Kratos Defense and Security Solutions Inc (KTOS) 2008 Q2 法說會逐字稿

Good everyone, and welcome to the Kratos Defense & Security Solutions Second Quarter 2008 Earnings Conference Call. Today's call is being recorded. (Operator Instructions).

For opening remarks and introductions, I would like to turn the conference over to the Vice President of Investor Relations, Mr. Michael Baehr, who will read the Company's warnings regarding forward-looking statements. Please go ahead, sir.

Thank you. Good afternoon, everyone, and thank you for joining us for the Kratos Defense & Security Solutions second quarter 2008 earnings conference call.

With me today are Eric DeMarco, Kratos' President and Chief Executive Officer, and Deanna Lund, Kratos' Senior Vice President and Chief Financial Officer.

Before we begin the substance of today's call, I'd like to make some brief introductory comments.

Earlier this afternoon, we issued a press release which outlines the topics we plan to discuss today. If anyone has not yet seen a copy of this press release, it is currently available on the Kratos corporate Website at www.kratosdefense.com.

Additionally, I'd like to remind our listeners that this conference call is open to the media, and we are providing a simultaneous Webcast of this call for the public. A replay of our discussion will be available on the Company's Website later today.

During this call, we will discuss some factors that are likely to influence our business going forward. These forward-looking statements may include comments about our plans and expectations of future performance. These plans and expectations are subject to risks and uncertainties which could cause actual results to differ materially from those suggested by our forward-looking statements.

We encourage all of our listeners to review our SEC filings, including our most recent 10-Q and 10-K and any of our other SEC filings for a more complete description of these risks. A partial list of important risk factors is included at the end of the press release we issued today.

Our statements are made on this call today, August 6, 2008, and the Company undertakes no obligation to revise or update publicly any of the forward-looking statements contained herein, whether as a result of new information, future events, changes in expectations, or otherwise for any reason.

Also, this call will include a discussion of non-GAAP financial measures as that term is defined in Regulation G. The most directly comparable GAAP financial measures and information reconciling these non-GAAP financial measures to the Company's financial results prepared in accordance with GAAP are included in the earnings release, which is posted on the Company's Website.

In today's call, Mr. DeMarco will discuss our financial and operational results for the second quarter of 2008. He will then turn the call over to Ms. Lund to discuss the specifics related to our second-quarter 2008 financial results. Eric will then make some concluding remarks about the business, and we will then open up the call to your questions.

With that said, it's my pleasure to turn the call over to Mr. Eric DeMarco.

Thank you, Michael. I will start out today with an update and the status of Kratos' strategy and business plan and some specifics on the integration process of our two recent acquisitions, and then I'll provide an operational overview of the business.

Coming out of our transformation at the end of last year, Kratos was a subscale national and homeland security product solutions and services provider. We were too small to credibly bid on and win large, multiyear contracts in the prime contractor role and not large enough to leverage off our fixed public company general and administrative cost infrastructure to generate acceptable EBITDA margins.

Over the past six months, we have made two strategic acquisitions - Haverstick Consulting and SYS Technologies. These acquisitions have not only doubled our Company's size, but they have also provided Kratos with the resources, the contract vehicles, customer relationships, past performance qualifications, and the overall critical mass required to create a business development organization that has the capabilities to pursue and win large, prime contract opportunities.

Specifically, the acquisitions we have made have put Kratos in the position to bid on several major contract opportunities with major branches of the Department of Defense, which this Company could not have bid on previously. This business development organization is now being led by Cliff Cooke, SYS' former chief executive and now the Senior Vice President of Strategic Development for Kratos. This business development function and its success is absolutely critical to a company like Kratos to generate and sustain organic growth. This is a function that Kratos had not had previously, primarily due to our limited size and resources.

As we move forward, this strategic development function will be absolutely instrumental in Kratos achieving and sustaining its strategic organic growth objectives of up to 10%. The successful integration of these acquisitions is also absolutely critical to Kratos achieving its EBITDA objectives.

Immediately after the SYS merger closed, we executed a planned realignment and consolidation of three Kratos business units into a single division. This business consolidation, in addition to enabling us to better focus our company's resources on the customer, resulted in a significant general, administrative, and overhead cost reduction through the elimination of redundant employee functions and related items, like travel, telecom, benefits, et cetera. Actions in cost reductions like this are an integral part of our acquisition strategy and process, and it is a key element to Kratos ultimately achieving our profitability expectations. Kratos will realize the benefit of these cost reduction actions later this year in the fourth quarter and into 2009, as severance-related costs wind down. Deanna will provide more information on these cost-reduction actions in her remarks.

We believe that it is continually important for us to communicate where we are in building Kratos, as this is clearly an ongoing process. And we are aggressively executing the strategic business plan that we have previously described to you. Now that we have combined the three companies, Kratos, Haverstick, and SYS, we are also looking in other areas to improve performance and profitability.

One of these areas relates to contract mix and increasing the relative portion of Kratos' direct labor in a contract as compared to lower- or no-fee bearing material and subcontractor costs. This can be difficult to achieve, as ideal contract characteristics for Kratos can sometimes be outside of our control. Additionally, in certain geographic areas, cleared personnel may be difficult to obtain as we try and increase the direct labor base. However, successfully executing a transition like this to increase the direct labor mix and recruit these personnel can ultimately improve overall EBITDA margins and cash flow, and this is an area we are working.

We are also currently assessing the business rate structures across the entire business, including general and administrative, overhead, material and subcontract rates, and fringe rates, with the goal of optimizing consolidated structures as we move into 2009 with potential new forward pricing rates. This is an area that may allow us to increase our business development resources in 2009 with minimal ultimate EBITDA impact to the business as we realign our discretionary cost pools.

From a second quarter results standpoint, we achieved our stated revenue growth and EBITDA objectives in Q2. During the second quarter, Kratos continued to make progress against substantially all of the financial and operational metrics of our business plan, and our forward direction is in line with our stated strategic plan. As we reported in our last earnings call, Kratos returned to profitability in the first quarter of '08, and, in the second quarter just completed, we improved on that profitability with expanded EBITDA margins, positive operating income, and positive EPS.

Through the first two quarters of 2008, Kratos is also tracking on the other elements of our business plan, the key aspects of which are - to focus on the markets and areas where Kratos has critical mass, established relationships, and key differentiators. These include command and control systems, weapons systems lifecycle extension and reset, federal IT and networking solutions, and public safety and security solutions. We are also continuing to look at other market areas which we believe are very complementary to our existing business and where we believe substantial opportunity exists. These include cyber security; modeling and simulation; military equipment and systems reset; and certain intelligence, surveillance, and recognizance areas. Specifically, we are organically growing, for example, a modeling and simulation capability in the Company, and we were recently awarded our first prime contract in this area.

The acquisitions of Haverstick and SYS have positioned Kratos to look towards these potential new markets and opportunity areas. This is not something that Kratos could have credibly considered just seven months ago.

For the second quarter, Kratos' major customer mix and related percentage of business were as follows. United States Navy 33%, United States Army 20%, public safety and security customers 18%, other federal government agencies just under 13%, United States Air Force 5%, and other business with other agencies and commercial customers 10% to 11%. This mix will change somewhat for the third quarter when we include SYS' business base in these calculations.

From a business development standpoint, Kratos' qualified bid pipeline at the end of the second quarter was approximately $2.2 billion. Our book to bill ratio during the quarter was greater than one to one. Over the past two quarters, Kratos has won approximately 25% of the new business awards we have pursued, and Kratos continues to win approximately 90% of our contract re-competes.

Important contract wins for Kratos in the second quarter included a $49-million award from the Naval Surface Warfare Center, Crane to support expeditionary warfare systems; an IT and networking infrastructure contract with the Defense Logistics Agency; and a $6.3-million networking and information technology contract win with a non-DOD government agency.

Additionally, during the second quarter, Kratos, along with its team member SA-Tech won its major 2008 re-compete on an aerial target and operations contract. This $59-million contract is for five years, with work being performed at the Naval Air Weapons Center, Point Mugu, China Lake, and at numerous deployed locations, such as White Sands and the Pacific Missile Range in Hawaii. For this particular contract, Kratos' overall revenue going forward will be lower [than] the past, as we are now the subcontractor on the program. However, our margin rate is expected to increase as a result of workload mix and Kratos not having as much material pass through as in previous years.

Kratos has no other major DOD re-competes in '08. We also now have most of our major federal government re-competes secured through 2009.

As I mentioned before, we are closely scrutinizing all of our programs and contracts in order to increase margins and EBITDA, increase Kratos' labor component, and reduce low- and no-fee subcontractor material contract components. As I mentioned before, though this may result in somewhat lower revenue, EBITDA margin rate and cash flow should be improved if we can successfully execute on this.

From a weapons systems and other systems delivery perspective, the Company performed well in the second quarter, especially as it relates to sequential Q2 '08 over Q1 '08 organic growth, with our weapons systems solutions business having a strong quarter, along with our public safety and security business.

As we have said previously, our weapons systems lifecycle extension business is directly related to ongoing programs, and therefore this business is both delivery and milestone driven, which can drive some quarter-to-quarter variation. For example, looking ahead, certain Kratos' weapons systems, related deliveries, and milestones are currently forecast for Q3 to be somewhat less than Q2, with Q4 being at least back to the second-quarter levels. With this in mind, and although our Q2 performance was relatively strong, we believe year-over-year growth is a more realistic manner to gauge the overall progression of the business.

Additionally and related to this, we are currently expecting either later this year or in early 2009 a follow-on order from a customer for an additional 1,400 surface-to-air missile systems. This will position this business very well for 2009 and 2010 and would continue this business' growth trajectory. As a reference point, this weapons system business grew organically nearly 10% last year on a year-over-year basis.

Equipment reset is an important part of Kratos' business, and it is an area we believe can bring solid opportunity for us in the future. Our foreign military sales, or FMS business, related to weapons systems also continues to perform well. This performance is being driven in part by the weak US dollar relative to certain friendly government currencies, which makes US-based systems less costly than non-US-based systems. Additionally, this is an area where the quality of US weapons systems continues to show itself as being superior to former Soviet Bloc and European systems.

Some of the other programs we were involved with during the second quarter and the first half of '08 include the following - a Naval Surface Warfare Center, Dahlgren work program. Our work here is related to gun range support, gun systems support, test firings on the range, and engineering support for test shots on the actual weapons range. Naval Operations, or OpNav program, where Kratos is performing work at the Pentagon, and we are supporting the Surface Warfare Directorate for combat systems on board ships. Work at NAVSEA. This is work related to the acquisition of new weapon and C4ISR systems and support for the lifecycle extension of existing systems. Work at the Cruise Missile Defense office and also work related to the SLAMRAM system at White Sands. Onsite system reset work on thermal viewers, site kilometers, and laser locator designators on units and systems returning from Iraq. Work related to certain other surface-to-air weapons systems. Various work on C4ISR programs. And public safety and security work on a major data networking center in the United States.

As we look ahead, some important second half 2008 operational activities for Kratos include the delivery of 11 Oriole rocket systems related to certain ballistic missile and missile defense programs, the operational tempo maintenance at various targets and weapons ranges, and the installation of certain C4ISR equipment and solutions. We currently have visibility into each of these programs, and they're each incorporated into our business plan for the balance of the year.

From an overall industry or market standpoint, we'd like to make some comments related to both '08 and '09 as we see it today.

The passage of the War Supplemental Spending Bill was a significant event, and we are hopeful that this will be a positive action for Kratos, as, in certain areas of our business, we have been adversely impacted by war requirements, which has resulted in certain of our Air Force projects being pushed out.

On the federal government IT side, we have recently seen a strong amount of new work opportunity and activity in this area, which we currently expect to continue, particularly in some of the defense customer areas where we work.

We are currently expecting there to be a continuing resolution situation later this year and possibly into '09. And we are in the process of addressing specifically what this could mean to Kratos. Preliminary, we do not believe that a continuing resolution will materially adversely affect our weapons systems sustainment, reset, foreign military sales, or C4ISR business areas. Additionally, we do not believe Kratos' public safety and security business would be adversely impacted by a continuing resolution, though overall weak economic conditions in the US may suppress certain areas here somewhat. There are some new awards Kratos is expecting in the second half of this year that potentially be adversely impacted or delayed by a continuing resolution, though we should have more clarity on this as we finish our assessment later on in Q3.

Also, as we know, we have a presidential election coming up in a few months, and both the perceived and real impact of a new administration is out there. The potential result of an administration change, for example, could be new regulations related to small business and other types of [set aside] mandates.

Finally, there is Iraq and if/when a drawdown occurs. This is an area where our weapons systems lifecycle extension or reset business could benefit.

Obviously, these are all items we are closely tracking and accounting for in our actions and in positioning the business.

Overall, we continue to believe the major focus areas of Kratos are well positioned for our Company to achieve our business plan, grow the business, and improve profitability.

I'll now turn the call over to Deanna, who will provide more details related to the Company's financial performance in the second quarter.

Thank you, Eric. Good afternoon. Today we reported quarterly revenues of $72.3 million, a $24.5 million, or a 51% increase, from comparable revenues of $47.8 million in the second quarter of 2007, which reflects a full quarter of operating results for the Haverstick merger, which occurred on December 31, 2007.

Our operating results do not include the impact of the SYS transaction, since the merger closed on June 28, the last day of our second quarter. Our quarter-end balance sheet includes SYS, but the operating results of SYS will not be included in our operating performance until the third quarter.

On a sequential basis, our second-quarter revenues were up $4.1 million, or 6%, from first-quarter revenues of $68.2 million.

Revenues in our government solutions sector were up sequentially $4.3 million, or 7.8%, from $54.9 million in the first quarter and $59.2 million in the second quarter. On a year-over-year basis, our government solutions revenues were up $23.7 million, or 67%, up from $35.5 million in the second quarter of 2007 to $59.2 million in 2008. This year-over-year growth includes the impact of the Haverstick acquisition, which contributed $22.3 million, thereby yielding an organic growth rate year over year of 3.9% in our government solutions segment. The sequential growth in year-over-year growth in our government solutions segment was the result of increases in certain C4ISR programs and weapons systems programs.

Revenues in our public safety and security segment were up year over year $800,000, or 6.5%, up from $12.3 million to $13.1 million, driven primarily by growth in our security access control and facility automation businesses. On a sequential basis, our second quarter public safety and security segment revenues were down slightly from $13.3 million to $13.1 million due to the completion of certain projects.

Our gross margin for the second quarter of 2008 was 17.8%, or $12.9 million, up from 15.7%, or $7.5 million, in the comparable second quarter of 2007. The increase in gross margins is primarily a result of margin improvements in our PSS businesses.

SG&A as a percentage of revenues was down from 22.6%, or $10.8 million, in the second quarter of 2007 to 15.5%, or $11.2 million, in 2008. Sequentially, our SG&A decreased from $11.9 million, or 17.4% of revenues, in the first quarter of 2008 to $11.2 million, or 15.5% of revenues, in the second quarter, primarily since a significant portion of our annual FY '07 audit fees were included in the first quarter SG&A, in the period in which the audit work was completed for our yearend audit.

Along that note, we are pleased to say that we have been successful in negotiating a sizeable reduction to our previous audit fees with our auditors, Grant Thornton, for our FY '08 audit. Now that the complexities of the legacy matters associated with our wireless business are behind us, the audit fee that we have been able to negotiate is more in line with what our comparable government peer companies pay. This audit fee reduction is part of our overall plan to reduce costs and fees throughout 2008 and to position Kratos to achieve its EBITDA objectives. As we have stated previously, our ultimate objective is to achieve EBITDA margins consistent with our comparable peer group as we head into 2009. Other areas where we are currently working to reduce costs include insurance, legal, and outside consultants.

Included in our second quarter operating expenses is a credit of $1.2 million for the recovery of unauthorized issuance of stock options from our insurance carrier and a reversal related to our excess facility accrual for unused office space. Of this amount, approximately $600,000 is related to the insurance recovery from the theft of stock options, which occurred in 2002 and 2003 and that we had discovered through our stock option review last year, with the balance of $600,000 related to the reversal of the unoccupied facility accrual reserves due to our unused office space that we will now occupy as we continue to move the SYS personnel into our San Diego headquarters facility as part of our integration plan.

As Eric mentioned, following the close of the SYS merger, we immediately took actions to execute a significant integration-related business realignment and cost-reduction action to reduce redundant costs, to further increase our profitability, and enhance our competitive position. With the realignment actions that we took and plan to take to integrate the SYS operations into our operations, these costs will be included in our acquired liabilities of SYS and will be included in our SYS purchase price allocation and associated goodwill. For the actions that we have taken in our existing Kratos businesses, these costs will be recorded as an operating expense in the period that the action was taken, which would be our third quarter. The annual cash savings from these personnel reductions, including fringe, is approximately $2 million, the full benefit of which we will realize in FY '09.

We hope to have the integration of both Haverstick and SYS substantially completed by the end of 2008 or by the first quarter of 2009. As we have previously discussed, certain of the integration actions cannot be completed until the first quarter of 2009 due to the timing and resources required to meet yearend financial reporting and Sarbanes-Oxley compliance requirements.

Also, as we have previously stated, we expected the restructuring and transformation actions and activities that we have taken to be substantially complete in the first quarter of 2008 and to return to operating profitability by the first half of 2008. As Eric mentioned, the first quarter of 2008 was the first quarter in which we returned to positive operating income since we exited our legacy wireless businesses and began our transformation activities in 2006.

As we expected, we continued to improve our operating margins and EBITDA margins into the second quarter as we reduced certain of our SG&A expenses, such as our external audit fees and other professional fees, and we began to see the benefits of leveraging our SG&A.

Our operating income was $2.9 million for the second quarter of 2008 compared to an operating loss of $8.3 million for the comparable quarter last year. Included in our current quarter's operating income is a $1.2-million credit related to the insurance recoveries on the stock option theft and reversal of the unused facility accrual. Excluding these credits, operating income was $1.7 million, or 2.4%.

As we have previously discussed, we continue to measure our progress and performance in terms of EBITDA, or earnings before interest, taxes, and depreciation and amortization. We believe that EBITDA from our continuing operations is a meaningful measurement of financial performance due to our extensive acquisition activity, especially since our entire federal business has been built through acquisitions that we have made since 2004 and our public safety and security business was built through acquisitions that were made in 2003.

Additionally, we currently have approximately $150 million in net operating loss carry forwards, which were generated from our legacy wireless businesses, and, accordingly, Kratos is not expected to be a material income tax payer in the foreseeable future.

Excluding the impact of the $1.2-million credit I previously discussed, our EBITDA was $3.7 million, or a 5.1% EBITDA margin, for the second quarter, up sequentially from first quarter EBITDA of $3 million, or a 4.4% EBITDA margin. Barring any unforeseen surprises, we expect to continue to achieve increased GAAP EBITDA profitability in the future through revenue growth, leverage on our SG&A infrastructure, and with the acquisition of SYS.

Income from continuing operations for the second quarter of 2008 includes $2.5 million of net interest expense, primarily related to borrowings on our new credit facility, which was used to fund the acquisition of Haverstick. In addition, included in our income from continuing operations is other income of $1.3 million related to the interest swap arrangement that we have mark-to-market, which was favorable this quarter. We have also excluded this gain from our EBITDA calculation, and it is specifically excluded from our bank's measurement of our EBITDA, as it is noncash in nature.

Our cash balance was approximately $17.4 million at June 29, which includes the SYS cash balances on hand at that time. Our current cash balance as of August 4 is approximately $7.3 million, which reflects the payment of SYS transaction expenses, scheduled principal and interest payments, and the funding of the 2007 securities litigation settlement, all of which were planned disbursements. The remaining funding of the 2004 securities litigation settlement of approximately $3 million is not expected to occur until mid-September.

The cash flow generated from operations was approximately $3.9 million for the first six months of 2008 with approximately $1.9 million generated in the second quarter. With the SYS merger now closed, we expect Kratos' cash flow to improve going forward.

Other key balance sheet and capital structure elements at quarter end are as follows. Accounts receivable, primarily from the US government and other agencies, was $89.1 million. Accounts receivable day sales outstanding, or DSOs, excluding the SYS receivables, were 95 days, down from 106 days in the first quarter, reflecting our continued focus on improving our DSOs. Our receivables include amounts unbilled due to milestone achievements and shipment requirements, particularly on the Company's contracts to provide Chaparral, HAWK, and other weapons systems which are scheduled for collection later on in 2008, once those systems are delivered and accepted.

Bank debt at June 29 was approximately $79.9 million, including $49 million on our five-year term note, $20.9 million on our line of credit, and $10 million in subordinated debt. Net bank debt net of cash as of June 29 is $62.5 million. Our debt to equity ratio at quarter end was 0.38 to 1.

Additionally, from a cash perspective, once substantially all the SYS lease agreements expire at the end of 2008 and early 2009, the combined company should realize overall cash savings in lease payments of just under $1 million per year going forward.

Lastly, as we have stated previously, part of our integration process includes establishing a consistent definition of backlog across our business units after evaluating and considering the various contract vehicles that we have. Since we are still in the process of integrating the recently closed Haverstick and SYS transactions, we anticipate that we will be in a position to report our consolidated backlog, incorporating all of our recently acquired businesses and utilizing a consistent methodology once we have a full quarter of operating performance including the SYS transaction. As we have stated previously, we will continue to define a consistent definition of backlog across all of our business units.

With that, I will turn the call back over to Eric for his final remarks.

Thank you, Deanna, very much.

So, in summary, for the second quarter, the business is performing on track with the business plan. With the SYS merger completed at the end of June, we are reiterating our annualized revenue run rate projection to be greater than $300 million for '08 and a run rate of approximately $400 million for '09. This excludes any additional acquisitions and currently assumes no changes in contract, labor, material, or ODC mix in the contract base.

The integration of Haverstick and SYS are substantially underway, including a third quarter business realignment in G&A infrastructure cost reduction, the full benefit of which is ahead of us and will not be fully realized until Q4 and Q1 '09 due to the runoff of severance payments. This realignment action is directly related to our stated plan to integrate the businesses and to continue to improve Kratos' EBITDA margins and consolidating our current business position.

The key element of the integration plan for Haverstick and SYS relates to business development and winning new work. One of the primary reasons for bringing these businesses together and executing this acquisition strategy is to combine the resource and the past performance qualifications in order to go after new work in the prime contractor role. This process has already begun, with Cliff Cooke, Kratos' Senior Vice President of Strategic Business Development, leading this absolutely critical initiative.

That concludes my remarks. Thank you for joining us today on this conference call. We'd now like to open the call up for any questions that you may have.

Thank you. (Operator Instructions). Our first question this afternoon comes from Mark Jordan with Noble Financial Group.

Three questions. Number one, given your service and product mix, what should be a reasonable long-term target for you on DSOs?

Very good, Mark. Assuming the mix stays the way that it is right now, long-term - 90 days or maybe high 80s. But that's about as good as it can get, assuming no changes in the delivery and milestone characteristics.

Okay. Secondly, with the addition of SYS, obviously, being purchased for stock, what would you project to be your incremental borrowing capacity, again, given the fact that you are larger and that acquisition was done for equity?

Right. Today's credit markets, of course, remain very challenging and tight. And we'd have to take into consideration any additional mark-to-markets of our credit facility, taking into consideration new market characteristics. But one way that we look it, Mark, is-- Let's just say that we were looking at a $50-million opportunity, and it's generating a 10% LTM EBITDA, or $5 million. We'd take that, and we'd add that into our bank EBITDA. We would look at 3 or 3.5 times that total number.

A final question. You just allude your target is to achieve industry norms EBITDA margins over the longer term, once the inefficient costs drop off. Could you define specifically what those EBITDA targets will be?

If we can get into the range of 7 to 9, 7.5 to 9.5, then 8 to 10, that would be fantastic for us.

Okay. Thank you.

(Operator Instructions). We move now to Mike Crawford with Reilly Investment Management.

I realize that we're probably not going to see ever some SYS numbers for the June period until-- at least we're not going to see that quarter. But can you give us just a rough indication? Was it around $19 million revenue and 7% EBITDA or something like that?

It was a little less than that $19 million; it was closer to $18 million. And the EBITDA was less than that due to some one-time transaction costs that impacted their performance that quarter.

Right. Deanna, if you backed out those one-time costs?

Mike, we haven't run that and looked at it that way because we don't pick them up until Q3.

Okay. And then, kind of further to that, I guess another way of looking at the $2 million in expected annual savings (inaudible), it's almost like adding 3 percentage points to their EBITDA margin.

Mike, let me clarify that. That $2 million is not from SYS alone. That $2 million is from the combination of Haverstick's Navy business, Kratos' Navy business, and SYS' Navy business and putting together three Navy businesses into one division, if you will, and the duplicity and the redundancy in G&A functions and overhead functions in both rate pools. It's a combination.

Okay. Eric, just on the guidance, can you just flush out what you mean by a $400 million run rate for next year? Do you mean you expect to enter the year at that level? Is that what you expect for next year? Or is that where you expect it to kind of end out in the Q4 of next year?

We're expecting to do somewhere around $400 million in revenue for 2009.

Okay. Great. In that expectation, I think there's an expectation that there's room for some upside related to missile test shot work. Do you have much in the way of that for-- those numbers?

There probably is, depending on the operational tempo at some of the bases. In some of the program work under that $100 million teaser contract we won a few months ago, there very well may be some room for some upside. However, as I mentioned, we are actively right now looking across the entire contract portfolio at material and subcontractor pass through revenue. So, over the next 18 months, if we're talking about now through the end of '09, if we can eliminate some of that to get out of our operational numbers lower- or no-fee business-- Our ultimate objective would be to increase the margins, and that could offset some of that upside on Oriole deliveries.

That makes sense. And one final question. This relates to SYS. They've been pursuing some public security contracts, where they set some inroads in, I think, Pennsylvania and some other local markets. Has there been any more progress on that?

Q3, the quarter that we're in right now, and maybe the first month or so of Q4 are going to be very telling on these opportunities for us.

Okay. Thank you.

That would conclude our question and answer session. At this time, I'd like to turn the program back to our speakers for any additional or closing comments.

Thank you. We'd like to thank everyone for joining us for our second quarter earnings conference call. We'll be back in touch with you the third quarter. Thank you.

Thank you, everyone, for your participation on today's conference, and you may disconnect at this time.