Building Backlog: The Key to United Industrial Corporation's Defense

| About: United Industrial (UIC)

United Industrial Corporation (UIC) designs, produces, and supports aerospace and defense systems through its wholly owned subsidiaries AAI Corporation, AAI Services Corporation, Aerosonde Pty Ltd, ESL Defence Limited, McTurbine Inc., and Symtx, Inc. Products and services include unmanned aircraft systems, including a complete family of advanced tactical unmanned aircraft systems - the Shadow 200, Shadow 400, and Shadow 600 systems. UIC also offers training and simulation systems that have helped train virtually all U.S. Navy and Air Force electronic warfare systems officers. In addition UIC provides automated aircraft test and maintenance equipment, armament systems, logistical and engineering services, and other leading-edge technology solutions for aerospace and defense needs.

Only the Defense business is shown in the table below, since the company has sold the Detroit Stoker, their energy business. Revenues for the 3rd quarter grew at a slower rate 12.4% than they grew for the nine months 21.0%. This slowdown in sales will be a concern if the company is unable to book new funded business that is greater than ongoing quarterly sales. The reduction in income for the quarter compared to last year was explained above and should be a one time event.

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Key Drivers, Barriers and Backlog

Drivers

UIC is a small defense contractor that is operating in several growing segments of the industry. While it has a growing backlog, as shown below, it is highly dependent on current and new defense procurements for its products and services. Presently it is building new and supporting upgrades to the Shadow Unmanned Aerial Vehicle (UAV) that is expected to be in the US Army through 2012. Additional opportunities for the current Shadow lines are available in other parts of the military, government agencies and foreign countries. They also have growing Services, Testing & Training and Advanced Programs business segments.
Barriers

At this point the primary barrier United has established is the success of the Shadow program for the U.S. Army. While not a significant barricade that the larger defense contractors cannot overcome, it does offer them some ability to sustain their position. Also, this backlog does not include funded sales from their recent acquisitions of McTurbine and Symtx estimated to be $10-12 million for the quarter.

Backlog

The company experiences “lumpy” sales that depend primarily on funded orders from the U.S. Government. During the fourth quarter the company received $183.7 million in new disclosed orders. This should continue to increase their current backlog, a good near term sign.

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Risks

Defense spending slowdown in the next year or so, should the US begin to pull out of the war. The initial impact on the company is likely to be minimal as they are contracted to deliver the funded products and services indicated above. Also, many of the services provided by the company are expected to be used in a more normal peace time, though the there may be some reduction in the need for some of the repair services. However, the expectations that there will be less defense spending is likely to cause investors to be wary of the stock.

Detroit Stoker, the company's energy business unit had potential asbestos liabilities. With the sale of Detroit Stoker, on December 29, 2007, the company transferred the liability to the acquiring company, reliving itself of this potential risk. UIC received $17.2 million in cash and a partially guaranteed promissory note for $5 million payable in 6 years.

Other Considerations

On November 14, 2006, the company acquired McTurbine, Inc. a privately held company, for $31 million in cash. McTurbine is an aerospace industry leader in the maintenance, repair, and overhead of military helicopter engines. In the trailing twelve months ended June 30, 2006, McTurbine realized revenues of approximately $24 million. McTurbine is expected to be immediately accretive to UIC's results of operations.

McTurbine is an authorized service center for Honeywell and Goodrich Corporation, providing overhauls of T53 and T55 turboshaft helicopter engines, as well as T53 fuel control units and governors. Located near the Corpus Christi Army Depot, McTurbine blends commercially licensed airframe and aviation powerplant mechanics with experienced former depot personnel. The company is scheduled to move into a new, larger production facility in Corpus Christi by the end of the year, more than doubling the size of its current facility and enabling it to meet anticipated growth.

In addition to an accretive acquisition, the McTurbine acquisition contributes to UIC:

• They work with many of the same U.S. Army depots as UIC, creating potential for expansion of relationships.
• U.S. Army Aviation is the company’s largest customer.
• UAV sophistication requires greater service requirements, which McTurbine can provide.
• They add to UIC’s engineering and design expertise.

On November 28, 2006, UIC acquired Symtx, Inc., a leading producer of automated test equipment. The purchase price was $34.3 million in cash with the potential for an additional payment of up to $5 million based upon the achievement of certain financial targets in 2007. Based in Austin, Texas, Symtx is a leader in the design and manufacture of high-performance functional test solutions for mission-critical electronic systems. Symtx's customers include most of the major defense and aerospace prime contractors, and the U.S. military.

In the 12 months ended September 30, 2006, Symtx realized revenues of $36.3 million. Symtx is expected to be accretive to United Industrial's results of operations in 2007. Symtx and its 169 employees will continue to be based in Austin, Texas, and will operate as a wholly owned subsidiary of AAI Corporation. Symtx test systems have been selected for use in the development and production of several new and emerging major U.S. military and civil aviation programs, including the F-35 Lightning II Joint Strike Fighter, the U.S. Navy's F/A-18 Hornet aircraft, the Global Hawk unmanned aircraft system, the U.S. military's next-generation Joint Tactical Radio System, and several significant classified satellite payload programs.

The acquisition of Symtx compliments UIC’s subsidiary AAI test business providing automated test systems for military aircraft. Symtx brings AAI additional customers and distribution channels for supplying test equipment and support services to DoD prime contractors. Symtx also provides AAI with new market opportunities as a major supplier of satellite test equipment to major military satellite manufacturers.

On December 1, 2006 UIC announced a new stock repurchase plan for $50 million. The timing of the buy-back and the exact number of shares to be purchased will depend on market conditions.

Conclusions

The key to UIC’s future success lies with their ability to continue to generate new funded backlog that is greater than their sales. While booking this backlog may be lumpy, it is key to the company’s future success. As long as backlog continues to grow, the company should experience good results. While there will be pressure to reduce spending on defense, UIC should be in a position to continue to receive funding for their UAV equipment and support services as the U.S. Army will need to refurbish their existing equipment and continue to find ways to improve troop support in the time of conflict.

Buy UIC near support levels or on breaks of resistance if the volume velocity is sufficiently strong.

Disclosure: Author holds a positionUIC.