Kratos Defense and Security Solutions Inc (KTOS) 2010 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Kratos Defense & Security Solutions fourth-quarter and year-end 2010 earnings conference call. (Operator Instructions). As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Laura Siegal, Vice President, Corporate Controller.

Good afternoon, everyone, and thank you for joining us for the Kratos Defense & Security Solutions fourth-quarter earnings conference call. With me today is Eric DeMarco, Kratos's President and Chief Executive Officer, and Deanna Lund, Kratos's 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 March 1, 2011, 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 adjusted EBITDA and the associated margin rates, pro forma EPS from continuing operations excluding transaction expenses, and amortization of purchased intangibles 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 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, 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 measure 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 fourth quarter and full year for 2010. He will then turn the call over to Ms. Lund to discuss the specifics related to our fourth-quarter and full-year 2010 results. Mr. DeMarco will then make some concluding remarks about the business, and we will then open the call up to your questions. With that said, it is my pleasure to turn the call over to Mr. DeMarco.

Great. Thank you, Laura, and good afternoon.

Today, we reported fourth-quarter revenues of just under $121 million and adjusted EBITDA of $12.9 million, or 10.7% of revenues. The 10.7% adjusted EBITDA rate is the highest in Kratos's history and is representative of how well the Kratos team is running the business and how well the business is operating.

I want to emphasize this point again here. The Kratos management team, our division presidents, our executive management, and our leadership team, is absolutely one of the best in the industry today. And this is a primary reason why we have been successfully executing our strategic business plan and increasing Kratos's profit rates every year since Kratos's inception and sequentially every quarter in 2010.

Kratos's EBITDA rate for all of 2010 was approximately 9.7%, and for 2011 we are expecting significant margin expansion once again, over and above the 2010 margin rate.

For 2010, Kratos generated cash flows from operations of $28.4 million, and excluding acquisition-related costs, 2010 cash flow was approximately $31 million. Our 2010 cash flow is testimony to the quality of earnings of Kratos and is also reflective of how well the Kratos team is running the business.

Importantly, this is also representative of the successful integration of the businesses we acquired in 2010, the elimination and reduction of duplicative costs, and true synergy realization, including in the business development area. The Kratos team are professionals in operations in M&A and in the related integration of acquired businesses, which is, as you know, is a key element in our strategy to build the premier national security business.

As we have previously communicated, in addition to GAAP EPS, Kratos reports a pro forma earnings per share, and moving forward we will continue to do so, with pro forma EPS reflecting the actual or expected cash amount to be paid for income taxes and excluding acquisition-related expenses and acquisition-related intangible amortization. We will report EPS in this way to reflect the true economic earnings of the Company, which takes into consideration the considerable long-term economic benefit our Company will realize from approximately $200 million in net operating loss carryforwards we have available.

As a result of these NOLs, which expire through 2029, Kratos is effectively 35% more cash flow profitable than a full income tax-paying business. We will discuss the value of this large tax asset later on in our prepared remarks. Deanna will provide all of the financial details of our fourth-quarter results and of our release today in her prepared remarks.

As Kratos begins 2011, consistent with our stated strategy we are becoming more and more pure-play specialized national security products, solutions, and services provider with our primary expertise and the majority of Kratos's offering related to C5ISR.

We also continue to believe that a significant portion of Kratos's business is focused directly on or is performing work related to mission-critical national security priority areas. These include intelligence surveillance and reconnaissance, command and control systems and total information dominance, cyberwarfare/cybersecurity situational awareness and information assurance, unmanned systems, force protection, combat and weapon system upgrade modification and sustainment, and homeland security/public security/critical infrastructure security, including work in the areas of chemical, biological, radiological, nuclear, and high explosives, or CBRNE.

Specifically related to mission-critical national security priorities and Kratos's fourth quarter, in the cyber area we believe that Kratos's proprietary NeuralStar and dopplerVUE products are clear differentiators for our Company and are some of the leading-edge products in the information assurance, situational awareness, and network management and protection industry today.

In the cyberwarfare and security area, similar to many other areas of Kratos's business, we are prohibited from announcing many of the contract awards or customer relationships that we have. However, during the fourth quarter we were able to announce a new $8 million prime cybersecurity and network management contract award with the United States Navy. Under this contract award, Kratos will be providing cybersecurity, information assurance, and information technology-related services and solutions.

Additionally, at the very end of September, Kratos was able to announce one of the largest cybersecurity awards in our Company's history. Under this multimillion-dollar award, Kratos will provide to a certain federal agency cybersecurity and network management products, solutions, and services to manage and protect this agency's global infrastructure, which consists of tens of thousands of network IT encryption, decryption, and the cybersecurity-related devices and elements.

Also, as we have discussed with you before, we see a significant opportunity to exploit Kratos's NeuralStar and dopplerVUE network management and cybersecurity products through Henry Brothers critical infrastructure security customer base, which is substantially all IP-based, with a significant portion of this business base related to surveillance, reconnaissance, and command and control security system integration for strategic asset protection here in the United States.

Also in Kratos's cyber business area, just a few weeks ago we were informed that a Kratos team has been awarded another very large multiyear cyberwarfare and security-related contract, which will include delivery of Kratos's proprietary software products. We have been unable to formally announce this award to date, but I wanted to mention it to you here so that you can see the momentum of Kratos's cyber business has continued as we have begun 2011.

Kratos's ballistic missile defense business also had just an outstanding fourth quarter with contract-related and other awards that will position Kratos for sustained growth in this area for years into the future. In October, the Kratos team was awarded a $1.6 billion unrestricted full and open Missile Defense Agency Engineering Support Services, or MiDAESS, contract vehicle. Under this five-year engineering support services contract, Kratos and its team will provide advisory, assistance, systems engineering, and test support to the Missile Defense Agency. Kratos has responded to a number of task orders under this contract vehicle to date, where we are awaiting award, and similar to Kratos's cyber business we are clearly looking forward to Kratos's prime MiDAESS contract vehicle being a key driver to our organic growth going forward.

Also in the fourth quarter, the Kratos and Missile Defense Agency team was awarded the Department of Defense 2010 David Packard Excellence in Acquisition Award for the design, deployment, integration, and launch of a family of cost-effective, flexible, and reliable ballistic missile targets that replicate a wide range of ballistic missile threats to the United States and our allies. In announcing this award to the Kratos team, Ashton B. Carter, Under Secretary of Defense, stated, "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."

Needless to say, the entire Kratos organization is extremely proud of the ongoing success of Kratos's Aegis readiness assessment Ballistic Missile Defense target vehicles and the significant contribution the Kratos team is making to United States national security. The receipt by the Kratos team of the 2010 David Packard Award is testimony to Kratos's outstanding employees and how entrenched Kratos's ARAV target vehicles are in the Aegis Ballistic Missile Defense program.

Directly related to Aegis-BMD and Kratos's ARAV targets, in November Kratos successfully launched an ARAV target rocket on the Pacific missile range facility Kauai Test Facility in support of a certain U.S. Ballistic Missile Defense test. Additionally, just a few weeks ago Kratos supported a critical Aegis Ballistic Missile Defense test, Atlantic Trident, where Kratos provided BMD targets, rocket launch, and engineering services.

The Atlantic Trident BMD test was the first live sea-based Aegis BMD test on the East Coast. It involved three United States Navy ships, the USS Monterey, the USS Vermont, and the USS Gonzalez. We will be able to speak more on Atlantic Trident on our first-quarter call in a few months, but I wanted to briefly discuss the successful critical test here today in order to emphasize the importance of Kratos's ARAV targets to the United States Ballistic Missile Defense program and the continued momentum we are seeing in this business, as this is another area where Kratos sees organic growth opportunity in the future.

Additionally, here are some other examples of why Kratos sees a growth opportunity for our Aegis Ballistic Missile Defense business going forward. Today, there are 22 Aegis BMD-capable ships in the U.S. fleet. It has just recently been reported that the number of Aegis BMD-capable ships will be increased by 30 ships over the next four to five years, with the ultimate target being greater than 60 Ballistic Missile Defense-capable ships in fleet, which is consistent with the Obama administration's stated phased adaptive approach to missile defense.

In December, the Japanese government stated it plans to increase the number of its Ballistic Missile Defense-capable Aegis destroyers from four to six. Several other foreign-friendly navies deploy Aegis BMD and are also Kratos customers.

In the Aegis Ashore program, having land-based Aegis BMD batteries is continuing to gain momentum, with the Navy announcing the set-up of an Aegis land-based facility in Hawaii, the Aegis Ballistic Missile Defense Agency's continued expansion of the Navy's Dahlgren base, where, as you know, Kratos has a workforce in excess of 200, and the first Aegis Ashore-related contracts recently being awarded to the relevant OEMs. Additionally, Kratos is involved with BMD's THAAD, or Terminal High Altitude Aerial Defense program, and we have a major initiative underway in our Company for Kratos's targets to address the THAAD, Aegis Ashore, and potential Patriot mission requirements, including in the FMS area. Here again, I think you can see why we are excited about the potential opportunities for Kratos's missile defense business area, which we believe is clearly a national security priority area.

During the fourth quarter, Kratos performed work related to a number of intelligence, surveillance, and reconnaissance related programs, including certain sensor-related programs. Kratos is involved with several specialized sensor technologies, including electro-optical, infrared, photonic, and other exotic and classified sensors.

Kratos is currently under contract and working on flexible membrane optical mirror sensors, and the utilization of electrical signals to adjust the shape of the sensors' optical mirrors, which allows the adjustment of focus and zoom level of an optical system with no moving mechanisms. An objective of this program in technology is to change the zoom, allowing sensor operators to track several targets simultaneously while meaning complete environmental situational awareness.

During the fourth quarter, we were awarded $23 million in contract awards directly related to unmanned systems, command and control infrastructure, including unmanned system command and control infrastructure, and other war fighter support-related products. Kratos is currently under contract on, involved with, or supporting a number of unmanned vehicle-related programs or platforms, including a critical United States Air Force UAV ISR related program which we have been unable to formally announce to date. Unmanned vehicles and ISR are mission-critical national security priority areas where we are building our business, increasing our bid and proposal pipeline, and focused on continuing to penetrate as an organization.

During the fourth quarter, Kratos was awarded a $2.9 million contract for continued work on the DDG-1000 Zumwalt-class destroyer and its electronic module enclosures, or EMEs. The EMEs provide isolation for electromagnetic interference, shock, and vibration, and provide security for certain mission system equipment. What we are doing here is very strategic relative to a new and low-cost approach to shipbuilding, electronics packaging and integration, and electronic security and protection, and later on in today's discussion we will discuss with you an opportunity this capability has resulted in for our Company.

During the fourth quarter, in Kratos's weapons or combat systems business, we also performed work -- program work related to the M1 Abrams Main Battle Tank, the M2 Bradley fighting vehicle, the HIMARS mobile rocket launch system, the OH-58D Kiowa warrior helicopter and its main weapon system, Hawk surface-to-air missile systems, Chaparral surface-to-air missile systems, Black Hawk helicopter, the CH-47 Chinook helicopter, and certain weapons systems' warheads.

During the fourth quarter, Kratos also performed certain program work related to various Army and National Guard units across the United States, including in Oregon, Connecticut, North Carolina, Illinois, and Florida, and Kratos performed program work related to the Avenger Air Defense System for the Ohio National Guard.

This is just a representative list of some of the combat or weapon systems program-related work that Kratos performed during the fourth quarter. As you know, a key thesis of Kratos's work in this area is the upgrade, maintenance, and sustainment of proven and deployed C5ISR systems, including combat or weapons systems. We continue to believe and see that as new leading-edge combat systems and weapon system programs are delayed, stretched out, or even canceled, the demand for the upgrade and sustainment of existing proven and deployed systems has remained solid.

We also believe that a similar opportunity exists in the foreign military sales, or FMS, market area, as most FMS customers do not typically procure or have in arsenal the newest U.S. weapons systems, but rather the previous generations, or older, proven, and successfully deployed systems. One of Kratos's largest C5ISR contracts today is an FMS program that will go through 2013, and we are currently pursuing in our bid pipeline a number of new foreign military sales opportunities, many of which we could not have previously pursued without Gichner or DEI. We see the C5ISR business area, the sustainment of proven and deployed command and control and combat systems, including in the FMS area, as another growth opportunity for our Company going forward.

At the end of the fourth quarter, Kratos completed the acquisition of Henry Brothers, which has been integrated with Kratos's public security and safety business. As a result, as we begin 2011, Kratos, combined with HBE, is one of the premier engineering design, integration, and deployment businesses for Homeland Security systems, critical infrastructure security systems, and public safety security systems in the industry.

We are currently performing on contracts or programs which include surveillance systems, sensor systems, and command and control system integration and operation for some of this country's most critical infrastructure, including power generation facilities; energy transport and fuel transport facilities and infrastructure, mass transit authorities, including major international airports, harbors and port authorities, subway systems, railroad and train systems, and other types of mass-transit vehicles, systems, and infrastructure.

Kratos is involved in the protection of some of the highest profile and strategic public assets and infrastructure in the United States today. This is an area where we see the opportunity for continued significant growth and margin expansion in the future. The number of opportunities in the Homeland Security and critical infrastructure area has been growing rapidly recently, and with Kratos now together with HBE and our combined greater capabilities, qualifications, and customer relationships, we are now pursuing and bidding on a growing number of larger security system deployments than we have in our history.

Additionally, as I mentioned previously, we believe that we have a significant cross-selling opportunity for Kratos's NeuralStar and dopplerVUE cyber network management and situational awareness products into the combined PSS and HBE customer and contract base for the management and protection of these very sophisticated IP-based security systems. We are forecasting significant growth and profit margin expansion for Kratos's public security and safety business in 2011 as a result of these factors.

I'll now turn it over to Deanna.

Good afternoon. Thank you, Eric.

Today, we reported quarterly revenues of $120.8 million, compared to fourth-quarter 2009 comparable revenues of $75.2 million, which reflects the aggregate contributions from the Gichner, DEI, and HBE acquisitions of approximately $46.2 million, organic growth in certain of our weapons systems, cyber warfare, ARAV target, and public safety businesses, offset in part by reductions in other areas, reflecting our continued reduction of lower-margin passthrough 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 of revenues previously generated under contracts that were originally awarded as small business awards to companies that we acquired.

Our government solutions business revenues increased year over year from $67.7 million to $108.9 million, reflecting the contributions from the acquired companies of $44.4 million, the organic growth in certain weapons systems, cyber warfare, and ARAV target businesses, offset by the aggregate net reductions I mentioned previously, which resulted in an approximate aggregate net reduction of $3.2 million.

Our public safety business has continued to grow organically and through the acquisition of Henry Brothers from a topline perspective, both sequentially from $9.7 million in revenue for the third quarter of 2010 to $11.9 million in revenue for the fourth quarter of 2010, representing an increase of approximately $2.2 million, and year over year from $7.5 million for the fourth quarter of 2009 to $11.9 million in revenue for the fourth quarter of 2010. Approximately $1.8 million of the revenues in the fourth quarter of 2010 were generated by Henry Brothers.

On a year-over-year basis, organic revenue growth was $2.6 million, or 35%, from $7.5 million in the fourth quarter of 2009 to the $10.1 million for the fourth quarter of 2010, which excludes the HBE revenues from the date of acquisition.

SG&A increased from $11.4 million in the fourth quarter of 2009 to $14 million in the fourth quarter of 2010, primarily due to the acquired companies, offset partially by cost-reduction actions we have taken. As a percentage of revenues, our SG&A has decreased from 15.2% in the fourth quarter of 2009 to 11.6% in the fourth quarter of 2010, which reflects the leverage we have been able to achieve as we have increased our revenues and eliminated costs through our integration actions.

From an operating segment standpoint, our government solutions segment generated $7.5 million of operating income in the fourth quarter of 2010, up from $4.2 million compared to the same quarter last year and up sequentially from $7 million in the third quarter. Our public safety and security segment generated $1 million of operating income in the fourth quarter of 2010, up from a loss of $100,000 compared to the same quarter last year and up sequentially from $0.8 million in the third quarter. The improvements in both of our operating segments reflect the contributions from the acquired companies, the growth in the businesses, a favorable mix of revenues, as well as the impact of cost-reduction actions we have taken and continued leverage of our SG&A as revenues increase.

From an operational adjusted EBITDA metric standpoint, our government solutions segment generated $11.7 million of adjusted EBITDA, or 10.7% of revenues, and our PSS segment generated adjusted EBITDA of $1.2 million, or 10.1% of revenues, in the fourth quarter of 2010. On a consolidated basis, our adjusted EBITDA for the fourth quarter of 2010 was $12.9 million, or 10.7% of revenues, up sequentially from $11.7 million, or 9.8% of revenues in the third quarter of 2010 and up year over year from adjusted EBITDA of $6 million, or 8% of revenues, in the fourth quarter of 2009.

Our adjusted EBITDA excludes the impact of approximately $1.6 million of acquisition-related expenses and stock compensation expense of $500,000. On a full-year basis, we generated adjusted EBITDA of $39.7 million, or 9.7% of revenues. This compares to $24.7 million, or 7.4% of revenues, for 2009 and $18.2 million, or 6.4% of revenues, for 2008.

On a GAAP basis, net income for the fourth quarter was $400,000, which included the $1.6 million of acquisition-related expenses and a loss from discontinued operations of $200,000. 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 provisions, which may be subject to variations on a period-by-period basis.

For instance, our fourth-quarter GAAP net income reflects a net $200,000 tax benefit compared to our average quarterly estimated cash tax payments of approximately $500,000. The difference is related to certain tax benefits that impact our GAAP tax provision but do not impact our estimated cash tax payments, similar to the credits that we have recorded in the third and second quarters of 2010.

In addition, as a reminder, we think it is important to note that due to our acquisitive activity that 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 life of those intangible assets, which typically range from a three-year to 10-year period. For instance, our fourth-quarter GAAP operating income includes an amortization charge for the purchased intangibles of $3 million, which is equivalent to approximately $0.16 per share as a majority of the purchased intangibles are not deductible for tax purposes.

On a pro forma basis, utilizing an expected average cash pay income tax provision of approximately $500,000, EPS from continuing operations of $0.4 million, excluding the acquisition-related expenses of $1.6 million and the amortization of intangibles of $3 million, or four -- $5 million in total before a cash tax provision of $500,000, or a net of tax number of $4.5 million, was approximately $0.24 per share.

Moving to the balance sheet and liquidity, our cash balance was $10.8 million at December 26, plus $8.5 million in restricted cash which primarily relates to the Gichner acquisition escrow amount held for indemnification obligations.

Our cash flow generated from operations was $3.6 million for the fourth quarter, which includes a use of approximately $1.4 million of acquisition-related expenses paid during the quarter. Our cash flow generated from operations for the year was $28.3 million, which includes $3.1 million of acquisition-related expenses paid during the year. This compares to $26.2 million of cash flow generated from operations in 2009.

Other key balance sheet and capital structure elements at December 26 are as follows. Accounts receivable primarily from the U.S. government and other agencies was $125.8 million. Accounts receivable days sales outstanding, or DSOs, were at 76 days, excluding the impact of the recent HBE and Southside acquisitions, which is down from 95 days in the fourth quarter of 2009. Debt under our outstanding notes at December 26 was $225 million with no borrowings on our line of credit. And total net debt, net of the $10.8 million unrestricted cash at December 26, was $214.2 million.

Our revenues generated from product sales for the fourth quarter was approximately 40%, and our contract mix for the fourth quarter was 64% of revenues generated from fixed-price contracts, 17% of our revenues from CPFF contracts, and 19% generated from time and material contracts. Revenues generated from contracts with the federal government were approximately 87%, including revenues generated from contracts with the DOD of 77% and revenues generated from contracts with non-DOD federal government agencies of 10%. We also generated 3% of our revenues from state and local governments and 10% from commercial customers.

Moving on to the guidance that we have reaffirmed today for 2011, we have reaffirmed our annual guidance for 2011 of revenues of $550 million to $560 million and adjusted EBITDA of $60 million to $62 million. GAAP EPS of $0.75 to $0.79 per share. EPS excluding amortization, acquisition expenses, and using an estimated cash pay income tax provision of $1.20 to $1.40, and cash flow generated from operations of $22 million to $24 million. Once again, all these forecasts are on a Kratos standalone basis, excluding the pending Herley acquisition, and reflect the EPS calculated on our estimated cash tax paid basis.

We expect our cash tax payments to be approximately $3 million for 2011 on a standalone basis. We estimate the annual amortization expense for purchased intangibles for 2011 to be approximately $12 million, reflecting the impact of the companies that we have acquired during 2010. As Eric mentioned before, this amortization expense is quite sizable on a relative basis as a result of our acquisition strategy, and we believe it is meaningful to present a pro forma EPS, excluding amortization, along with GAAP EPS.

As we've previously stated, we will continue to provide forward guidance on an annual basis, rather than a quarterly basis, primarily due to the large product-related mix of our business, which we expect will continue to increase, especially with the pending acquisition of Herley, which can at times be lumpy from month to month due to the timing of shipments and deliveries.

As you may know, posted on Kratos's website is a Herley briefing which provides certain estimated, preliminary, pro forma, combined company financial information related to the pending acquisition, including a pro forma forecast for 2011 and 2012 for the combined business as if the two companies were combined as of January 1, 2011. We will be providing and updating 2011 guidance for the combined Kratos-Herley business once a pending transaction closes.

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

Thank you, Deanna.

As you probably saw, last Friday we initiated a tender offer for the Herley shares. The current expected timeline we are tracking to is for the tender offer to close around March 25. A week or so prior to that, we intend to commence the process to tack on the additional notes to our currently trading notes, and we expect the acquisition of Herley to close some time in Kratos's fiscal second quarter.

I do not think I can convey how excited Kratos is as an organization and how excited I am personally for the merger with Herley and for Rick Poirier and his team and Herley employees to join forces with Kratos. Not only do we estimate that the combined business will have pro forma 2011 revenues of approximately $750 million and EBITDA in excess of $100 million with cash flows from continuing operations of approximately $45 million in our first full year together, but the combined business will also be involved in a substantial number of long-term mission-critical national security priority programs that are expected to be well funded into the future. Many of these programs are described in a briefing on Kratos's website that Deanna mentioned previously.

Rich and the Herley team are just outstanding, similar to the Kratos team, and key Herley managers have executed long-term agreements with Kratos. Together, the combined company will be pursuing a number of new opportunities that the independent businesses could not have previously pursued, including in the international and foreign military sales areas.

As Deanna mentioned in her remarks, Kratos is reaffirming its previously communicated 2011 financial guidance, and we are also reaffirming our target topline organic growth rate of approximately 4% to 6%. As we have discussed today, we clearly have business areas within Kratos that are growing and that are expected to continue to grow in the future at much greater than 4% to 6% organically.

However, as you know, the government industry has been operating under a continuing resolution for the past five months, since October 1, 2010, and it appears that this week the CR is going to be extended once again. While the DOD, Kratos's primary customer, is not a stranger to operating under continuing resolutions, the current CR under which we are operating represents the longest timeframe that the DOD has operated under a continuing resolution since the 1970s.

What a continuing resolution basically means is that the funding for current government fiscal year, or current government fiscal 2011, is basically capped at government fiscal-year 2010 levels, and that there are few to no new contract starts or rate increases in existing current contracts. Even though Kratos is performing very well and is focused on many of this country's highest national security priority areas, there have been a number of contracts where Kratos has expected a contract award, but the award has been delayed directly as a result of the continuing resolution, or we have received a new contract award but we have not been able to start work.

One example where we have experienced such a delay is the MiDAESS contract vehicle, where we are currently still awaiting awards on a number of task orders where Kratos submitted bids months ago.

Also as you know, this industry is highly competitive and is becoming even more so. Accordingly, as a result of these factors, we're going to be cautious and maintain and reconfirm our previously communicated topline organic growth targets of 4% to 6%, and hopefully if the government comes off of the continuing resolution shortly and approves the 2011 budget, this growth target will turn out to be conservative.

Accordingly, as Deanna and I both mentioned before, we are reiterating our previously communicated 2011 revenue and EBITDA guidance with Q2, Q3, and Q4 probably ramping a little more, primarily as a result of the impact of the CR.

Looking forward, as we discussed previously, Kratos's bid and proposal pipeline is the largest and of the highest quality today than at any point since the inception of this Company. There currently are a number of large opportunities that Kratos has outstanding where we have submitted the bid and are awaiting award, certain of which we currently expect to be awarded by the middle of this year.

Additionally, we are currently in the capture process for a couple of very large opportunities, which we are looking to go after in the prime contractor position where the teams are currently being established, bids are due late in 2011, and the awards are currently expected in the first half of 2012.

I want to convey to you here that, putting aside the current continuing resolution and threat of government shutdown situation, that the Kratos business, in my opinion, is currently operating at its strongest in its history, and the opportunities that we are pursuing are at the highest level and of the highest quality.

Directly related to this, we wanted to finish up today by informing you of just some wonderful news our Company has just received. We were just recently informed that Kratos has been awarded the low rate initial production contract for the mission module packages or containers for the Littoral Combat Ship. As I mentioned earlier today, Kratos is producing the electronic modular enclosures for the DDG-1000. The LCS mission modules have been a strategic opportunity that Kratos has been specifically pursuing and is one of the primary strategic reasons that we acquired Gichner, and Tom Mills and the entire Gichner team and the business have been just a grand slam combined with our Company.

There are 55 Littoral Combat Ships planned with the first two ships, the Independence and the Freedom, having been completed. LCS numbers three and four are currently under construction, and the contracts for the next 20 ships have just recently been awarded. The LCS is designed to replace 30 FFG-7 Oliver Hazard Perry-class frigates, 14 MCM Avenger-class mine countermeasure ships, and 12 MHC-51 Osprey-class coastal mine hunters. Each LCS is currently envisioned to have several different types of interchangeable mission module packages and configurations, currently including surface warfare packages, mine countermeasure operations packages, and anti-submarine warfare packages.

These are designed to be flexible and have multi-mission capabilities, and the LCS will utilize these interchangeable modules depending on the specific mission. One of the Littoral Combat Ship's primary missions will be to go into shallow seas to combat mines, diesel subs, and small agile vessels.

We are not approved to say much more than this on this very recent contract award. Hopefully, when we have our first-quarter call in a couple months, we will be able to provide additional information on what this could mean for Kratos in the future.

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

(Operator Instructions). Mike Crawford, B. Riley & Co..

Thank you, Eric. That's great news on the LCS. Regarding the EMEs for the Aegis BMD ships, with the 30 ships that are to go into service in the next five years, does that mean that each of those will need to have EMEs installed into the ship?

Right, the EMEs are for the DDG-1000, not the DDG-51 or the CGV-47, the two ballistic missile ships. So, the DDG-1000 has the EMEs, the LCSes have the mission modules, and on the DDG-51 and the CGV-47, the Ballistic Missile Defense ships, that's where we are providing the aerial targets when you read about the tests.

Okay. And I think it's been reported that three mission module packages for the LCS include about 16 EMEs. But when you're looking at each -- for each ship, but on the Aegis BMD, the number is just a few per ship?

Right. On the Aegis BMD ships, we are not providing mission modules for those. Those don't have them. The Aegis Ashore, the land batteries, will have the land-based infrastructure to hold the command and control equipment and the radar equipment. That is what we are targeting.

Okay, thank you. And then, Eric, you also mentioned opportunities for margin expansion in your Homeland Security business, including Henry Brothers. But was that other than with NeuralStar and dopplerVUE, and what are you thinking about there?

Right. So Kratos's Homeland Security business prior to the merger with HBE, a significant portion, somewhere around 15% or 20%, was a recurring revenue stream where we maintain and operate the security systems that we design and deploy.

Those streams can be very profitable.

The Henry Brothers business had a lower mix of that type of a business. That is an area we have and are specifically targeting to start growing immediately, which we've begun to do, which will clearly drive margin expansion in that business as we grow that recurring revenue stream.

Okay, thanks. And then, final question relates to the capture process. You're going through now with teams that you're forming for awards next year. Are those primarily prime opportunities for you, and are there any you can name by program?

Right. One I'll name by program, and it's Eagle. And it is not the DHS Eagle. It's a different Eagle. And we are looking at that and at the others in the prime role right now, very similar to Midas and Alliant, which we won as primes.

John Parker, Jefferies & Company.

You spoke so quickly and with so much excitement, I missed the new cyber contract you missed in your opening remarks. Can you give me the details on that -- that you announced in your opening remarks?

Right. The one that we mentioned in the opening remarks was a cyber contract with the United States Navy, which we were awarded last quarter. That was one.

Another one that we -- that I mentioned that we have not been able to formally announce yet in a press release, we are part of a team -- this is a very large award. It could turn out to be even larger than the one we announced at the end of -- the beginning of Q4 or the end of Q3 last year for us. Hopefully, we are going to be able to put something formal out on that in the next couple of months. That might be the one, John.

Okay, yes, that was it. Then, you mentioned amortization of intangibles of $12 million for next year, but you did $3 million in the fourth quarter of this year. Were you excluding Herley from that estimation?

Yes. John, that's just on a standalone basis.

Okay. And then, I guess, Herley, you probably haven't settled all that yet, obviously.

And then, your SG&A seems to be persistently staying low, even with all these acquisitions. I had modeled it going a little bit higher, but can you give us any guidance on how to think about that going into 2011? Would you expect your SG&A to stay at these levels or would you expect it to go up a little bit with the acquisitions?

I would expect it from a dollars perspective to come up, because if you keep in mind that the last two acquisitions that we closed on, HBE and Southside, there is very little contribution from either of those acquisitions in our fourth quarter, so from a full run-rate perspective, Q4 is not indicative of what we would expect going forward on a standalone basis, so I would expect the dollars to come up.

Clearly as a percentage of revenues, we expect that to continue to come down as we continue to see the results of the leverage off of our SG&A infrastructure as we grow revenues.

And then, finally, it seemed that your service margins were the highest in the quarter since you've been disclosing that segment breakout. I'm talking about the service revenues and this cost of service revenues. Is there -- and that kind of flies against what I've seen from many of your competitors. Is there anything, a change in the mix that caused that, or is it just a one-time thing?

It's a favorable mix of various service revenues during the quarter.

Okay. And would you expect those types of revenues going forward, or is it hard to say at this time?

For a standalone, excluding the Herley acquisition, for 2010, our EBITDA rate blended came in at something like 9.7%. And for 2011 against standalone, we are looking for the EBITDA rate to be in the mid-tens, 10.5% or so, and so we are looking to be able to maintain the mix in the 10.5% range.

Michael Kim, Imperial Capital.

First on Aegis BMD, can you talk a little bit about the schedule and your sense of the opportunity for ARAV and the balance of the year with the increase in the program, what your sense is in the percentage or dollar contribution, and also just on the relative share versus maybe one of your large prime competitors for that program?

Right. On ship-based Aegis, we -- the second half of this year, there are currently scheduled a number of launches -- in the second half of this year and in the first half of next year.

If those hold to schedule, we expect the business to continue to be one of the strongest growers and the most profitable in the Company. We are not disclosing in detail how big this business is, but it's becoming more and more sizable for us.

On -- relative to our competitors on ship-based BMD, we believe that we are winning right now the vast, vast majority of the work in the launches. And we believe that's going to, so long as we continue to be successful on the missions with our customers, that that's going to continue.

Now related to that, I mentioned and Deanna mentioned that relative to investments we are making right now, we are right now underway with the largest internal investment our Company has made before, and we've talked about this -- I talked about this at a conference. It's $4 million or $5 million of internal spend, and this is impacting our cash flow in 2011, which is why cash flow is flat or down a little bit, because we are making some modifications to some of our target vehicles to address Aegis Ashore, THAAD, and Patriot.

And if we are successful with this, and we are working with our customer on this, taking that over and above ship-based BMD, we could see -- it's possible in 2012 -- a step function increase in this business.

I think there's been some news about international orders for THAAD and Patriot. Is that an opportunity that you guys are close to looking at as well?

We -- I will tell you this. We have -- we are involved in that. We have launched targets for friendly foreign navies that have Aegis-capable BMD ships, including one we've talked about today and including some others, and it's an area we are involved in and that we are absolutely, absolutely focused on going forward, and we believe we are going to win a significant amount of that work, too.

And just on Aegis Ashore and Gichner, at the facility in Hawaii and Dahlgren, are those being built out currently or is that scheduled for later in the year?

That, I'm not sure on the NDAs we've signed on that, Michael. So that one, out of caution, I don't want to comment. I just am not sure what they all say.

And then, touching on Herley, can you -- I know it's a little early in the process and I'm sure you can talk a little bit later in the year, but can you talk about some of the revenue synergies or the combined operating synergies that you think you can pursue jointly, similar to some of your other acquisitions?

Absolutely. So I want to reiterate here that what I said in the prepared remarks that we are -- we couldn't be more excited and pleased about Rich and his team. And they are just outstanding.

And the more we've gotten to know them and work with them, the more we are convinced that combined with us, this is going to be another grand slam, similar to Henry Brothers and similar to Gichner.

One area that we are talking about and we are targeting has to do with electronic warfare and electronic attack on unmanned vehicles. And as you know, the primary electronic attack and electronic warfare platform right now is the EA-18G. And that is just hitting significant production and that's going to go for a number of years, and that's one of Herley's largest programs.

Replacing that in the future will more likely than not be unmanned aircraft. And -- so that will take a different type of -- that will take different types of products with different form factors and different fit and different power, and we have a significant relationships with government customers in the UAV field, as I -- as you know. And so this is an area that we are targeting, no pun intended, now, real-time, and when this is -- we are, and when this transaction closes, we are going to do that jointly with Rich and his team, and it's an area I'm very, very excited about.

Another one is in the foreign military sales in the international area, where Herley has a significant presence right now with a certain customer set. We have a very significant presence with several different customer sets, and that is an area that I believe is going to be another one plus one equals 2.5 or three for the combined company.

Then, lastly, just on the mission -- the award, the LCS award for mission modules, is it your expectation that with the new builds, the mission modules would be constructed concurrently with that, and if they will have a full set upon completion, or would they build that out over time?

I was on the phone today with some gentlemen on this program, and it's -- at this time, Michael, it's just best that I -- and I apologize, but I just leave it at what we've said until we are cleared to talk about it some more.

Okay, fair enough. Thank you very much.

John Nelson, State of Wisconsin Investment Board.

Eric and Deanna, congrats to you and your team on another excellent operating quarter.

Thank you, John.

Thank you very much. Thank you, John.

My question is related to, since I haven't talked much about this lately, is on the contract structures. Are many of the contracts or the recent contracts being signed, are they cost-plus versus fixed price? And is there any change in trends of types of the -- those types of contracts being issued or negotiated with the government for these various programs that you're winning?

More and more of our contracts are firm fixed-price. They are not fixed-price development contracts. They are fixed-price production contracts or fixed-price level of effort contracts.

We believe, as we move forward, the mix is going to continue to trend towards more and more fixed price, for us less and less time and material, and less and less cost-plus fixed fee. And the fixed-price area is, in our opinion, is just a win-win for our customers and for our Company and our stakeholders because on a fixed-price contract, the risk to the customer is capped at the fixed price, and there is a strong opportunity for the contractor, for Kratos, if we are perform as expected and we execute, that we can see margin expansion.

And John, this is one of the reasons why, very candidly, our margins have continued to expand. In addition to the reasons Deanna said on the integration of the acquired businesses and leverage on G&A, it has to do with mix, and our mix is trending very favorably, and it looks like it's probably going to even accelerate into the new year, based on what we are seeing.

Okay. Great. Also, when you're winning these significant new contracts, how easy or difficult is it to staff up for them?

Right. So on these significant new ones, the good and -- there is good and the bad.

The real good right now is that, thank God, we -- a lot of the groundwork that our team and our employees laid last year and two years is coming to fruition, and we are winning some good awards.

As I mentioned in the prepared remarks, the continuing resolution is impacting some of the starts. So you can win an award, but it's not funded. And so, thus far, staffing them has not been an issue. We are hopeful that if the continuing resolution gets resolved in the next month or so, that a good amount of this is going to free up, and we are having the time now to plan if -- for ramp schedules on the labor-based ones. So, so far, so good.

At this time, I would like to turn it over to Mr. DeMarco for any closing remarks.

Very good. Thank you very much for joining us this afternoon. We will -- we look forward to chatting with you again on the first-quarter call in a few months. Thank you.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may all disconnect. Everyone, have a great day.