Kratos Defense and Security Solutions Inc (KTOS) 2009 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Kratos Defense & Security Solutions Second Quarter 2009 Conference Call. Your speakers for today are Mr. Eric DeMarco, President and Chief Executive Officer; Deanna Lund, Executive Vice President and Chief Financial Officer; and Laura Siegel, Vice President and Corporate Controller.

(Operator Instructions). As a reminder, this call is being recorded today, August 6, 2009.

I will now turn the conference over to Ms. Laura Siegel, who will read the Company's warning regarding forward-looking statements. Please go ahead, Ms. Siegel.

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

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

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

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

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

We encourage all of our listeners to review our SEC filings, including our most recent 10-Q and 10-K, and any of our other SEC filings for a more complete description of these risks. A partial list of 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 August 6, 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 second quarter of 2009. He will then turn the call back over to Ms. Lund to discuss the specifics related to our second 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 is my pleasure to turn the call over to Mr. DeMarco.

Thank you, Laura. Good afternoon. Today we reported our second quarter results, and the Company is continuing steady progress against our previously stated business plan. Deanna will go through all the details on the financial statements that we filed today, with the highlights being -- revenues increased both year over year and sequentially over the first quarter of the year, with year-over-year growth of 30%, including both organic growth and growth from our 2008 acquisitions of SYS and DFI; the Q1 to Q2 2009 sequential revenue growth of approximately 9.5% reflects 100% organic growth for our Company.

For the second quarter, we also reported our sixth straight quarter of improved EBITDA profitability, with EBITDA profitability increasing approximately 66% over the second quarter of 2008, with a significant portion of this increase being directly related to the ongoing integration efforts for our recent acquisitions and overall cost reductions. And our second quarter 2009 EBITDA also increased 5% sequentially over the first quarter of 2009.

For the six months of this year, our KGS business has generated an EBITDA rate of approximately 8%, which is about in line with the comparable peer group range.

Our PSS business, which is being adversely impacted by overall economic conditions, has not generated the revenues or EBITDA rates we expected at the beginning of the year, which is reducing our overall EBITDA results and is expected to continue to do so for the remainder of the year.

Also, very importantly, for the three months ended June 30, 2009, Kratos generated in excess of $6 million in free cash flow from operations. And for the six months ended June 30, Kratos has generated in excess of $13 million in cash flow from operations. We believe this cash flow generation is representative of the fundamental soundness and strength of our Company's business model.

Also, as you know, Kratos has in excess of $200 million in net operating loss carry-forwards, which expire through 2023 from our disposed wireless businesses. These NOLs shield Kratos from paying virtually any cash income taxes.

From an operational or programmatic standpoint for the second quarter, we had increased military equipment and weapons systems contract PRE-SET and RESET work on various systems and platforms at numerous military facilities and other locations. As an example, we performed RESET work in Europe for the man-portable common thermal night sight systems assigned to the 2d [Armored] Stryker [Calvary] Regiment, and maintenance and repair work on several other various types of sighting and laser location systems.

During the quarter we experienced increased contract support work at the [Armed Helicopter] Project Office. We provided support on numerous terminal high altitude area defense, or THAAD, vehicles and systems.

We experienced a 100% success rate in all of our military weapons range and targets operational firings. These include or relate to SLAMRAAM missile firings, Patriot and AIM-9 missile system firings, F-22 air-to-air engagement firings, and various other types of aerial target missions.

During the second quarter we continued contract work related to the Advanced Hypersonic Weapons systems, and we continued contract work related to the electromagnetic railgun system.

In the second quarter we experienced significantly increased contract work with our Rocket Support Services business and the Kratos Oriole Rocket Target System, which was one of our key organic revenue growth drivers. Due to scheduled operational tempo, we expect a reduced level of RSS activity in the third quarter, with operations and deliveries picking up again later this year or early in 2010. This is typical and expected for a business unit like this, as it's based on customer scheduling and operational tempo.

On a year-over-year basis, our RSS business is organically growing and is expected to continue to grow in the future based on our contract backlog, bid pipeline, and increased national security focus in this area of missile defense.

During the second quarter we also had increased work and deliveries of systems related to IED neutralization, which we also expect to be somewhat lower in the third quarter based on customer requirements and delivery schedules.

In the quarter we experienced increased work for certain of our modeling and simulation programs that we perform for the Space and Missile Defense Command; specifically, in integrated modeling and simulation and tactical assets supporting experimentation, analysis, and training on field artillery and air and missile defense systems for the Fires Center of Excellence.

And during the second quarter we continued development of the NLOS-T unmanned system, which in early July we announced that we had had an extremely successful initial flight of this system at China Lake. With the success of the development phase contract of NLOS in Q2 with our customer, this phase of the program is expected to wind down over the balance of the year, and we are now looking to exploit this system for its capabilities to production, product, or other applications later this year or in 2010.

The unmanned systems area, and specifically related to NLOS systems, C4ISR, aerodynamics, flight efficiency, propellants, power systems, inertial guidance, and COTS are areas where Kratos believes we have differentiators and where we are looking for growth in the future.

From a strategic positioning standpoint, we believe that Kratos has significant intellectual property, capabilities, or qualifications in the following key areas -- unmanned systems, obviously including the NLOS-T and related C4ISR and sensors technologies; target rocket and sounding rocket support services, including the Oriole rocket system and Kratos Rocket Support Services business; and critical network management software products and tools, including as related to information assurance and cyber security.

Related to this, we believe that from a macro national security and homeland security standpoint, there will continue to be significant and increased fundings in the years ahead in the areas of missile defense, including Aegis, THAAD, targets, sounding rockets, and related products, solutions, and services; unmanned systems of all types, including micro and mini unmanned systems and the C4ISR related to such systems; military equipment PRE-SET and RESET and weapons systems sustainment; and information assurance and cyber security for critical networks not only for the Department of Defense but for most other government agency networks and commercial networks.

As we look out for the balance of this year and 2010 and beyond, we believe our Company is well positioned in many of these areas.

From a contract win, pipeline, and bookings standpoint, during the second quarter, representatively, Kratos won the following contract vehicles.

Kratos was awarded with our partner INDUS a $21-million contract related to the Naval Undersea Warfare -- from the Naval Undersea Warfare Center out of Keyport, Washington. Under this contract, Kratos will be providing technical support, including fleet operation support, test and evaluation support, magnetic silencing, facility operational support, technical analysis and assessment, and information technology support for the undersea warfare training ranges. This work will be performed at Pearl Harbor and at the Fleet Test and Evaluation Center at Barbers Point.

During the second quarter, Kratos was awarded an important network security product and services contract for a certain, non-disclosed, national security agency. This contract is related to network engineering and network management and utilizes Kratos' flagship network management product NeuralStar.

The Kratos NeuralStar product has a unique ability to provide situational awareness and ensure mission readiness by providing enterprise visibility and integrated security, as well as fault performance and configuration events and analysis. We are planning on additional product sales or contract wins here in the second half of this year as part of our business plan, with one large contract opportunity in particular currently scheduled to be awarded in Q3 that we are competing for. We believe that with our proprietary products in this area, Kratos will be a key player in the information assurance and the cyber security arena in the future with many federal government agencies.

During the second quarter Kratos was awarded a $6.6-million foreign military sales weapons system sustainment task. This fully funded, 18-month task is related to ensuring complete weapons systems readiness for one of Kratos' key FMS customer's systems and brings the total value of tasks awarded to Kratos under this contract, which we are working for, to in excess of $70 million.

Sustainment of foreign military weapons systems is a key differentiating area for Kratos as related to our peers and an area where we are continuing to build our bid pipeline for hoped for significant new awards in 2010 and beyond.

Also during the second quarter, and as I mentioned previously, in April, Kratos announced it was an awardee of the Alliant GSA information technology-related contract vehicle. We believe that the Alliant vehicle was designed for the provision of support in a variety of areas which are central to Kratos' business model, including information technology, security, design and support, modeling and sim, and distance learning. The initial tasks have just started to come out under this vehicle. We have prepared our capture and partnering strategy, and we're looking forward for meaningful contributions from this new contract vehicle next year.

During the second quarter Kratos was awarded in excess of $10 million in Public [Security & Safety]-related contracts, including an up to $2.4-million award for a large, international, conglomerate facilities security system here in the United States.

Related to our PSS business, as we announced today and as we mentioned on last quarter's call, during the second quarter, Kratos discontinued a small portion of this business, which, for a number of reasons, has been unable to generate acceptable profitability. We are currently in the process of preparing to approach potential buyers for this piece of business. With the discontinuance of this piece of business, we believe that Kratos' remaining Public Safety & Security business is capable of generating acceptable profitability in the future and, in particular, once the non-investment-grade credit markets improve.

The discontinuance of this piece of business, which in 2008 generated approximately $11 million in revenue and recorded an EBIT loss of over $1.5 million, will reduce this year's forecasted Kratos' revenues accordingly.

Related to the credit markets and PSS, an issue that we have run into this year and one which has become more acute as 2009 has progressed, is the ability for Kratos to obtain reasonable terms and pricing on performance bonds for certain PSS contract opportunities. More and more often as 2009 has progressed, certain Kratos PSS businesses -- business non-Department of Defense, non-federal government customers have required performance bonds or fully backed letters of credit as a result of overall adverse market conditions. This is an industry-wide issue directly related to the non-investment-grade credit market conditions.

We believe that our future revenues and EBITDA profitability for this business will continue to be impacted as we may pass on certain PSS security system integration or installation opportunities for which we are unable to obtain reasonable pricing or terms on performance bonds. We have taken these factors into consideration for the balance of our outlook for '09.

Accordingly, we are currently looking at some overall financing alternatives for Kratos to address this issue, which, if we were to execute, would provide us the ability to bond these new contract awards and also reduce our overall cost or expected risk and cost of capital and position us to achieve greater organic growth and greater overall profitability.

Thank you, Eric. Good afternoon. As a reminder, all financial data presented today reflects a division of our PSS segment which we made the decision to sell as discontinued operations in accordance with FASB 144. This includes the current period, as well as prior-period comparable data.

Today we reported quarterly revenues of $90.6 million, a $21.1 million, or a 30.4% increase from comparable revenues of $69.5 million in the second 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, second quarter revenues were up approximately $8 million, or 9.7%, from first quarter revenues of $82.6 million, with an $8.8-million sequential increase in our Government Solutions segment, offset partially by a sequential decrease of $800,000 in our Public Safety segment. The increase in our Government Solutions segment was driven primarily by increased shipments in our Rocket Support Services business, increased modeling and simulation work, and deliveries of software systems.

On a year-over-year basis, our Government Solutions segment revenues increased $24 million, or 40.5%, from $59.2 million in the second quarter of 2008 to $83.2 million in the second quarter of 2009. For the first six months of 2009, our Government Solutions segment revenues increased $43.5 million, or 38.1%, from $114.1 million in the first six months of 2008 to $157.6 million in the first six months of 2009.

This year-over-year growth for the second quarter includes the impacts of the SYS and DFI mergers, which contributed an aggregate of $15.7 million and $16.7 million, respectively. 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 re-competed and awarded to a small business in early 2008.

On a year-over-year basis, revenues at our Public Safety & Security segment were down $2.9 million, or 28.2%, from $10.3 million in the second quarter of 2009 (sic - see press release) to $7.4 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 these projects, as well as the performance bonding issue, which Eric mentioned earlier

On a sequential basis, our second quarter Public Safety & Security segment revenues were down $800,000, or 9.8%, from $8.2 million to $7.4 million 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 margins increased for the second quarter of 2009 to 19.2%, or $17.4 million, from 18%, or $12.5 million, in the comparable second 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 12.9%, or $9 million, in the second quarter of '08 to 12.4%, or $11.2 million, in '09. Sequentially, SG&A decrease of $11.4 million, or 13.8% of revenues, in the first quarter of '09 to $11.2 million, or 12.4% of revenues, in the second quarter, primarily reflecting the impact of cost-reduction actions that we have taken.

Included in our operating income of $3.2 million in the second quarter of 2008 was a $1.2 million related to a recovery from the unauthorized issuance of stock options and a reversal of an unused office space accrual. Excluding this credit, our operating income was $2 million, or 2.9% operating margin, in the second quarter of '08, which increased by $1.8 million to $3.8 million in the second quarter of '09.

Our EBITDA for the second quarter of '09 was $6.3 million, or 7%, up sequentially from $6 million in the first quarter and up year over year from $3.8 million in the second quarter of '08.

From an operating segment standpoint, our Government Solutions segment generated $4.4 million of operating income in the second quarter of '09, up $2.6 million compared to $1.8 million in the same quarter last year, while our Public Safety segment recorded an operating loss of $400,000 in the second quarter of '09 compared to operating income of $400,000 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 Solutions segment generated $6.5 million of EBITDA, or 7.8% of revenues, and our PSS segment recorded a negative EBITDA of $200,000. For the first six months of '09, operational, pro forma EBITDA for our Government Solutions segment was $12.7 million, or 8% of revenues, and our PSS segment recorded a negative EBITDA of $400,000.

The loss from discontinued operations of $2.8 million includes a $2-million, noncash impairment charge to write down the value of the discontinued PSS business to estimated fair value.

Our cash balance was approximately $4 million at June 28, plus $400,000 in restricted cash.

Our cash flow generated from operations was $6.2 million in the second quarter and $13.3 million generated for the first six months of '09.

Kratos has cash on hand today approximately of $12 million.

Other key balance sheet and capital structure elements at June 28 are as follows. Accounts receivable, which are primarily from the US government and other agencies, was $89.5 million. Accounts receivable day sales outstanding, or DSOs, were 90 days, down sequentially from 97 days in Q1 '09. Bank debt at June 28 was approximately $75.3 million, which includes $45 million on our senior term note, $20.4 million on our line of credit, and $9.9 million on our subordinated term note. Net bank debt, net of the $4 million cash, at June 28 is $71.3 million.

As Eric mentioned earlier, we are looking at various financing alternatives to enhance flexibility in our capital structure. We plan to replace the two existing, expired registration statements that we currently have on file and to update the statements for the Company's current strategy and organizational structure within the next week.

Our total backlog at the end of the quarter was approximately $640 million, including approximately $130 million in funded 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 government-wide acquisition contracts, or GWAC contracts, or General Services Administration, or GSA schedules, beyond awarded or funded task orders.

Our contract mix for the second quarter was 38% of revenues generated from fixed-price contracts, 30.8% from CPFF contracts, and 31.2% on T&M contracts.

For government revenues, approximately 69% are performed as a prime, with the remaining 31% performed as a subcontractor.

Revenues generated from contracts with the federal government were approximately 86.5%, including revenues with the DOD of 80.9% and revenues from non-DOD, federal government agencies of 5.6%. We also generated 4.3% of our revenues from state and local governments and 9.2% from commercial customers.

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

Great. Thank you, Deanna. So, a few final items, and I'll turn the call over for questions.

Kratos is on track and performing against our previously stated business plan. Overall, we had a solid first half of 2009, with our DOD business generating EBITDA consistent with our peers and in spite of continued industry issues that are adversely impacting our PSS business.

Overall, we expect to stay on track with our business plan for the second half of the year, with our DOD business continuing to perform within the range of our peers and our non-DOD business driving for improved profitability as a result of the discontinuance of a small, unprofitable piece of this business.

With the discontinuance of the piece of the PSS business and the continued delay of an expected official award of a large weapons systems-related contract, revenues are now forecasted to be approximately $350 million to $360 million.

Importantly, also over the past few weeks, we have executed a letter of intent for a new facility lease for Kratos' corporate headquarters in San Diego, as our existing lease expires at the end of the first quarter next year. The annual cash savings to Kratos, once our current lease expires and we move into the new facility in the first half of next year, will be in excess of $2 million per year. And this will occur over the approximate eight-year term of the new lease.

Obviously, this $2 million in annual savings beginning next year is very significant to our Company, both from an increased cash flow and P&L standpoint, and is representative of another legacy-type cost that is rolling out of our cost structure in the next nine months.

Additionally, we are also executing a facility consolidation plan for our operations in Huntsville as part of the integration plan with DFI, which we are also looking to complete next year, generating additional synergies and savings.

These types of integration-related and legacy cost items and others like them are all considered in our future business plan as we continue the process of building our Company.

Finally, we also announced today that we will be effecting our previously announced and shareholder-approved reverse stock split on September 10 at a ratio of 10 to 1. Since our shareholders overwhelmingly approved the reverse split at our annual meeting in June, we have been encouraged by some of our largest shareholders, as well as potential new investors, to effect the reverse split so that the resulting higher Kratos stock price would enable new or additional investors to invest in the Company.

With that, we'll turn it over for questions.

(Operator Instructions). Mark Jordan, Noble Financial.

A couple of questions. Relative to the FMS, it sounds that you had some significant business that you've been awaiting. It seems to be pushed out, so you're hedging if it's going to be a meaningful contributor to 2009. What can you say with regards to the absolute visibility that business will come in? Is this delay an Administration change-related issue or funding or questionable demand?

It is absolutely not related to demand or funding. It is related to Administration change, which resulted in a re-review of certain awards, which has not been completed. In our understanding now, it's completely Administrative. And that's the status.

Okay. So you would expect that it's a high probability issue. It's just you can't tell if it kicks in early enough to favorably impact this year but definitely an early 2010 event?

Yes. And I would characterize it as a very high probability.

Okay. Secondly, relative to the NLOS-T, clearly, that program is moving towards the latter stage of its development cycle. What visibility do you have or assurance that it will transition into a production program? I guess I'm asking what kind of visibility you have to the quality of sponsorship it has with the Army.

That's a great question, Mark. Great question. We are right now in the process of coming off of the very successful first flight, far exceeding, I'll, at least say, our expectations and, our understanding, the customer expectations of the non-line of sight system.

We believe, based on what is going on in the unmanned system area, especially in the micro or mini aspects of that area, that the technologies that we have, that we've demonstrated and that were customer-funded and that met all of the requirements, are in demand. And we are going to be successful in exploiting these; maybe not in a sole production contract of our own unmanned system, though that may happen. But also, potentially, were certain aspects from the proprietary aspects of this system having to do with the wing -- the fold-out wing and the telescopic nature of it and the packaging of the system and the guidance system of the system can be applied to other systems that are out there or, more importantly, to new systems that are coming down the pipe. And so that's kind of how we see it right now. Between now and the end of the year -- We have already begun. We've been talking to potential customers, and we have numerous other ones lined up where we're going in with this successful system to see how we can convert this successfully to production or elements of that next year.

Okay. Related to your Oriole rocket, we saw the Missile Defense Agency did a successful live-fire test last week. I think in a Lockheed press release they threw out a figure that the test firing cost about $40 million. That's obviously a dramatically higher cost structure than your Oriole. What visibility do you see that you will have the opportunity to have the Oriole utilized in some of these live-fire situations driven by the cost advantage you have?

Right. This system of Kratos is one of those areas that could truly be a game-changer for our Company if the stars line up. We have several shots under contract right now. And right now what is currently scheduled is that, in the fall, there is a significant increase in activity and the number of shots that are going to happen.

In addition to that, we have already supplied bids on some procurements that have come out. And we are preparing to respond on some additional ones that are coming out.

And this is an area where our system is successful. It has an outstanding success rate. Our customers are extremely happy. New, potential customers are now aware of it. And, hopefully, over the next year, two, three, this can be an area where we can see some significant growth at some reasonable margins.

Okay. With the announced reverse split, I would assume that you're going to have a higher investor relations profile in the months leading up to the effect date of September 10. Clearly, stocks trade when they have a high share price on fundamentals. What will you be talking to people in terms of this Company's performance metrics that they should expect, say, in 2010, which, by September, clearly should be the important valuation metric used to value your stock?

Right. The first part of your question, yes. We are going to increase the investor relation and marketing activity of the Company leading up to the split date on September 10.

On the fundamentals and what we see the business looking like next year, if you take a look at our performance thus far this year, and keeping in mind that just six months ago, at the end of December of '08 with the merger with Digital Fusion, that 12-month period before that, we had brought together four approximate equal-sized businesses with Digital Fusion, SYS, Haverstick, and Kratos, previously WFI. So we've been together now, and this integration process has been underway with these four companies for six months.

But, with the results we've reported for the first six months of the year, as you can see, our Company generates a significant amount of cash. That is going to continue. Our EBITDA profitability has increased quarter over quarter, sequentially quarter to quarter. And a good portion of that is because of the integration of the businesses and synergies and reducing duplication. As I mentioned in my prepared remarks, we still have some big chunks of cost that we can't dictate the timing, like the facility lease, that are going to be coming out of our business model nine months from now.

And so, keeping all that in mind as you look out to next year with our backlog and our book of business, we fully intend to have a company that generates organic growth -- no acquisitions -- organic growth in the five -- top line, in the 5% to 10% range, that generates EBITDA consistent with our peers. If you take a look at our peer companies, at the high end of the range, some of them do 10; at the low range, some of them do 8. We expect to be right in there. And, if we're successful on some of the cyber security bids we have with our products, it can be at the higher end of the range. If we're successful in the Oriole rocket area, it could be at the higher end of the range. And we fully expect to generate higher free cash flow than most, if not all, of our peers because of our net operating loss coverage and the fact that, as we're configured today, we don't pay any income taxes. And so that's our model -- take the free cash flow and pay down debt.

Okay. I guess two final questions, if I may. Question number one. Obviously, this year has been negatively impacted by the economy. If you're looking at a normalized, organic growth rate of 5% to 10%, that should be, one would think, logically applied from a normalized 2009. What would you say would be a normalized base for 2009 that one could apply your 5% to 10% organic growth rate to?

Mark, that's going to probably be a better question to answer a couple of months from now, after the next call. Let me tell you why. I am assuming, and as I said before, I'm very confident, that we're going to win -- We're going to officially be awarded this follow-on systems contract that's a multiyear contract -- tens of millions of dollars a year -- that will be incremental, let's say, starting next year. We have some other bids out there, including a couple cyber security ones, a couple of IT ones, and a couple of engineering ones, that are expected to be awarded in the latter half of this year or at the beginning of next year. We're going to have clarity. I think we're going to have better clarity on a lot of that or some of it in September and October, and that will give a better baseline of what I think '10 will look like relative to '09.

Okay. A final question. I apologize for asking too many. You mentioned the potential for doing some refinancing work or strengthening your balance sheet, which would allow you to address some of your bonding needs. Would this include the potential refinancing of your very high bank debt, because, obviously, where net/net that transaction would be an interest savings for you?

Right now, Mark, what we're looking at is we're primarily focused on the performance bonding issue. And if it's not a performance bond, it's a letter of credit issue, because we're having to pass up on some work that we've been awarded that the pricing or the cost structure and risk profile of the bond doesn't make sense relative to the profitability profile of the contract.

The credit markets, as I said in my remarks, are still very, very difficult. However, certain elements of them have improved. They have improved. So what we're going to be looking to do if we can, and we're not sure that we can -- but, if we can, would be to refinance either part or all of our credit facility with additional flexibility in mind, reduced cost in mind, and a reduced risk profile in mind. Those three. And I would give each one of those equal weighting. And that's kind of how we're looking at it from a debt standpoint.

Okay. Thank you very much.

Michael Kim, Imperial Capital.

First off -- I don't know if I missed this earlier. But can you talk a little about your visibility on the bidding proposal pipeline? You did mention some opportunities in cyber and IT. But, just on an overall basis, how you see that.

Right. Our bid pipeline, considering we just brought these four companies together six or seven months ago, I feel is very adequate for our Company today and especially in the areas -- the few areas where we have differentiating or proprietary products or solutions. And those few areas, I chalk them up to three -- our Oriole rocket system in our RSS business in targets; our network management, information assurance, and cyber security software products; and the work that we're doing with certain foreign military sales customers on weapons systems sustainment. So I look at it today as adequate.

A year from now, and I'm saying this, Michael, because, as you know, the procurement cycles in this business can be two years or longer -- a year from now, I'm looking for it to be nothing short of outstanding. And everything is tracking toward that. Why is that? Because we would have been together as a company 12, 18 months at that point. We will have clearly defined and refined all of our past performance qualifications, understanding what we have. We're targeting and tracking some bid opportunities now that are coming out in the first half of next year and the second half of next year that we couldn't bid on a year ago. But we can bid on these because of our past performance qualifications and our scale.

And so I look at it as adequate today but improving significantly over the next 6, 12 months, just as a result of where we are in this building the business process.

And, in the interim, are there any significant re-competes to think about maybe coming up here in the next couple of quarters?

We have one significant re-compete. First of all, none of our contracts generate more than 3% or 4% of revenue a year. So we're not -- we have no major contract that generates a bunch of revenue. We're extremely well diversified. We've got one coming up, either in Q3 or Q4. But there's word that it may be extended out to next year. And that's the only one that jumps out at me.

And billable headcount? Did that --? I don't know if you can provide a number or a percentage change in the quarter.

Yes. That one -- Michael, we don't have that one right here at our fingertips.

Okay. That's fine. And then, in regards to the stimulus, I know it's been a little bit slow out of the gate here. But do you have any expectations to see some opportunities later in the year or early part of next year, particularly as it relates to your PSS business?

That's exactly right. The only opportunities we potentially see right now that are not near term -- they're either Q4 or, most likely, Q1 on the stimulus side -- have to do with our public security and safety security system integration business and new construction, including some new construction at military bases and the physical security that would go with that.

And is it your sense we might be able to see a little more visibility towards the end of the year? Or, I guess, this has been a little bit slow -- but early part of next year then?

I'm very hesitant to say because, three months ago if you would have asked me this, I would have said by the middle of the year I think we'd have visibility. But it continues to be so slow; I'm hesitant to say.

Okay. And then, maybe on a broader scale, can you talk a little about what your view is on maybe seeing a higher mix of fixed-price contracting, maybe moving away from incentives, and how that might potentially impact the Company?

Right. That's another great question. If you take a look at the contract mix that Deanna mentioned for Kratos, we are roughly a third fixed price, a third time and material, and a third cost, plus fixed fee. And Kratos, like all companies out there in our space -- our fixed price business and our time and material business is by far the highest margin-generating business that we have.

Because of the nature of a significant portion of our range services and operations work -- not our RSS business but our range work, which is predominantly CPFF -- Kratos' CPFF mix is higher than most, if not every one, of our peers. And, again, CPFF contracts bring a lower margin.

We have started to see the beginning indices of this Administration's push to reduce the amount of CPFF and move that to FFP. If that were to happen, this would only be significantly beneficial for us, because this is not high risk CPFF work. This is not customized software development work. This is routine operations, meaning maintenance, technical services, and engineering. And anything that would reduce our CPFF business we think would be significantly beneficial to us from a margin standpoint, because we've got a little bit of a handicap on the margin rate side because of our high mix of CPFF work.

You have a very strong understanding of your range work business, for example, that would enable you to bid very productively on a firm, fixed-price type of contract.

Absolutely. In my mind, Kratos is one of the top players -- the top, prime contractors in range work in this country.

And, hopping back to your comment on visibility and pipeline, et cetera, there are two range contracts coming up for bid; neither one Kratos is on -- one next year and, I think, one in 2011 that are very big that we are going to go for as the prime. And we have great quals for both of these. And maybe we can pick one of them off. So that's an area where we know our stuff very, very well.

For those particular contracts, are some of the incumbents or your competitors there --? Do they tend to be fairly large primes or a similar size? Or do you have a sense of who the incumbents might be?

Oh, yes. They're big.

Interesting. And then maybe just one last housekeeping question. DSOs demonstrated some improvements here in the 90 days. Is it your expectation that you should be able to continue to bring down DSOs a little bit, or is it probably hovering around this range?

We would hope to see some continued improvement from the 90 days. But, as we've said, historically, due to some of the milestone conditions for payment -- progress and payment schedules in certain of our contracts, we are limited to the amount of improvement that we can see significantly below that 90 days. We do expect to or hope to bring that down some but not by a material amount.

Not dramatically. Okay. No. That's great. Thank you very much.

Mike Crawford, B. Riley & Co.

One, could you talk a little bit about what part of the PSS business you're carving out?

It's part of the operation that does the predominant amount of its work down in the southeast.

And it's up east?

Southeast.

Okay. And did it come primarily from one acquisition -- Madison or --?

This was a business that WFI acquired in 2003.

Okay. Second, I think in your prepared remarks you talked about reinstating two expired registration statements. Did I hear that correctly?

Well, we've had -- the Company has had two shelf registration statements that have been sitting out there for a number of years. They were put out there under WFI, when, obviously, the Company was a different size, a different shape, a different structure, and had a different strategy.

Those have expired, and we are replacing those with one general shelf registration that is specifically related, in our minds, to the financing discussion that we were having a few minutes ago. It's just replacing just some general, global shelves-- the ones that have expired now-- with a much smaller one and just putting it out there.

Mike, I think those ones we had out there we've had out there for four or five years. And we never used them. But, again, we just want it out there for flexibility because you never know.

Okay. Great. And then a final question is back to that NLOS-T. You had the successful test flight, and you had some-- what, a handful or more of prospective customers watching in China Lake?

There are several numerous customers that were either there or are aware of this system.

So, assuming you're able to get a production contract, and, I think, in your press release you talk about-- you mentioned, I think, "thousands to tens of thousands" of these things. You're not a manufacturing company. So how would this work operationally?

Well, if, God willing, Kratos were ever to get involved in something like that where the customer-- this particular customer, who did say this is the type of system, extremely low-cost, extendable, can be used in many, many different configurations-- If there were to be a large production run and we were to be involved in that, it is highly unlikely we would be the one to produce it. We would either subcontract it out, or we would do some type of a joint venture with-- We're thinking a joint venture or a teaming agreement with the manufacturer or something like General Dynamics, for example, did with [Forest Protection].

Okay. Great. Thank you.

Michael Lewis, BB&T.

I'm also on a train. I got dropped a few times from this call. So, if I ask a question that was already answered, I apologize.

I'm interested to hear about whether Kratos is experiencing any procurement or award delays. And, if so, has that had any impact to your (inaudible)?

Right. We've had some procurement delays. And, yes, we have had some work delays. We have. We've been fortunate so far that, for the most part, we've been able to offset that with some of the areas in our business that are showing some strong growth; for example, in the second quarter, our RSS business. But we are-- Mike, we are seeing some things move slowly to the right on us.

With regard to the quarterly revenue slip, can you quantify that for us? Was it a material amount or just a few million bucks? Can you give us a little detail there?

Yes. Think about like $5 million.

Okay. But you do--

Which, to us, Mike, of course, is significant.

Okay. That's fair. But the key point is that this is not a contract that was lost; this is just revenue that's moving to the right. Is that fair?

Absolutely. The one in particular that's moved to the right-- There is one significant one that has moved to the right on us. It has moved to the right on us for a few quarters now. But it is significant. It's approximately $15 million or more a year in revenue for us at a high margin.

Okay. And if we look out into your bid and proposal pipeline right now, what proportion of your bids outstanding do you expect to have awarded over the next, say, 6 to 12 months? And can you also quantify the dollar amount that you would expect to see there?

Mike, that's a hard question to answer. Let me explain why -- because we don't do factoring here on a bid that we're out there. We're either going to win it or lose it, and it's a zero or a one. And we've got a number of-- a slew of smaller contracts that we've been on, particularly in the IT and information assurance area, where it's customers we have, customers we know. We're extremely well qualified. We have great relationships with them. I think in the next six to nine months we're going to win a good number of those on the IT side. But they're smaller types of three-year contracts.

We've got a handful of FMS opportunities that are big -- tens of millions of dollars-- that it's us and one other guy we're competing against, virtually in each case. If we were to win more than our fair share of this, it moves the needle. But we don't factor-- We put those in as-- Our assumption is zero. Those are new. We're up against a good guy. But we've been fairly successful of late. That's why it's hard to say what percentage we think we're going to win.

Okay. So, in other words, if you're on a zero or one system and no factoring, the level of visibility in your backlog is better than other companies that would factor. Would you agree with that?

I would agree. Based on our understanding of how other companies-- and I'm not-- how other companies characterize their backlog, I believe that our backlog on our bid pipeline is-- It's a higher visibility for us.

Okay. Thank you very much for taking my questions.

And that does conclude our question and answer session. I'd like to turn the call back over to today's speakers for any additional or closing remarks.

Very good. Thank you very much, and we'll be chatting with you in a few months on our third quarter results. Thank you.

That does conclude today's conference call. And we thank you for your participation.