopefully this quarter it will come through. Capital expenditures should be in the 70 to $75 million range with depreciation and amortization between 65 and $70 million.

Finally I would like to briefly touch on two income statement items. The tax rate in the quarter if you've computed it was 33% and we are planning on that same rate to continue for fiscal 2006. Another point is net operating loss in the quarter was about $1 million which was down quite a bit from our second quarter where we had some anomalies where we had sold some underwater securities. Going forward I expect that nonoperating loss to be in the 1 to $2 million range per quarter. Back to Howard.

Thanks, Brian. Let me conclude my remarks by discussing our outlook for fiscal years 2005 and 2006. We have increased our fiscal year 2005 earnings guidance based on Q3 results from a previous range $1.43 to $1.48 per diluted share to a range of $1.45 to $1.50 per diluted share. Revenue in fiscal 2005 is now expected to grow by 17 to 18% compared with fiscal year 2004 to nearly $3 billion. This compares to previous guidance in the 16 to 18% growth range. Revenue in government communication systems is now expected to grow 19 to 20% compared to previous guidance of 16 to 18%.

Expected operating results for the year include income of about $14 million as I've previously stated from the settlement of fiscal years 2001 and 2002, overhead rates with the U.S. Government. Operating margin for fiscal year 2005 if you exclude those adjustments should be around 10.5% reflecting nice improvement over fiscal year 2004 and continued excellent program performance and program award fees. Revenue growth in RF Communications for the year will likely be 21 to 22% higher than last year compared with 19 to 20% at previous guidance. Operating margins including the benefit of the Bowman cost reduction which I've discussed should reach 30 to 31% of sales for this year.

In the microwave segment stronger third quarter international orders should drive sequential revenue growth in the fourth quarter. But we still have that tough compare with last year because of the MTN Nigeria business. Higher sales volume and a more favorable product mix of TRuepoint would certainly improve operating income and margin in the fourth quarter sequentially. In the broadcast segment we are extremely pleased with the results of the Encoda Systems acquisition expected to continue to perform as previously expected. Order rates in the core broadcast business in the third quarter should help again drive higher revenue and operating margin sequentially in the fourth quarter similar to microwave. The level of operating margin improvement will be limited in the near term, however, due to the soft international demand and manufacturing over capacity and expenses in Europe.

Now moving on to fiscal year 2006. As previously announced in our March analyst meeting we expect earnings in the range of $1.63 to $1.68 for the fiscal year. To achieve these earnings we expect revenue growth of 8 to 10% for the Company. Revenue growth at Government Communications Systems, Microwave Communications and the core Broadcast Communications segments are expected at the lower end of this range of around 8% year-over-year. Revenue growth at the RF Communications segment is expected to be at the high end of this range of about 10%, or above, depending on future orders. The full year contribution from Encoda Systems of course will also be added to year-over-year revenue growth.

And finally on the profitability side for fiscal year 2006 at the Government Communications Systems and RF Communications segments we believe we should be able to sustain return on sales at fiscal year 2005 levels when you adjust for the two special income items that I've articulated. Profitability at Microwave Communications and at the core Broadcast Communications business are expected to continue to steadily improve as a result of cost reduction programs, new products and higher revenue. At this time we would like to ask the operator to open the line and we will take your questions.

[OPERATOR INSTRUCTIONS] We will take our first question from Byron Callan from Merrill Lynch.

Just out of curiosity the supplemental you mentioned hasn't been passed, it will get done in May, but do you think you really have pretty good visibility in all that's going to come out of that? I think at the March meeting there were still some questions about how some of the intelligence programs might benefit and this may be another way of feeling you out on fiscal 2006 if there still may be some upside from a final version of the supplemental packets for '05.

Well, first of all we'll have to see what they come out of conference with. I think that the guidance we've provided, Byron, indicates what we have high confidence in receiving especially in the RF tactical radio area. There's always opportunities for upside. With regard to specific intelligence funding, I think that's still a bit of an open switch. We don't really have any better information than we provided in March at that time. We said that our customers were telling us their overall budgets were going to grow pretty much with inflation and having said that in the previous supplemental budgets we have gotten some additional business for various activities and technology but at this point we just don't have that granularity, I'm sorry, I hope that by the time we get to the July call and poised for the new year that we will have better visibility there. But we are certainly feeling very positive as it relates to how the supplemental is going to help provide additional orders and therefore revenue for the RF division?

Just a follow-on if I can, on the acquisition front, anything new to report there? Is it fairly quiet, or are you actively looking at things? Can you just give us some color on that front?

I can't comment on any specific activities until we would be ready to announce but, yes, we certainly continue to look at strategic acquisitions. I'd say we are doing that on a regular basis but not with any kind of a timetable to force something to happen. And as we said in March, all things being equal we would like to work toward better balancing the Company with commercial revenue and government revenue so we are looking at probably a larger list of commercial opportunities but Bob and I also have been talking about opportunities that exist on the government side. So our view is if it's strategic to our business, if it fits with our technology play, and if it creates financial value for shareholders, we need to be engaged in those discussions and we are.

I will turn it over to someone else. Thank you.

That you.

We will go now to John Bucher with Harris Nesbitt.

A question for you on the RF communications profitability that you are expecting FY '06. You said comparable to FY 2005 which I think is 30 to 31% or so. And this past quarter we saw 34.5% or so due to the more favorable contract manufacturing terms. That was just a one time increase in operating profitability you are anticipating that you saw this quarter?

Yes. The way that the percent of completion accounting worked John is when we got this big cost reduction that meant that our total program cost went down and so we had to prorate that back and take the income, the savings essentially for what we've already shipped program to date and that calculated to $8 million. So we would suggest you take $8 million out of whatever you expect this year to be and use that as our guidance for next years margin. We think that those, that return on sales with maybe a slight upside because we are expecting growth and higher volume would kind of direct you to what we think we can do in terms of returns next year.

I see. Thank you. And then one other question, on the broadcast market, you indicated a softer than expected international market. Do you think it was primarily just soft conditions region wide where you had penetration, or do you think there could have been any sort of market share decline?

I can't pinpoint any particular item. I think it falls into two categories. Europe has been soft and we had expected it to rebound and to help drive higher revenue. That hasn't happened and so as a result we are looking at our overall cost structure and what actions if any we want to take. When I talk about international we are talking primarily about high power A. M. Analog radio transmitters and analog television transmitters primarily going into developing or emerging markets and the issue in those markets as is always the case is funding. The demand is clearly there. The need to upgrade systems as was done in Romania but the, it tends to be kind of lumpy because these tends to be fairly good size projects and you don't always get them in the quarter when you expect. So we will continue to pursue them. We think funding will come along in most of them. But clearly the overall demand for those kinds of products are a little lower than we had expected.

Thank you. Impressive RF numbers.

We agree. Thank you.

Chris Donaghey with SunTrust has our next question.

Howard, I was wondering if you could maybe provide some color on what the fate of the Cluster one program is. You've already had the date push back from '05 to '08 and it's being reported today that Boeing has been given notice by the Army, a 30-day notice that it could terminate for default the company's contract for cluster one just based on a limited ability or I guess they just don't have the confidence that Boeing can deliver. Can you provide some additional commentary on what's going on with the Cluster one?

Sure. Let me ask Bob Henry to address that.

Yes, I believe what Boeing is expecting is what they call a show cause letter.

Correct.

Boeing will have a certain period of time to respond to that letter. This is as far as I'm concerned this is all part of the process that occurs in the government and it's -- they use it mainly to get the contractors attention especially the prime contractors attention. So although it doesn't occur all the time it does occur when there's cost issues on a program. We are continuing with some of the work on the, on Cluster one. So we haven't stopped all our work on Cluster one. And I expect that within the 30, 60-day period of time Boeing will have responded to that with help from Harris. And a new plan will be in place to move forward. So I believe that we actually will get over this and I say we I mean Boeing as the prime, and the rest of the teammates will get over this to go forward with a new program.

What I would add, Chris, is that we are not counting on Cluster one or Cluster AMF, the two that we are participating on, to drive a huge amount of revenue in FY '06. We've kind of discounted most of that. All the programs together are this year only around 20 to $25 million and we don't have them going up a whole lot next year for us. Frankly, we have the radios available now that work and the customer is very happy with them and we've had no problem in getting waivers and my personal view is when we have the Falcon III and start releasing that we are going to have, make a very strong case that a company like Harris is already producing these products and we will see what impact that might or might not have on some of the programs in the JTRS area. Clearly the interoperability between space, air, and ground is all very important and JTRS helps to accomplish that but it's a very, very large program.

I guess just as a follow up to that with a little bit more color, should JTRS continue to slip can you talk a little bit more about what the implications are with both Falcon II and Falcon III over the next three to four years?

Well, certainly it's only speculation but Cluster five probably has the most direct implication on it. Cluster one which is vehicular and AMF which is primarily the air -- airborne, that really was incremental for us. So I don't think -- we don't right now see a big down side. We are developing wave forms. We are developing crypto solutions and it is -- so it's contributing some revenue but I think that as those slip to the right I personally think our situation certainly is not hurt and one could argue that we even get stronger.

One last question. You mentioned you had 215 million in orders in RF in third quarter. Can you comment on what the total backlog is there?

Yes. We said 215 million, 2 1 5 in orders, and the backlogs in excess of $400 million, 215.

We will go next to Jim Mcilree with Unterberg, Towbin.

Could you comment on the sequential increase in headquarters expense up a couple million bucks?

I don't know anything specifically that comes to mind, Jim, with that. I honestly don't. Nothing is jumping out at me unless Pam or Brian can think of it.

The rising -- and it affects our --.

Every time the stock price goes up we have shares held in a supplemental retirement plan which we mark-to-market. So that's one of the them. But I suspect it was just timing if I recall last quarters was maybe a little low sequentially. So probably was just a timing issue. We are still paying attention to our Ps and Q.s here in terms of overhead cost at headquarters and are only adding people where there are major initiatives of such as the supply chain initiative where we've added several senior people and they are going to earn with their program many times their cost. So we are trying to keep a lid on rising costs and corporate headquarters line always lower than revenue.

Can you help me understand the broadcast margins because if I'm looking at this right, Encoda for a full quarter seems like it should have contributed at least versus the prior quarter about 2 million extra in income? And if that's right then it means that the core broadcast was down, maybe $4 million, 4, $5 million? And it just seems like a really large decline in income for a business that's doing 70 million a quarter. And it seems like it's barely break even, the core broadcast business at 70 million a quarter. Is my math right and if it is can you explain to me what's going on there?

Well, I think your math is close. You say 4 to 5 million. I think it's about 4. Some of that is clearly on the lower sequential volume and the mix of that volume being much lower in the analog international products in television and radio; as well as lesser demand in Europe than the previous quarter which clearly under absorbed our factory overhead cost. And then the third point is we made specific decisions to add cost to move along some development programs and give them additional funding as well as to place more emphasis on sales and marketing investment. While we run the business certainly individual division by division our overall performance of the Company is meeting or exceeding any expectations we set and I think now is the time that you invest for future growth and so, Jeremy Wensinger and I talk about that frequently and we are clearly investing in both our software and our hardware side of that business. Having said that we were disappointed by the international revenue and are working on various actions to try and increase revenue or re-examine the cost side to improve profitability somewhat.

Okay. I'm just, I'm not disputing that or arguing with that it's just that in fiscal '06 at least the way that you've constructed your guidance you need big improvements in microwave and broadcast margins in order to hit the EPS numbers that you've suggested. So having a decline in the margins now unless something is done or this revenue shortfall in your, the way you called it is temporary, I mean you've got an issue there.

Well, clearly we are expecting higher margins next year, We could probably debate how much higher or whatever. We are about on track I think in microwave with where we expected to be at this point, Jim. We are a little behind that track now in broadcast on where I had hoped to be. On the other hand the opportunity and the results in Encoda are outstanding. That's the reason we did the acquisition. We are putting those businesses together in terms of the Harris software business and Encoda. There's more cost to take out there. We are going to go after getting that.

I still feel that, obviously we feel we can achieve the overall EPS we've set for next year and improvement in microwave and broadcast will be required to do that. This quarter from a return on sales standpoint was not great in broadcast. We agree. We've articulated some of the reasons for it. Some of them will be recurring. Some of them will not be recurring. And clearly part of what's factored into our guidance for next year are some additional cost actions that we will most likely be in a position to announce some time in Q4.

We'll take our next question from Larry Harris with Oppenheimer.

Yes, thank you and congratulations on the results for the quarter. With respect to the supplemental, assuming that it works its way through the conference committee and is signed by President Bush, say, in the May time frame, what sort of impact would that have, say, upon the pattern of revenues at the RF division in fiscal 2006. Could we see the revenues being stronger than has been the historical norm in the first half of the year? Any thoughts as to what the pattern of revenues might be.

We've been looking at that. I will have the best answer for you in July. Once we kind of have the orders. But I think it's likely we will have a little stronger first half than we had this year. But the customers are giving us the orders they don't want them all next week and so we are scheduling out with the customers the dates for delivery and so on. So I think you could have the total year be a little higher in the first half as a percent of the total but I don't think it's going to be drastically different than this year, again as orders continue to come in in Q4 we will have a better feel for that. But I think your conclusion if you start the year with a higher backlog than the previous year you will probably have a pretty good first half revenue-wise relative to the previous year. We certainly think that's all true.

With respect to the domestic broadcast business you see signs of significant interest for full power transmitters from some of the smaller stations in the digital TV area?

Yes. I think there is what we call a measured transition going on but I don't think that's going to drive a huge amount of our growth. The growth, the year-over-year has to come from many of the new initiatives that we've been talking about such as HD radio which is providing that growth. We need to get back on track in the international revenue area. We have a new manager on board focused on international channels distribution. I recently signed an agreement I think in Italy, expect to see some benefits from that. So, yes, we are seeing the process start to get lined up for spending capital on digital television but not at a rate that would be above what we've been seeing the past few quarters or we would have highlighted that. We are still hopeful that that will come in a little faster but we are not counting on it at this point.

Finally with respect to the order that you received in Mexico are you seeing any increased interest even of on a longer term basis in terms of digital or HDTV outside of the U.S.?

There's a lot of talk. I've kind of discounted most of the talk in Europe because we haven't really seen it but I think we are seeing in some of the developing markets, we are seeing some discussions . And as this starts to -- as the consumer wave continues to build in North America with millions and millions of HD ready sets being sold there's no question in my mind it is going to build internationally. We are interested in seeing some of those markets that have committed to the ATSE standard start to make investments. I think TV Azteca is a major international broadcaster. I think they're going to have a major impact and cause a lot of other people to rethink what they are doing starting first with their competitive broadcast networks in Mexico.

Thank you.

We will go next to Chris Quilty with Raymond James.

Good evening, gentlemen. Got a question for you on the broadcast business. There's been some recent activity in Congress to enforce a December 31, deadline on the broadcast transmission to digital. If that were to happen, would that be, do you think you would see some incremental gains to your current projections and could you give us an idea of the potential size of upside?

Yes, I suppose it would be incremental. No, I'm not in a position sitting here to try and quantify that. I personally think the probability is low but certainly if it starts, if that momentum starts to build we will be in a position to quantify it for you. But I think it's just highly unlikely. Coming back from the trade show I met with a number of senior executives and our customers and I just don't believe it's going to happen.

Okay. Shifting gears to the RF com segment, if the Falcon III radio is going to be available in June can you give us an idea presumably that will be out years before competition has an approved radio. What approval authority might be needed in order to actually sell that product and what would be the realistic time frame from when you might start to generate sales from its launch date?

Well, certainly NSA certification is a prerequisite to use it for classified transmissions within the Department of Defense. We are in the process of getting that already. I don't recall the specific timing, but my impression is that it's not that far after the hand held radio is going to be available in the June time frame or so. So I would expect that sometime this calendar year, the first half of the next fiscal year we were able to actually start shipping some of those hand held radios.

And would that draw away from or cannibalize some of your existing sales or does it create a totally incremental revenue stream for the Company?

Yes, that's the elegance of the way we are structuring this is the hand-held, today we don't have a product to compete with the MBITR radio which is multi-band, something, ,something, from the U.S. unit of Tallus. So this gives us a very competitive hand held unit and, oh, by the way, it is FCA compliant.

Great. Thank you.

We will take one more question.

Our final question comes from Rich Valera with Needham & Company.

Thanks, just a quick one. Did you have a reserve reversal in the current quarter in the government com business?

Yes, that was $3 million and that was related to the 2002 fiscal year. The close out or the anticipated close out, $3 million was reversed in Q3 and we expect another 3 million in Q4 and that's on top of the approximate 8 million which was done in Q1 and Q2 for government year 2001. We've never had this happen before where we closed out two years during one of our fiscal years and had both of them resolve such that we did not need the disallowance reserves. So this is truly extraordinary from that standpoint and if you add those numbers together, about $14 million of the total year income at GCSD from that item and certainly we would suggest that you not include that for next year in calculating your estimates for income from that division. Having said that you take the 14 million out of this year, my expectation for Bob and his team is that they will have some margin expansion next year even if it's a tenth or two on a big base that's a lot of dollars and he and his team have signed up to do that every year.

Very good. Thank you.

Thank you, Rich.

I thank everyone for joining us today and we will talk to you next quarter.

This concludes today's conference call. Thank you all for joining us.