Kratos Defense and Security Solutions Inc (KTOS) 2009 Q3 法說會逐字稿

Good day and welcome to the Kratos Defense & Security Solutions third-quarter 2009 earnings conference call. Today's conference is being recorded. At this time I would like to turn the conference over to Ms. Laura Siegel. Please go ahead.

Good afternoon, everyone, and thank you for joining us for the Kratos Defense & Security Solutions third-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.kratodefense.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 filing, including our most-recent 10-K and 10-Q and any of your 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 November 3, 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 third quarter of 2009. He will then turn the call over to Ms. Lund to discuss the specifics related to our third-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. Eric DeMarco.

Thank you, Laura, and good afternoon. I will provide a brief financial summary of our third-quarter results, and then Deanna will be providing a complete detail of what we reported today. I'll also go through the operations, contract and programmatic information, other highlights since we last reported Q2, and then I'll close with what is going on from an industry standpoint and some recent very good news for our Company.

For the third quarter the Company remained on track with our previously-stated business plan. Revenues increased approximately 10% year over year and Kratos' EBITDA continued to improve. Our Government Solutions business, which represents approximately 92% of our Company and where -- excuse me -- and where we primarily support the United States Department of Defense, and other national security related to customers and agencies, generated an EBITDA margin rate of 8.6% in Q3, and the entire Company's EBITDA margin rate increased to 7.4% for the quarter. Some additional good news here related to our PSS segment, and the Public Safety & Security business and industry overall. Over the past quarter, we have seen an increase in PSS-related security system procurement activity and we are also seeing an increased order flow. We are hoping that this will continue, which would bode well for 2010 PSS revenues and EBITDA profitability. Additionally, with the third quarter equity raise and the result in overall deleveraging, Kratos' PSS business is now positioned to either put in place letters of credit, or obtain performance bonds, if required, without onerous terms and conditions, which also could assist the business as we head into 2010. Since the equity raise Kratos has already received performance bonding at a reasonable cost and reasonable terms for a new contract award.

During the third quarter Kratos generated $9.9 million of cash flow from operations, bringing our total year-to-date cash flow from operations for the corporation through September to over $23 million. We believe that cash flow from operations is not only representative of the quality of Kratos' earnings, but also of the success we have had to date in the integration of the acquired businesses and in achieving operational efficiencies. Very importantly, as related to cash flow and liquidity, at the end of Q3, Kratos' net bank debt position was approximately $45 million and we are very focused on utilizing our operational cash flow as we move forward to continue to pay down the debt, which we believe will increase the equity component of Kratos' overall enterprise value.

As we have stated before, Kratos pays virtually no federal income taxes, as we have approximately over $200 million in NOLs, which expire through 2027. This effectively means that Kratos' real cash profitability is 35% to 40% higher than it would be without these NOLs. Kratos' annual capital expenditures are less than $1 million per year and cash for working capital uses is not expected to be significant. All of this means that as we move forward, and if the contract mix and DSOs do not change materially, we believe that we are in a good position to continue to generate a significant amount of real cash flow from operations, significantly pay down the Company's debt, and increase our Company's equity value over the next couple of years, which is what we currently intend to do.

From an operational and contractual standpoint for the third quarter, during the third quarter, Kratos was awarded a very important $43 million contract with the US Army Space and Missile Defense Command, or USA SMDC Army Forces Strategic Command. This competitive award is specifically related to providing solutions for new and innovative ideas for space and missile defense technology. Some of the work that Kratos will be performing under this contract includes unmanned system and other airframe technology work, including as related to sensors and certain weapons systems and platforms; modeling and simulation work, including M&S work specifically related to intelligence, surveillance and reconnaissance; electro optical and infrared technology and systems and certain types of seekers; and advanced, electro optical and infrared sensor-related work. These are all areas that Kratos will be very focused on as we move forward, and these are also areas we believe will have continued national security emphasis and support in the future.

During the third quarter, Kratos announced that we had successfully completed the first NLOS-T unmanned system test flight at China Lake. We did this with the following customers; the US Army Aviation and Missile Research Development and Engineering Center, the MR DEC, the NLOS-LS project office, and the US Army Strategic Missile Defense Command. The successful NLOS flight was performed at China Lake in California. NLOS-T program is for a canister launch to missile, or unmanned system, capable of delivering a variety of lethal and non-lethal payloads and of providing intelligence, surveillance and reconnaissance information. The success of the first NLOS-T flight importantly demonstrated Kratos' capability in many areas related to this type of system, unmanned systems, and technologies. Modeling and simulation, specialized aero sciences and miniaturized sensors development are all areas that Kratos is directly pursuing related to this, and here again, these are areas that we currently believe are national security priorities, which funding is stable, and we recently were awarded a $1 million contract in the miniaturized sensor area.

In September, Kratos announced that we had been awarded another task order under our Company's $100 million multi-year Theoretical Studies in Engineering, or TSER contract, which we were awarded just last year. The task order we received under this contract is to provide rocket launch services, engineering support, and associated hardware, for the AEGIS ballistic missile defense, BMD, Japanese flight test mission, which has now been successfully completed. Also during the third quarter Kratos was a key participant, including the delivery of certain RSS hardware, to the successful August ballistic missile test, Stellar Avenger. We believe that Kratos, with the AEGIS Readiness Assessment Vehicles, or ARAV's, and the Kratos Oriole Rocket Target Systems is extremely well positioned in the ballistic missile defense arena and especially as related to proven AEGIS ballistic missile defense systems. Specifically, we believe that the current administration's redirection on European missile defense, the cancellation of GMD in Poland and the Czech Republic, and the emphasis on proven AEGIS systems provides opportunity for Kratos' RSS business, the AEGIS Readiness Assessment Vehicles and Kratos' Oriole Rockets, as this is a specific market that we serve.

Additionally, we understand that the Navy wants to have at least five of its 22 AEGIS cruisers and all of its AEGIS destroyers, which is 66 DDG51s funded in prior years, plus additional DDG51s funded in FY '10 and beyond under the new DDG51 restart, to be equipped for ballistic missile defense. What this would mean is that the Navy currently wants to eventually have more than 67 BMD-capable AEGIS ships, up from 19 today, which is a specific area that Kratos is involved in and positioned for in the future. Additionally, as related to this, on September 17th the White House released a fact sheet on US missile defense policy, which reiterated the administration's position to deploy proven capabilities today, specifically including the AEGIS-BMD capability, on ships, as well as potentially land based. So in summary, we had a very encouraging and successful third quarter as related to our rocket support services business, including from a future market potential and dynamic standpoint, and we are looking for this to be one of Kratos' growth drivers in the future.

Other operational highlights and work performed included weapons systems sustainment, reset/preset and range work. Kratos provided on-site support and a readiness assistance support and technical effort on ground tube-launched optically-tracked wire-guided TOW 2 missile systems and manned portable common thermal night sites to the second 11th Calvary Regiment, California Air National Guard, at Fort Irwin, California. Kratos performed work at Fort Carson, Colorado, for the reset of ground vehicular laser locator designators, and MCTN's assigned to the 1st Combat -- excuse me -- the 1st Brigade Combat Team 4th Infantry Division. Kratos provided support at the Joint Attack Munitions System, JAMS, project office and designed designator mount work on the Hellfire missile launcher system.

During the quarter, we also provided work related to the Cruise Missile Defense system. At Hunter Army Airfield in Savannah, Georgia, we performed work related to the MP3 Machine Gun system. At Fort Eustis, Virginia we performed work related to the OH-58D Kiowa War Helicopter Weapons system. We provided range support for the Program Manager Armed Scout Helicopter Project Office, the Aviation Technical Test Center and the Redstone Technical Test Center. At the White Sands Missile Range, we conducted in excess of 20 aerial target flights during the quarter, including numerous related to Patriot Missile firings, and we continue to work on certain FMS-related weapons systems with tasking on this one contract now in excess of $71 million.

During the quarter Kratos' Workforce development, learning performance, training and measurement business within our Networking and IT Solutions division continued to perform very well. Third-quarter contract awards in this area of note relate to the United States Navy Workforce Development. Under these contracts, Kratos will be assisting the Navy in advancing the skills, knowledge, and capabilities of the Navy's information technology workforce. Included in this work, Kratos will be developing modules for a Virtual Radio Room Simulation in support of the Journeyman Communication Core and Information Technology Specialist Accession curricula at the Center of Information Dominance. Under these contracts, Kratos will also be deploying -- developing policy process, performance aids, and training materials to support the complete management of training devices, simulators, and technical training equipment in Navy information technology classrooms throughout the United States. The training and simulation market is very large and growing, with the land and air segments of this market alone estimated to be approximately $41 billion through 2016. Distributed training offers the potential to train forces at remote locations, as well as enable multi-national simulation exercises at much lower costs than traditional military exercises. Training, simulation, distributed training and workforce development solutions for the Department of Defense and other federal government agencies are focus areas for Kratos, and we believe that out-year funding is solid and potentially increasing here.

During the third quarter our Public Safety & Security business was recognized among the top US Public Safety & Security systems integrators and Kratos' PSS business was awarded Cisco's elite physical security premiere partner certification. Contractually, during the quarter Kratos' PSS business was awarded a $2.7 million contract by the United States Army for a video surveillance and security contract. This contract award with Kratos will be integrating specialized video cameras, which utilize advanced analytical techniques, is included in what we saw as increased activity in order flow in the PSS market space in Q3, and particularly late in the quarter.

Deanna?

Thank you, Eric. Good afternoon. As a reminder, all earnings per share and diluted shares outstanding data presented today reflects the impact of the 10:1 reverse stock split that occurred in September. Today, we reported quarterly revenues of $86.1 million, an $8.2 million, or a 10.5% increase from comparable revenues of $77.9 million in the third quarter of 2008, which reflects a full quarter of operating results for the DFI merger, which occurred on December 24, 2008. The revenues generated by DFI, of $15.2 million were offset partially by reduced revenues of approximately $2.9 million in our public safety business, which has been negatively impacted by the current adverse economic environment, as well as the planned and anticipated reduction of small business and other set-aside contract work from previously-acquired companies, and past due work in our Government Solutions segment. As expected, sequentially third quarter revenues were down from $90.6 million, to $86.1 million, primarily due to the timing of increased shipments in our Rocket Support Services business that occurred in the second quarter. This also resulted in a reduction of sequential revenues in our Government Solutions segment, from $83.2 million, in the second quarter of 2009, to $79 million in the third quarter.

On a year-over-year basis, our Government Solutions revenues increased $11.1 million, or 16.3%, from $67.9 million in the third quarter of 2008 to $79 million in the third quarter of 2009. For the first nine months of 2009, our Government Solutions segment revenues increased $54.6 million, or 30%, from $182 million in the first nine months of 2008 to $236.6 million in the first nine months of 2009. On a year-over-year basis revenues in our Public Safety & Security segment were down $2.9 million, or 29%, from $10 million in the third quarter of 2009, to $7.1 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' abilities to obtain financing for these projects, as well as the challenges we had experienced in obtaining performance bonds prior to our recent equity financing, which Eric discussed previously. On a sequential basis, our third quarter Public Safety segment revenues were down $300,000, or 4.1%, from $7.4 million to $7.1 million, due to the impacts mentioned earlier.

Gross margins decreased for the third quarter of 2009, to 20.6%, or $17.7 million, from 22.1%, or $17.2 million in the comparable third quarter of 2008. The decrease in gross margins is primarily a result of the change in mix of revenues. SG&A as a percentage of revenues decreased from 15.1%, or $11.8 million in the third quarter of '08, to 13.7, or $11.8 million in '09. The decrease in SG&A as a percentage of revenues reflects the impact of our cost reduction efforts, as well as leverage on our revenues. Included in our operating income of $4.3 million in the third quarter of 2008 was a $1 million credit related to a recovery from our insurance carriers for costs previously incurred by us and the previous investigation of historical stock option grants. Excluding this credit, our operating income was $3.3 million, or 4.2%, in the third quarter of 2008. Included in our operating income of $4.5 million in the third quarter of '09 is a $500,000 credit, which was recorded in this quarter to reflect the reduction of a previously-recorded accrual for estimated settlement costs for our derivative litigation based upon the pending settlement. Excluding this credit, our operating income was $4 million, or 4.6% operating margin, in the third quarter of '09. Our EBITDA for the third quarter of '09 was $6.4 million, or 7.4%, up sequentially from $6.3 million, or 7% in the second quarter, and up year over year from $5.9 million in the third quarter of '08.

From an operating segment standpoint, our Government Solution segment generated $4.9 million of operating income in the third quarter of '09, up $1.4 million compared to $3.5 million in the same quarter last year, while our Public Safety & Security segment recorded an operating loss of $500,000 in the third quarter of '09, compared to operating income of $500,000 in the prior year, reflecting the impact of the reduced revenues, and the resulting pressure on operating margins, partially offset by cost reductions in those businesses. From an operational pro forma EBITDA metric, our Government Solutions segment generated $6.8 million of EBITDA, or 8.6% of revenues, and our PSS segment recorded a negative EBITDA of $400,000. For the first nine months of '09 operational pro forma EBITDA for our Government Solutions segment was $19.5 million, or 8.2% of revenues and our PSS segment recorded a negative EBITDA of $800,000. Our net income for the third quarter was $2.7 million, which included a $100,000 benefit for income taxes on taxable income of $2.3 million.

As we have discussed previously, we have over $200 million in net operating losses, all of which are currently fully reserved from the balance sheet perspective. What that means from a quarterly P&L period is, that as we generate taxable income, a corresponding amount of NOLs are utilized in that same period to offset the taxable income, and the reserve related to that utilized NOL is reversed, thereby reducing our overall federal tax provision. Then tax expense or provision is recorded for any state taxes and the impact of any permanent tax items that cannot be offset by the NOLs. All this equates to a tax provision that is significantly less than a typical statutory 355 to 40% tax rate. We believe that this will be the case for the foreseeable future, as long as the NOLs remain fully reserved on the balance sheet.

Moving to the balance sheet and liquidity, our cash balance was approximately $10.9 million at quarter end plus $400,000 in restricted cash. Our cash flow generated from operations was $9.9 million in the third quarter, and $23.2 million generated for the first nine months of '09. Additionally, we currently have on hand cash of approximately $10.1 million today. Other key balance sheet and capital structure elements at September 27th are as follows. Accounts receivable, primarily from the US government, and other agencies, was $80.3 million. Accounts receivable day sales outstanding, or DSOs, of 85 day, down sequentially from 107 days at year-end 2008, and down sequentially from 90 days at the end of the second quarter. The cash flow generated in the first nine months of 2009 reflects our collection efforts to reduce our DSOs to a more normalized level in the mid 80-day range. As we expect our DSOs on a go-forward basis to be in this range, we do not expect the cash flow generated from the reduction of accounts receivable to be as significant as we have seen in this year to continue in the future, especially with the potential impact of the continuing resolution on our collections. Bank debt at September 27th was approximately $56.5 million, including $43.8 million on our senior term note, $2.9 million on our line of credit and $9.8 million in subordinated term note. The bank debt reflects the paydown of $17.5 million on our line of credit of the net proceeds from the registered direct stock offering that we completed in September. Total net debt, net of $10.9 million in cash, at September 27th is $46.6 million.

On October 16th we executed a settlement agreement and a third amendment to our credit agreement with our lenders. The settlement agreement consisted of the mutual release of actions filed by the parties and the third amendment consisted of the correction of the error in the minimum liquidity ratio. The requirement of the net proceeds of $17.5 million from our recent equity raised to pay down the first lien term debt at par with no prepaid penalty, and if the Company refinances the remaining balance of the first lien term debt by March 12, 2010, the extinguishment of the term loan will be at par with no prepayment penalty. In addition, the term of the revolver was extended one year to December, 2012. Accordingly, on October 16th we paid down the term loan by drawing by drawing $17.5 million on the revolver and paid the lenders the $500,000 fee for the amendment. The permanent paydown of the $17.5 million in the fourth quarter will result in the accelerated amortization of previously-deferred financing costs, to be recorded as interest expense, of approximately $700,000 in the fourth quarter. As of November 2nd the balances outstanding on our bank debt are as follows; $26.2 million on the first lien term loan, $9.8 million on the second lien term loan and $20.4 million on the revolver.

Moving on to backlog, our total backlog at the end of the quarter was approximately $620 million, including approximately $130 million in funded backlog. Our contract mix for the third quarter was 40.5%, on fixed-price contracts, 29.7% on CPFF contracts, and 29.8% on T&M contracts. For our third quarter government revenues approximately 63.7% are performed as prime with the remaining 36.3% performed as a subcontractor. Revenues generated from contracts with the federal government were approximately 86%, including revenues with the DoD of 80% and revenues with non-DoD federal government agencies of 6%. We also generated 4.3% of our revenues from state and local governments, and 9.6% from commercial customers.

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

Thank you, Deanna. From an industry standpoint, there is, as you probably know, a lot going on. Kratos, like many of our peer companies, has very recently been experiencing the adverse impact of the federal government's insourcing initiatives and directives. This is where work previously contracted out to a company like Kratos is being brought inside the government with the contractors' employees becoming government employees. We are being impacted somewhat by this insourcing. For example, late in the third quarter we were informed by one of our government customers that approximately 15 Kratos employees work will be insourced by the federal government over the next few months on a particular information technology and networking contract. Also from an industry standpoint, the Congress continues to be distracted by the healthcare reform debate, which has led to most federal government civilian agencies having begun federal 2010, which commenced on October 1st, under a continuing resolution. The continuing resolution means for affected agencies spending is kept at FY 2009 levels and it prevents the start of new programs and new contract awards. This has resulted in the delay of certain contract awards. Other industry-wide issues that contractors like Kratos are also dealing with include the continued delay in the approval of lower-level political appointees and the continued understaffing of government procurement positions, which also can result in the delay of new contract awards.

As we previously discussed, our acquisitions last year of SYS and DFI brought to Kratos a certain amount of small business set-aside work where Kratos is not eligible to bid on the recompetes in the prime position, but Kratos will be bidding on the recompetes in 2010 as a sub with a reduced scope of work, which was our original plan when we acquired these companies, which we communicated, and which will result in a partial reduction in Kratos' scope of work and revenue on these contracts commencing some time in 2010. We also continue to reduce lower margin and pass-through revenues in order to increase our overall operating margins and improve our cash flow and liquidity position. We've been back filling the impacts of these items where we can with the new bids and contract awards and we have some very good news here today related to this. The US Army has very recently notified Kratos that the sole-sourced FMS Chaparral Missile overhaul case has now been fully executed and is currently being staffed for final contract award to Kratos. Once again, this is very good news for our Company, as this is a large multi-year award. The follow-on award is now expected for Q1 of 2010, and though the delay of this contract, along with the impact of the items I just mentioned, will reduce our Q4 and 2010 revenue somewhat, the execution of this FMS case is very good news for us, in 2010 and beyond.

As we sit here in November of 2009 and we look into 2010 we have a $620 million backlog and a $1.6 billion qualified BMP pipeline, and as a result, a very significant portion of our 2010 business is already under contract, or we have very good visibility into it. Accordingly, with the government insourcing we are experiencing, the impact of the small business awards and reduction on the pass-through on lower margin revenue, and the delays in the contract awards being offset by some of our recent contract wins, the outstanding bid, and the FMS case, we are currently looking at 2009 revenue of approximately $340 million, and the 2010 revenue range of $350 million to $360 million, with 210 -- 2010 EPS operating income and EBITDA all continuing to improve and increase over 2009. Considering the expected acquired business -- small business contract reductions next year that I just mentioned, for 2010 this would reflect substantial organic growth year over year for our Company. We believe that we are very well positioned with AEGIS and SAT ballistic missile defense, EO-IR sensors, C4ISR and information protection and assurance where our products are currently being used by the intelligence community, to grow the Company and execute the business plan.

And finally, we have some additional very good news for the corporation. Since we last -- excuse me -- since we last updated you at the end of the second quarter we have favorably settled some major legal items with the corporation; the derivative matter and the investigation related to the stock-option backdating, with no material financial or other impacts to the corporation. The settlement of the derivative matter, and the official closing of the stock-option backdating investigation will bring to closure the last of the major legacy matters for the Company and mean that both significant management distraction and the significant cost element, primarily in attorney fees related to these matters, will be gone in 2010.

With that, we'd like to turn it over to questions.

Thank you. (Operator Instructions). We'll take our first question from Mark Jordan with Noble Financial.

Good afternoon, everybody. Eric and Deanna, I would like to talk a little bit about the interest expense and see if I can understand what's the moving pieces here. Is the $2.2 million -- I guess what is the -- once you have paid down early this quarter the first lien, what is the base interest run rate of your current debt load? And I assume for the fourth quarter we need to add on that nonrecurring amortization of $700,000, is that correct? And what is that basic run rate in terms of cost now?

Sure, Mark. The basic run rate that we see is roughly in the 1.7 to 1.9 range, with that -- and then additive to that would be the $700,000 related to the accelerated amortization on that deferred financing cost that we -- of the debt we've retired.

Okay --

Now that --

Yes?

That also includes a couple hundred thousand of estimated expense related to our swap instrument that we have.

Okay. Also, in your October 8-K you mentioned that you -- and you talked about the ability to refinance -- potentially refinance that first lien, which I understand, if I remember, has got about a 12% effective yield. What is your strategy here, and I would assume that you could refinance this in the 9% -- 9% to 10% range but it'd also give you flexibility to pay it down more rapidly. Is that what your strategy would be and is that the impact?

Yes, Mark, our -- it's Eric. Our strategy is to pay that down with debt replacement, not with equity, and based on current market conditions we believe the rates that you mentioned there in a refinance would be in that ballpark.

Okay. You mentioned that FMS Chaparral is in multi-year, could you wrap around what are the terms? Is that a -- how many year opportunity is it, and give us a range of potential revenues that could be realized over that range of period?

Right. It is -- I don't want to get too specific yet, but think three to four years in total and at rate 12 to 15 a year.

Okay. With the -- Public Safety segment of the business, obviously dragging down the overall EBITDA margins and not contributing, what -- is it possible to get that back towards the corporate average by the second half of next year, or what would be your goals for that business in 2010?

Our plan right now is very consistent with what you just said, Mark. We -- we're hopeful that we can slowly -- with the market and the industry turning around, as I talked about in my prepared remarks, we're seeing some signs of life, we're able now to obtain big performance bonding at a reasonable cost. Our plan is by the second half, that our PSS business is contributing equally with the Department of Defense business, that's the plan. If we're sitting here toward the latter part of next year and for market or industry reason that's not attainable, we will have to recircle and think about what we're going to do. But there is a -- once again, as I said in my prepared remarks, we're seeing a significant increase in bid activity here, which is a good thing, and so we have to see if we can win some of these at a reasonable margin and then execute on them and see what happens.

Okay. Last question from me and this gets down into the Oriole live fire and clearly, if it's 19 shifts or 21, which is the count at the end of the year, there's also, under the AEGIS program, an action to put in place next generation 4.0 iteration of the system, which would be, obviously, much more capable with regards to ballistic missile defense. How do you see and what timing do you think that you'll start to see more, what I call real-time live fire training versus, say, the Japanese test that occurred off Hawaii last month? And is the Oriole the rocket of choice for that, or is it for all applications, or is it for more theater missiles -- replicating more theater-scaled missiles?

Right. First off, we are extremely familiar and right in the middle of the qualification of 4.0. We're very, very familiar with that. I don't want to get out ahead of the program or the customers here as far as what we're seeing, but we are -- we're very comfortable right now and we have some pretty good expectations that if things continue to go the way they're going that along with our customer, the AEGIS Readiness Assessment Vehicles and the Oriole targets, which is our program, this could be a fairly significant growth driver for us going forward. And I think we're going too see the off-tempo continue to increase next year, and especially in 2011 and 2012 based on the scheduling we're seeing right now.

Okay. I guess a final question relative to overall revenue guidance. You're obviously peeled back $15 million to $20 million in terms of revenue. You threw out some industry-related issues, insourcing, which we're getting some visibility on across the industry, also continued slow contracting. And then I guess finally this large foreign military sales being something that probably you were expecting mid '09 and it's really going to start ramping Q1 of next year. Are those just the major swing factors, more industry-related issues and pushout on one or two larger contracts is really the delta here, that it's not necessarily a loss of business per se, but more industry issues and pushing out of some very large significant programs?

It clearly is -- clearly, we have been impacted and we've been hit with a back -- our team has done a great job back-filling this Chaparral contract moving to the right on us. They've done just a great job. We have a slew of information secur -- information assurance and cyber security opportunities that are lined up, which we're going to win some of these. We're going to win them but they've just moved to the right. We've got a slew of those. In addition to that there are -- and we talked about there briefly, either last time we got together on the phone or the time before, there are a couple, two, large opportunities that we bid on that are going to be awarded in 2011. We understand first half of 2011 right now, we understand one of them Q1 2011 right now. These are 100% incremental to us. These are very large that -- obviously they're binary. If we were to win one of these, or God-willing both of these, then we have a different dynamic going here, but it is hard to factor those types of things in.

And so we've taken the route -- the Company's growing, it's generating a significant amount of cash, the profitability's going to continue to improve next year, we're going to back-fill over $20 million of small business work where we're not going to be the prime next year, we're going to back-fill it 100% and then some probably, so we're going to take the conservative route and we like the hand of cards we've got right now, we really do.

Just another quick one. You mentioned a number of IT opportunities in the cyber-related areas. Is this the first payoff of the alliance win, is that the contract vehicle you're working those under?

Some of it is related to that and some of it is specifically, specifically related to the acquisition of SYS, and some products, some information assurance, some network management, and protection, software products they brought that we're having some success in the intelligence community and we've got several, literally, and they've just moved to the right on us.

Okay. Thank you, I've monopolized it enough.

Thank you, sir.

Thank you. Our next question is from Michael Crawford, with B. Riley.

Thank you. Eric, that first large contract in 2011 you're talking about is that Net Sense 2?

It's 2010, and no, it's not.

Okay. Then you can talk about who you're teaming with on any of these -- the two large ones further down the road that you mentioned?

One of them, we're the prime, and then the other one we're on a team, with share agreements and it's I'm sure -- I'm sorry, it's inappropriate to get into the teams right now.

Okay. All right. Changing tack a little bit, can you talk about in general what certain expertise Kratos brings to a sub-system design for UAV's?

Sure, I'll give you an example. A specific area that we're involved in has to do with aerodynamics and modeling and simulation on aerodynamics and flight characteristics on unmanned aerial systems, or flight duration, stealth purposes, the weapon deployment and weapon-carrying purposes.

And on the system sensor side?

We're involved in the development and design of certain types of sensors that go on various types of unmanned systems and these include electro-optical, infrared-type sensors that go on the aircraft.

Okay, thanks. And then just back to the Oriole business, so I think you're -- well, what you said was you expected a slight increase in tempo expected next year, and then maybe accelerated pace in 2011, 2012. Do you have a rough approximation of revenue of what you're getting from that AREV business now in 2009?

Mike, it's very fluid right now what's happening. We were just involved a few weeks ago in four shots, all 100% successful, and the government is right now, literally as we speak, looking at their program plan and their off-tempo plan for '10, '11, and '12, and we have a pretty good baseline of what we think is going to happen, but that could move and it could move significantly. It could move significantly, it probably won't move significantly down too much but it could move significantly up and it's just hard to say. And we -- we're not breaking out specifically what we're doing in that area right now in the delivery of the systems and the services around them. But I can assure you that it's one of the fastest growing and we expect it to be one of the fastest growing pieces of our business in the foreseeable future, based on what's going on from an industry standpoint.

Okay. So in other words, you're not comfortable sharing an approximate revenue, say, in 2008 or in 2009, for that business, is that -- did I hear you right?

That's correct.

Okay. And I'm sorry, I missed the beginning of the call, but did you talk at all about what you're doing in Fort Bliss?

We did not talk much about it, but right now we've got just under 100 people down there and we're doing a number of things, including we're targeting work relative to equipment reset -- weapon system reset work. As you know it's a major BRAC location, it's one that we targeted, and we believe that's going to be one of our fastest-growing geographies over the next several years with the various commands that are moving down there starting next year.

Okay, good. Thank you.

Thank you, sir.

Thank you. And our next question is from John Nelson with State of Wisconsin Investment Board.

Hi, congratulations here on your team for doing a great job of building the business over the last quarter. My questions's related to Obama's decision on Afghanistan, upsize or downsize significantly. What effect, either way on that decision do you think it'll affect your Company over the next year or two?

Thank you, John. We -- and this would be directly related most importantly to the work we're doing in the weapons system sustainment and the reset of the system. Our initial thinking is that if there is a -- let's go with the down side. If there is a downsizing and there was a reduction in force and there was a reduction in equipment and that equipment came back either to this country or the various bases and arsenals and locations, the equipment that we have our qualifications on we would be one -- we believe we would be one of the contractors involved in resetting that equipment, so it would not be initially a bad thing for us. But after a period of time, a couple of few years, that work would -- unless there was another issue, or additional contracts to do that work, it would tail off. I think that if there's an increase it would have to be a significant type of an increase than the work that we're doing, and we're doing some work overseas relative to reset and modification. That would increase for the time being. But again, once it ramped down and it came back there'd be work there, but then that would roll off unless there was something to replace it.

Okay. So the Afghanistan decision really shouldn't have too much of a near impact on your Company either way?

Yes, we don't see it in the near term, two or three years, near term, and it would be immaterial either way for us.

Okay.

We think that from what we're seeing is going to be a pretty steady state.

Okay, thank you. Appreciate it.

Thank you, John.

(Operator Instructions).

Very good, Sarah. Okay. Sarah, thank you, very much, and thank you, all, for joining us. We'll circle back with you when we do the year-end and the fourth-quarter results, and as we head into 2010. Thank you.

And that does conclude our presentation. Thank you for your participation.