Kratos Defense and Security Solutions Inc (KTOS) 2010 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Kratos Defense & Security Solutions Second Quarter 2010 Earnings Conference Call. (Operator Instructions). I would now like to turn the conference over to your host, Vice President and Corporate Controller, Ms. Laura Siegal.

Good afternoon, everyone, and thank you for joining us for the Kratos Defense and 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 5th, 2010, 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. Certain of the information discussed, including organic revenue growth, EBITDA, pro forma EBITDA and the associated margin rates and pro forma EPS from continuing operations, excluding deferred financing costs, interest charges and transaction and other acquisition costs using a cash tax rate are considered non-GAAP financial measures.

Kratos believes this information is useful to investors because it provides a basis for measuring the Company's available capital resources, the operating performance of the Company's business and the Company's cash flow, excluding extraordinary items and non-cash items that would normally be included in the most directly comparable measures calculated and entered in accordance with generally accepted accounting principles. The Company's management uses these non-GAAP financial measures, along with the most directly comparable GAAP financial measures, in evaluating the Company's operating performance and capital resources and cash flow.

Non-GAAP financial measures should not be considered in isolation from, or as a substitute for, financial information presented in compliance with GAAP. And non-financial measures as reported by the Company may not be comparable to similarly titled amounts reported by other companies. As appropriate, the most directly comparable GAAP financial measures and information 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 2010. He will then turn over the call over to Ms. Lund to discuss the specifics related to our second quarter 2010 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.

Very good. Thank you, Laura. Good afternoon.

Today we reported our second quarter results and Kratos remains on track with the previously stated business plan and we believe that we are well positioned in mission-critical areas for United States national security.

Deanna will provide all the details of our financial highlights, with the highlights being Q2 revenues of $99.1 million, which includes a 15% sequential organic revenue growth above the first quarter of this year. Kratos' EBITDA margin increased over 30% above last year to 9.3% for the second quarter. And during the second quarter, Kratos generated cash flow from operations of $8.6 million and we had over $43 million of cash on the balance sheet at the end of the quarter.

During the second quarter, we completed a $225 million bond deal, with approximately $140 million of the proceeds utilized to acquire Gichner, $60 million of the proceeds utilized to refinance Kratos' existing debt, and $25 million of the proceeds included as cash on the balance sheet.

We had originally planned on a bond offering of $200 million, however due to strong demand for the Kratos offering, we increased the size of the bond deal by $25 million. Since the offering, Kratos' bonds have traded very well and they are currently trading above par at around $1.03 to $1.04.

Gichner has been part of Kratos for just under three months now. I can tell you that the integration is going very, very well. It's almost complete and that Gichner is just a fantastic business, which fits extremely well with Kratos' weapon systems sustainment business.

As I've stated before, in my opinion, the Gichner management and leadership team, led by Tom Mills, Bill Wilson and Scott Sarine, is just outstanding and second to none in their business area and the combined Company's contract vehicles, qualification, capabilities and resources have already enabled us to pursue contract vehicles with new programs that independently neither company could have previously pursued.

During the quarter, Gichner performed program and contract work in several areas, including intelligence, surveillance and reconnaissance related platforms and systems, unmanned aerial systems, electronic modular enclosure products for Navy warships, products and systems for military ground vehicle programs and products, shelters and systems for war fighter support.

We believe Gichner is very well positioned for the United States military's continuing transformation to a more expeditionary force to meet today's global asymmetric threat and we believe, based on what we have seen to date, on expected on future DoD spending and budgeting, that Gichner's business is in well-funded priority areas.

During the second quarter we just completed, Kratos had a number of important contract awards and wins, including the award for an additional five years of Kratos' largest contract, at the Naval Surface Warfare Center in Dahlgren. Under the five-year, $50 million prime contract, Kratos will be providing services and solutions related to weapons systems performance, characterization, lethality, vulnerability and weapons systems explosives evaluation and management.

With this recent Dahlgren five-year contract award and our recent $49 million prime contract award for the upgrade and refurbishment of certain surface-to-air missile systems, Kratos now has under contract for the next several years two of our Company's largest prime contract vehicles. Additionally, Kratos' contract re-compete win rate remains above 90%.

Also during the second quarter, the Kratos team was awarded a $51 million contract for tactical data link systems support at the Space and Naval Warfare Systems Center, Pacific, or SSC Pacific. During the quarter we were awarded a five-year $25 million prime contract to develop missile-related technology for the US Army. Under this particular contract, Kratos will help develop sensor technologies, missile and aviation component technologies, guidance systems and other missile-related technologies and systems.

During the quarter, we were awarded a 12-month fully funded engineering task order for approximately $10 million for the support and sustainment of certain foreign military sales or FMS weapons systems or platforms.

During the second quarter, Kratos successfully launched a hypersonic propulsion research payload in a successful Mach 7 flight, demonstrating and testing technologies for future air-breathing strike weapons, intelligence, surveillance and renaissance missions and responsive strike vehicles.

And during the second quarter, Kratos' public security received new contract awards of approximately $10 million for security system design, deployment, integration, operation and maintenance for certain strategically important assets and infrastructure in the United States and we believe that Kratos' public security business has now returned to profitability and growth.

During the second quarter, some of the other programs we performed on included work on the previously mentioned Q1 2010 $49 million contract award related to the refurbishment and lifecycle sustainment for 1,400 Chaparral surface-to-air missile systems.

Kratos' rocket support and services business performed work related to Aegis ballistic missile defense readiness test and evaluation. As you know, this is an area where Kratos has proprietary products, targets, Aegis Readiness Assessment Vehicles and solutions, all addressing ballistic missile defense, which is currently one of the highest national security priority areas in the United States. I will speak more about this Kratos business area a little later on and the future opportunities we currently see here.

During the quarter, we performed intelligence, surveillance and reconnaissance system and platform-related work, including work on certain programs which we have not been able to formally announce. Kratos performed contract work related to unmanned aerial systems and related platforms, including contract work on defensive systems to neutralize or terminate potential adversaries' unmanned aerial systems.

We continue to perform work in the information assurance and cyber security areas, including Kratos' proprietary NeuralStar situational awareness and network management product for certain unnamed national security agencies. We are also under contract for certain cyber-battlefield-related work with certain other national security agencies.

Most federal agencies are now focusing on how best to continuously monitor their computer networks and the Department of Defense is looking at the next steps in securing its networks. Related to this, US Army General Keith Alexander, head of the Defense Department's new Cyber Command, recently stated the Pentagon must move to real-time situational awareness and to a common operating picture. These are the real-time issues that Kratos' NeuralStar and dopplerVUE products are designed to address and we are currently looking for this business to have a strong second half to 2010.

Cyber security, situational awareness and overall network management and security are some of Kratos' fastest-growing business areas today.

Closing out programmatics for the quarter, during the second quarter we continued reset and maintenance work on manned portable common thermal night sights and associated equipment assigned to the 2nd and 3rd Brigade Combat Teams in the First Cavalry Regiment.

We performed work at Fort Carson, Colorado, related to ground vehicular laser locator designators.

Kratos performed work related to enhanced position location reporting systems for the Ohio and Mississippi National Guard's Avenger Air Defense Weapons System.

During the quarter, we were involved in numerous target operations and support missions, including support of certain special projects, classified missions and F-22 programs.

And during the quarter we continued to perform on the demilitarization of numerous Hawk surface-to-air missile system elements.

I'll turn it over to Deanna now.

Thank you, Eric. Good afternoon. Today we reported quarterly revenues of $99.1 million, compared to second quarter 2009 revenues of $90.6 million, which reflects a contribution from the recently closed Gichner acquisition of $20 million, offset, in part, by reductions in our Government Solutions segment, reflecting our continued reduction of lower-margin, pass-through revenues in an effort to enhance our operating margins, the impact of in-sourcing in certain of our Government Solutions contracts, as well as the expected reduction in revenues previously generated under contracts that were originally awarded as Small Business Awards to companies that we acquired.

In addition, our Public Safety business has continued to grow from a top-line perspective, both sequentially from $7.2 million to $7.5 million in revenue and year over year from $7.4 million to $7.5 million in revenues.

Our gross margins increased for the second quarter of 2010 to 21.6% from 19.2% in the second quarter of 2009, as a result of the favorable mix of revenues comprised of our higher margin ballistic missile defense, information assurance, cyber security business areas and the continued reduction of lower margin work.

Our SG&A increased from $11.2 million in the second quarter of '09 to $12.9 million in the second quarter of 2010, primarily due to the Gichner acquisition, offset partially by cost reduction actions we have taken.

Our pro forma EBITDA for the second quarter of 2010 was $9.2 million or 9.3% of revenues, up sequentially from $5.9 million or 8.6% of revenues in the first quarter of 2010 and up year over year from pro forma EBITDA of $6.3 million or 7% of revenues in the second quarter of '09.

From an operating segment standpoint, our Government Solutions segment generated $6.6 million of operating income in the second quarter of 2010, up from $4.4 million in the second-- in the same quarter last year and up sequentially from $4 million in the first quarter.

Our Public Safety and Security segment was slightly profitable in the second quarter of 2010, consistent with the performance sequentially in the first quarter of 2010 and up from a loss of $400,000 in the second quarter of '09, reflecting the impact of cost reduction actions we have taken in '09 and the corresponding improvement to operating margins in those businesses.

From an operational pro forma EBITDA standpoint, our Government Solutions segment generated $9.1 million of pro forma EBITDA or 9.9% of revenues, and our PSS segment generated pro forma EBITDA of $100,000.

On a consolidated basis, we generated pro forma EBITDA of $9.2 million, representing a 9.3% pro forma EBITDA margin, excluding the impact of approximately $1.1 million of acquisition-related expenses from the Gichner acquisition and stock compensation expense of $600,000.

On a GAAP basis, net income for the second quarter was $10.7 million, which included the $1.1 million of acquisition-related expenses, a loss from our discontinued operations of $400,000, an interest charge of $1.7 million related to the write-off of deferred financing costs related to our recent refinancing, and a non-recurring $12.2 million tax benefit related to the reduction of certain of the reserves against our net operating losses.

As we have stated previously, from time to time, there may be events that occur that can result in significant swings in our tax expense or credit, which is the reason we have encouraged our investors to focus on the cash tax payment, rather than the changes in the tax income statement account.

As you know, our over $200 million of NOLs are 100% reserved on our balance sheet. Any reduction of these reserves will result in a tax benefit or gain to our income statement. Specifically, the acquisition of Gichner has resulted in the reduction of certain of our reserves against our NOLs, which were triggered by tax liabilities related to the Gichner acquisition that can be offset by our NOLs, which, therefore, requires a one-time release or tax benefit of approximately $12.2 million of these reserves.

After this credit, our NOLs continue to be fully reserved. Similar events in the future can cause an additional reduction to our tax reserves. As we have previously stated, we believe that the most relevant tax amount to focus on is the cash taxes for the quarter of approximately $500,000.

On a pro forma basis, earnings per share from continuing operations, without the acquisition charge and without the deferred financing charge, and utilizing an expected cash-based income tax provision, was approximately $0.10 per share.

Moving to the balance sheet and liquidity, our cash balance was approximately $43.4 million at June 27th, plus $8.6 million in restricted cash, which primarily relates to the Gichner acquisition escrow amount, held for indemnification obligations.

Our cash flow generated from operations was $8.6 million for the second quarter, after adding back $1.3 million paid during the quarter for acquisition-related expenses.

Other key balance sheet and capital structure elements at June 27th are as follows. Accounts receivable, primarily from the US Government and other agencies, was $92.7 million. Accounts receivable days sales outstanding, or DSOs, were 71 days, after adjusting for the Gichner acquisition, which is down from 124 days in Q1, primarily as a result of the large milestone billing that was made at the end of the first quarter, which was collected in the second quarter, and as a result of the Gichner acquisition.

Debt under the note at June 27th was $225 million, with no borrowing on our line of credit. Total net debt, net of the $43.4 million of unrestricted cash, at quarter end was $181.6 million.

Our contract mix for the first quarter was 52% of revenues generated from fixed-price contracts, 24% from cost-plus fixed fee contracts and 24% from time and materials contracts. As expected, our fixed-price contract mix has increased due to the Gichner acquisition.

For our second quarter government revenues, approximately 59% were performed as a prime, with the remaining 41% performed as a team member or as a subcontractor. As expected, the ratio of work performed as a prime has changed as a result of the Gichner acquisition, as a significant amount of the work Gichner performs is directly for the OEMs and their specific system, platform or application.

Revenues generated from contracts from the federal government were approximately 86.6%, including revenues from the DoD of 72.9% and revenues with non-DoD federal government agencies of 13.7%. We also generated 3.7% of our revenues from state and local governments and 9.7% from commercial customers.

Finally, as I mentioned on our last call, we will continue to report a pro forma EPS number, which will reflect EPS utilizing the actual cash taxes Kratos expects to pay. As we have seen this quarter, the income taxes recorded on our income statement may not necessarily reflect the true economics of our earnings or cash flows. Therefore, we continue to believe that a pro forma EPS, as we are defining it here, based on the expected cash paid income taxes more accurately reflects the true economics of Kratos' earnings and cash flow.

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

Thank you, Deanna. I'd like to reiterate that we continue to believe that Kratos is very well positioned in mission-critical areas for national security priority. I previously mentioned cyber security, cyber warfare, situational awareness and Kratos products and solutions currently under contract in these areas.

Additionally, related to Kratos and missile defense, Navy Secretary Ray Mabus submitted a report to Congress in April noting the huge demand for Aegis ballistic missile defense assets and unveiling plans to have nearly 60 ships with Aegis BMD already installed or funded for installation by FY 24. The Navy has indicated that it wants to put the Aegis system on all 62 original Arleigh Burke-class destroyers and all of the newbuild DDG-51s.

The Navy has also indicated it wants to put the Aegis BMD system on nine baseline-4 Ticonderoga-class cruisers. Additionally, the Navy may also add BMD capability to six baseline-3 cruisers, as well.

Aegis BMD has so far been installed on 21 United States Navy ships and, as you know, Kratos provides targets, products, solutions and services directly related to Aegis, including Aegis Readiness Assessment Vehicles, or ARAVs, to the Navy, directly related to Aegis and ballistic missile defense. Accordingly, we see a potential strong growth opportunity for Kratos in this area.

Additionally, there are also currently five active Aegis international programs at this time -- Australia, Japan, Norway, South Korea and Spain -- and Kratos is supporting certain of these international programs.

Directly related to these Aegis BMD initiatives, just last week Kratos announced another award under our $100 million TSER contract for Kratos' proprietary Aegis Readiness Assessment Vehicles.

The Navy has also recently announced that it envisions Aegis Ashore, land-based ballistic missile defense systems similar to the ship-based systems. We believe that Aegis Ashore is an additional opportunity area for Kratos and Kratos ARAV systems and offers a new potential growth area for the combined qualifications of Kratos and Gichner.

We also believe that Kratos' intelligence, surveillance and reconnaissance related businesses, including in the areas of sensors, optics, information dominance and ISR platform and systems support, will continue to be both funding and national security priority areas.

And finally, as noted in the QDR and by Secretary Gates, the US armed forces are evolving into a global, multi-mission, rapidly deployable fighting force, which, as I mentioned before, is exactly what a large portion of Gichner's product offering addresses.

Accordingly, and in closing, we are increasing our previously communicated 2010 financial guidance. We are increasing our 2010 revenue guidance range from a previously noted $395 million to $405 million, up to $405 million to $410 million.

Additionally, we are increasing our 2010 EBITDA guidance. We're going to take it up to the high end of our previously communicated range, up to $37 million to $38 million. We are also reiterating our previously communicated 2011 guidance for revenues of $470 million to $480 million and for EBITDA of $49 million to $52 million or a margin rate of 10.5%.

We'd now like to turn it over for questions.

(Operator Instructions). Our first question comes from Michael Lewis of BB&T Capital Markets. Your line is now open.

Thank you so much for taking my questions here. First, a quick question for Deanna. Could you help us understand what the actual effective tax rate would have been on the $500,000 in cash taxes in the quarter? And also, with regard to the triggering event for the reversals of the taxes, you said that this was attributed to the acquisition of Gichner?

That's correct, Michael. So to address your first question, as far as the effective tax rate, as you may recall on previous calls, we have talked more about a dollar amount rather than a rate, because the dollar amount, we believe, is going to be consistent with approximately $500,000 to $700,000 per quarter of cash paid taxes. So even with-- with the fluctuations that we see in the pretax income, that's the approximate amount that we see on a per quarter basis from a tax cash paid perspective. So we haven't really talked about the actual effective rate, because that can change, depending on what the pretax income is.

As far as your second question on the $12.2 million non-recurring tax benefit that was taken as a result of the Gichner acquisition, it relates to the-- without getting too technical on this, because it is fairly technical, it relates to the purchase intangibles of the Gichner acquisition that has certain tax attributes that resulted in deferred tax liability, which we can schedule out into the future as far as what the tax ramifications of those purchase intangibles will be.

And that-- GAAP requires you to view the-- all the tax attributes from the combined Company as a whole. And when you combine those tax attributes from those deferred tax liabilities that were a result of the Gichner acquisition, then that results in a deferred tax asset that needs to be recorded in combination of the two companies, which currently are-- all of our deferred tax assets are fully reserved, so that resulted in a release of the reserves related to those deferred tax liabilities resulting from the Gichner acquisition.

Yes, I understand that it's complicated and I think I do follow you. And so if I wanted to compare apples to apples versus my actual model in this quarter, you would suggest just take the $500,000 and see what comes out thereafter. Is that the safe way to look at it?

That's correct, yes.

Okay. Okay, thank you there.

It's going to be a long-winded answer to your question, yes.

That's fine. And, Eric, just a quick question on a recent development. Today Lockheed and Raytheon -- I'm sure you saw this -- but Lockheed and Raytheon announced a joint for GMD development and sustainment. And what I was wondering here is how this-- will this benefit or does this impact your MDA work over, say, the next year or two, or is this totally unrelated to your operations.

It's totally unrelated, Michael. We do very, very little with GMD.

Okay, that's fair. And then just a final question here, with regard to Gichner it did exceed my expectations by about $8.5 million. What is your expected full-year contribution now from Gichner and did this perform better than your internal plan, since you picked up the asset?

Yes. So the second part of your question first. Yes, it performed a little better than plan. And we-- the transaction closed a little bit sooner, on May 15th, than we previously thought it would, so we picked up a little bit more there.

Now for the first part of your question, as we talked about when we made the acquisition, Gichner had approximately $150 million in backlog and it's a book-and-burn backlog. And the business has continued to perform very, very well, which is one of the reasons why we're comfortable taking up our guidance for the rest of this year.

They are products. There are product deliveries and there are scheduled products each month. And they can split quarters, as you know. We might have something scheduled for September and it falls in October. We might have something scheduled for December and it falls into January.

So with that as a baseline, we're looking for a contribution from them of somewhere around $40 million to $45 million a quarter over the next three quarters or so. It just depends on where it falls. It could be $40 million. It could be $45 million. It just depends on where the shipments fall.

Okay, so almost line a 1 to 1 book-to-bill there?

That was up through June and that book-to-bill has-- it can be lumpy, again, because it's product. We anticipate it to remain at least 1 to 1.

Okay. And then just a final question, Eric. When do you anticipate that you will file your Q?

Michael, that will be today, later today.

Thank you so much.

Sure.

Thank you. Our next question comes from Mark Jordan from Noble Financial. Your line is now open.

Thank you. Good afternoon, Eric and Deanna. One question relative to Aegis. At least from an observer's standpoint, it seems that most of the work that you have done from a test simulation and range area has been in the validation of 4.0, next generation. My question is, will we get to a point of inflection in the Aegis opportunity for you where you shift-- where the opportunity shifts not only from just development and sort of confirmation work to one where you really have a growing amount of actual field test and training, which would have a significant increase in the number of shots that would occur?

The answer to that is yes and we actually have the operational readiness and test shot program planned through 2014. And so we-- that's why increase can definitively answer your question yes.

Can you get a sense as how much that will allow that business to grow organically?

We are hoping that that business, on average, over the next, say, three or four years, grows organically 15% to 20%.

Okay. The FMS Chaparral contract, it sounds like that started kicking in and one of the reasons for the organic-- helped the organic growth in this quarter. What is the revenue profile of that contract over the three-year term?

The revenue profile is, of the $49 million contract, we would expect roughly between 40%-- about 35% to 40% of that in 2010 and then a good balance of that in '11 and then a smaller portion in 2012.

Okay. Another question relative to M&A activity, Eric, you did upsize the bond offering by $25 million, which, obviously put $25 million more in your bank account, but, also, it did come at a relatively high cost that would be dilutive to GAAP earnings until it's deployed. Could you share with us what your goals would be with regard to M&A to potentially put some of that incremental money to work to limit the EPS dilution?

Mark, you're absolutely right and our capital structure right now, in our opinion, is extremely strong. We are extremely well positioned. We're generating a significant amount of cash. As Deanna talked to Michael about, we're going to pay $500,000 or so a quarter in income taxes and that's it and so we're going to continue to generate it.

And so with that cash we're generating and the additional $25 million we took down on the bonds, we do have some negative arbitrage. There are some very interesting opportunities out there. I'll use the term that you guys have used with me before, that are tuck-in, that fit right in with us that would be extremely accretive to us. If, hypothetically, you're sitting on $25 million of excess cash that's making nothing and you can pick up something that's making 10% to 15%.

And so we are very aware of that situation, but we want to make sure that we-- whatever we do is accretive to our growth characteristics, which right now look very, very good for us, our margin characteristics. I mean, as you know, we just came in just under 9.5%. We're looking at 10.5% next year. We've got some great programs. We don't want to dilute that and so those are the kind of things we're balancing off against that negative arbitrage.

Okay. A final question, if I may. And, Eric, I'd like-- what kind of contract and/or funding risk do you have to your revised $405 million, $410 million revenue assumption for this year? And could you sort of give-- add a little color as to how you see, sort of on the same basis, your guidance for next year?

Right. So, as we sit here at the beginning of August, from a funding standpoint and a contract standpoint, the first thing I want to point out is we generated the 15% or so sequential organic growth and the margins we did and we still have a few significant contracts under bridge because of what's going on in the procurement area of the DoD.

These are contracts where we have won follow-ons with expanded scope, but they have not been formally awarded yet and so we're under bridges. Some of these bridges go through the end of this year into next year. Okay? As we talked about, two of the largest contracts in our Company -- they may be the two largest, the range work at Dahlgren and the Chaparral contract -- those are both bolted in through at least 2012, if not longer. The Dahlgren one, of course, goes through 2015.

So with that as a backdrop, as we sit here right now, unless something significant happens at a macro level, we feel very, very comfortable, or we wouldn't have done it, taking up our guidance for 2010.

One of the reasons why we're reiterating 2011 and we're not doing anything with that is for the reasons you're alluding to. There's a lot going on, on the procurement side and the awards side, right now. We don't have anything significant hanging out there that we think could adversely impact us in 2011. We're just going to wait until we get farther on in this year and maybe a little earlier in next year before we would even think about touching that. But as we sit here right now, we reiterated and we feel pretty good about it, because a significant piece of it is under contract.

Thank you very much.

You're welcome.

Thank you. Our next question comes from Mike Crawford from B. Riley & Company. Your line is now open.

Thank you. Regarding your information assurance, cyber security business, I mean, that's probably your highest margin business. You also said that 9.7% of revenues were commercial, so I guess two questions, the first being what kind of growth rate do you expect from that business and, maybe, part B, how does the new US Cyber Command you referenced with General Alexander heading, how does that factor in? The second part is, how much of that commercial business might be dopplerVUE?

Okay. So let me talk about the latter part of the question first and then I'll circle back to the commercial part.

On the cyber work, there have been a number of articles and publications in the last several months that's talking about situational awareness for the military. And situational awareness is real-time data and information that something going on with your network, i.e., for example, a cyber issue. So it's not an after-the-fact forensic identification. It's real-time situational awareness.

This just happens to be what two of our proprietary products do. And, yes, they are some of the highest-- this is some of the highest-margin work in our Company and once the products are installed it has like a long tail on it, because we maintain it.

Some of that situational awareness or information assurance or cyber work is absolutely on the commercial side and it is in that number you referenced. Absolutely. We're doing it both for DoD agencies, national security agencies and commercial companies.

The other part of that commercial business is our Public Security and Safety business, which, as we know, last year and the year before that had a very difficult time of it with the macroeconomic rollover, but it has turned back around. It's organically growing again.

It's profitable again and, as I said, we believe it's going to continue to grow. It's going to continue to be profitable. I'm not sure it'll grow as fast as the rest of our business, because we've got some areas we think are going to do really, really well because they're right in the area of national security priority. But we're comfortable they will add to our organic growth rate and they will be-- they will contribute to our profit margin.

Thanks. Just to put you on the spot, you cited 15% to 20% growth for BMD. For cyber security, do you think the same, faster growth?

For which one?

Cyber.

For cyber? I think it definitely has the potential to be the same or faster, but it's products. It's lumpy. You can do great for two quarters and then you can work on it for two quarters. And you can do great for three quarters and you work on it.

So we don't look at it quarter to quarter. We look at it-- I'm looking at both of these year to year. So I'm going to say I think it can grow at least that rate as our BMD business.

Okay, thanks. Just a couple clarifying questions. So part of the Gichner opportunity is with you called it war fighter support. Do you mean containerized housing or--?

No. These would be like communications shelters or command post platforms, things like that.

Okay.

So communications support.

And also, what's an air-breathing strike weapon?

An air-breathing strike weapon is a hypersonic weapon that can go above Mach 5, which is a hypersonic speed. And it's air-breathing, so-- and that's significant, because a hypersonic weapon needs a fuel and it needs ignition and at that altitude and at that speed, there's not enough oxygen to keep the thruster going. But this is a technology that enables it to continue to do that and that's why it's called an air-breathing strike weapon. It's not a ballistic missile that is air burning.

Okay, thanks. And then on your NOLs, has there been any confirmation whether there's been a lock-in on annual Section 302 limitation that may or may not have been triggered?

Mike, this is Deanna. We are still working with our tax advisors. The finalization of that calculation will be once we complete our 2009 tax return, which should be done in the third quarter.

But at this point, you expect it to be at a sufficiently high level that it wouldn't really change the discounted net present value of that asset?

Correct. No, we do not expect the range of the limitation that we discussed on previous calls to change materially.

Okay. And then, just to get back to BMD, so, I mean, it would seem that Gichner has quite an opportunity for Aegis Ashore since there's been consternation about how do you just slice this thing off of a ship and make sure it works on the ground. Is that something that you're already working on or just trying to work on?

That is something that we are actively pursuing and your analogy of that is exactly correct. It's taking the command control equipment that is on an Arleigh Burke or a Ticonderoga that has the Aegis BMD. It's going to be land-based, so that Aegis command and control and the radar, the SPY radar system, need to be housed in something and that's what Gichner does.

Thanks. And then final question is, with the move towards best value awards it would seem to favor a company like you with a much lower cost per test operation than Aegis prime. Is that something that-- how do you see that move in that space and in other parts of your business?

That's actually-- that's a very-- in my opinion, that's a very good question. We have seen and we are seeing firsthand a sea change, a current change, to best value, i.e., lowest cost that can satisfy the mission requirement. And, frankly, in my opinion, that's one of the reasons why right now we're doing-- being so successful in the targets and the Aegis Readiness Assessment Vehicles.

And we are actively pursuing some other areas of our business where we believe we have an opportunity to exploit this sea change where the government doesn't want to pay the gargantuan overhead rates that some of the primes have where a mid-tier guy or a smaller guy, like us, can very aggressively compete on cost.

Thank you very much.

You're welcome.

Thank you. Our next question comes from Michael Kim with-- excuse me, the next question comes from Don Nelson of the State of Wisconsin Investment Board. Your line is open.

Hi. That's John Nelson. But good quarter. Congrats to you and your team, again for delivering good results, Eric and Deanna, and also my question is related to concerns about spending delays in the defense budget. Should I be concerned about that? Why or why not?

Certain of those bridge contracts that we're under right now, John, kind of, sort of relate to spending delays where we've been awarded the follow on. The follow on has scope increases for us and our teammates, so it's bigger, which means it's going to be a revenue opportunity for us, but they're being bridged out. So when they're being bridged out, we're on the current spend plan. We can't hire additional people to do the new mission, et cetera.

So we are being impacted, around the edges, on that, somewhat, somewhat. However, we believe that the primary areas of our business, the vast majority of our business in weapon systems sustainment, upgrading and sustaining existing weapons systems. So when a new platform, a leading edge platform like an F-22 or something like that gets terminated or truncated, that's good for us. So when those types of spending things happen, the legacy or the older equipment is going to be upgraded with new command and control systems, new guidance systems, new things like that. That's what we're involved in.

The ballistic missile defense area, it is one of this Administration's, as you know, highest priorities. He's come out with the phased adaptive approach, which is Aegis, THAAD and Patriot, programs that we are on. So unless there is a significant change at the Administration level, that is an area on our ballistic missile defense, on our Aegis defense, we've got the sails at our back.

The other area is in the cyber area. In the information assurance and situational awareness, we clearly are in the right place at the right time on that one.

The only other area where we are being impacted, we-- is on in-sourcing, government in-sourcing is an issue in our industry. However, it's primarily related to program management seats or seat management seats or IT and networking. So we don't have a big business there. Our IT business, if you take our cyber business and our products and our information assurance and all that, is probably a $40 million piece of business that's exposed to that and we've got some-- a few, maybe a handful of people in the Pentagon that are exposed to it, but that's it.

Thanks very much. I appreciate it. Keep up the good work.

Thank you very much, sir.

Thank you. And our final question for today's call will come from Mark Jordan from Noble Financial. Your line is now open.

Thank you for the follow-up opportunity. Eric, we talked-- you mentioned Aegis Ashore and also, clearly, you also mentioned THAAD and there are advanced versions of Patriot. Why do you think the Aegis will, essentially, move ashore when you already have a THAAD development program and existing Patriot strategies?

Right. Two reasons and I'm just going with what I know from the industry and from what I see. This Administration and the Secretary want to go with proven systems, systems that are proven. No more research and development efforts, et cetera.

The Aegis system is a proven system. And I don't know if it was you or one of the other gentlemen that made the comment on-- I think it was you, the software system level that they're at, the upgrades to that. We're all over that, because as they're upgrading the Standard Missile-3 and they're going to the Standard Missile-6 for different types of missions, that's all types of different software upgrade work for those intercepts, which our targets are adaptive to. So, number one, it's a proven system and that's what this Administration wants to go to.

On THAAD, the Terminal High-Altitude Aerial Defense System, that's a terminal system, as it says in its name, Terminal High-Altitude Aerial Defense. The Aegis system is a terminal system, but it's also a mid-course system. So there's boost phase, there's mid-course and there's terminal. So it's a different part of the ballistic missile defense layer and there's a significant amount of political support behind Aegis right now.

Okay, thank you. And foreign military sales, you got the Chaparral contract here earlier in the year, that was in the sales and bid and competition cycle for what seemed a very long time. Given the fact that there are long competitions, could you tell us or give us some color as to what you have in the pipeline in the FMS arena that-- kind of the bigger ticket arena?

Right. So I mentioned in the prepared remarks there are other contracts that we've won that we are not allowed to formally announce. There's a contract that's significant to us, a significant product contract to us related to an ISR platform that we won in the second quarter. We cannot announce it. Similarly, there's an FMS contract we have won. We're not allowed to announce it, another one.

We are-- there is a pipeline, as we've talked about before. Some of the systems we're going after are additional surface-to-air missile systems, but there are some other systems we're going after. So the pipeline there is-- it's a good, solid pipeline and that FMS business is an area we think is going to grow. We are-- we grew from our first lot on Chaparral to our second lot.

We've just won this other one I just mentioned, we haven't been able to announce yet. It's not on surface-to-air missiles. It's on a different type of-- it's a communication platform and we're-- we've got a pipeline and we're bidding on some other ones. I probably, for competitive reasons, shouldn't get into too many details.

With those contracts you cannot announce, is there-- will there-- will they be announced at some point in time? Or is it-- are you just waiting to go through the approval process?

There's one of them I know will not be announced, ever, because there's just no way. And I'm talking about the FMS ones. The-- there are-- the ISR one, I don't think we'll ever be able to announce.

All right. Thanks a lot.

All right.

Thank you. I would now like to return the program to the presenters for any concluding remarks.

Very good. We appreciate you joining us this afternoon and we will look forward to speaking to you at the end of our third quarter. Thank you.

Ladies and gentlemen, thank you for your participation on today's conference. This does conclude the program and you may now disconnect.