ITEM 2. MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The Notes to Consolidated Financial Statements are an integral part of Management's Discussion and Analysis of Financial Condition and Results of Operations and should be read in conjunction herewith.

OVERVIEW

We derive a significant portion of our revenues from work performed under our contracts with the U.S. Navy ("Navy") and the U.S. Coast Guard ("Coast Guard"). Work under such contracts is scheduled by and at the convenience of the Navy and the Coast Guard.

We currently hold a Multi-Ship/Multi-Option cost-type contract ("CVN contract") for the non-nuclear repair work on the aircraft carriers home ported or stationed in Puget Sound. We were first awarded the CVN contract in 1999 and completed our second five year contract during the third quarter of fiscal year 2009. During the second quarter of fiscal year 2009, we were awarded a new five-year contract to continue our work on the aircraft carriers through 2013.

In July 2007 we, as prime contractor, commenced negotiations with the Washington State Department of Transportation, Ferry Division ("WSF") for the terms and conditions of a contract to build up to four 144 auto ferries. We concluded those negotiations and executed the prime contract with WSF in December 2007. The contract is issued in two parts. Part A provides for the design of the ferries and Part B will dictate the terms of the actual construction of the ferries. Part A of the contract was awarded for $2.3 million that will be shared between us, our primary subcontractor, and Guido Perla & Associates of Seattle, Washington, who will provide ferry design services. We reached agreement on the terms and conditions of a subcontract with Martinac Shipbuilding of Tacoma, Washington in December 2007 to be a subcontractor to us. Once the design and cost estimate are complete, we will negotiate a price and delivery schedule for Part B of the contract, covering the construction of the ferries, with WSF. The current timetable discussed between us and WSF would project contract execution of Part B during the winter of 2008-09. There are no assurances that we will reach agreement with WSF on a price for construction of the ferries, a mutually acceptable delivery schedule, or that the necessary funding will be available from the State of Washington to build any or all of the ferries.

On December 1, 2008 we were awarded a $65.5 million firm fixed price contract from WSF for the construction of one 64 - Auto Ferry. The ferry, to be built in our Seattle shipyard, is scheduled to be delivered 18 months after the Notice to Proceed was issued by WSF on January 5, 2009. Our newly acquired Everett Shipyard, Inc. is a major subcontractor on the project.

ACQUISITION OF ASSETS OF EVERETT SHIPYARD, INC.

On March 31, 2008, we acquired the assets of Everett Shipyard, Inc. ("Everett"). Everett performed ship repair work for a range of government and commercial customers, including the United States Navy and Washington State Ferries, at two locations in Everett, Washington.

The assets acquired include Everett's interest in a 1,000 ton dry dock. Everett and our Seattle shipyard do not generally compete for the same contracts. Everett has assumed the collective bargaining agreements with the International Brotherhood of Boilermakers, Local 104 and the United Brotherhood of Carpenters, Local 1184. The new yard employs the workforce previously employed by the former owner.

Operating Results

All comparisons within the following discussion are to the corresponding period in the previous year, unless otherwise stated.

Revenue - Our third quarter 2009 revenues of $33.5 million reflects a $5.6 million or 14% decrease from the same period last fiscal year. The quarter to quarter decrease largely results from lower ship repair volumes. Cost-type work decreased by 65% from the same period last fiscal year due to the timing of Navy and Coast Guard work. Firm fixed price work increased by 85% from the same period last fiscal year.

Revenue for the first nine months of fiscal year 2009 was $80.3 million, which reflects a $22.6 million decrease or 22% from the same period in fiscal year 2008. The year to date decrease largely results from lower Navy ship repair volumes. We previously reported that we received a notice from DCAA questioning the reasonableness of a payment to one of our subcontractors for work performed on the aircraft carrier USS John C. Stennis in fiscal year 2005. We established a reserve for this item in the amount of $3.1 million and booked the resulting transaction as a reduction in revenue in the first quarter of fiscal year 2009.

The ship repair business consists of individual and short duration repair events, some of which are exercised by the Government under its various multi-ship, multi-option contracts. Consequently, operating results for any period presented are not necessarily indicative of results that may be expected in any other period.

Cost of Revenue - Cost of revenue during the third quarter of fiscal year 2009 was $22.1 million, or 66% of revenue. Cost of revenue during the third quarter of fiscal year 2008 was $26.8 million, or 69% of revenue. The decrease in the cost of revenue in the third quarter of fiscal year 2009 is primarily attributable to a change in volumes versus the same period in the prior year. The decrease in the cost of revenue as a percentage of revenue in fiscal year 2009 is primarily driven by a quarter-on-quarter increase in the relative profitability of work performed in fiscal year 2009.

Cost of revenue during the first nine months of fiscal year 2009 was $55.2 million, or 69% of revenue. During the comparable period in fiscal year 2008, cost of revenue was $75.0 million, or 73% of revenue. The decreases in the cost of revenue in the first three quarters of fiscal year 2009 are primarily attributable to a change in volumes versus the same period in the prior year. The decrease in the cost of revenue as a percentage of revenue in the first nine months of fiscal year 2009 versus the prior year are primarily attributable to the increase in the relative profitability of the work performed in the current year.

Administrative and Manufacturing Overhead Expense - Overhead costs for administrative and manufacturing activities were $8.7 million, or 26% of revenue, for the third quarter of fiscal year 2009. During the same period of fiscal year 2008, administrative and manufacturing overhead costs were $8.8 million, or 23% of revenue. The $0.1 million decrease in administrative and manufacturing overhead is attributable to the volume decrease in the third quarter of fiscal year 2009 and cost containment measures implemented by us in the current fiscal year.

Administrative and manufacturing overhead costs for the first nine months of fiscal year 2009 were $23.8 million, or 30% of revenue. During the same period of fiscal year 2008, administrative and manufacturing overhead costs were $26.4 million, or 26% of revenue. The $2.6 million decrease is the result of lower volumes during the first nine months of fiscal year 2009 versus the same period in the prior year and cost containment measures mentioned above. But for the need to establish the $3.1 million revenue reserve (discussed above) in the first quarter of fiscal year 2009, the administrative and manufacturing overhead expense as a percentage of revenue in fiscal year 2009 would have been 29%.

Investment & Other Income - Investment and other income (including gain on available-for-sale securities) was $1.3 million for the third quarter of fiscal year 2009 and $3.5 million for the nine months ended December 28, 2008. During the same periods in fiscal year 2008 investment and other income was $0.8 million and $3.1 million, respectively. Investment and other income in fiscal years 2009 and 2008 has been impacted favorably by contracts to lease certain facilities and provide related services to Kiewit-General in connection with their construction of the Hood Canal Floating Bridge.

Income Taxes - Our effective income tax rate was 34% in the quarters of both fiscal year 2009 and 2008. In the third quarter of fiscal 2009 we recorded $1.3 million of expense associated with federal income tax. During the same period in fiscal 2008 we recorded $1.4 million in federal income tax expense.

Our effective income tax rate was 34% in the first nine months of both fiscal years 2009 and 2008. We recorded $1.6 million in federal tax expense in the first nine months of fiscal year 2009, and $1.5 million in federal income tax expense in the first nine months of fiscal year 2008.

LIQUIDITY AND CAPITAL RESOURCES

Management anticipates that our cash, cash equivalents and marketable securities position, anticipated fiscal year 2009 cash flow, access to credit facilities and, if necessary, capital markets, taken together, will provide sufficient liquidity to fund operations for fiscal year 2009. Accordingly, shipyard capital expenditures are expected to be financed from working capital. Changes in the composition and/or timing of projected work could cause planned capital expenditures and repair and maintenance expenditures to change.

Working Capital

Working capital at December 28, 2008 was $32.0 million, a decrease of $2.3 million, or 7%, from the working capital reported at the end of fiscal year 2008. The overall decrease is due to a decrease in cash of $6.7 million, primarily due to the cash outlay for the acquisition of Everett. Accounts receivable increased $6.2 million, accounts payable increased $1.8 million and sales in excess of billings increased $1.3 million, primarily due to the timing of work and the conclusion of several large fixed price projects in the first nine months of fiscal year 2009.

Capital Expenditures

Capital expenditures of $1.4 million for the third quarter and $1.9 million for the first nine months of fiscal year 2009 were attributable to planned improvements to the Seattle shipyard facility. These capital expenditures were offset by a favorable determination by the Washington State Department of Revenue regarding sales tax that was previously capitalized with the construction costs for a pier trestle, which resulted in a $0.2 million decrease of the total capitalized cost for the construction of a pier trestle which was recognized in a prior quarter of the current year.

Credit Facility

In the third quarter of fiscal year 2009, we extended our $10.0 million revolving credit facility through July 2010. As of December 28, 2008, we have a letter of credit outstanding of $0.5 million, reducing our available credit facilities to $9.5 million. The credit facility, which is renewable on an annual basis, provides us with greater flexibility in funding our operational cash flow needs. Borrowings on the line of credit have an interest rate, at management's discretion, of either the prime rate or LIBOR rate plus 1.5%. Furthermore, we have certain financial debt covenants that it must meet in order to maintain this line of credit. We are in compliance with all debt covenants and had no outstanding borrowings as of December 28, 2008 and March 30, 2008, respectively.

Dividends

On September 22, 2008 and on December 23, 2008 we paid dividends of five cents ($0.05) per share to all shareholders of record as of September 5, 2008 and December 8, 2008, respectively. The cumulative amount of dividends paid on a year-to-date basis as of December 28, 2008 was $0.9 million. Our Board of Directors announced a dividend of five cents ($0.05) per share to be paid on March 20, 2009 to all shareholders of record as of March 5, 2009.

Correction of Prior Period Misstatements

During the current quarter ended December 28, 2008, we discovered an error in how we reported several funds that were held by one of our health insurance carriers. These funds are held in a premium stabilization fund account (the "PSF Account") and an incurred but not reported claims reserve account (the "IBNR Reserve"). Although these funds were not previously reported on our balance sheet, management has determined that they are reportable assets and that their value should be included in our consolidated financial statements and would have reduced our past insurance expenses.

Accordingly, management has determined that our accumulated retained earnings were understated by $2.9 million as of April 3, 2006, and net income was overstated by $71,000 and understated by $7,000 as of the end of fiscal years ending April 1, 2007 and March 30, 2008, respectively. For the three and nine months ending December 28, 2008 and December 30, 2007, the error had no impact on reported cash flows from operating, financing or investing activities and is considered immaterial to previously reported results of operations. Since the cumulative impact of correcting this error would be material to the results of the current quarter ended December 28, 2008, we applied the guidance of Staff Accounting Bulletin No. 108 ("SAB 108"). This guidance requires that the prior period financial statements be corrected, even though such revisions previously were, and continue to be, immaterial to the prior period financial statements. As the accounting for the PSF Account and IBNR Reserves is based on annual reporting that we receive in the fourth quarter of each fiscal year, the misstatements only impact the balances during the fourth quarter of each prior fiscal year.

We intend to establish a Voluntary Employees Benefit Trust (the "VEBA Trust") to fund health benefits for retired employees by the end of fiscal year 2009 and transfer a portion of the funds held by one of our health insurance providers into the VEBA Trust to pay future health benefits for certain retired employees. The value of the funds expected to be transferred is approximately $2.7 million.

We have also discovered that the annual amounts transferred in prior periods from the Todd Shipyards Corporation Retirement System defined benefit plan (the "Retirement Plan") to fund health benefits for certain retired employees did not consider the funds available in the PSF Account and IBNR Reserve. We calculate the amount to transfer from the Retirement Plan based on the requirements provided by Section 420 of the Internal Revenue Code (the "Section 420 Transfer"). In the fourth quarter of fiscal 2009, we intend to make a contribution to the Retirement Plan of approximately $2.1 million, in order to return $1.1 million of principal and $1.0 million of accrued interest to the Retirement Plan. We are still determining any potential tax implications from this matter. See Note 13 for further details.

RESERVES AND OTHER CONTINGENCIES

As reflected in the balance sheet and discussed in Note 4 to the financial statements, we have provided total aggregate reserves of $11.2 million at December 28, 2008 for our contingent environmental and bodily injury liabilities. As of March 30, 2008, we had recorded aggregate reserves of $11.4 million. All of the decrease from the prior period bodily injury liabilities relates to the settlement of bodily injury claims. Due to the complexities and extensive history of our environmental and bodily injury matters, the amounts and timing of future expenditures are uncertain. As a result, there can be no assurance that the ultimate resolution of these environmental and bodily injury matters will not have a material adverse effect on our financial position, cash flows or results of operations.

We have various insurance policies and agreements that provide coverage of the costs to remediate environmental sites and for the defense and settlement of bodily injury cases. These policies and agreements are primarily with two insurance companies. During the second quarter of fiscal year 2009 the AM Best credit rating for the underwriter providing the coverage for the Harbor Island Superfund Site was reduced from A+ (Superior) to A (Excellent). The primary underwriter for bodily injury cases maintains an A+ (Superior) rating as of the quarter ended December 28, 2008. Based upon the current credit rating of both of these companies, we anticipate that both parties will be able to perform under the policy or agreement.

As of December 28, 2008, we have recorded aggregate assets of $9.0 million related to our reserves for environmental and bodily injury liabilities. As of March 30, 2008, we recorded aggregate assets of $9.1 million. These assets reflect receivables under contractual arrangements with the insurance companies to share costs for certain environmental and other matters, as well as amounts deposited to securitize certain remediation activities. Amounts recoverable from insurance companies are recorded within our Consolidated Balance Sheets as insurance receivables and, in the case of reimbursements currently due, as a current asset. Amounts held in security deposits are recorded within our Consolidated Balance Sheets as restricted cash.

We previously reported that we received notice from the DCAA questioning the reasonableness of a payment to one of our subcontractors on the 2005 dPIA of the aircraft carrier USS John C. Stennis. During the first quarter of our fiscal year 2009 the DCAA issued its final report disapproving $3.1 million of costs related to payments made to the subcontractor and costs incurred by us to perform work which was contracted to the subcontractor. The Navy contracting officer then issued the decision to disallow the costs and withhold the above stated amount from payments due on our current contracts with the Navy. In response, we filed a Request for Equitable Adjustment ("REA") with the Navy contracting officer to allow the $3.1 million in incurred costs. In the event of an unfavorable decision on our REA we will file an appeal to the Armed Services Board of Contract Appeals or directly to federal court. We established a reserve for this item in the amount of $3.1 million and booked the resulting transaction as a reduction in revenue in the first quarter of fiscal year 2009. The Navy collected the entire amount in the second quarter of fiscal year 2009 through the non-payment of other outstanding project receivables. We continued to meet with the Navy in the third quarter of 2009 and the Navy agreed to return the $3.1 million while they considered our REA. We agreed to supply additional information to the Navy to assist in the resolution of the REA which we have now accomplished. We re-billed the Navy for the $3.1 million outstanding and the Navy paid the invoices in the third quarter of fiscal year 2009. There are no assurances that the Navy will agree with our REA. Our current financial statements continue to reflect a reserve for the $3.1 million at issue.

The Navy's Puget Sound contracting office has notified us of several instances of potential noncompliance with the Cost Accounting Standards ("CAS") relating to our Planned Incremental Availability ("PIA") contract to perform repair work on the aircraft carriers located in the Puget Sound. The instances under review primarily focus on our long standing allocation methods applicable to other Navy contracts and the degree to which indirect costs are allocated to work performed under our PIA contract. We believe that we have valid positions and defenses to the findings of potential noncompliance and we are responding to the notification in an effort to resolve the matter prior to action by the Navy to determine that noncompliance exists. An unfavorable outcome in this matter could have a significant impact on our cost structure with the Navy and, depending upon the scope of any retroactive relief sought by the Navy, could be material in the period recorded. At this time, we are unable to estimate our potential exposure for this item.

BACKLOG

At December 28, 2008 our firm shipyard backlog consisted of approximately $89.5 million of repair and overhaul work. Our backlog at March 30, 2008 was approximately $12.0 million. The increase in the backlog of work at the end of the first nine months of fiscal year 2009 is primarily due to the timing of commercial and Government ship repair projects and the award of a contract to build one new 64-Auto Ferry for Washington State Ferries.

LABOR RELATIONS

During the second quarter of fiscal year 2009 we completed our negotiations for a new collective bargaining agreement with the Puget Sound Metal Trades Council (the bargaining umbrella for all unions at Todd Pacific Shipyards). The five-year agreement ratified by our workforce provides for an average increase in wages and benefits of 4.5% per year with an expiration date of July 31, 2013. We believe our relationship with our labor unions is stable.