Kratos Defense and Security Solutions Inc (KTOS) 2010 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to your Kratos Defense & Security Solutions third-quarter 2010 earnings conference call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. (Operator instructions.) And as a reminder, this is being recorded.

I would now like to introduce Ms. Laura Siegal, Vice President, Corporate Controller. Ms. Siegal, you may begin.

Good afternoon, everyone, and thank you for joining us for the Kratos Defense and 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.kratosdefense.com.

Additionally, I'd like to remind our listeners that this conference 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 November 4, 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 pro forma EBITDA and the associated margin rates and pro forma EPS from continuing operations 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 noncash items that would normally be included in the most directly comparable measures calculated and presented 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 nonfinancial 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 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 address our financial and operational results for the third quarter of 2010. He will then turn over the call over to Ms. Lund to discuss the specifics related to our third-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.

Thank you, Laura. Good afternoon. We believe that we have a lot of good things going on with our company since our last earnings call. So today's call will be a little longer than usual so we can adequately cover these items with you. Today we reported third-quarter revenues of just under $120 million and pro forma EBITDA of $11.7 million or 9.8% of revenue. The 9.8% pro forma EBITDA rate is the highest in Kratos' history and it's representative of how well the Kratos team is running and managing the business.

Additionally, for the third quarter Kratos generated cash flow from operations of $18.1 million, or greater than $1.00 per share of cash flow for the quarter. This again is representative of the outstanding operational job our team is doing across the Company, including the management of the Company's accounts receivables and overall working capital. I personally believe that the Kratos management team across the board is second to none in our industry today.

We believe that these financial results are also representative of the successful integration of the businesses that Kratos recently acquired. And, as you know, acquisitions are a critical element of our strategic plan to obtain additional contract vehicles, customer relationships, critical mass and pass performance qualifications, which enable Kratos to bid on larger contract vehicles to drive our organic growth. The most recent and important example of this is Kratos' recently announced $1.6 billion MiDAESS contract win, which I will discuss later on in my remarks.

For the third quarter Kratos reported pro forma earnings per share of $0.11. As we have previously communicated, in addition to GAAP EPS, Kratos reports pro forma earnings per share reflecting an actual or expected cash amount to be actually paid for income taxes. We report EPS in this way to take into consideration and reflect the considerable economic benefit our company receives from approximately $200 million of net operating loss carryforwards we have available. For example, for the third quarter Kratos' estimated tax liability is just $400,000. As a result of the NOLs, Kratos is effectively 30% more cash flow profitable than a full income tax paying business. These net operating losses expire in 2027. Deanna will provide all the financial details of our third-quarter results in her prepared remarks.

As I mentioned a moment ago, the integration of Gichner is now substantially complete. The business is performing fantastic and Gichner is contributing meaningfully to the overall operations and performance of the Company. Importantly, Gichner's and Kratos' business development organizations are working extremely well together and we are actively pursuing new opportunities as a combined business, which neither standalone business could have previously independently pursued. Certain of these new opportunities we are pursuing are related to foreign military sales, or FMS, where Kratos currently has significant contract work, customer relationships and expertise.

As we have discussed with you before, we believe that significant areas of Kratos' business are focused on and aligned with United States continuing national security priorities, including information assurance, cyber security and cyber warfare. During the third quarter and over this past year Kratos' cyber warfare and cyber security business unit has been one of our company's fastest growing and best performing.

During 2010 Kratos has won a number of cyber warfare and network protection contracts, including during the third quarter, with various national security and federal government agencies. We believe that Kratos' proprietary NeuralStar and dopplerVUE cyber products are clear differentiators for our company and are some of the leading edge products in the network management and protection industry today.

As with other areas of our business, in the cyber security and cyber warfare areas we routinely receive contract awards that prohibit us from announcing the customer, the contract value, and at times we are not permitted to provide any customer relationship recognition at all. For example, during the third quarter of 2010 Kratos announced a multi-million-dollar situational awareness cyber security and network management contract with a major unnamed federal agency. The cyber and network award was an extremely important win for our entire company. Under this contract award, which is the largest cyber award to date for Kratos, this customer will be using Kratos' NeuralStar products to manage and protect its global infrastructure, which consists of tens of thousands of network, IT, encryption, decryption and cyber security devices and elements. In addition to this award, we have already received a scope increase, significantly expanding the value of this opportunity to our company.

We also see a significant opportunity to exploit Kratos' network management and cyber security products through Henry Brothers' critical infrastructure security customer base, which I will discuss later on in my remarks. We want to reiterate here today that Kratos' cyber and network business is one of our company's strongest business areas and one of the areas that we believe will be an organic growth driver for our company going forward.

Another national security priority area is C4ISR, including as related to force multiplication and situational awareness. Kratos is involved in a number of programs in these areas. And intelligence, surveillance and reconnaissance is one area in particular where we routinely receive contract awards that prohibit us from making formal public announcements, including in the manufacture, production and deployment of ISR platform-related products and solutions.

One intelligence, surveillance and reconnaissance related area where Kratos is involved is in the sensor area, including electro-optical, infrared, photonic, and other exotic or classified sensor initiatives. During the third quarter, Kratos' sensors and space systems group was awarded a BAA contract that specifically focuses on flexible membrane, optical mirror sensor related technologies from the Office of Naval Research. What we can say about this program publicly is that the objective of this initiative is to use electrical signals to adjust the shape of sensor-related optical mirrors. This approach will allow optical designers the freedom to adjust the focus and zoom level of an optical system with no moving mechanisms. This approach will result in the ability to dynamically change the zoom, allowing the sensor operator to track several targets simultaneously, while maintaining total and complete situational awareness of the intelligence, surveillance and reconnaissance environment. This is a new and an exciting area for our company.

Also in the ISR area, Kratos is involved in photonic and polarization-related technologies and sensors. Polarization aids in the material and shape discrimination. These types of techniques can be very important in the differentiation of manmade objects versus natural background. Photonic and polarization technologies are also very important in the differentiation of real targets versus 2D decoys and real targets versus inflatable decoys. These techniques can be very valuable in the identification of targeting of buried or underground facilities or bunkers. This type of ISR and overall battlefield situational awareness utilizing sensors, ISR platforms, and related systems is another critical national security priority area.

A separate type of situational awareness area that is also a national security priority area and one where Kratos is heavily involved is related to critical national security networks and infrastructure protection in the cyber domain. This is where you have real-time situational awareness in an information technology system or network where you can, in real time, identify that an aberration, an intrusion, or that something bad is happening. Not after the fact versus foren -- via forensics, you do this real time so action can be taken. This is directly related to having a common operational picture for your network environment and this is another area where Kratos has outstanding qualifications and we are winning contracts.

Another national security priority area where Kratos is significantly involved is ballistic missile defense, including one of this administration's lynchpin BMD programs, Aegis. During the quarter, Kratos was awarded under our $100 million [TSER] contract vehicle an approximate $8 million fully funded task order to directly support the Aegis ballistic missile defense program. Under this new task order award, Kratos will manufacture and deliver 12 Oriole Rocket Systems, which are used in the Kratos Aegis Readiness Assessment Vehicle, ARAV B target missile configuration. Kratos' ARAV targets are used in ballistic missile defense testing.

Under this administration's phased adaptive approach to missile defense Aegis BMD is becoming more important to United States national security and our country's overall integrated ballistic missile defense strategy. Today there are 22 Aegis-BMD-capable ships in the United States fleet. The FY10 Defense Authorization Act previously submitted by Navy Secretary Ray Mabus states that the Navy and Missile Defense Agency plan to implement Aegis Modernization Program, which includes the installation of the latest version of Aegis BMD on all 62 original BDG 51 Arleigh Burke class destroyers and 9 Baseline 4 CG-47 Ticonderoga class cruisers. The Aegis BMD system will also be installed on all new-build BDG-51s.

Current targets for overall Aegis-BMD-capable ships now stand at approximately 80. The Navy is experiencing a surge in demand for its Aegis BMD equipment due to the phased adaptive approach to missile defense, including in Europe, that will rely heavily on Aegis BMD ships in the first phase. Internationally, certain friendly countries are also outfitting their ships with Aegis BMD and Kratos is directly involved in supporting the Aegis readiness assessment. Kratos was recently involved in several additional new friendly government Aegis BMD test shots at a certain missile range facility, which were 100% successful and which we are unable to formally announce at this time.

Additionally, this past quarter some of the initial contract awards have been made for Aegis Ashore, the land-based Aegis ballistic missile defense system. Some of the initial Aegis Ashore program work is to be performed at the Pacific Missile Range Facility at Barking Sands, where Kratos has a significant presence. In addition to ship-based Aegis BMD, we believe that Aegis Ashore represents a future growth opportunity area for Kratos, including for Kratos' Oriole and ARAV targets, ground support, and mission support areas.

Additionally and very, very importantly, this week we announced that the Kratos and Missile Defense Agency team won the 2010 Department of Defense David Packard Excellence in Acquisition Award. This award for the Aegis readiness assessment vehicle team was for the design, development, integration and launch of a family of cost-effective, flexible and reliable ballistic missile targets that replicate a wide range of ballistic missile threats. In announcing the award, Ashton B. Carter, Undersecretary of Defense, said of the Kratos/MDA team, "This is our most prestigious acquisition team award and recognizes organizations that have demonstrated exemplary performance and innovation in acquiring and delivering products and capabilities for the war fighter."

Our entire corporation is extremely proud of the receipt of this award with the Missile Defense Agency and we clearly see the Aegis BMD area as an opportunity for long-term growth for Kratos in the future. And Kratos is one of very few companies that have the qualifications, expertise, and products to support this critical national security mission.

Kratos' weapons system sustainment, reset and upgrade business is also a critically important national security priority area. This is where Kratos upgrades, sustains and maintains deployed proven national security and weapons systems which are in arsenal. As the cost of newer platforms and weapons systems continue to rise, major new weapons programs are being reduced, terminated or cancelled, which has resulted in a significant reduction in the number or quantity of brand new fielded units and a significant price increase in per-unit cost of new units that are fielded. This is resulting in the need to sustain, upgrade and extend the life cycle and enhance the technology associated with existent, proven, and already-deployed weapons systems.

This is one of Kratos' largest and strongest business areas, where we have significant capabilities, qualifications, and contract work on programs and systems that include the tube optically wired guided missile system, or TOW, the Chaparral and Hawk surface-to-air missile systems, the Kiowa helicopters and related weapon systems, the AMRAAM, SLAMRAAM, and Hellfire missile systems, the Command Post Platform, Humvee, [BEAR], and numerous other wheeled and tracked military vehicle programs. Additionally, we are also currently working on Avenger and certain cruise missile defense systems.

Directly related to weapons systems sustainment, maintenance, and training, during the third quarter Kratos acquired DEI Services Corporation, which supports proven and deployed ground combat vehicles, including the M1 Abrams Main Battle Tank and M2 Bradley Fighting Vehicle. The cancellation of the Future Combat System has made the sustainment of the M2 Bradley and the M1 Abrams critically important. And Kratos is now deeply involved in these deployed proven systems of which there are thousands fielded.

DEI also supports proven and deployed fixed-wing aircraft, including the Tiger, the Harrier, and Prowler aircraft, each of which the life cycles are being extended due to the significant cost of new or replacement systems. DEI also produces products and solutions that support rotor-wing aircraft, including the Black Hawk, Chinook and Sea Stallion helicopters. Here again, the life cycles of these platforms are being significantly extended, as planned replacement programs have either been terminated or significantly delayed.

Similar to Gichner, DEI has an outstanding management team led by Jose Diaz, made up of industry experts in the weapon system life-cycle extension and system-maintenance training area. The integration of DEI into Kratos is well underway and, extremely importantly, we are already working closely together on some large foreign military sales opportunities that could come to fruition for Kratos in 2011. From a financial standpoint, as we previously noted, the DEI acquisition is immediately accretive to Kratos' financial matrices. And we acquired the business at approximate 4 times EBITDA to enterprise value.

Unmanned systems is another critical national security area where Kratos is involved, including unmanned aerial systems, the weaponization of unmanned systems, and now the termination or neutralization of adversaries' unmanned aerial systems. One example of some of the work Kratos is doing in these areas -- during the third quarter Kratos was able to announce the award of an $11 million contract vehicle related to electronic weapons systems and rapid-fire laser weapons systems to shoot down certain potential adversaries' unmanned aerial systems. One of the missions of this program relates to destroying, eliminating or neutralizing an adversary's low-cost UAVs or other systems which may attack in great numbers or in swarms. With these types of low cost per shot or engagement electronic lasers, ray guns or energy systems being used instead of multi-million-dollar surface-to-air missile systems.

With that, I'll turn it over to Deanna.

Thank you, Eric. Good afternoon.

Today we reported quarterly revenues of $119.9 million compared to third-quarter 2009 revenues of $86.1 million, which reflects a contribution from the recently-closed Gichner and DEI acquisitions of approximately $40.5 million, combined with organic growth in our cyber warfare and public safety businesses, offset in part by reductions in other areas reflecting our continued reduction of lower-margin pass-through revenues in an effort to enhance operating margins, the impact of government 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 businesses -- small business awards to companies that we acquired.

Our public safety business has continued to grow organically from a top-line perspective, both sequentially from $7.5 million in revenue for the second quarter of 2010 to $9.7 million in revenue for the third quarter of 2010, representing an increase of approximately 29%, and year over year from $7.1 million for the third quarter of 2009 to $9.7 million in revenues for the third quarter of 2010, an increase of approximately 37%.

Our gross margins increased for the third quarter of 2010 to 21.5% from 20.6% in the third quarter of '09 as a result of the favorable mix of revenues, primarily comprised of our information assurance cyber security business areas, and the continued reduction of lower-margin work.

SG&A increased from $11.4 million in the third quarter of '09 to $14.5 million in the third quarter of '10, primarily due to the Gichner and DEI acquisitions, offset partially by cost reduction actions we have taken.

Our pro forma EBITDA for the third quarter of 2010 was $11.7 million, or 9.8% of revenues, up sequentially from $9.2 million, or 9.3% of revenues in the second quarter of '10, and up year over year from pro forma EBITDA of $6.4 million, or 7.4% of revenues in the third quarter of '09.

From an operating segment standpoint, our government solutions segment generated $7.1 million of operating income in the third quarter of '10, up from $4.9 million compared to the same quarter last year and up sequentially from $6.6 million in the second quarter. Our public safety and security segment generated $700,000 of operating income in the third quarter of 2010, up from approximately breakeven in the second quarter of 2010 and up year over year from an operating loss of $500,000 in the same quarter last year. The improvements in the PSS operating margins reflect the growth in the business as well as the impact of cost-reduction actions we have taken.

From an operational pro forma EBITDA metric, our government solutions segment generated $10.9 million of pro forma EBITDA, or 9.9% of revenues and our PSS segment generated pro forma EBITDA of $800,000 or 8.2% of revenues in the third quarter.

On a consolidated basis we generated pro forma EBITDA of $11.7 million, representing 9.8% margin, excluding the impact of approximately $400,000 of acquisition-related expenses from the DEI acquisition and stock compensation expense of $400,000. And we have excluded a $1.4 million credit that we recorded in the third quarter related to a favorable insurance settlement.

On a GAAP basis, net income for the third quarter was $3.2 million, which included the $400,000 of acquisition-related expenses and the $1.4 million favorable insurance settlement. Our GAAP net income for the third quarter, similar to our second quarter GAAP net income, also included a tax benefit for a gross credit of $1.3 million related to the reduction of our reserves against our deferred tax assets, reflecting the tax attributes related to the DEI acquisition.

As we have stated on previous occasions, we believe that our cash income tax payments more closely represent the economics of our earnings, rather than our GAAP income tax provision, which may be subject to variations on a period-by-period basis. For instance, our third-quarter GAAP net income reflects a net $1.1 million credit, or benefit, on pretax income from continuing operations of $2.2 million, therefore increasing our overall GAAP net income.

In addition, as a reminder, we think it is important to note due to our acquisitive activity that the amortization of purchased intangibles, which are part of the purchase price allocations of the acquisitions that we complete, are required to be amortized or expensed over the estimated useful lives of those intangible assets, which typically range from a three to five-year period. For instance, our third-quarter GAAP operating income includes an amortization charge for the purchased intangibles of $2.9 million.

On a pro forma basis, utilizing an expected cash pay income tax provision of approximately $400,000, EPS from continuing operations was approximately $0.11 per share.

Moving to the balance sheet and liquidity, our cash balance was approximately $51.3 million at September 26, plus $8.7 million in restricted cash, which primarily relates to the Gichner acquisition escrow amounts held for indemnification obligations.

Our cash flow generated from operations was $18.1 million for the third quarter, which includes a use of approximately $300,000 of acquisition-related expenses paid during the quarter.

Other key balance sheet and capital structure elements at September 26 are as follows. Accounts receivable, primarily from the US government and other agencies, was $92.6 million. Accounts receivable days sales outstanding, or DSOs, were 70 days, which is down slightly from 71 days in the second quarter of 2010. Debt under our outstanding notes at September 26 was $225 million, with no borrowings on our line of credit. And total net debt, net of the $51.3 million unrestricted cash at September 26, was $174.9 million.

Our contract mix for the third quarter was 63% generated from fixed-price contracts, 22% from cost-plus-fixed-fee contracts; and 15% from time-and-material contracts. As expected, our fixed-price contract mix was increased due to the Gichner acquisition.

For third-quarter revenues, approximately 57% are performed as a prime, with the remaining 43% performed as a team member or as 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 OEMs and their specific systems, platforms, or applications.

Revenues generated from contracts with the federal government were approximately 89%, including revenues with the DoD of 80% and revenues with non-DoD federal government agencies of 9%. We also generated 4% of our revenues from state and local governments and 7% from commercial customers.

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

Thank you very much, Deanna.

Just after the third quarter ended, we announced that Kratos has entered into a definitive agreement to acquire Henry Brothers Electronics, or HBE. Henry is a pure play homeland security solutions provider and a nationally recognized leader in the design, engineering, integration and operation of electronic surveillance and biometric-technology-based security systems. Henry is also a leader in the design, building and operation of command and control systems for the protection of United States critical infrastructure and assets. Henry has specialized expertise in the deployment and system integration of specialized surveillance, thermal imaging, radar, and analytics-based surveillance systems.

Kratos had been following and was in discussions with HBE for a long period of time. And over this past year we have gotten to know Jim Henry and his outstanding management team very well. Through this process we became aware of the incredible capabilities that Henry has and the potential significant opportunities that we can pursue together as a combined company by bringing together our respective customers, relationships, expertise, proprietary products, resources and critical mass.

HBE today has one of the highest backlogs in the company's history at approximately $50 million, a very strong multi-year bid pipeline, and proprietary first-responder-related communication products and solutions which we intend on exploiting. Additionally, with Kratos' size and more robust capital structure, as part of Kratos, once the transaction closes HBE will be able to pursue and bid on larger security program opportunities that independently they could not have previously pursued.

Also, Kratos will provide Henry the opportunity to put in place bid bonds and performance bonds, which will also open up an entire new area of larger homeland security opportunities that HBE did not have the financial wherewithal to practically bid on previously. Once the transaction is closed HBE will be integrated into Kratos' public safety and security division, where Ben Goodwin is President and where Kratos and HBE have very similar capabilities, solutions and technical competencies.

Now, and very, very importantly, Jim Henry has agreed to a five-year employment arrangement with Kratos and Jim will be Executive Vice President of Business Development for Kratos PSS, homeland security and our overall public security business.

Jim Henry and his team's being enthusiastic about the merger was critically important to Kratos' decision to move ahead with the transaction. We know that Jim Henry and his team and the Henry Brothers employees are the business. Jim and his employees are the company. We know that if Jim and his team were not excited and enthusiastic about this opportunity that the business would suffer. We also know that Kratos has a very entrepreneurial, small business culture, similar to Henry Brothers. And after our respective teams spent significant time together, we know that Jim and his team are extremely comfortable with Kratos, our plan for Henry Brothers, and the Henry Brothers employees and that they will be motivated in staying and building the combined business together with Kratos. I believe that I can say that Henry Brothers team is extremely excited about this transaction with Kratos.

Additionally, and confirming the joint enthusiasm of this transaction, Jim has agreed to acquire a significant amount of Kratos common stock on the open market after the transaction closes.

From a strategic standpoint, as I briefly mentioned before, we see the opportunity to cross-sell Kratos' NeuralStar and dopplerVUE information assurance, network management, and cyber security software products into Henry's large customer base and significant installed base of IP and electronic surveillance networked and security systems and infrastructure. We believe that the cyber threat relative to the IP-based security systems and security systems and networks protecting critical infrastructure and strategic assets here in the United States is very real. It's growing. And this is an area where we truly hope to exploit the combined companies' proprietary products and qualifications.

We have agreed to acquire HBE for approximately $45 million in cash. And we expect to realize significant immediate cost synergies, as duplicate and redundant public-company-related costs, including costs related to directors and officers insurance, board costs, accounting, tax, consulting and other such costs are eliminated, with additional back office, systems, facility and other costs to also be eliminated after the transaction closes. The identification and the elimination of the two businesses' redundant public-company-related costs can be very significant to overall combined company profitabilities for companies our size, which added to the attractiveness of this opportunity.

As a result, the $45 million purchase price is approximately five times pro forma EBITDA and the HBE transaction, which is currently expected to close in December of this year, will be immediately accretive to Kratos' GAAP EPS, pro forma EPS, pro forma EBITDA, cash flow from operations and free cash flow.

Concurrent with the announcement of the pending HBE transaction, we announced a successful completion of an underwritten public offering of Kratos common stock, which I am extremely pleased to say was substantially supported by virtually every major Kratos institutional shareholder, all of which also supported the HBE transaction.

We will now turn the call over for questions.

(Operator instructions.) Mark Jordan; Noble Financial.

Eric, relative to the $1.6 billion missile defense IDIQ, could you scale the opportunity that it has for Kratos? Was there business you were previously been doing rolled underneath this new vehicle? Or is this all net new opportunity for you?

This is all net new opportunity for us. 100% new.

And do you have a sense of what pipeline you might be able to develop in the next 6 to 12 months?

We do. As you know, we could not put out a release on this because of certain rules by the MDA. And there are similar rules around what we can say related to this. What we can say is that the initial task orders have already come out. We have already bid on and submitted one. It was a very large task order and we've received a second one.

If you take a look at our team, and we are of course the prime, we have a number of large players on our team that brought with them not only significant qualifications, but work that had been being performed on vehicles that were consolidated under MiDAESS, for example, [Task] and Kinetic. So all of that taken together, we are very optimistic that as we get into the second half of next year once these task orders start rolling out more and we're bidding on them and, God willing, we're successful on them that this will be one of those significant growth drivers and events that we've been talking about.

The Packard award relative to the ARAV-C development program -- it obviously was a very successful one in the eyes of the customer. Since it's the next-generation target missile, when do you believe that it will start to be utilized in the field and therefore start to see a flow of orders from that opportunity?

Okay. So the ARAV-C is complete and it has already been successful. So it is done and we've -- it's been successfully utilized. Probably more importantly, Mark, is we are with the customer and a major subcontractor right now making some additional modifications. This is beyond the A to B and the ARAV-C to our target, which will be ready next year, which is going to, we believe, open up a substantive new market for us.

Okay. The NeuralStar and dopplerVUE, could you talk about in the contracts you've won what has been the competition that you're bidding against and what is the competitive attributes that NeuralStar has that makes it a winner?

Okay. So there are really two or three other credible competitors out there that show up that have a proprietary product like ours that we run into in these bids. We started a couple years ago -- and this was one of the reasons why we acquired SYS, right here because of NeuralStar. The research and development efforts have been focused on certain specific networks and customers. And that has all been now successfully complete. So we have products here that have been targeted and tailored specifically for certain national security customers. And that's a big differentiator, instead of something that hypothetically is a kludge, or that has been modified to fit an application. Ours were targeted. The dollars were spent and the product is done. And now we're winning some work.

Okay. Finally, on the pro forma $0.11 presentation, is the reversal of fees included in that, or that excluded?

I'm sorry; the reversal of what, Mark?

Of the fees -- recovery of legal fees?

No, that is not. So to not further complicate the matter, what we did was take the pretax continuing ops income, which I believe was $2.2 million. We took the $400,000 of tax that was paid during the quarter to get to $1.8 million over 16.3 million fully diluted shares to arrive at $0.11.

Okay, thank you.

John Parker; Jefferies & Company.

I was wondering, it looks like in your guidance for 2011 you have your EBITDA margins going up by perhaps another 50 basis points. And what do you think will be driving that over the next year?

The mix of our business is moving more toward product base than services or IT based, which was a strategic change that we made because we saw some dynamics happening in the market a couple of years ago. And so our product business and our cyber product businesses, that mix is what has been and is going to be driving increased margins going forward.

Okay. Now, is it -- I think when you were talking about your cyber products and the potential application to Henry customers, you were talking about doing nongovernment applications of those products. Is there any nongovernment exposure now? And did I understand you correctly?

There is very, very little nongovernment exposure right now. We have some. It's related to, I'll just call them financial types of institutions and things that they want to protect against. But most of it today is DoD or classified agencies.

But you think there is an opportunity to do nongovernment work. Correct?

Absolutely. We have -- one of the specific strategic reasons we acquired Henry Brothers is because of the IP-based security and network management systems, protect these assets and the threats that are against those and deploying our products in that customer base.

Okay. One more quick question. I think you've told me before, but could you remind me when you talk about the number of Aegis ships you're talking about, how many practice shots does a typical ship take in a year?

I can tell you what we have -- what our understanding is. And our understanding is is that at the right cost point and the right type of target missile they are looking to do hopefully two per ship per year.

Great. That's all I have. Thank you very much.

Mike Crawford; B. Riley & Company.

Eric, perhaps if we'd start with Gichner, can we -- it seems that there's ample room for growth of that company, given cutbacks and things, like the JLTV. I mean, for example, with that one, that's got to give some upside to Humvee storage, right, for Gichner?

Yes, sir.

Can you quantify that at all?

Well, there are approximately 150,000 Humvees in the military fleet today. And one of Gichner's main lines, customers, is not only relative to building out the Humvee fleet and the products that go on them, but now maintaining and repairing the -- resetting the equipment. So it's a very, very large installed base. And as new systems are designed in, either a new weapons system or a new radio or a new Command Post Platform, or a new ISR product, new Gichner products and solutions are required on the Humvees. So we look at that as it's a very, very important opportunity for us.

Okay. So that's just one case where new over-cost, over-budget platform isn't coming in and that's extending your life. And I think that you're seeing similar -- that scenario play out in multiple points across your business, such as with like a new helicopter platform, right, for -- that would affect your DEI training business?

Yes. That would affect both DEI and their trainers. It also is an opportunity for us in our core weapons systems business relative to the Kiowa. The new, the next-generation armed Scout has been terminated, cancelled and the Kiowa's life cycle is going to be -- has already been extended. And we are heavily involved in the Kiowa.

Are you able to give an approximate breakout of what your core sustainment resets business is?

No. It's blurring, especially now with Gichner and DEI. DEI, they're in our ITS division, but they're going to be involved heavily, as I said, in FMS opportunities, which is our weapons systems business. Which, you know, is the plan when you acquire companies, not only to get their contracts and their relationships and their quals, but you're really look for 1 plus 1 to equal 2.5. And the 1 plus 1 equals 2.5 or 3 is when the acquired business really can be additive and can cut across a big portion of your business which is what is happening. I can tell you our weapons systems sustainment division is like $300 million in revenue.

On an annualized basis.

On an annualized basis. It's about $0.3 billion, weapons systems sustainment. And if you throw in some other range work that we do, which is tied into weapons system sustainment and everything, it's probably closer to $350 million.

Okay, great. And then, just turning back to Gichner, so okay, we've got the Humvee opportunity and then you talked about Aegis ships. So if you piece together various releases you put out -- there's one where it's like 16 electronic module enclosures per ship and then there's another one where you were supplying three more modules to Raytheon for almost $3 million. I mean, is that the way to think of it, $10 million to $15 million per ship opportunity for Gichner, at least for destroyer?

I would say on the lower side of that for a DDG 1000, yes. You know, the big one, we're -- the bigger one -- our DDG 1000 program that we currently have goes through 2012 or 2013. The big one is the Littoral Combat Ship, their mission modules. And the announcement that came out yesterday was very important, very important, where it looks like the Navy is not going to down select to one team. But they're going to order ten ships from each of the OEMs. And without getting into too much competitive discussion, that is very, very good for us.

And with the 20 LCS, do you intend to be the supplier to both teams, both ships?

That would be our intention.

Okay. Then, regarding Henry Brothers, so are we still looking for a December close? Is that the target?

As we sit here today with you, absolutely.

Okay. And in addition to just simple things that you can provide performance bond on, I mean, what are some of the broader national opportunities you could pursue together that you couldn't alone? Like nuclear power plant protection -- is that something they're doing now or that's something you intend to go after or -- ?

So that is an area where Henry absolutely has qualifications, in security systems for nuclear power plants. And that is an area we intend on aggressively going after. Another area that we intend on aggressively going after has to do with border protection. Together we will be of the critical size that our company will be able to go after some of these very large -- there's a procurement out there right now, very large border protection security systems here in the United States. Also there are some very large energy company and energy transport opportunities, pipelines, things like that, where we are seeing significant activity in the energy area, where combined with Henry we believe we're going to be a very powerful force with our combined quals.

Right, because they have the, say, physical surveillance technology. But then would the idea be you bring in something like a NeuralStar network management platform and you can see if someone's trying to do a cyber attack that -- like to launch a [stocks net] type of -- is that --

That's exactly right. And that's not just on new opportunities, but that's on their existing customer base where they already have thousands of deployed cameras and thermal imaging systems and/or radars already and protecting those already deployed systems at our customers and at Henry customers, protecting them with our network management software.

Okay. And then, final question regarding Henry, they have this large program with L-3 for urban warfare after-action review. So what's the status of that? How much is left to run on that and what might you be able to do for any other part of the DoD in that regard?

Right. So I have to choose my words carefully here. That is a very large program. It goes into next year. It is -- there are additional opportunities that we are discussing with them right now beyond that program. And if that one program that is already in place goes all the way through, it is tens of millions of dollars to the company.

All right. Thank you very much.

Michael Kim; Imperial Capital.

You talked about information insurance and cyber security becoming a much higher profile part of your business, one of the stronger -- strongest growing segments for you. Can you talk about, maybe Deanna, the contribution to organic revenue growth, maybe quantify that as well as the contribution to margins as well in the quarter?

From a percentage or organic growth, Michael, what we did discuss, or what I discussed in my prepared remarks, was that the organic growth that we did experience in the quarter were -- I think the two specific areas I discussed were related to that cyber security business and information assurance business in our public safety business. Clearly from a margin perspective for competitive reasons we don't discuss that, unfortunately. But there was, as you saw, an increase in our gross margin, which was due to a favorable mix related to certain of those products. And that was a contribution to the organic growth that we saw in that business as well.

Michael, this is an area we need to be very, very cautious of from a competitive standpoint. Because we -- as Mike Crawford asked, the guys that we're competing against and we're beating, they're big guys. And we don't want to let out any more information than we need to on what's going on here. I will follow up what Deanna said, year to date our cyber business is one of the fastest growing businesses in our company.

And then in terms of the opportunity and I'm not sure how much you can framework on this, but are you primarily seeing it on the DoD side or the three-letter intelligence agencies? And then maybe if you could talk a little about the opportunity to expand into some of the federal civilian agencies as well.

Right. So we are seeing it today in DoD and other national security agencies and in other federal government agencies that one could say is related to security. You would say they're non-DoD federal government. They're not typical three-letter or national security, but they're other agencies like that. We are seeing -- we are winning contracts across all three of those today. We are bidding across all three of those today. And if I had to say, because this is where our niche is right now, this is where we're going to be putting a significant amount of our business development resources, sticking to our knitting in those areas right now. And then once Henry closes, because they will bring a channel of distribution with their customer relationships and they will bring a sales force, we will lever off of that. And that way we don't have to bring in an incremental hedge to try to penetrate a new market. So we're sticking with the three that you mentioned for now.

Okay. And then just going on to the guidance, what are you seeing in terms of the fiscal '11 budget? Or are you looking at (inaudible) under the continuing resolution to extend? What would drive towards the lower end of your guidance, the higher end of your guidance? Can you provide some commentary on the sensitivity?

Yes, that's a very good question. Right now, based on our book of business and our radar screen and the customers that we have, we are -- we don't think that the continuing resolution is going to materially impact us one way or the other unless it really, really gets extended it out and then it's going to impact the whole industry. So we're not -- that's not a big flex point to us right now.

Here are the two flex points for us. As I mentioned a minute ago, more and more of our business is going -- turning toward products. We're actually working on products that are being delivered. And as you know, with products things can split quarters. So you can expect something to be delivered on March 31, but it goes on April 2 so you can have a little bit of lumpiness. Okay? And there's nothing wrong and it's not big extensions, but it's lumpiness around quarters. And so we're going to be -- as our product business now is nearing 50% of the Company, or approximating 50% of the Company, quarter to quarter we're going to be a little more lumpy, which is why we're going to give annual guidance because we know the business is going to grow year over year. One quarter might not be as strong as another just because some shipments didn't go. They went the next quarter. That's number one. That could impact the high end of the range and the low end of the range, just the lumpiness of it. We could have a fantastic Q4 if we shipped some extra stuff at the end of December and then Q1 could be a little lower because it went out in Q4 and then we're at the low end for that year. That's that piece.

The other piece is the in-sourcing seems to be slowing down. Now, as you know, we made that strategic shift where we're not so much focused on program management or IT or the inherently governmental areas that were being in-sourced, thank God. It's a very small piece of our business. It's probably in total right now $40 million or $50 million in revenue. We have continued to get nicked there. I think in the last 20 months net we've lost 100 slots where the job was in-sourced. We have built into our plan next year that we are going to continued to get nicked, nothing significant. As you know, Secretary Gates came out and he said that the in-sourcing had failed in the cost reduction initiatives that they had hoped for and that they were going to be backing off with that. Okay?

If things stay the way they are, then that's where our forecast is. If things change and they start in-sourcing significantly again -- again, it's not a big deal to us, because it's not a big part of our business. But it could be a couple, 3, $4 million in revenue which would then move it toward the middle point of the lower end of the range. Those are the two ones we see.

And are you also assuming significant task orders under the MiDAESS contract or how do you expect that to layer into fiscal '11?

We have very, very, very little at all in our 2011 plan for MiDAESS, very little. So if we, God willing, we were to win one or two big task orders, that would move us -- that would be very very good.

Great. And then just switching gears to FMS, you talked about some fairly significant opportunities you're seeing for Gichner and for DEI in 2011. Can you expand on what opportunities you're starting to see there and the scale of those opportunities?

Okay. So, again, competitive -- there's always the competitive dynamic. I will say that some of the tracked and wheeled vehicle programs that we talked about in our prepared remarks, those tracked and wheeled systems are part of the FMS friendly government military base arsenal. And very candidly, they need the type of work that companies like we do, with our Gichner division and our DEI division. And these are not pie in the sky. These are active cases under FMS. They're active cases that we're bidding on. That's really all I should say. But they're types of platforms that I mentioned in our prepared -- our remarks.

And these are platforms that both Gichner and DEI are familiar with?

Either yes -- the answer is yes, where either Gichner is familiar with a certain platform or DEI is familiar with a certain platform or they're opportunities where both of them are familiar with it and it will be the combined force of Kratos, Gichner, and DEI bidding on it.

And is it your sense the competitive landscape for some of these opportunities are as aggressive as you've seen in some of the other markets? Or do you believe that with Gichner, with DEI, that you have better quals, or better positioning in some of these segments?

We feel very -- as of today, it's less competitive in these areas because of our quals. And we've been focused on it for a while and hypothetical others have not.

Great. Thank you very much.

John Nelson; State of Wisconsin Investment.

Congratulations again, Eric, to you and your team for a job well done, and great progress in building up the Company. Very much appreciate that.

Thank you, John, very, very much. We all appreciate it.

My questions relate to the -- with a larger percentage of revenues coming from products and then also adding in cyber warfare security systems, should we be expecting the R&D to go up significantly over the next 6 to 12 months?

Right. No. The answer is no, R&D is not expected to go up significantly. The vast majority of the R&D that we do today is not IR&D, internal research and development. It is funded R&D from the customer. And as I mentioned, our cyber products are -- they're there. There will be continuing I'll call maintenance R&D for the next versions but nothing significant.

Okay. And, again, your company has successfully incorporated a number of very significant strategic acquisitions over the last couple of years. Are there any holes left to be filled for you to provide what you think would be the total package -- goods and services for the government?

As we sit here today, we believe we are very, very good in five areas -- one of the best, if not the best. And the areas are the missile defense area and targets; the weapon systems sustainment and upgrade of the weapon systems; the information assurance and the cyber area; the homeland security and critical infrastructure protection; and I'll call C4ISR, which is all of our (inaudible) intelligence work, our sensor work, our UAV work, et cetera. I'll never say never, but our plan would be anything significant is just going to continue to augment and build our qualifications in those five areas where we're really, really good. We're not big enough to be a shotgun. We're going to stay a rifle and we're going to stay a rifle in these areas where there is -- where we think there's going to be continued significant adequate funding because they're national security priorities.

Thanks very much.

Thank you. At this time I would now like to turn the program back over to Mr. DeMarco for any additional remarks.

Very good. We appreciate you spending the last hour or so with us. We know this went a little bit longer, but as I mentioned up front, a lot of good things going on with the Company and we wanted to update you in detail since the last time we spoke with you. We will be circling up with you at the end of our fourth quarter. Thank you.

Ladies and gentlemen, this does conclude today's program. You may now disconnect and have a wonderful day.