Kratos Defense and Security Solutions Inc (KTOS) 2008 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Kratos Defense & Security Solutions fourth quarter 2008 conference call. Your speaker for today will be Mr. Eric DeMarco, President and Chief Executive Officer; Deanna Lund, Senior Vice President and Chief Financial Officer; and Rob Babbish, Vice President Corporate Communications. At this time, all participants are in a listen-only mode. As a reminder, this call is being recorded today, March 9th, 2009.

I will now turn the conference over to Mr. Rob Babbish, who will read the Company's warning regarding forward-looking statements. Please go ahead, sir.

Good afternoon, everyone, and thank you for joining us for the Kratos Defense & Security Solutions fourth quarter and fiscal 2008 earnings conference call. With me today are Eric DeMarco, Kratos's President and Chief Executive Officer, and Deanna Lund, Kratos's Senior Vice President and Chief Financial Officer.

Before we begin the substance of today's call, I would 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 available on our Kratos corporate website, www.kratosdefense.com. Additionally, I would 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 these important risk factors is included at the end of the press release we issued today.

Our statements on this call are made as of March 9, 2009, 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. This conference 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 fourth quarter of 2008. He will then turn the call over to Ms. Lund to discuss the specifics related to our fourth 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. DeMarco.

Thank you, Rob. Good afternoon, and thank you for joining us. During the fourth quarter, Kratos continued to make progress across all elements of our business plan, including a fourth successive quarter of EBITDA growth, generating an EBITDA margin rate of over 6% for the fourth quarter just ended. For 2008, we grew our Company's revenue by over 50% through a combination of organic growth and acquired growth, and we are looking for top-line revenue growth of approximately 30% in 2009 over 2008 with no additional acquisitions, including in this target. This growth target does include the 2008 end of year acquisition of Digital Fusion, which brought Kratos around $45 million in full and open competition contract revenue.

From a strategic standpoint, the DFI acquisition significantly enhances Kratos's capabilities in the areas of command and control systems, unmanned vehicle systems and solutions and technologies, sensors and sensor technology, including photonics, super computing, modeling and simulation, and intelligence, surveillance and reconnaissance capabilities. These are all areas we believe are national security priorities and areas which we'll continue to see solid funding going forward. The DFI acquisition also substantially increased Kratos's presence in the key BRAC location of Huntsville, Alabama, where Kratos now has approximately 600 people headquartered.

Also strategically, in June 2008, Kratos acquired San Diego based SYS Technologies, which brought us increased expertise, customer relations, and contract vehicles in C4ISR, information technology, information assurance, cyber security, and network management products and solutions, including as related to certain classified networks and three-letter agencies. Additional expertise was also brought to Kratos in the areas of training and simulation. The SYS acquisition significantly increased Kratos's presence in the important and growing BRAC location of San Diego, and significantly increased Kratos's presence with the Space and Naval Warfare Systems Command, or SPAWAR, as well as several other important customers, including classified customers. As you know, a key element of Kratos's overall strategic plan is to position ourselves at major customer and funding locations and BRAC locations.

Accordingly, Kratos's major points of presence today are all major BRAC or customer locations and include Huntsville, Alabama and the Redstone Arsenal; Dayton, Ohio, and Wright-Patterson Air Force Base; San Diego, California; Maryland; Northern Virginia; and Washington, D.C. Beltway area; and the Hawaiian Islands; various installations on the California coast; White Sands; and Keyport, Washington. Let me give you just one specific example of what we're trying to do with our strategy here.

Three years ago, the US Department of Defense acknowledged China's military modernization in its Quadrennial Defense Report. The QDR sets long-range plans for the Armed Forces, including the east to west shift of Navy Forces, resources, and ships. Accordingly, with China's military expansion, the Pentagon will be shifting additional resources, surface ships and submarines to the West Coast. And additionally, the first of the Navy's new Littoral Combat Ships will be assigned to San Diego.

Simply stated, a key element of our strategy is to build Kratos where our customers are, where they are moving to, and where there is expected to be increased funding. With these strategic steps successfully completed and as we conclude 2008 and enter into 2009, we now have a company that has substantial critical mass, customer relationships, contract vehicles, and capabilities in each of our strategic focus areas. These include weapon system lifecycle extension, sustainment and reset, C4ISR advanced sensors and modeling and simulation, information technology, information assurance, cyber security and network management, weapons range operations and technical services, and Homeland and public security system integration.

For our 2009 target revenue of approximately $400 million, we believe that our customer concentration risk is low with no single Kratos contract expected to account for more than 3% or 4% percent of total Kratos revenue. Additionally, based on our most recent assessment of this administration's national security-related commitments and priorities, at this time, we feel very comfortable with the stability of our programs, our contracts, and our business base. One reason for this is that Kratos's strategic focus areas and virtually all of Kratos's contract work is focused on existing, deployed and in inventory systems and platforms, and is not tied to high profile programs like the Air Force F22, the Navy's DDG 1000, the new aerial tanker, the Missile Defense Agency, or the future combat system.

Related to this, a material component of Kratos's business base today is directly related to maintaining the operational effectiveness of our Armed Forces and its existing and currently deployed systems. This was also a key element of our overall strategy in building the Company. The critical mass that we now have, we believe we can successfully pursue larger and larger prime contract opportunities and generate sustained organic growth as one of the premier mid-tier government contractors. Directly related to growth, as we completed 2008 and as we enter 2009, Kratos's qualified bid and proposal pipeline is approximately $2 billion. This is a record for our Company.

Kratos's book-to-bill ratio in the fourth quarter including expected work under the recently announced SPAWAR, technical services contract of approximately 1 to 1, and Kratos's full year 2008 pro forma book-to-bill ratio was approximately 1.3 to 1. During the fourth quarter, areas of operational performance and operational highlights for Kratos included work at the Navy Surface Warfare Center Dahlgren, including work on the Electromagnetic Railgun system program. Kratos's Rocket Support Services program work and work related to our Oriel Rocket and Target System, including as related to the AEGIS Missile Defense System, which I will talk about more further on.

Missile Defense Strategic Project Office work, including work related to the Terminal High Altitude Aerial Defense, or THAD UAEFMS Case Development, Avenger Missile System work, and Cruise Missile Defense System Project office work, related to a foreign military sales customer, on-site equipment reset and LBE field support for on-the-ground vehicular laser locator designator systems, and work on Chapparal surfaced air missile systems for certain customers. Additionally, Kratos also continues to be directly involved in the rearming of the Kiowa Warrior Helicopter and its new gun-system platform, as well as equipment sustainment and reset-related work at Fort Bragg, Fort Stewart, and at Fort Hood.

Offsetting organic growth in the quarter were reductions in deliveries or services on certain weapon systems contracts, which are timing in nature and can fluctuate quarter-to-quarter, previously forecasted reductions in no or low-fee bearing material costs on certain contracts, which we will continue to try and reduce as we move forward, and a previously communicated work reduction related to the conversion of Kratos from prime to a subcontractor on a [range] contract that was awarded to a small business (inaudible) earlier in 2008.

From an organic growth standpoint for 2009 and beyond, we continue to target up to 10% organic revenue growth. This growth target includes the previously mentioned Kratos Rocket Support Services business, where Kratos is providing Oriel Rocket Systems and Launch Services to customers for a variety of national-defense-related activities, and is just one area which we are currently very optimistic about. For example, as more and more AEGIS Combat System capable ships join the United States fleet, Kratos's Oriel Rocket capability system and services can directly support this system in targeting and test operations, and as you know, in 2008, Kratos was awarded a $100 million multi-year contract related to this type of work.

Today, there are approximately 20 AEGIS-capable US Navy ships with estimates of this increasing to 60 or more over the next few years with the Navy just recently awarding a new contract to make additional Navy Combatants AEGIS-capable. There are very, very few competitors to Kratos in this area as companies cannot obtain the qualifications and capabilities to compete. And as you know, this is one of the key thesis that Kratos's strategic plan was developed around. This could be a significant opportunity area for Kratos, especially under the new administration and it's objectives related to DoD procurement cost rationalization and this is a relatively low-cost system as compared to our competitors. There is also a very large, greater than $1 billion in total contract value, multi-year target and counter measures opportunity that Kratos, just a year ago, could not have contemplated competing for in a substantive way, that we are currently assessing.

Additionally, as you know, foreign military sales, or FMS, is also a major part of Kratos's strategy in business, and more and more friendly foreign Navies are also outfitting their combatants and systems with AEGIS and other missile defense capabilities. Here again, competition is limited due to the difficulty of potential competitors obtaining the qualifications, credibility, and relationships to effectively compete. Kratos will be specifically targeting RSF and Oriel rocket opportunities globally for growth in future years, both with the Department of Defense and internationally.

FMS opportunities related to range work and targets is also an area that Kratos is specifically pursuing for organic growth going forward. And here again, the competition is limited to a very select few that have the past performance qualifications and capabilities across all relevant areas, and the FMS customer relationships and contract vehicles to compete for this work. As we head into 2009, we are also excited about the potential for Kratos's information technology business unit, including our information assurance and cyber security capabilities, which today accounts for greater than $100 million in revenue. With the critical mass that Kratos has achieved in this business unit, we now have the capabilities and qualifications to pursue brand new opportunities in the prime contractor role for which previously we could not have effectively competed. This is also an area where Kratos has true differentiator that is proprietary networking software products.

These products are currently deployed at certain national security-related and other customers, and new channels of distribution from our recent acquisitions, we believe, will provide additional organic growth opportunities for Kratos in these areas. Kratos is still in the process of integrating our two most recent acquisitions, and right sizing the Company's cost infrastructure, which are both key elements of our plan of action to continue to increase our EBITDA margins as we move forward. We are also on track in combining the business development and contract capture resources of our Company, as well as augmenting this capability with new hires.

This is another important element of Kratos's strategy in building the Company, and one which we are hopeful of having substantially set and in place by the end of the first quarter. Once complete, this will enable us to target additional new incremental and larger prime contract opportunities. There are also specific additional actions that we took during the fourth quarter of this year, as part of our integration, cost reduction and margin expansion plans, including the exiting of certain acquired contracts or businesses that are either not core to Kratos's stated strategy or not additive to Kratos's profitability. Though certain of these actions, along with the reductions in low or no margin material passthroughs, will result in somewhat lower revenue generated in '09, we expect all of these actions to positively impact 2009's EBITDA margins once they are completed and the impact is fully realized.

Finally, in the fourth quarter, Kratos recorded a goodwill writedown of approximately $100 million, which Deanna will discuss in detail in her remarks, which was driven primarily by overall terrible equity and capital market conditions. I do feel compelled to say that it is ironic that we are recording such a writedown at this time, when as we head into 2009, Kratos, in my opinion, is from an operational, financial, profitability cash flow and overall business standpoint, in a better position than the Company has ever been.

I would like now to turn the call over to Deanna, who will discuss our financial results in more detail.

Thank you, Eric. Good afternoon. As a reminder, all of the numbers reported today have reflected the businesses that we exited in the fourth quarter as discontinued operations. Accordingly, all relevant prior-period data has also been reclassified to present the results of those operations as discontinued operations. Additionally, our fourth quarter operating results do not reflect the performance of the recently closed merger with DFI, as the transaction closed on December 24th, 2008.

Our fourth quarter balance sheet, however, as of December 28th, 2008, includes the balance sheet of DFI. Accordingly, we will have a full-year's result of DFI in our 2009 performance. Today, we reported quarterly revenues of $76.2 million, a $26.9 million increase, or 55% increase, from comparable revenues of $49.3 million in the fourth quarter of 2007, which reflects a full quarter of operating results for the Haverstick and SYS mergers, which occurred on December 31st, 2007, and June 28th, 2008, respectively. Sequentially, fourth quarter revenues were down, as expected, by $4.4 million, or 5.5%, from third quarter revenues of $80.6 million, driven by the expected reduced revenues of SYS, which declined from $18.3 million in the third quarter to $14.9 million in the fourth quarter, primarily reflecting the anticipated impact of the reduction of certain SYS lower-margin and subcontract work.

As we have previously discussed, we based our purchase price multiples of SYS assuming a go-forward full and open and government services revenue base of approximately $60 million per year, and this quarter-to-quarter reduction was expected. As we move forward into 2009, this approximate $60 million revenue run rate is the baseline which we will be basing our growth targets on. Also, in our PSS business, we experienced some project delays caused by the current economic and credit crisis, which impacted the timing of certain of our enterprise projects.

In our government solution segment, revenues increased $29.5 million, or 84%, from $35.1 million in the fourth quarter of 2007, to $64.6 million in 2008. Revenues here sequentially decreased $3.3 million, or 4.9%, from $67.9 million in the third quarter, to $64.6 million in the fourth quarter, primarily due to the SYS projects previously discussed. The year-over-year growth includes the impact of the Haverstick and SYS mergers, which contributed $22.8 million and $14.9 million, respectively. Additionally, Kratos experienced organic growth in the following: Our network and information technology business in which we provide information technology and information assurance solutions at certain defense agencies.

Kratos's information technology business is one of the highest profit margin and EBITDA margin businesses in the Corporation. We also experienced organic growth in our rocket support services business, which we acquired with Haverstick. This was offset by previously discussed expected reductions in lower margin passthroughs and subcontract work, reduced revenues as the result of the conversion of our work as prime to subcontractor that occurred earlier in the year, as well as planned reduced shipments and work under certain of the Company's weapons systems contracts that Eric also mentioned.

Also, revenues in our public safety and security segment were adversely impacted by project delays and suspensions caused by the current economic crisis, which impacted certain of our commercial customer's abilities to obtain financing for these projects, as well as due to the completion of certain other projects. Revenues decreased year-over-year $2.6 million, or 18.3%, from fourth quarter 2007 revenues of $14.2 million to $11.6 million for the same period of 2008.

On a sequential basis, our fourth quarter public safety segment revenues were down from $12.7 million to $11.6 million due to the completion of certain projects and due to the project delays and suspensions mentioned earlier. We have factored into our 2009 financial target expected continued overall economic and market challenges as related to the PSS business. Gross margins increased for the fourth quarter of 2008 to 21.7%, or $16.5 million, from 17.4%, or $8.6 million in the comparable fourth quarter of 2007. The increase in gross margins is primarily the result of the impact of the SYS and Haverstick revenues, which have been historically higher gross margin businesses due in part to the favorable mix in software revenues, and due to the classification of costs incurred between costs of sales and SG&A in accordance with government accounting standards.

SG&A, as a percentage of revenues, decreased from 19.5%, or $9.6 million, in the fourth quarter of 2007, to 16.8%, or $12.8 million, in 2008. Sequentially, SG&A increased from $11.7 million, or 14.5% of revenues, in the third quarter of 2008, to $12.8 million, or 16.8% of revenues, in the fourth quarter, primarily reflecting the impact of an approximate $1.2 million net discretionary write-off of certain rate variances, which we made the decision to make in the fourth quarter, which we believe should help strengthen our competitive position and overall profitability going forward. Excluding this rate variance, our SG&A as a percentage of revenues, was 15.2%.

Included in the fourth quarter operating results is an impairment charge for goodwill of $105.8 million. This charge is both non-cash and non-operational and does not impact our credit facilities. It is similar to the impact that has been reported by other companies, which had been acquisitive prior to current reduced market valuations, and general unfavorable economic conditions. The impairment charge reflects a deterioration of the global equity market through December 28th, 2008. As the market continues to deteriorate in the first quarter of 2009, the Company believes that it is more likely than not that this could be an indication of additional goodwill impairment, and could potentially result in a triggering event under FASB 142 and an additional goodwill impairment charge in the first quarter of 2009.

Also included in our fourth quarter operating expenses is a credit of $2.9 million primarily related to additional insurance reimbursement of previously recorded legal fees incurred related to the investigation of stock options. The total amount of the reimbursement was collected in the first quarter of 2009. Excluding the goodwill impairment charge, our operating income was $3.6 million for the fourth quarter of 2008, compared to an operating loss of $4.6 million for the comparable quarter of 2007.

Included in our current quarter operating income is the $2.9 million credit discussed previously, offset in part by the $1.2 million write-off of rate variances discussed previously, as well as a $600,000 charge for unused office space resulting from our facilities consolidation plan. Excluding the goodwill impairment charge, the insurance credit, the write-up of rate variances, and the facilities accrual charge, operating income was $2.5 million, or a 3.3% operating margin, and pro forma EBITDA, excluding these same items, was $4.8 million, or 6.3%, up from the pro forma EBITDA margin of 5.8% in the third quarter.

As a reminder, Kratos has over $200 million in net operating loss carry forwards, which will result in Kratos paying minimum income taxes in future years as we utilize these carry forwards. This will, of course, help increase Kratos's overall free cash flow. Income from continuing operations for the fourth quarter of 2008 includes $2.5 million of net interest expense, primarily related to borrowings on a credit facility which was used to fund the acquisition of Haverstick. In addition, included in our results from continuing operations is other expense of $2.3 million related to the interest swap arrangement that we have mark-to-market, which was unfavorable this quarter due to the volatility in interest rates. We have excluded this loss from our pro forma EBITDA calculation as it is specifically excluded from our bank measurement of our EBITDA as it is non-cash in nature.

As we recently announced, we have exited three non-core elements of recently acquired businesses, which have been reflected in the results from discontinued operations. As we previously discussed, we have been evaluating these businesses since the acquisition and came to the conclusion to exit these businesses in the fourth quarter. These businesses have incurred aggregate operating losses of approximately $1.4 million in 2008, since the date we acquired them in June 2008.

The loss from discontinued operations of $4.9 million in the fourth quarter reflects an impairment charge of approximately $4.5 million to reduce the carrying value to the estimated fair value, which was driven primarily by the impairment of allocated goodwill and purchased intangibles to these businesses. Our cash balance was approximately $3.2 million at December 28th, 2008, plus $400,000 in restricted cash. Our cash flow used for operations was approximately $4.7 million for the fiscal year with cash generated from operations at break-even in the fourth quarter. The fourth quarter operating cash flow includes a $3 million one-time disbursement to fund the remaining securities litigation settlement.

The fiscal 2008 cash flow used for operations included a number of disbursements related to our Legacy Wireless business, such as $4.9 million to fund the securities litigation settlement, $5.5 million paid in 2008 for legal fees incurred on our stock option investigation which was completed in 2007, less approximately $4.9 million in recoveries from the theft of stock option and insurance recoveries during 2008, or an aggregate net use of cash of $5.4 million for 2008 related to these Legacy legal matters. Cash on hand today is approximately $9 million.

Other key balance sheet and capital structure elements at December 28th are at follows. Accounts receivable primarily from the US Government and other agencies was $100.5 million. Accounts receivables day sales outstanding, or DSOs, including the receivables from the recently acquired DFI, were 99 days, up slightly from 98 for the third quarter. Our DSOs are clearly impacted by the timing of the milestone achievements and shipping timelines of these weapons systems contracts, as well as a software systems sale, which was recorded as net versus gross due to the terms and conditions of the transaction.

We are continually focused on reducing our DSOs in the future as we achieve certain of these milestones. Additionally, as we are negotiating new weapons systems contract terms and conditions, we will be striving for more favorable liquidity terms. Bank debt at December 29th was approximately $78.8 million, included $47.5 million on our five-year term note, $21.4 million on our line of credit, and $9.9 million in subordinated debt. Net bank debt net of cash at 12/28 is $75.2 million. Our debt to equity ratio is .32 to 1.

As we have previously stated, our ultimate objective is that Kratos achieves EBITDA profitability consistent with our comparable industry peer group as we head into 2009. Our total backlog at the end of the quarter was approximately $750 million, consisting of $160 million in funded backlog. As we have stated previously, we have and will continue to refine a consistent definition of backlog across all of our business units.

Our contract mix for the fourth quarter was 45.7% of revenues generated from fixed-price contracts, 29.4% related to cost-plus fixed B contracts, and 24.9% generated from time and materials contracts. For our government revenues, approximately 68.1% are performed as a prime with the remaining 31.9% performed as a subcontractor. Revenues generated from contracts with the DoD were 72.7% with 4.7% generated from non-DoD federal agencies, 5.5% from state and local governments, and 17.1% from commercial customers. With that, I'll turn the call back over to Eric for his final remarks.

Thank you, Deanna. As you can see from Deanna's comments and as we have previously communicated to you, Kratos went through a significant amount of integration, divestitures, discontinuances, and refining of our business in the fourth quarter in order to position the Company for even greater profitability and growth in 2009 and beyond.

Accordingly, I would like to conclude and summarize with the following comments. The 12-month period ended December 31st, 2008, was a period in which four businesses were brought together to create what Kratos is today. We have substantially completed the integration of Kratos and Haverstick, the integration of Kratos and SYS, and are in the process of integrating Kratos with DFI. We've completed 2008 at approximately $300 million in revenue, and we will have a full year of DFI results combined with Kratos in 2009, and accordingly, are targeting approximately $400 million in 2009 revenue, which includes up to 10% organic growth target.

During 2008, we had four successive quarters of sequentially growing and increasing EBITDA profitability, and we are targeting even higher overall EBITDA profitability for 2009. As we enter 2009, we have a record high backlog, an all-time high bid and proposal pipeline, and are positioning to bid on and pursue a greater number of and larger contract opportunities than ever before. We want to thank all of our stakeholders, and most importantly, our employees, for just an outstanding job in the last year of building this Company.

With that, we'd like to open it up to any questions you may have.

Thank you. The question-and-answer session will be conducted electronically. (Operator Instructions). Our first question will come from Mark Jordan, Noble Financial.

Good afternoon, Eric and Deanna. Eric, looking at your business, you stated that you have got your weapons system, target range, C4ISR, info assurance, is that the way you are going to look at it, those four major groups moving forward? And if so, if you were to theoretically have $385 million in revs in '09, how would those revenues roughly break down by those four product categories, or service categories, excuse me?

Right. So, Mark, yes, those are the four areas that we're going to focus on in building the Company going forward. We don't expect any major deviations from those. There may be some additional products or solutions within those, but those are the areas. So going down them, it's fairly well balanced. The weapons systems work in the way we categorize it, and reset and sustainment is about $100 million. The C4ISR, which we include modeling and simulation in there, that's roughly $100 million. Our information assurance, information technology, and cyber security, that's about $100 million. Range work, which includes the rocket work and how we categorize it, is $50 million or so, and the balance of the business is Homeland security and public safety system integration.

Mr. Jordan, any other questions, sir?

Yes. Would you talk a little bit about your cash -- free cash flow outlook for '09? And could you also talk about your bank lines, and what specific covenants you have to meet for 2009?

Yes, from -- Mark, this is Deanna. From a covenant standpoint, we have a minimum EBITDA covenant on an LTM basis, and mind you, the LTM EBITDA takes into consideration, on a pro forma basis, all acquisitions, so from DFI's perspective and SYS's perspective, that would be a full LTM EBITDA for those two acquisitions. We have a minimum liquidity ratio, a maximum leverage ratio, and a fixed-charge ratio.

Again, free cash flow outlook for '09, and what do you view is the most, of those three or four covenants, what is the most restrictive one, and specifically what is it?

Well, on the free cash flow, Mark, in the -- one primary assumption in this is we talked about, on some of the major weapons systems works, we're going to be renegotiating some contracts and we're going to try to get better terms, which would bring down our DSOs. So, assuming that we're successful in that, and assuming EBITDA in the high 20s or 30s. CapEx in the business is de minimis. It's $1 million, $1.5 million, $2 million. Interest expense, $9 million or $10 million. The working capital assumption, assuming we can hold that flat by bringing down our DSOs, the net operating losses should shield the remaining of it, other than some small tax amounts.

Okay.

That's how we're looking at it.

Okay. You were talking about EBITDA margins, I would assume, obviously, with the continued assimilation of the acquired activities, you're going to see -- you would assume increasing EBITDA as the year evolves, what do you think might be a reasonable exit rate for EBITDA for the fourth quarter?

Right. So we're -- we're clearly looking at '09 -- for '09's EBITDA margins to be greater than -- than 2008's, and we look for them to increase each quarter-over-quarter as the business executes. If we could exit the year in the mid-8s, in that quarter, that would be great, but we're going to have to see the timing on some of the deliveries, on some of the sustainment and reset work.

Okay. Okay. So final question, if I may, you have obviously been very active in the M&A marketplace between Haverstick and Fusion and SYS. Given where the market is, is it fair to say that other than -- something that could be very minor that you are looking at an organic business model in '09?

Right now we are very, very focused, as you can imagine, as completing the integration, having operational excellence and efficiencies, and driving the organic business. We -- we look at '09 as, really, year one that we've -- we've brought these companies together, and now we have the critical mass to truly go out and competitively bid on some of these larger opportunities that we could never bid on before.

Okay. Thank you very much.

(Operator Instructions). At this time, we will take our next question from Mike Crawford, B. Riley & Company.

Thank you. Just to make sure we are comparing apples with apples next year, I think if you break down the guidance you've given with 10% organic growth starting from a base of $300 million, $45 million in full and open contracts at Digital Fusion, is that implying that there is another $20 million or so in contracts that you might get the benefit of for the next year, year and a half, before they might have to convert to subcontractor status?

Mike, from an apples-to-apples basis, the $300 million does not include the full year of SYS, so that is part of the disconnect. So that's only a six-month window with SYS, and does not include DFI.

And -- and the answer to your question on the $45 million, Mike, is yes, there is a portion of DFI's business that when we -- when we acquire the Company, we talked about is not full and open, that we are going to try to either get converted to full and open, or put a mitigation plan in place when the contract runs in 2010 to convert from a prime to a subrole.

Okay. Thank you. And then, on the Oriel contract, so you said -- I think we have seen there's some 20-odd AEGIS platforms right now with, I think Lockheed got a contract to supply -- outfit a number of other ships. And then, you are not including the four military sales to Japan and other allies?

Right. There are -- last count I saw, there are 18 AEGIS-equipped combatants in the US Navy. There is approximately another 10 foreign FMS, Korea, South Korea, Spain, et cetera. And yes, your point is correct. The -- the Pentagon just recently let a very large contract to start increasing the number of the US combatants with AEGIS capability. We are involved in these programs, and we're specifically focused on this being a growth area for us going forward, as we talked about.

Great. And then, if -- perhaps you could just help me with some math here. I mean, if you are talking about -- call it a hair under $400 million in revenues, and maybe under 8% EBITDA margin, I mean, you are getting to EBITDA pretty close to $30 million for '09; is that correct?

That math is correct.

Compared with an enterprise value of about $160 million today? What -- your diluted share count should be what, about $132 million?

Say [all in] about $1.33.

Right. So, that -- I mean, we've -- I don't think we have seen any deals -- any M&A deals done that low. I mean, how do you look at that -- at those metrics?

Yes. I -- the way I look at it right now, Mike, is in my opinion, we're kind of in micros cap, and small cap purgatory. Some people would call it hell. Where we have been trading about 100,000 to 150,000 shares a day and, for whatever reason, if certain people need to monetize or liquefy -- liquidate their positions, especially in the stock market environment we have been in, they are going to do that, and the price comes down.

Your thesis is -- is correct. We're probably trading right now on an enterprise-value basis somewhere between five and six times the 2009 EBITDA on an enterprise-value basis, and that's why we just need to keep our heads down, execute, and when -- when more normalcy returns, historical trading multiples have been 9 or 10 times, which -- those are trading multiples, not transaction multiples.

Right. In a transaction multiple, presumably, you could take out some of the public company, costs, and other G&A that could be eliminated by the acquiring company?

Yes. I'm talking just operational GAAP EBITDA with the numbers you talked about.

Okay. And, again, from a liquidity perspective, I think if you -- if you run down -- do the math as you laid it out, that implies, depending on what happens with your working capital, that you are looking at -- over $10 million in free cash flow in '09? Do you think that's fair?

Yes, and if we -- hopefully, we can look at the -- the DSOs on the shipments, and if we can [invert] those [there's] an opportunity to drive that even better.

Right. So if -- and when will you know if you are able to do that on the contracts?

That's -- that's going to be probably over the next couple of months, Mike.

Okay. Great. Thank you.

Thanks, Mike.

(Operator Instructions). We will go now to Michael Potter with Monarch Capital.

Hey, Eric. Appreciate the detail. I'm going, I guess, kind of ask the question straight on. We have free cash flow generation. We have a good pipeline of business and a good backlog of business. We are, I'm assuming, meeting or exceeding our covenants, why not buy back stock at these levels, or at least have the flexibility to buy back stock if -- if large blocks of stock became available at these levels?

Right. And that is -- that is the discussion that we need -- we need to have with our lenders, with the credit facility to obtain that flexibility that you just talked about.

Okay. So the plan is, I guess once the K is filed, to have a conversation with our creditors?

We are definitely going to be having -- first of all, we are in compliance with everything, as you said. That's not an issue. And yes, we are going to be having some discussions with the lenders on a number of topics soon. Shortly.

Okay. I mean, even though it's painful for us to go through this, especially on our end, I don't know if the Company will ever get an opportunity like this to buy back the stock at these levels again, so --

I agree with that statement.

Okay. Thanks.

Thank you.

And we have no further question in our question roster. I would like to turn the conference back to our speakers for any additional or closing comments.

Very good. Thank you for joining us this afternoon, and we'll be recircling back in a few months at the end of the first quarter.