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 Navy and the U.S. Coast Guard ("Coast Guard"). The Navy and the Coast Guard schedule work under such contracts at their convenience.

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. The Navy first awarded us the CVN contract in 1999 and we completed our second five-year contract during the third quarter of fiscal year 2009. During the second quarter of fiscal year 2009, the Navy awarded us a new five-year contract to continue our work on the aircraft carriers through 2013.

On December 1, 2008 Washington State Ferries ("WSF") awarded us a $65.5 million firm fixed-price contract 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 wholly owned subsidiary, Everett, is a major subcontractor on the project.

In July 2007, we, as prime contractor, commenced negotiations with 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. WSF issued the contract 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, which was awarded for $2.3 million, is shared between us and our primary subcontractor, 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 for Part B of the contract. Once the design and cost estimate are complete, we are contractually obligated to negotiate a price and delivery schedule for Part B of the contract, covering the construction of the ferries, with WSF. The timetable for the contract execution of Part B is dependent upon the availability of funds from WSF. 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.

Operating Results

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

Revenue - Our first quarter revenue of $34.6 million reflects a $16.4 million (90%) increase from the same period last fiscal year. The quarter to quarter increase largely results from higher ship repair and new construction volumes. Cost-type and firm fixed price work revenues increased 1709% and 3%, respectively, between the first quarters of fiscal years 2010 and 2009, while work under time-and-material contracts decreased by 48%. New construction volumes increased primarily due to the construction of a new WSF ferry and cost-type volumes increased due to the timing of Navy and Coast Guard availabilities, the most significant of which was the USS Abraham Lincoln. 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, which was a cost-type contract in fiscal year 2005. We established a $3.1 million reserve for this item in the first quarter of fiscal year 2009. We continue to believe that the costs were legitimate and will appeal this matter to the Armed Services Board of Contract Appeals or directly to Federal Court.

The ship repair business consists of individual and short duration repair events, some of which the Government exercised 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 first quarter of fiscal year 2010 was $24.8 million, or 72% of revenue. Cost of revenue during the first quarter of fiscal year 2009 was $13.4 million, or 74% of revenue. The increase in the cost of revenue in the first quarter of fiscal year 2010 is primarily attributable to an increase 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 2010 is primarily driven by the establishment of a $3.1 million revenue reserve (discussed above) in the first quarter of fiscal year 2009.

Administrative and Manufacturing Overhead Expense - Overhead costs for administrative and manufacturing activities were $8.1 million, or 23% of revenue, for the first quarter of fiscal year 2010. During the same period of fiscal year 2009, administrative and manufacturing overhead costs were $7.8 million, or 43% of revenue. The $0.3 million increase in administrative and manufacturing overhead is primarily attributable to the volume increases in the first quarter of fiscal year 2010 versus the same period in the prior fiscal year. The decrease in administrative and manufacturing overhead as a percentage of revenue is attributable to the relatively fixed nature of many of these costs.

Investment & Other Income - Investment and other income (including gain/(loss) on the sale of available-for-sale securities) was $0.5 million for the first quarter of fiscal year 2010. During the same period in fiscal year 2009 investment and other income was $1.0 million. Investment and other income in the first quarter of fiscal year 2010 was impacted negatively by the completion of 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 first quarters of both fiscal year 2010 and 2009. In the first quarter of fiscal 2010 we recorded $0.8 million of expense associated with federal income tax. During the same period in fiscal 2009 we recorded $0.7 million in federal income tax benefit.

LIQUIDITY AND CAPITAL RESOURCES

We anticipate that our cash, cash equivalents and marketable securities position, anticipated fiscal year 2010 cash flow, access to credit facilities and, if necessary, capital markets, taken together, will provide sufficient liquidity to fund operations for fiscal year 2010. However, we expect to finance shipyard capital expenditures 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 June 28, 2009 was $29.6 million, an increase of $1.5 million, or 5%, from the working capital reported at the end of fiscal year 2009. The overall increase is due to an increase in cash of $0.6 million, a decrease in accounts receivable of $1.5 million, a decrease in accounts payable of $1.3 million, and an increase in cost in excess of billings of $3.1 million, which is primarily due to the timing of work and the conclusion of a fixed price project.

Capital Expenditures

We made capital acquisitions of $0.5 million and $0.2 million in the first quarters of fiscal years 2010 and 2009, respectively, for planned improvements to our shipyard facilities.

Credit Facility

Shortly after the end of fiscal year 2009, we re-negotiated certain terms of our $10.0 million revolving credit facility. As of June 28, 2009, 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 a bi-annual basis, provides us with flexibility in funding our operational cash flow needs. We have certain financial debt covenants that we must meet in order to maintain this line of credit. As of June 28, 2009, we were not compliant with all bank covenants and received a waiver from our lender related to this noncompliance. We had no outstanding borrowings as of June 28, 2009 and March 29, 2009, respectively.

Dividends

On June 23, 2009 we paid a dividend of five cents ($0.05) per share to all shareholders of record as of June 8, 2009. The cumulative amount of dividends paid on a year-to-date basis as of June 28, 2009 was $0.3 million.

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 $11.1 million at June 28, 2009 for our contingent environmental and bodily injury liabilities. As of March 29, 2009, we had recorded aggregate reserves of $11.1 million. 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 maintain various insurance policies and agreements that provide coverage for 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. Based upon the current credit ratings of both of these companies, we anticipate that both parties will be able to perform under the terms of their respective policy or agreement.

As of June 28, 2009, we recorded aggregate assets of $9.0 million related to our reserves for environmental and bodily injury liabilities. As of March 29, 2009, we recorded aggregate assets of $9.0 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. We record amounts recoverable from insurance companies within our Consolidated Balance Sheets as insurance receivables and, in the case of reimbursements currently due, as a current asset. We record amounts held in security deposits within our balance sheet 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 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 we 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 an 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 in billings in excess of sales for the $3.1 million at issue.

We previously reported that the Navy's Puget Sound contracting office has notified us of several instances of potential noncompliance with Cost Accounting Standards relating to our contract to perform repair work on the aircraft carriers located in the Puget Sound. The instances under review primarily focus on our long standing cost allocation methods applicable to our Navy contracts and the degree to which we allocate indirect costs to work performed under Navy cost-type contracts. We believe that we have valid positions and defenses to the findings of potential noncompliance and we have responded to the notification in an effort to resolve the matter prior to action by the Navy. We have submitted proposals for consideration by the Navy to resolve the outstanding issue but have not received a response. 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 and have not established a reserve.

BACKLOG

At June 28, 2009 our firm shipyard backlog consisted of approximately $82.2 million of repair and overhaul work. Our backlog at March 29, 2009 was approximately $84.0 million. The decrease in the backlog of work at the end of the first three months of fiscal year 2010 is primarily progress on projects.

LABOR RELATIONS

In September 2008, we reached an agreement for a new collective bargaining agreement with the Puget Sound Metal Trades Council (the bargaining umbrella for all unions at Todd Pacific) which the rank and file members at the Seattle shipyard subsequently ratified. The five-year agreement, which was retroactive to August 1, 2008, will expire on July 31, 2013. The shipyard workers employed by Everett are represented by the Boilermakers and Carpenters Unions under a separate collective bargaining agreement that will expire July 31, 2010. We consider our relations with the various unions to be stable.