Kratos Defense and Security Solutions Inc (KTOS) 2009 Q1 法說會逐字稿

Welcome to the Kratos Defense & Securities Solutions first quarter 2009 earnings conference. Your speakers for today are Mr. Eric DeMarco, President and Chief Executive Officer, Deanna Lund, Executive Vice President and Chief Financial Officer and Rob Babbush, Vice President Corporate Communications. At this time, all participants are in a listen-only mode. As a reminder, this call is being recorded today, May 12, 2009.

I would now like to turn the program over to Mr. Rob Babbush who will read the Company's warning 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 first quarter earnings conference call. With me today are Eric DeMarco, Kratos President and Chief Executive Officer and Deanna Lund, Kratos Executive Vice President & Chief Financial Officer.

Before I 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 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 playing a simultaneous webcast of this call to the public. A replay of our discussion will be available on the Company's Web site 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 vary or 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 issue today.

Our statements on this call are made as of May 12, 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 first quarter of 2009. He will then turn the call over to Miss Lund to discuss the specifics related to our first quarter 2009 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. Kratos reported its first quarter 2009 results today and our Company remains on track with our previously stated business plan and we are continuing our momentum for even more improved financial performance as we move forward. Deanna will provide all the details of our financials and our numbers. The highlights from our report today include first quarter revenues of approximately $84 million, which increased 23% over the previous year's first quarter. EBITDA profitability increased over 70% above the first quarter of 2008, including Kratos government segment's business generating first quarter pro forma EBITDA of 8.4%. We have now reported our fifth consecutive quarter of sequential quarter over quarter EBITDA improvement as a Corporation and as a reminder, calendar Q1 is typically Kratos' weakest, with Kratos calendar quarters of Q3 and Q4 around the federal government September 30 year end typically being our Company's strongest.

Gross margins continued to increase, primarily due to continued improvements in contract mix and higher gross margin contracts from our recent acquisitions and the continued reduction of no or low fee pass through revenues from around the business. General and administrative costs as a percentage of revenues continued to decline as did other indirect costs across the Company due to our fourth quarter 2008 reorganization, continued integration efforts, continuing cost cutting actions and improved efficiencies.

During the first quarter, Kratos generated positive cash flow from operations of approximately $7 million. Included in our 23% overall growth, Kratos' government systems organic growth for the first quarter was approximately 3% after adjusting for the previously mentioned commercial business software sales, small business set aside work that is nonrecurring, reduced pass throughs and certain weapon systems deliveries. Even more importantly, Kratos' contract win book-to-bill ratio as defined in the first quarter was greater than one-to-one. The Company's defined total backlog today is approximately $0.67 billion and Kratos' defined qualified bid pipeline is approximately $1.7 billion.

Directly related to business development, book-to-bill and future organic growth, I am going to spend some time on this call related to Kratos' business development efforts, contract wins and strategy, all of which are integral to our business plan going forward. During the first quarter, Kratos was awarded some very important contract vehicles. Of these awards, most of which are new contract vehicles for Kratos, we are looking for incremental revenue to our existing business base commencing in the second half of this year and continuing thereafter for many periods in the future. These new contract wins in our BMP pipeline are directly related to our previously stated objective of up to 10% organic revenue growth, which we are reaffirming once the integration of the business development resources of the acquired businesses is complete.

As these first quarter contract wins are extremely important components of Kratos' overall strategy in achieving our 2009 and forward business plan, I will summarize some of the key aspects of these first quarter contract wins here. In the quarter, Kratos was awarded a new $11 million prime contract with the Naval Undersea Warfare Center in Key Port, Washington. The contract is to support the United States Navy's Antisubmarine Warfare Training Program, which is a key strategic focus area for Kratos as related to the perceived Chinese and other related potential threats. Under this contract, Kratos will be providing operational life cycle support, including engineering, technical and logistics services and solutions for the NK30 undersea target system, including the MK30's associated launch, handling and test equipment. The MK30 is an unmanned undersea vehicle that simulates certain threats which have a submarine's characteristics by emitting acoustic and magnetic signatures that can be detected and tracked by surface ships, aircraft and submarine crews engaged in antisubmarine warfare or ASW training exercises.

The acquisitions that Kratos has made have brought Kratos impressive qualifications in the area of military weapons ranges, targets, and training, all of which were critical to this antisubmarine warfare related contract win. Antisubmarine warfare support is an area that we believe will continue to see and receive solid funding in the future due to perceived threats in this area. This contract win will provide incremental revenue growth to Kratos as we move forward, including in the second half of this year.

Additionally, we also currently have several other bids outstanding at Key Port, all of which would be new awards for Kratos and each of which would add incremental organic revenue to our Company in which we expect to hear on later this year and 2010. During the first quarter, Kratos was also awarded a new $84.6 million prime contract with the space and naval warfare system center Pacific or SPAWAR. Kratos was one of four companies to be awarded this contract vehicle. Under this contract, Kratos is supporting the SSC Pacific RF communications division in the evaluation of both existing and developing communications technology. The objective of this program is supporting the Department of Defense and the United States Navy in identifying, implementing, developing and proving and enhancing the FORCENet command control communications computing and intelligence network centric warfare system. The SSC Pacific's RF communications division's programs consist of RF communications systems covering the entire RF spectrum from very low frequency or VLF through laser, wide band, narrow band and protected and secure communications on various afloat, ashore, airborne, submerged and space-based systems. This significant contract win for Kratos would not have been possible without the merger last year with SYS. Revenue from this new Kratos contract will be as a result of our previous acquisitions, qualifications and capabilities and we believe SPAWAR is a growth opportunity area for our Company as we move forward. Of the first four task orders let thus far under this contract, Kratos has been awarded three of them with several more currently outstanding.

During the first quarter, Kratos was awarded a new contract from the program executive officer or PEO, command, control, communications and intelligence or C4I. Under this C4I contract, Kratos will be providing the PEO comprehensive and integrated learning solutions for the commercial broadband satellite program or CBSP to support the operations and maintenance of this system.

Also during the first quarter, Kratos was an awardee on the Alliant GSA 10-year $50 billion IDIQ contract vehicle. This is also a new contract for Kratos. The Alliant contract win may turn out to be an extremely important strategic award for Kratos. As the scope of this large contract vehicle, which is very broad, will enable us to much more effectively market the complete breadth of expertise within Kratos' information technology solution business in addition to Kratos' significant modeling and simulation capabilities to multiple new agencies and customers, which Kratos previously did not have access to with existing prime contract vehicles. Specifically related to the Alliant contract win, the acquisitions that Kratos has made over the past few years have given us a concentration of capabilities in network management, network operations, applications, development and integration, network security, including cyber security and information security and information assurance. We believe that the Alliant contract vehicle is the perfect vehicle for Kratos to leverage our full range of information technology and information assurance and security applications and capabilities on broader and larger business opportunities with multiple US government agencies. We are optimistic about the potential substantial positive impact this contract award could have on Kratos' future growth.

With each of these new contract wins, the potential of our strategy, including our acquisitions, is being clearly demonstrated as Kratos has significant capabilities and past performance calls in each of these areas. Another key element of Kratos' strategy, I would like to update you on due to a lot of recent activity is the positioning and building of our Company in key BRAC recipient locations throughout the United States and taking advantage of military commands and their requirements in moving to these BRAC recipient locations.

In October 2006, Kratos acquired Madison Research, headquartered in Huntsville, Alabama and in December, 2008 Kratos acquired Digital Fusion, also headquartered in Huntsville which brought Kratos' total employee presence in Huntsville to approximately 600 with substantial capabilities and weapon system sustainment, intelligence, surveillance and reconnaissance technologies and solutions, including specialized sensor technologies, modeling and SIM and unmanned vehicle products and technologies including ISR. The acquisitions of Madison and DFI were extremely strategic also from a geographic presence standpoint, as Kratos is one of the largest subcontractors in Huntsville.

Specifically related to this, in 2005 the Pentagon made the decision to move thousands of jobs from the Washington, D.C. area to Huntsville. The Army material command is currently in the process of moving its headquarters from Washington to Huntsville. The deadline for the Army material command in completing the move to Huntsville is September 2011. The missile defense agency is also moving its headquarters from Washington, D.C. to the red stone Arsenal in Huntsville, Alabama. The deadline for the MDA completing this move is also September 2011 and the Army space and missile defense command just completed moving its headquarters to Huntsville as well. Huntsville is where Kratos has its largest concentration of employees and resources and we believe that Kratos' weapons systems division headquartered out of Huntsville will be one of our strongest businesses going forward. Kratos' weapons systems division is also where we are expecting certain weapons systems contract wins, including certain follow-on wins in the second half of 2009 to help us achieve our growth expectations going forward.

In June of 2008, Kratos acquired SYS Technologies headquartered in San Diego, California. The merger with SYS significantly increased Kratos' presence in San Diego and with the Space and Naval Warfare Systems Command, Kratos today is one of the largest contractors headquartered in the San Diego area. The merger with SYS was also extremely strategic to Kratos' business plan as San Diego was also a key BRAC location. Admiral Len Hering who commands the Navy region southwest in April last month stated that the United States military is spending approximately $5 billion to upgrade, improve and enhance its facility throughout San Diego county over the next five years. Additionally, San Diego has the largest concentration of war ships and support vessels in the world which is primarily due to the importance of San Diego's geopolitical location on the Pacific Ocean. San Diego recently received from a BRAC move several additional antisubmarine and antimine vessels along with their systems support requirements all from Texas.

We also understand the first DDG 1,000 will be stationed in San Diego. Additionally, the SPAWAR System Center Specifics Research and Applied Science Department in San Diego has been growing at a compounded rate of almost 10% per year. Similar to Huntsville, we believe that Kratos headquartered here in San Diego is very well positioned to take advantage of the increasing technical and support requirements at various San Diego government customers as additional national security assets and resources are added here.

In December '07, Kratos acquired Haverstick; directly as a result today Kratos has approximately 200 employees at the naval support facility in Dahlgren, Virginia and the military range facility located there. Kratos today is one of the largest contractors at Dahlgren; in the northern Virginia, Maryland, Washington, D.C. belt way area is where Kratos' largest concentrations of employees and resources preside. Just last month the US Navy stated that it will be establishing a new missile defense command. The Navy Air and Missile Defense Command or NAMDC at the naval support facility in Dahlgren, Virginia. The NAMDC will serve as the single center of excellence to synchronize and integrate Navy efforts across the full spectrum of air and missile defense, including air defense, cruise missile defense and ballistic missile defense. The NAMDC will be the lead organization for Navy joint and combined integrated air and missile defense. Kratos is involved in numerous aspects of missile defense in many areas throughout the Company.

Directly related to this, the Navy is planning to add to its current fleet of 22 AEGIS ships, both cruisers and destroyers. AEGIS platforms are completely ballistic missile capability and able to track, discriminate and intercept short and medium range missiles. Kratos is also specifically focused on AEGIS in various areas throughout our Company. Similar to Huntsville and San Diego, we believe that strategically, Kratos is very well positioned in Dahlgren, Virginia and with the new missile defense command to pursue and capture future new opportunities.

And finally, Kratos also through our acquisition of Haverstick has a prominent presence at Wright Patterson Air Force Base where the Air Force research lab and its sensors directorate will be moving and the 77th aerospace systems group will be moving in 2010. We believe that Kratos' strategy to build the Company's primary points of presence at major BRAC geographies have positioned the Company for continued future success and sustained growth going forward.

Now for first quarter operations. During the first quarter on the programmatic side, some of the highlights included Kratos provided M3P weapons system support modifications and maintenance support for training in gunneries at Avon Park, Florida for the First 230th Calvary and at Fort Bragg, North Carolina for the first 17th Calvary. Kratos performed weapons and other systems related reset work at Fort Stewart, Georgia and Fort Hood, Texas on LBE equipment and systems including man portable common night sight systems. The Kratos team provided on site equipment reset and LBE field support on the ground vehicular laser locator designator system at Fort Benning, Georgia and at Fort Hood, Texas.

Kratos personnel provided onsite equipment reset and LVE work on various systems and platforms at Fort Drum, New York, Fort Campbell, Kentucky, the Schofield Barracks, Hawaii, Fort Benning, Georgia and Fort Bragg, North Carolina. Kratos performed work with the cruise missile defense system project office related to certain foreign military sales program cases. Kratos provided targets and operations for support for the slam ram and for live fire patriot tests. At White Sands, we conducted a total of nine target flights during the quarter, all successful, including six flights related to a certain FMS customer and surface to air missile assets. And at the PMTC, we conducted a total of five special projects related to target flights, all successful.

Additionally, our work at the Navy Surface Warfare Center in Dahlgren continued to be very solid as did our work with the naval operations or NAVC. The vast majority of Kratos' government business, which makes up the majority of Kratos' overall business performed very well in the first quarter, the primary disappointment being a continued delay in a large follow on weapons system sustainment program, which we were looking for in the first half of the year and it now looks like the award will be in the second half. We understand that the delay is primarily due to the change in the administration last year.

Kratos' PSS business continues to be adversely impacted by the overall poor economic conditions, which are causing delays in some new security program starts and a stop work delay on two data center security programs we are under contract on. Though we currently understand that the data center work will continue later on this year and that stimulus funding may actually alleviate certain of the work delays we have experienced, we are going to be even more conservative in our expectations for the PSS business for the balance of the year or until we get better clarity on some of these project delays. With PSS, we have been taking action relative to the situation and we will continue to do so to ensure that this business representing a small part of our Company does not keep us from achieving our objectives.

With the new contract wins for our government business and the expected award of a large weapon system sustainment follow-on contract in the second half of this year that I just mentioned, along with the continuing integration and cost cutting actions, improving contract mix and reduced pass through items, we continue to believe that Kratos' 2009 EBITDA will continue to improve to the range of our peers and be on target for our expectations. The 2009 revenue is now forecast at approximately $375 million to $380 million due primarily to PSS and to a lesser degree to the timing of the weapon systems sustainment program.

Deanna?

Thank you, Eric. Good afternoon. Today we reported quarterly revenues of $83.9 million, a $15.7 million or a 23% increase from comparable revenues of $68.2 million in the first quarter of 2008, which reflects a full quarter of operating results for the SYS and DFI mergers, which occurred on June 28, 2008 and December 24, 2008 respectively. Sequentially first quarter revenues were up approximately $7.7 million or 10.1% from fourth quarter revenues of $76.2 million driven by the acquisition of DFI, partially offset by reductions of $2 million in our PSS business due to the impact of the macro economic conditions, which Eric previously mentioned, as well as due to the completion of a sizable contract in the southeast division of PSS and the expected impact of the reduction of certain pass through lower margin and subcontract work in our KGS segment.

On a year-over-year basis the government solutions segment revenues increased $19.5 million or 35.5% from $54.9 million in the first quarter of 2008 to $74.4 million in the first quarter of 2009. The year-over-year growth includes the impact of the SYS and DFI mergers which contributed an aggregate $29.8 million. This increase was partially offset by expected reduced shipments on one of our weapons systems projects as well as the impact of reduced revenues as a result of the conversion of certain of our work as prime to subcontractor, which was recompeted and awarded to a small business in early 2008.

Additionally, Kratos organic growth included growth in the following: Our network business and our information technology business in which we provide information technology and information assurance solutions at certain defense agencies. Kratos' network information technology and information assurance businesses continue to be the most profitable businesses in the Company with EBITDA margin rates in the low to mid-teens. Kratos also generated organic growth in defense engineering solutions division C4ISR business and specifically where we provide support at the naval support facility at Dahlgren.

On a year-over-year basis, revenues in our public safety and security segment were down $3.8 million or 28.6% from $13.3 million in the first quarter of 2008 to $9.5 million in the same period of 2009. As previously mentioned, the revenues were adversely impacted by project delays and suspensions caused by the current economic crisis, which impacted certain of our commercial customers' ability to obtain financing for those projects as well as due to the completion of a certain sizable project in our southeast division. On a sequential basis our first quarter public safety and security segment revenues were down $2 million or 17.4% from $11.5 million to 9.5% due to the impacts mentioned earlier. We have factored into our 2009 financial targets expected continued overall economic and market challenges as related to the PSS business.

Gross margin increased for the first quarter of 2009 to 20.4% or $17.1 million from 18.5% or $12.6 million in the comparable first quarter of 2008. The increase in gross margins is primarily a result of the improvement in margins in our government systems segment. SG&A as a percentage of revenues decreased from 15% or $10.2 million in the first quarter of 2008 to 14.4% or $12.1 million in 2009. Sequentially, SG&A decreased from $12.8 million or 16.8% of revenues in the fourth quarter of 2008 to $12.1 million or 14.4% of revenues in the fourth quarter, primarily reflecting the increased leverage on our SG&A infrastructure as we increase revenues as well as due to the negative impact of an approximate $1.2 million net discretionary writeoff 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 decreased from 15.2% in Q4 '08 compared to the 14.4% in the first quarter of 2009.

As previously announced, included in the first quarter operating results is an impairment charge for goodwill of $41.3 million. This charge is both noncash and nonoperational 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. As previously discussed, the impairment charge that we recorded in the fourth quarter reflected the deterioration of the global equity market only through December 28, 2008. As the market has continued to deteriorate in the first quarter of 2009, a further impairment charge was required to be recorded in the first quarter, which was measured reflecting the market values as of February 28, 2009. We obviously consulted with our external auditors prior to our issuance of our fiscal 2008 financial statements and the ultimate conclusion was that a further impairment would be required in the first quarter of 2009 to reflect the continued market deterioration, which occurred in the first quarter.

Also included in our first quarter operating expenses is a charge of $300,000, primarily related to legal fees associated with the ongoing DOJ investigations into our historical stock option granting practices and related to certain of our subcontractors. The first quarter operating expenses also include an adjustment of $600,000 related to our accrual for unused office space in our corporate San Diego facilities, as we continue to consolidate space in our facility primarily as a result of the commercial businesses that we disposed of during the first quarter. Excluding the goodwill impairment charge, our operating income was $1.7 million for the first quarter of 2009 compared to operating income of $700,000 for the comparable quarter in 2008. Excluding the goodwill impairment charge, the litigation fees related to the investigation and the facility's accrual charge, operating income was $2.6 million or 3.1% operating margin and pro forma EBITDA, excluding these items was $5.2 million or 6.2%, up from the proforma EBITDA of $4.8 million in the fourth quarter.

From an operating segment standpoint, our government solutions segment generated $4.2 million of operating income in the first quarter of '09, excluding the $41.3 million goodwill impairment, up $3.4 million compared to the $800,000 in the same quarter last year while our public safety business recorded an operating loss of $1.3 million in the first quarter of '09 compared to operating income of $100,000 in the prior year, reflecting the impact of the reduced revenues and the resulting pressure on operating margins. From an operational pro forma EBITDA metric, our government solution segment generated $6.2 million of EBITDA or 8.4% of revenues and our PSS segment recorded a negative EBITDA of $1 million.

Our cash balance was approximately $3.2 million at March 29, plus $400,000 in restrictive cash. Our cash flow used -- our cash flow from operations generated $7 million in the first quarter, including a cash generation of $9.1 million from the collection of our receivables. Additionally, Kratos cash on hand today is approximately $14.5 million, which we are quite pleased with as in the first quarter just ended we made a number of disbursements significantly reducing the Company's liability and improving our balance sheet. These first quarter nonrecurring disbursements totaling approximately $6.6 million included the payment of approximately $3 million in hold backs related to the Madison and Haverstick acquisitions, $2.1 million of payments on the SYS subordinated debt and $1.5 million of payments related to the sale of our legacy wireless deployment business. These reductions in our liabilities resulted in an improvement in our current ratio from 1.43 at the end of the fourth quarter to 1.56 at the end the first quarter.

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 $91.5 million. Accounts receivable day sales outstanding were 99 days, down sequentially from 106 days in Q4 '08. Our DSOs continue to be impacted by the timing of the milestone achievements and shipping timelines of these weapon systems contracts. We are continually focused on reducing our DSOs in the future as we achieve certain of these milestones. Bank debt at March 29, 2009 was approximately $79.6 million, including $46.3 million on our five-year term note, $23.4 million on our line of credit and $9.9 million in subordinated debt. Net bank debt, net of cash at March 29 is $76.4 million.

As we have stated previously, a primary objective is that Kratos achieves EBITDA profitability consistent with our comparable industry peer group as we head into 2009 and we believe that we are on track to achieve this goal. Our total backlog at the end of the quarter was approximately $690 million, including approximately $165 million in funded backlog. As we have discussed previously, as we are integrating the recently acquired businesses, we are working to establish consistent and standardized definitions of what we include in backlog. Our unfunded backlog reflects our estimate of future revenue under awarded government contracts and task orders for which either funding has not yet been appropriated or expenditure has not yet been authorized. Our total backlog does not include estimates of revenues from governmentwide acquisition contracts or GWAC contracts or general service administration or GSA schedules beyond awarded or funded task orders. For instance, we have not included any amounts under the recently announced Alliant award, which Eric mentioned earlier.

Our contract mix for the first quarter was 40.3% of revenues generated from fixed price contracts, 28.4% of our revenues from cost plus fixed fee and 31.3% generated from time and materials. The recent acquisition of DFI has increased our time and materials contract mix from 24.9% in the fourth quarter of '08 to 31.3% in the first quarter of 2009 which, of course, are typically higher margin contracts.

For government revenues, approximately 67% are performed as a prime under -- with the remaining 33% performed as a subcontractor. Revenues generated from contracts with the federal government were approximately 85%, including revenues with the DoD of 78.5% and revenues with nonDoD federal government agencies of 6.6%. We also generated 3% of our revenues from state and local governments and 11.9% from commercial customers, which has decreased from the 17.1% from commercial customers from the fourth quarter of 2008 due primarily to the acquisition of DFI.

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

Thank you, Deanna. In closing, Q1 of 2009 was the first quarter after the 12-month period that we brought together four small businesses; WFI, Haverstick, SYS and DFI to create what Kratos is today. In the first quarter since our Q4 '08 reorganization, which aligned all of the acquired Companies' capabilities, Kratos today has no material program or contract concentration with no single contract contributing greater 3% to 4% of annual revenue. Our Company's business base is very well diversified. We have just reported our fifth sequential quarter of improved EBITDA profitability growth with $7 million of cash flow generated from operations. We are paying down our debt and today we have just under $15 million in cash on the balance sheet. We are building the business. We have approximately $200 million in net operating loss carry forwards to shield us from virtually all cash taxes going forward, further improving future cashflow. In short, we believe we're executing the stated business plan.

We'd now like to open up the call for any questions that you may have.

Thank you. (Operator Instructions). Our first question is -- this evening will come from Mark Jordan with Noble Financial.

Good morning, everyone. Eric, I would like to talk a little bit initially about sort of the revenue outlook through the balance of the year. You stated because of contract awards and normal seasonality that you expected third and fourth to be stronger. Should one assume that, therefore, those quarters should kind of in excess of $100 million and Q2 would be sort of a stair step towards that direction?

Yes. Good morning, Mark. Mark, it depends on the timing primarily of a couple of these weapons systems contracts which are -- two of them are -- one of them is a follow on and some of them are new and when we -- and when we get them. We're not going to put in any cost infrastructure or anything until we get them and so it's just a question of timing on them.

Okay. With the -- clearly it was excellent performance on the government and national security adjusted EBITDA, 8.4%. Is it reasonable then to assume that as you exit the year that you should have the opportunity to sort of cauterize and improve PSS and this Company has the opportunity of exiting '09 with an EBITDA, in the 8% plus range?

We -- yes, sir. As I said in the prepared remarks, Mark, we will not let the smallest part of the Company by far prohibit us from achieving our objectives and so we're working it -- we're working it very hard and we're going to take the actions that are necessary to ensure it doesn't -- it doesn't prohibit us from getting there.

Okay. You had two EBITDA adjustments that -- excuse me a second. You had two EBITDA adjustments for unused floor space and the legal for the options, that $900,000 in aggregate. When does that fall off and disappear?

Mark, this is Deanna. Related to the facilities accrual that the most recent charge of $600,000 is directly related to the San Diego corporate headquarters facility and the resulting impact of the SYS commercial businesses that we divested in the first quarter, those people all departed this building, so that resulted in a charge. We don't foresee that there would be any further charge on this building as this lease is up in April of 2010.

Yes. And, Mark, on that, I want to take the opportunity to say that the building that we're in right now, we're in -- it's approximately 93,000 square feet and since we've transformed the business from the commercial business to the government business, now we need only approximately 30,000 and rental costs here in the city have basically been cut in half from when they were when this facility was leased nine years ago. So when we -- when we renew this lease, either here or in a different facility, we're going to reduce the square footage by two thirds and we're going to cut the cost per foot in half, so we're looking at a significant additional G&A and cash flow improvement of 2010 over '09 just related to that.

Okay. Thank you. With the fusion acquisition you alluded to some small business. Did you just segregate that out and not show it all in the revenue stream? How did you handle that mechanically?

It's in all the reported numbers because it has to be reported per GAAP, so it's in the reported numbers, but when we give you an internal growth rate of 3%, for example, we pro forma-ed out that business because that business is not -- is not going to be sustaining in its current form with us for a long period of time.

A final question for now, you allude to some significant awards that you -- both for weapon system sustainment and foreign military sales that you expect in the latter part of the year. Can you give us a sense of, how visible and tangible those revenues are -- and how have you handicapped, any future delays, into your expectation?

Right. We've -- on the tangible side, these are extremely tangible and they are -- nothing is guaranteed in life except death, but they are -- we believe they're extremely high probability based on customer needs and the fact that we've been working for these customers sole source for many, many years. So they're extremely tangible. On the handicap side, we have handicapped that these will be late in the year now and I think it's important to note that our business is -- our business base is very solid and so in the second half of this year, whether it be Q3 or Q4 hopefully when we get these, it's going to be significantly incremental for us.

And then relative to AEGIS and your [Oriel] missile, would you talk about where you are in terms of having that system -- simulation system used and what opportunity you think you've got over the next 12 to 24 months?

Right. So on the AEGIS target and we're certain of the target missions we're working under right now are classified, but that business for us historically has been $9 million to $11 million in revenue. With the activity that we're seeing, particularly related to AEGIS, we are hoping that over the next year or so that business potentially could be a $20 million or $25 million business.

Okay. Thank you.

You're welcome.

We'll take our next question from Mike Crawford with B. Riley & Company.

Thanks. So first, just on the acquisition front, the charges, so we've -- I think have you cleared out all of the potential hold backs? Are there still potential accrued expenses that could result in future cash outflows?

Mike, there is one further hold back that is related to the Haverstick acquisition and that is due in the fall of this year, I believe that's $600,000. There is a piece, also, that's related to stock which I believe is about $8 million, $8 million or $8.5 million. So the final remaining cash payment is $600,000.

And how does the stock piece work?

I'm sorry, Mike?

How does the stock piece work?

That is released, I believe, in the same time period provided there's no further indemnification obligations that have not been satisfied.

And that -- and how are those shares carried now?

They are -- how are they reflected in the balance sheet or -- ?

Yes.

They're reflected as an offset in additional paid in capital. I believe the issuance is at -- is at the current -- current Kratos price.

So assuming those shares are released, then a go forward diluted share count for you guys would be -- would it be increased by that $8 million or is it the same?

It would be -- let me check on that for you, Mike.

Okay. Great. And then I'm kind of -- I've been picking through the Q that you filed today while you've been going through these comments, but -- so you say that the cash is up to $14.5 million and where is that debt that was at -- that altogether totaled $79.6 million in March?

The debt is roughly at about the same -- the same level.

Okay. Great. And then so now, getting back to, some of the business items, so you touched on the AEGIS opportunity and, Eric, is that an all encompassing -- is that just US or are you -- or if you did something for AEGIS for -- in SMS, is that in a different bucket?

No, I just included what we believe is the US opportunity.

And do you think you have a foreign opportunity as well?

We do believe we have a foreign opportunity. We think that that would be farther out in 2010 and maybe 2011, but we believe it's there because of the friendly foreign Navies that have already outfitted certain of their ships with the AEGIS combat system and the additional ones that are slated to occur in the next 20 -- excuse me, the next 12 months.

Okay. And then regarding -- you didn't really say much about unmanned aerial vehicles in your script.

Right. Right. I could have because there's a lot going on there. I want -- I thought it was very important to talk about the contract vehicles we won in the first quarter, substantially all of which are new and are going to be incremental for us moving forward in the second half of the year and then over the terms of the contracts and which obviously -- what's obviously been going on on the BRAC side.

On the unmanned vehicle side in summary, we have a significant unmanned vehicle, not just unmanned aerial vehicle, but all types of unmanned systems capability on the intelligence surveillance and reconnaissance side, on the command and control side, on the sensor side and on -- relative to some other aspects that we are under contract on and we are actually going to be -- be flying our unmanned system at a weapons range this summer. And so we're -- that's an area that we are -- we're very focused on because as you probably know, especially with the unmanned aerial vehicle directorate that just came out, unmanned vehicles at part of the US military over the next four or five, ten years are expected to grow exponentially in all types, under sea, on surface, air and land.

And is there any way that you can kind of break out how much, if any, revenues you're getting now from unmanned vehicles?

I think we -- I'm sure we could, but I don't have it at our fingertips right here with us. It's included in the -- our weapons systems business, which is around $140 million.

Okay.

Mike, just to respond to your previous question on the Haverstick shares, that will be required to be released related to the indemnification obligations in the hold back, that's actually approximately 2.9 million shares. The $8.5 million is the value at which we -- that we set at when we originally acquired the Company at the end of '07.

And the 2.9 million shares would pretty much be new shares to add to the diluted count?

That is correct. They're currently not included in our diluted shares, especially from an EPS perspective since -- due to the goodwill impairment this quarter, we have a loss, so that would be our actual -- our basic shares rather than our fully diluted shares.

Right. Right. And your basic shares are at 130 million at the end of April?

Correct.

Okay. I can figure it out from there. So I think maybe the last thing that you have talked about in the past, but not so much today is, a desire to get in to the Colorado area.

Right.

So are you still trying to break into there from the Haverstick side or no, is that more of the focus?

Yes. We have a small presence there today and we are growing that small presence organically and that's the route that we're taking right now.

Okay. And if I could just confirm, you think we're pretty much done with kind of the one-time charges and other items that -- that you typically would back out of a GAAP number or do you think there's more -- you said you might take some actions with regard to PSS.

I thought you were talking more about on the -- the goodwill or the intangible side. Yes. Mike, all I can say is I sure hope so because, the sooner that we can get the core business normalized and moving forward without any of those, the better off we'll all be.

And then, you know, on the M&A front, are you -- is the focus now just on blocking and tackling with what you have or are you still out looking for more opportunities today?

The primary focus has been on block and tackling. We -- there's a lot of activity going on in the space. I know you know that. The consolidation continues. I think it's going to -- once the -- Gates' recommendations get sorted out in Congress one way or the other, I think when people see how those cards are going to fall, it's going to drive additional M&A activity in the certain areas that the cards fall. But right now, we're focused on blocking and tackling, but it's an active environment.

Okay. Great. Thank you.

You're welcome.

We will take our next question from Mike Kim with Imperial Capital.

Hi, good afternoon, Eric, good afternoon, Deanna.

Hi.

Hi, Mike.

Just actually on your last comment, can you throw out some of your thoughts on what you're -- the opportunity that you're seeing from the proposed defense budget and specifically as it relates to cyber warfare, if you have the resources in house to address some of those opportunities or is that an area that you would expect to build upon?

Right. I talk about the cyber security area from our standpoint, Mike, more on the information assurance side and on the -- related to information technology or on the IT side and information assurance on that side and we -- we have a -- for a Company our size, I believe we have a pretty darn good information assurance or information security presence and our customers and the ones we work with like the defense logistics agency or the DCMA, a number of classified agencies that we're selling our product, our network management and network monitoring products into, I think that it's -- I think it's a real opportunity for us because I think a lot of money -- a lot of additional money is going to continue to flow there and I think we're pretty well positioned with our contract base, with our employee base and maybe most importantly with our product base to get a piece of it.

And then some other components to the proposed defense budget, do you see some particular opportunities?

Yes. I -- the focus on ISR specifically related to unmanned vehicles, that's an area where I think that we're extremely well positioned with the contracts that we have and some of the bids that we have out there. As you know, a significant portion of our business is related to weapon systems sustainment and resetting existing weapons systems and existing platforms and I think that if you take a look at what the recommendation is, where it stands right now and what the recommendation is related to the F22 and truncating that after just a few more aircraft, not moving ahead with the DDG 1000 and starting up the [Arly Burke] line again and making the vast majority if not all of Arly Burkes AEGIS compatible, moving missile defense from strategic more towards tactical, AEGIS and FAD those are all areas that we are involved in.

We are not in any material way, hardly in any way at all involved in any of the what I call high profile programs that the Secretary has recommended either be canceled or limited. We're not involved in them. We are primarily involved with the existing install base, sustaining it and upgrading it.

And it was probably a problem -- or more critical issue maybe a year or so ago, but are you facing the same challenges in finding sufficient numbers of cleared personnel or people with high security clearances, is that starting to open up a little bit more, or are you starting to actually see more competition from government or how is that starting to play out?

What you just said is it. It has started to open up. We're seeing more competition from the federal government. That's exactly what is happening.

Presumably you can pay them better?

Presumably we can and we go after it to do that. And, there are certain areas -- that's primarily in the D.C. area where we're seeing that right now in the D.C. area. In areas like Huntsville or in San Diego or in Dayton, we're not seeing it so much and the access to those high value types of individuals has eased off a bit in the last nine months.

And then going back to your earlier comments on backlog, could you clarify, I think you mentioned $0.67 billion, was that funded did you mention or can you just provide some clarification on that?

Yes, Michael, that was in my prepared remarks, it's $690 million total with $165 total funded.

Okay. And so I assume the majority of the funded is recognized as revenue this year and then the remainder coming from the unfunded side?

Right. Exactly. And the unfunded stuff, it's almost all -- it's incrementally funded, it's task funded, so those numbers can move around month to month or quarter to quarter, the funded portion versus the unfunded portion, depending on cycling of the vehicles.

Okay. And then on the integration side with DFI, can you provide an update on how that's progressing, if that's essentially starting to, you know, be resolved this quarter or how far along are you in that process?

Yes. The -- our management team down in Huntsville where DFI, of course, is headquartered or was headquartered and where our significant presence is headquartered, the first quarter, a substantial amount of time has been focused on the integration of the businesses, particularly on the business development side, however, on the operational side, we have already seen some successes where we were subcontracting out, for example, on our [ORO] rocket system, we were subcontracting out to certain subs for capabilities we didn't have. We're now having DFI do that for us, so it's being done internally. So we're taking out that level of fee that we were paying the sub, we're doing it internally, which is improving the margins, and so so far on track and I would expect to continue to see that integration to go very smoothly and very well through Q2 being substantially complete in the second half of the year.

Okay. Great. And then switching gears, I know PSS is a little bit smaller part, but can we infer from your comments that you're looking at that continue to pull back from where we are today or are you actually starting to see that flatten out with maybe some up side from stimulus dollars coming in the second half?

Yes, I'm -- we're hopeful for second half, but we're not expecting it and we're looking at to be -- we're looking at it to be relatively flat or the up sides, our contracts that we believe that we're going to have that are funded that bonding requirements are not required because that is one of the primary issues right now out there, it has to do with the credit crunch and bonding typically which is tied into either a letter of credit or a line of credit, it's just not available out there, it's not available to the customers, it's not available to the contractors, which is what's impacting the business and we're not going to get involved in businesses where -- we're going to try not to get involved in business where there's any risk or potential risk that the work is done and then there's the collection issue going forward.

And so what I meant specifically by my comments at this point is we have taken the action and we're continuing to take the action to right size the business to the expected revenue base to ensure that it is not materially adversely impact our profit margins going forward because our military business is doing just great and that's our tact right now and we will do whatever is necessary to ensure that it doesn't adversely impact us from achieving the objectives here.

And just one last question, are there any significant recompetes coming up here, either,on a small business perspective or other area you would consider that might not --

Yes, we've got a couple of small ones in '09. In 2010, and I -- and primarily in the middle or the second half of 2010, we've got two that I know of offhand that are coming up.

Okay. So it sounds like for the remainder of the year we should carry on pretty much where -- with your existing programs?

Yes. I -- as I tried to -- yes. Yes, Michael. As I tried to explain in the prepared remarks, we feel pretty good that the existing business is bolted in, the contracts that we won in the first quarter, we've won some tasking on some of those IDIQ vehicles already and other directs, we've already started to ramp up, we're looking for that for incremental in the second half of the year and we're looking at other ones that if we can pull them off, they'll be incremental as well. That's how we're kind of seeing the hand going forward in the next 12 months.

Well, great. Terrific. Thank you very much.

Thank you, sir.

We will take our next question from John Nelson with State of Wisconsin Investment Board.

Hi. Good job on the quarter. My question was answered by one of the previous questioners, so again, good work. Thank you.

Thank you, sir.

We will take a follow-up question from Mark Jordan with Noble Financial.

Good afternoon again, Eric. In your proxy statement you've outlined a desire to get authorization to do a reverse split. Usually if those are successful in helping to attract attention it's because there's solid visibility of forward profitability. Could you talk a little bit about your strategy and motivation and timing that you're going to apply to this -- this potential event?

Yes. Absolutely. We have -- through our discussions over the past several months, we have talked with several institution -- potential institutional buyers who have indicated an interest in the Company and an interest in acquiring the Company stock, but as they have stated to us for their internal reasons, they are prohibited from doing that or in a stock that's under a certain threshold and we are under that threshold. And so one of the primary reasons we are -- we have put this in the proxy is to open the Company up, provide access to additional potential shareholders, large shareholders, institutional shareholders of the Company's stock. That's one reason.

Another reason is if you take a look at the peer companies to Kratos -- when I say peer, roughly the same size in revenue, so say $300 million to $500 million to $600 million in revenue or $200 to $600 million in revenue, same relative type of industry, national defense, security, government contracting, etcetera, you will see that -- and we've taken a look at this, that a good number of them, that the shares that they have outstanding are between somewhere around 10 million and 30 million shares. That seems to be the sweet spot. If you take a look at those companies, virtually every one of those companies is a long-term established Company and/or at that Company that went public through an IPO process and that is vastly different than our Kratos came to be with our background. So what that means, with our legacy, with our history, with our background, we being a wireless Company, where the methodology back in the commercial wireless days was to compensate high end engineers more on the equity side with stock options and do things with stock and maybe lesser on the cash compensation side to be sure that they were bought in and enjoy the big upside in wireless, we have a significant amount of shares outstanding.

Prior to us moving out on acquiring and merging the companies with our stock, we had 80 or 90 million shares outstanding and as Michael was just talking about, we have about 130 million shares outstanding right now. So from an optic standpoint that all ties together in optically putting ourselves in comparison with what our peer companies have for outstanding shares in that 10 to 30 million share range, which then from an optical standpoint -- of course, mathematically on an enterprise value or equity value to EBITDA doesn't matter, but optically it does and we think that would provide an opportunity for additional shareholders as well.

And thirdly, though this was a lesser of an issue, it has to do with the Nasdaq listing requirements, which as you know have been extended once again. Last I saw, I think 25% of the Nasdaq was trading under a dollar or something like that, so they're going to have to keep extending that or they're going to lose a significant portion of their clients, but at some point that's going to change and so we looked at this is the time, now that we brought these four companies together in the 12 month period ended December 31, '08 in the way we did it, in the way Kratos was created, this was the most opportune time to do it now that the organization is set and the business is set.

Any comment on timing of when you might execute that and do you think it would be in concert with the market's ability to really get a much firmer grasp on the what the fundamentals for 2010 would be at the same time?

Right. That's a very good question and now that we have filed the proxy and that this plan is public, we have been meeting with face to face and/or talking with over the phone the vast majority of our major shareholders and all of our institutional shareholders and discussing that with them and discussing it with these potential new or additional shareholders, both from a split and what the split would be standpoint and a timing standpoint to try to make it as efficient and as effective as possible.

Okay. Thank you.

You're welcome.

And this would conclude our question-and-answer session. At this time I would like to turn the program back to Mr. DeMarco for any closing remarks.

Very good. Thank you for the questions, very good and I appreciate the -- you asking these questions on the line here to give us the opportunity to explain some of the happenings here, the strategy here and the stock split. Thank you.

This concludes today's conference. You may disconnect at this time.