Kratos Defense and Security Solutions Inc (KTOS) 2012 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Kratos Defense & Security Solutions first quarter 2012 earnings conference call. (Operator Instructions). As a reminder, this call may be recorded.

I would now like to introduce your host for today's conference, Laura Siegal, Vice President and Corporate Controller. Ma'am, you may begin.

Thank you. Good afternoon, everyone, and thank you for joining us for the Kratos Defense & Security Solutions first quarter earnings conference call. With me today is Eric DeMarco, Kratos' President and Chief Executive Officer, and Deanna Lund, Kratos' Executive 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 and matters that are likely to influence our business going forward. Any matters discussed today that are not historical facts, particularly comments regarding our future plans, objectives, and expected future performance, constitute forward-looking statements.

These forward-looking statements may include comments about our plans and expectations of future performance. This plans and expectations are subject to risks and uncertainties, which could cause actual results to differ materially from those projected 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 May 3rd, 2012, 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 and using a statutory tax rate of 40%, adjusted cash flow from operations, reflecting cash flow from operations excluding transaction-related items and adjusted free cash flow, reflecting cash flow from operations excluding transaction-related items and less capital expenditures, 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 actual and forecasted 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 actual and forecasted 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-GAAP financials 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 discuss our financial and operational results for the first quarter of 2012. He will then turn the call over to Ms. Lund to discuss the specifics related to our financial 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's my pleasure to turn the call over to Mr. DeMarco.

Great. Thank you, Laura. Good afternoon.

First quarter revenues and EBITDA performance came in pretty much as expected at $215 million and $24.4 million, respectively, with adjusted cash flow from ops approximately $32 million, exceeding the highs end of our expectations.

Accordingly, the business plan is on track and we are reaffirming our previous 2012 revenue guidance of $950 million to $1 billion, adjusted EBITDA guidance of $120 million to $130 million and adjusted free cash flow guidance of $50 million to $65 million.

The integration of the critical infrastructure business that we acquired at the beginning of the first quarter is well underway, with significant cost-cutting actions already having been implemented, which will result in significantly greater EBITDA margins over the balance of 2012 and, in particular, the second half of the year.

Additionally, certain back office and administrative functions during the first quarter were being provided to Kratos by the previous owner of this business under a transition services agreement or TSA, which Kratos is paying for which TSA is currently in the process of being phased out.

The required services under this TSA are expected to be substantially eliminated by the end of the second quarter or early in Q3. The elimination of the TSA and its associated cost at the end of Q3 or early -- excuse me, at the end of Q2 or early in Q3 is expected to further increase the overall EBITDA margins of the business and for Kratos as a whole.

The bottom line here is that the integration is going very well. It is on track and we expect the profitability of this acquired business to continue to improve throughout the remainder of the year, as we had originally planed.

Kratos' Public Safety and Critical Infrastructure Security business had a record backlog at the end of the first quarter and the bid pipeline remains extremely strong as we continue to address some of the most significant potential threats to our country's strategic assets and critical infrastructure, including cyber-related threats.

Our Critical Infrastructure business' book-to-bill ratio in the first quarter was 1.3 to 1, reflecting the strength and opportunity that we are seeing here with this business making up approximately 20% of Kratos' overall business today.

A significant portion of our Critical Infrastructure Security business is the maintenance or operation of the specialized security systems that we deploy and with strategic accounts, which are large national or international businesses, enterprises, or agencies, where Kratos has the strategic agreement to provide all or a substantial portion of these entities' critical infrastructure security requirements. Virtually none of Kratos' Critical Infrastructure business customers are US Department of Defense related.

With the acquisition of the Critical Infrastructure business at the beginning of the first quarter, we substantially increased the number of these strategic accounts, in addition to increasing the related annuity-type security system operating and maintenance services portfolio that we have.

Accordingly, we have good visibility for a significant portion of this business due to the long-term nature of these assignments and the recurring nature of these operation and maintenance assignments once these security systems are deployed.

Related to the momentum we are seeing with this business, we believe that we will be able to formally announce next week an extremely important new strategic customer relationship and related contract award with an entity that has in excess of $20 billion in annual revenues and with sites in over 20 countries internationally. This is, obviously, a huge achievement for our Company and we're looking forward to formally announcing this contract award next week.

As we have discussed previously, our country's critical infrastructure -- power plants, refineries, transportation systems, data centers, and water treatment facilities -- all current Kratos PSS customers, depend on the integrity and security of their computer networks. Approximately 85% of this critical infrastructure is owned by the private sector and last year alone there were over 200 disclosed, attempted, or successful cyber intrusions of the control systems that run these facilities, which was nearly a fivefold increase from the previous year.

Kratos is building a significant cyber practice, which is proprietary products, solutions, and services based, and which is seeing incredible demand in the military, security, commercial, and critical infrastructure areas. Kratos' acquisition of SecureInfo late last year is turning out to be fantastic for our Company, with SecureInfo's cyber solutions and services now being active across virtually all of Kratos' customer sets throughout our entire Company, including in our critical infrastructure security division, with the only limitation we see for our cyber businesses growth potential being the recruitment of adequate qualified resources.

In the cyber area, a key Kratos focus area and differentiator for our Company is our specialized and proprietary products such as Kratos' NeuralStar and dopplerVUE which we have deployed at multiple customer networks to address their cyber-based and network management situational awareness needs, including DoD, other federal government agency, commercial, critical infrastructure, transportation, and black customers.

Further in Kratos' cyber software product offering, a few weeks ago we announced a family of some of our newest cyber security products, which we call the CyberC4 product suite, which addresses cyber-based equipment hardening, insider threats, situational awareness, focused on the satellite communications and related terrestrial communications markets where, as you know, Kratos has currently a significant customer presence.

One of these new Kratos products, CyberC4 Alert is a force multiplier for network and security personnel who otherwise face the difficult task of manually going through thousands of log files generated per second to identify if the network is being threatened. Kratos' CyberC4 Alert is a real-time situational awareness cyber threat identification product.

Very recently in a report to Congress the Pentagon stated that it is planning to dramatically speed up the development of new cyber weapons, giving it the ability to field such weapons against specific targets, which is designed to respond to urgent, mission-critical needs, when risk to operation and personnel is unacceptable if such threats are not addressed quickly. This is just one of the most recent, high-level indices of the accelerating threat profile in the cyber area across this country.

There are also current discussions in national security circles as to where electronic warfare ends and cyber warfare begins. In electronic attack, cyber is the message and the conveyances is the electromagnetic signal. For example, you inject a cyber signal into the emitter that makes what you are targeting, a radar or a sensor, think that the signal it is seeing is something else. Cyber is what occurs when this spoofing signal gets into the receiver of the target network and you either spoof it or inject it with malware.

Today's cyber weapons and other sophisticated countermeasures can attack aircraft, ships, and ground vehicles through their antennas. Additionally, the threat of electronic and cyber attack against US forces is very real, both in the manned and unmanned areas, with the Chinese and Russians having designed specific EW platforms to attack high-value US assets.

This type of warfare is going to be a major part of any significant future conflict. A very large part of Kratos' business is in the electronic warfare and electronic attack arena and Kratos is directly involved in EW developing into cyberfare.

Our Electronic Warfare, Electronic Attack, and Electronic Products business had another extremely solid quarter in Q1, including the receipt of new contract awards that are positioning this business for the balance of 2012 and into the future.

Bookings in Kratos' EW, EA, and EP business have been extremely strong year to date, including thus far into Q2. Some of the important awards that we recently received in the business, and which we have been cleared publicly to disclose, including as specifically related to electronic warfare and electronic attack, include a $17.2 million sole-source award for a certain US electronic attack platform, a $9.4 million sole-source single award contract to provide electronic-warfare-related threat simulation products to an international customer, and a $6.7 million award to support the Airborne Threat Simulation Office.

We were also just able to recently announce a production award related to the US Navy P-8A Poseidon program. The Poseidon is the US Navy's newest maritime reconnaissance aircraft. It is a long-range anti-submarine warfare, anti-surface warfare, intelligence, surveillance, and reconnaissance aircraft capable of broad area maritime and littoral operations.

Just a few weeks ago, the US Navy celebrated fleet delivery of the first P-8A Poseidon, which is the replacement for the P-3 after 50 years of P-3 service. There are currently over 115 P-8s planned for the US Navy and Kratos is designed in with significant content on this very strategic platform, which will be in service for decades in the future.

As I've stated before, this concept of being designed in is a critical element of Kratos' business model across virtually our entire corporation, including in the EW and EA, Electronic Products, SATCOM products, AEGIS BMD and targets, specialized training systems, cyber, and PSS' security systems.

In our Electronic Products business area, Kratos also recently received a $24 million sole-source award for three extremely specialized microwave products for a certain international missile program. Though we are unable to say much about this opportunity, we believe that over the next few years this specific program could easily become one of the largest in our Company as we are now designed in and supporting a system that is addressing extremely lethal threat profiles.

At the macro level in this same Tactical Missile Systems and Electronic Product area, Israel is seeking $700 million from the United States to fund additional batteries of the Iron Dome counter rocket system, along with funding for the Arrow, SPYDER, Barak and the Sling of David missile defense systems -- all programs that are supported with similar specialized Kratos products.

Continuing in the missile defense area, in the first quarter, Kratos' Rocket Support Services business substantially completed one of the largest single internally funded efforts in our Company, a program to engineer, design, and produce a new Kratos Aegis Readiness Assessment variant, which culminated with the successful test firing of this significantly enhanced capability system, which we were formally able to announce just last week.

Kratos has invested several millions of dollars in the successful effort to address several new ballistic missile defense programs opportunities and threat profiles, which we cannot get into details publicly. Kratos' internally funded effort on this program is now substantially complete and we have already received new orders from certain customers for this very capable BMD system.

Kratos' RSS BMD or Aegis-related business was the fastest organic growth business in Kratos in the first quarter and with our new [TVC] rocket system, we expect Kratos' RSS business to continue to be a key growth driver for our Company in the future.

Kratos' RSS business and Kratos' ARAV, including Kratos' new ARAV variant, is a recent example where Kratos has designed into a major strategic national security program and where we have made a rifle shot investment on a proven, deployed, and low-cost product or system to address new markets and where we believe there is a clear demand. We have successful executed on this strategy with this ARAV, including the new customer orders for this new Kratos system that I just mentioned.

Kratos is also involved in or supporting Aegis, THAAD, Patriot, GMD, Chaparral, Hawk, and other missile-defense-related programs and platforms and we believe strategically that both tactical and strategic missile defense will remain very well funded areas, both domestically and internationally, as the proliferation of missile systems throughout the globe is accelerating rapidly, which we can all see clearly in current world events.

In the EW and EW arena, the Australian government is moving forward with its plans to upgrade its F-18 fleet with Growler electronic attack equipment. The F/A-18 and Growler programs are some of the largest in our Company today and the Australian plan is good news for Kratos and our future book of business.

In Kratos' Satellite Communication business, where Kratos' products are used on more than 85% of space missions, there was a lot of activity on Kratos-supported programs over the past few months.

The Air Force accepted control of the fourth Wideband Global satellite communications spacecraft, with Air Force operators at Schriever Air Force Base, Colorado, currently conducting tests before moving the satellite into its operational position for its expected entry into service this summer. The Air Force has already placed orders for five additional of these space systems.

During the first quarter, on-orbit testing was completed on the first Advanced Extremely High Frequency military communications satellites. The AEHF system will be a constellation of communications satellites in geosynchronous orbit that will replenish the existing EHF system Milstar satellite at a much higher capacity and data-rate capability. The AEH constellation will provide survivable, anti-jam, worldwide secure communications for both strategic and tactical users, and there are currently four AEHF satellites planned.

Kratos is also under contract and supporting the Mobile User Objective System UHF satellite system program, which is a planned four satellite constellation. Kratos is also currently under contract on the Space-Based Infrared System, or SIFRS High program, which is to consist of four dedicated satellites operating in geosynchronous earth orbit and two satellites in a highly elliptical orbit.

And finally, Kratos is also supporting the Global Positioning or GPS system, which is currently expected to consist of at least 24 satellites on orbit at all times.

Kratos' SATCOM business is primarily specialty product and specialty proprietary software based and we are expecting this business to be a growth driver for our Company for many years into the future.

Our Specialty Training Systems business, also primarily specialty proprietary products based, is coming off an extremely strong year in 2011 and continued its outstanding performance in the first quarter of '12. This business is where Kratos designs, engineers, produces, deploys and maintains full-scale and sub-scale specialized training systems for a number of proven and deployed platforms in the aviation, missile system, armored vehicle, and unmanned systems area.

As the number of new or replacement platforms or systems is reduced, either through new program cancellation or truncation, proven deployed systems are being upgraded with new C4ISR systems, weapon systems, propulsion systems, and other systems, which are driving this training business for Kratos.

Major current programs that Kratos is designed in on or holds the beta rights for these Specialized Training Systems, include Chinook, Blackhawk, Abrams, certain unmanned systems, and certain other national-security-based platforms.

Here at the macro level, a recent report indicated that the United Stated Department of Defense spends approximately $13.7 billion annually on training and simulation and also predicted that a significant uptick in the need for operational training to keep soldiers battle ready as troops are redeployed from Iraq and Afghanistan.

Training and sim is an important element of Kratos' business and we are looking to making some very specific tactical investments in this area in the future, especially where we can develop or obtain specialized proprietary products or products or systems are proven, deployed, and designed in to existing customer requirements and where there is limited competition.

Directly related to the importance of this market area to Kratos an example of focused business development investments we are making, several weeks ago we were awarded an $86 million prime contract to provide technology-based training solutions for the Navy's Education and Training Command. This is a new contract award for Kratos and it'll enable us to expand our training business to a new customer set across new programs, platforms, and systems.

Kratos' Unmanned Systems business was solid in the first quarter and performed as expected, including in the avionics, electronics, ground flight control station, and related support equipment areas. Unmanned Systems is an area where Kratos is very well embedded on a number of programs with our specialized products and this is another area where Kratos is looking to invest, as we believe that this-- to be a solidly funded area in the future and I will talk more about some of the success of our investments here later on in my remarks.

Kratos' Weapon System Sustainment business, where we provide specialized product services and solutions for a number of weapons systems, performed well in the first quarter in a very tough budgetary environment. This business was down somewhat from last year and we are currently forecasting this business to continue to contract slightly this year, as compared to last year, primarily due to the current budgetary environment and budgetary flows. In our existing bid and proposal pipeline, there are a number of bids that we are preparing to submit, which we are currently expected to be awarded later this year or early next year specifically related to this business unit.

Finally, Kratos' traditional federal government services type business, which is currently approximately $80 million in annual revenues to our Company, as expected, continued to contract as compared to last year due to extremely heavy pricing competition, commoditization of this space, and in-sourcing by the government customers. We expect and have forecasted for this trend to continue for the foreseeable future.

I'll now turn the call over to Deanna.

Thank you, Eric. Good afternoon.

The first quarter's financial performance remained solid in what continued to be a very difficult, challenging, and changing Department of Defense, national security, and overall federal government budgetary environment.

Our revenues of $215 million were substantially as we had expected, which was to be at or slightly below our fourth quarter revenue levels. Our adjusted EBITDA of $24.4 million, or 11.3% of revenues, were impacted by a less favorable mix in revenues, which can be choppy at times, based upon the mix of products shipped in any given quarter, as well as due to the recent acquisition of the Critical Infrastructure business we closed at the beginning of the quarter, which Eric touched on earlier.

The recently acquired business was an asset acquisition we made to acquire the Critical Infrastructure business from a large multinational corporation, which continues to provide certain back office administrative and other support services, as well as providing facility lease space until we can integrate the business into our existing Public Safety and Security business.

The cost of these services provided by the seller were approximately $1 million during the first quarter, which negatively impacted the operating performance of our PSS business this quarter. As previously mentioned, we expect to transition and integrate a substantial portion of these services and facilities to our existing PSS business by the end of this quarter and in the third quarter, resulting in the reduction and elimination of certain duplicative costs.

As originally planned, we substantially completed our planned integration of back office administrative functions associated with the Integral Systems acquisition, with many of the support functions, such as accounting, payroll, treasury, and contracts administration being transitioned to our San Diego shared services organization.

Also as originally planned, we are continuing our analysis and evaluation of certain underperforming, non-core businesses within Integral Systems and expect to complete our assessment of these businesses in the second quarter.

Kratos' policy is to make investments only in business areas where we believe we will have a clear advantage and there are some small Integral Systems businesses that we are currently assessing. The financial performance of certain of these non-core underperforming businesses negatively impacted the overall performance of our Government Solutions segment operating margins during the first quarter.

In addition, as we have discussed in previous quarters, we anticipate that we will continue to make select investments in internally funded research and development efforts to expand select product offerings that we believe we will have an advantage, such as in our core Satellite Communications and Electronic Warfare/Electronic Attack businesses.

Today we reported [fourth] quarter revenues of $215 million and adjusted EBITDA of $24.4 million, up from first quarter 2011 revenues of $122.8 million and adjusted EBITDA of $12.6 million or 10.3% of revenues. Our adjusted EBITDA for 2012 excludes the impact of approximately $900,000 of acquisition-related expenses, and stock compensation expense of $1.1 million.

The increase in first quarter 2012 revenues reflects the aggregate contributions from the acquisitions dated 2011 of Herley Industries, Integral Systems, SecureInfo, and the Critical Infrastructure business acquired in 2012, all of which contributed a net aggregate increase of $114.3 million in revenues during the first quarter, which was offset by the impact of continued government in-sourcing, the final rolloff of an acquired small business at the end of the first quarter of 2011, the impact of increased weakness and/or competition in certain of our legacy services businesses, and the timing of product orders and shipments in our Ground Equipment business.

Our gross margins increased from 22.3% in the first quarter of 2011 to 26.9% in the first quarter of 2012, down slightly on a sequential basis from 27.1% in the fourth quarter of '11.

Our mix of revenues for the first quarter is 51% products and 49% services, representing an increase in products as a percentage of revenues from the first quarter of 2011's mix of 35% products and 65% services.

From an operating segment standpoint, our Government Solutions segment generated revenues of $174.4 million and operating income of $9 million in the first quarter of '12, up from $97.4 million and $6.6 million, respectively, compared to the same quarter last year. On an adjusted EBITDA basis, the Government Solutions segment increased from $10.7 million in the first quarter of '11, or 11% of revenues, to [22.3%] in the first quarter of 2012 or 12.8% of revenues.

Our Public Safety and Security business generated revenues of $40.6 million and $1.2 million of operating income in the first quarter of '12, up from revenues of $25.4 million and $1.2 million of operating income in the same quarter last year. On an adjusted EBITDA basis, the Public Safety segment increased from $1.9 million in the first quarter of '11, or 7.5% of revenues, to $2.1 million in the first quarter of 2012, or 5.2% of revenues.

The reductions in the adjusted EBITDA margins year over year were due primarily to the transition services agreement mentioned previously, which we expect will be winding down in Q2 and Q3, and other duplicative and excess costs from the acquired Critical Infrastructure business that are being eliminated or reduced as we integrate this business into Kratos.

On a GAAP basis, net loss for the first quarter was $3 million, which included the $900,000 of acquisition-related expenses, $10.5 million of expense related to amortization of intangible assets, as well as a $4.2 million income tax benefit or credit.

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, similar to what we experienced this quarter. We continue to believe it is meaningful to provide the average quarterly estimated cash tax payments of approximately $1.2 million for the first quarter and approximately $5 million for the year.

We continue to believe it is also meaningful to provide our earnings per share excluding the amortization expenses and acquisition-related expenses, and reflecting the cash pay income tax. On a pro forma basis, EPS from continuing operations, excluding amortization and merger expenses, and utilizing an expected average quarterly cash income tax provision of $1.2 million, was $0.09 per share for the quarter.

Moving to the balance sheet and liquidity, our balance sheet -- sorry, our cash balance was $74.8 million at March 25th, plus $700,000 in restricted cash. This cash balance reflects the payment of $20 million in January for the Critical Infrastructure business.

For the first quarter of 2012, we generated $29.5 million in cash from operating activities or $31.8 million in adjusted cash flow from operations, excluding the payment of the acquisition-related expenses of $2.3 million during the first quarter. After taking into consideration our capital expenditures of $2.7 million for the quarter, our adjusted free cash flow, excluding acquisition expenses paid during the quarter of $2.3 million, was $29.1 million, which is in line with our full-year expectation of $50 million to $65 million.

Our DSOs for the first quarter are at 110 days, which is above our target DSOs of approximately 90 days. As expected, our DSOs have been impacted by Integral's DSOs, which are higher than our typical DSOs, due, in part, to the mix of milestone-related payment billing terms and other related terms.

In addition, as expected, the recent acquisition of the Critical Infrastructure business, which has approximately $25 million of accounts receivable, has impacted our DSOs by approximately 5 days.

We believe that as these milestone-related contractual payment billing terms are met under the Integral contracts, and as we have now implemented our more rigorous billing processes and procedures, we also expect to be able to reduce the overall DSOs and receivables of the newly acquired Critical infrastructure business. In total, we view these excess receivables as an opportunity to generate additional operating cash flows as we achieve the contractual billing milestones and we implement our rigorous billing processes and procedures.

We currently have an undrawn revolving line of credit of $90 million, with approximately $13 million of letters of credit outstanding today. Our cash on hand today is approximately $63 million. Our total available liquidity today is approximately $140 million.

Debt under our outstanding notes at March 25th was $625 million, plus new issuance premium of $21.8 million. Total net debt, net of the $74.8 million unrestricted cash at March 25th, and the issuance premium of $21.8 million, was $557.9 million.

Our contract mix for the first quarter was 76% of revenues generated from fixed-price contracts, 15% from cost-plus fixed-fee contracts, and 9% from time and material contracts.

Revenues generated from contracts with the federal government were approximately 67%, including revenues generated from contracts with the DoD of 62% and revenues generated from contracts with non-DoD federal government agencies of 5%. We also generated 4% of our revenues from our state and local governments, 22% from commercial customers, and 7% from foreign customers.

Backlog at quarter end was $1.1 billion with $494 million funded.

Moving on to the guidance for 2012, consistent with prior years we provide annual guidance and not quarterly guidance due to the choppiness on a quarter-over-quarter basis consistent with the heavy product mix.

We are reaffirming our previous estimated fiscal 2012 revenues to be $950 million to $1 billion and adjusted EBITDA of $120 million to $130 million. As previously discussed we expect amortization expense to be approximately $36 million for 2012, with $9 million in Q2 and Q3, and approximately $7.5 million in Q4.

We are also reaffirming our previous estimated pro forma EPS for 2012, excluding amortization, acquisition expenses, and using an estimated cash pay tax provision of $5 million, estimated $0.95 to $1.25. Using a full statutory 40% tax rate, excluding the amortization and acquisition expenses, we estimate pro forma EPS to be in the range of $0.68 to $0.88.

In addition, we continue to expect to generate free cash flows, excluding acquisition-related items, after interest payments and capital expenditures, of $50 million to $65 million a year. This is derived by the $120 million to $130 million of adjusted EBITDA less annual cash interest payments of approximately $62.5 million, annual capital expenditures of $10 million to $14 million, and annual cash tax payments of approximately $5 million, and a working capital source from the reduction of DSOs previously discussed of approximately $8 million to $16.5 million, which reflects an approximate reduction of 3 days to 7 days.

As a reminder, our semi-annual interest payments of approximately $31 million on the senior notes are paid in June and December. Therefore, we expect our free cash flow for the first quarters and third quarters to be the stronger cash generation quarters as the interest expenses is accrued in those quarters and not paid until the second and fourth quarters of the year.

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

Thank you, Deanna. Three years ago, Kratos made the strategic decision to stop investing in or pursuing the non-differentiated government contracting services or support marketplace and we believe that what is happening in the market right now is validating that decision.

In this Government Services area, the government customer is making procurement decisions based on the lowest cost technically acceptable criteria time and time again, which is basically commoditizing the space. This is being exacerbated by the government's increasing use in this area of multiple award and IDIQ contracts, which is further driving down cost points and accelerating this commoditization.

And the government is also actively looking for ways to significantly reduce overall contract services support spending and use competition and contracting terms, like MACs and IDIQs, to further reduce margins and eliminate non-essential tasks. This environment has caused companies competing in this space to protest contract awards as a normal course of business, which further delays the commencement of contracted work, and makes planning and forecasting virtually impossible.

Related to this, just this week it was disclosed that 11 companies have now protested one of the Air Force's largest IT contracts, NETCENTS, and the Air Force is now rethinking its entire award decision.

Strategically, we believe that the business plan that we made the decision to pursue three years ago, the area of specialized and differentiated products, is an important differentiator for Kratos in this current environment.

Our strategy -- identify mission-critical national security priority areas, Electronic and Cyber Warfare, Electronic Attack, Missile Defense and Targets, Adversary Threat Representation, and Satellite Communications. Be designed in to these mission-critical national security areas with proven, deployed products, software, systems like Kratos' ARAV, our NeuralStar, our CyberC4 product suite, specialized electronic products, SATCOM products, Unmanned Systems products, and products where there is limited competition. And make rifle shot investments in these areas to enhance the capabilities of your proven, existing, and proprietary products and be one of the very best providers in these targeted areas.

Some of the other targeted areas where we are currently investing and we see growth opportunities include digital radio frequency memory or DRFM, where Kratos currently produces products and are involved with certain EW, EA, and other platforms, programs, and equipment, which we will not publicly disclose here, primarily for competitive and specific customer-related reasons. Patriot, where the opportunity activity for Kratos has been significantly increasing, including, most recently, due to the possible end of the Medium Extended Air Defense or MEADS missile system. The next generation jammer, where the Navy just recently issued the request for information, and though this is a longer-term capture opportunity, we believe that Kratos is extremely well positioned from a technology, customer relationship, platform familiarity, and past performance qualification standpoint. And SEWIP, the next generation surface electronic warfare program, which has been picking up speed and momentum in a number of areas for Kratos.

Coming off our first quarter results, we have reaffirmed our 2012 guidance and we are focused on achieving operational excellence and achieving our financial forecasts, continuing to generate significant free cash flow, and delevering and de-risking the Company's balance sheet.

Though due to the current industry dynamics order flow and award timing is not always going to turn out exactly as planned or expected, what we do believe is important is the overall momentum and trajectory of the business, which for Kratos is very good, and our bookings thus far into the second quarter have remained solid.

Related to this, as I mentioned earlier, we have just recently received a very strategic contract award in our Critical Infrastructure Security business with a $20 billion-plus multinational enterprise we will be formally announcing next week.

Additionally, we have now received customer approval for a formal press release on another very strategic -- for Kratos -- Unmanned Systems program, which we are also currently planning on formally announcing next week. And on this one, I could not be prouder of the entire Kratos team in receiving this award.

And finally, we were just recently informed that a customer in the BMD area has exercised a very large option for Kratos products and services, which we also expect to formally announce next week or the following week.

With that, we'll now turn the call over to the moderator for questions.

(Operator Instructions). Our first question comes from Mike Crawford of B. Riley & Company. Your line is now opened.

Thanks very much. Eric, there's a lot to go over. We'll just start with one. You said you want to invest further in Unmanned Systems. Can you talk about the opportunity with unmanned combat systems and what Kratos brings to the table there?

Sure. We -- currently we manufacture avionics and electronics that go in certain aircraft and we also manufacture electronics in the ground control stations for certain unmanned systems or unmanned drones.

We have outstanding visibility into this marketplace because of our electronic product suite and our existing customers and this is an area especially related to area access, area denial, that is going to be well funded and we are positioned with the right customers, the right products, and the right technology. And so it's an area we -- we're involved with.

Okay, thank you. Also, you talked about evaluating some underperforming businesses with Integral Systems, which I believe you may think has been, perhaps, your most successful acquisition. So, I guess, one, is that -- the second half of that assumption, is that correct? How would you assess Integral Systems overall? And then, two, what is the likely outcome here with the salvage? Is there some kind of value to be extracted or is it more just a shutdown situation with the parts that were talking about?

Sure. So, Integral Systems has turned out just to be outstanding, an outstanding acquisition for our Company. And it is just killing it. And I went through a number of the programs we're allowed to talk about where we -- where we are seeing significant growth areas.

Approximately 90% or 95% of that company's business has to do with strategic satellite communication operations. So, 90%, 95% of that revenue has to do with the software that command and controls the space assets, the people that are working with the customers that are command and controlling those space assets, products and software that do communications conversion from satellites to terrestrial communications, cyber-related work on the geo location of RF interference and potential cyber threats to the fleet. So, that is 90% or 95% of the business.

Another small percent of the business was related to flyaway VSAT terminals, for example, or little antenna systems, for example, and there's nothing wrong with these businesses, but we're not big enough and we don't have the resources to be the best at everything.

And so, in the 90% or 95% where Integral Systems' software and products command and control 85% or 90% of the space segment, that's where we're going to stay focused and on the other small areas we're assessing if we should make a run at it, if maybe we should go to someone else who's primarily focused in that area and see if they'd be interested in it. We're just making an assessment there.

Okay, thank you. And then final question, about operations on this ATREX test that NASA conducted using your rockets. If you go to the NASA site, they talk about using not only the Oriole, but also Terrier-Orion and Terrier-Improved Malemutes, which are old, I believe, Kratos rockets an earlier acquisition, DTI, but is -- are those rockets relevant to what you're doing now or is that just getting into the area of too much detail?

Those rockets are absolutely relevant to what we're doing now. Part of that test had to do with plume analysis if there were certain events that happened where those rockets were launched and it is an area that is extremely well funded and there are, like, one or two additional players, other than Kratos, so it's very limited competition and we have the, we believe, the lowest cost solution that meets the customer's requirements.

Okay. Thank you very much.

You're welcome.

Thank you. Our next question comes from Michael Ciarmoli of KeyBanc Capital Markets. Your line is now opened.

Hey, good afternoon, guys. Thanks for taking my questions.

Hi, Michael.

How are you, Eric? I guess maybe if we could just start on the revenue line, what's sort of the -- have your assumptions changed about the organic growth rate at all for the business as you look out for the remainder of the year? I mean, it seems organic growth was a little light in Q1 and I know -- I think you talked about it on the last quarter, but have you kind of changed your outlook there?

No, it's -- if you go back and look at what we said at the last call, we -- it came, as I said in my prepared remarks, pretty much as expected. If you take a look at the businesses that we're in, primarily the products businesses you're in, for what I believe is government year-end reasons of September 30, being the government fiscal year end, Q3 and Q4, historically, has been the strongest, especially with very quick procurement and purchase decisions by the government.

I think it has to do with their nearing -- in calendar 2, 3, they're nearing 9/30. They want to either spend or obligate their funds, which then will go into Q4 to make sure that they don't lose it and that has caused upticks in the past in those areas and we're seeing that lining up right now again.

In addition to that, we have pretty good visibility on a number of programs that we're currently building that we are going to be delivering in Q3 and Q4 and those are in house. And those -- the assumption is that really hasn't changed too much. It's pretty much on track. I'm hoping that it'll stay on track at least through Q3 and then we'll see what happens with the election and maybe a 2013 CRE.

Yes, that's a good segue. I mean, what's been contemplated in the guidance as you look out later in the year? It sounds like you're expecting things to ramp, but you've probably got a continuing resolution, a debt ceiling, sequestration. I mean, it's -- I mean, I'm just trying to get a sense of bracketing the risk, how you guys kind of formulated the guidance there. I mean, obviously, there's unknowns.

Well said. Yes, all of the above. Well said.

So, here's how we've been looking at that risk. Our Critical Infrastructure business is about 20% of our Company right now and this is our hedge. Other defense contractors are going into health IT, they're going into renewable energy. They're going into stuff like that that's non-DoD funded. We made a decision to stay with security and we've gone into the Critical Infrastructure business.

And, as I said in my remarks, virtually none of the revenue there is -- none of the customers there is Department of Defense-related. The book-to-bill ratio in Q1 was 1.3. The backlog is at a record high. There are very, very few players in this space, especially players that have the critical infrastructure, the size that we have, that can do a national deployment of a uniform and ubiquitous security system across an agency or an entity, an enterprise, a commercial enterprise, that has locations across the country.

So, now, with that as a backdrop to answer your question, we are -- in our assumptions, we're assuming that things are going to flatten out in Q4 on the DoD side, but our Critical Infrastructure business is going to remain strong and that's what we're seeing right now.

So, that's what we've -- that's what we've hedged for this year. As far as sequestration, which is supposed to kick in, in January of '13, we are doing all the prudent things right now that we can do to control things. We are consolidating -- we're not talking about this much. We're consolidating facilities where we have leases running off across the country. We are buddying up facilities.

We are significantly reducing the G&A infrastructure in the Company. Deanna talked about that relative to the PSS business. We're doing it elsewhere in the Company and battening down the hatches is probably too strong of a word, but we're tightening things up in anticipation of sequestration, because that's what we can control and if that were to happen, then we're just going to have to make an assessment of okay, here it is, what programs did it hit, how did it impact us, and then we can make business development or customer or revenue decisions from there.

Okay. Okay, perfect. And then, just the last one I had and then I'll jump off here. Still expecting the gradual quarterly ramp?

Yes.

I mean, looking at the Public Safety and Security operating margins, do they gradually ramp or do we sort of see a step function jump in Q2 maybe back up towards those Q3, Q4 '11 levels of 11%.

Michael, it's Deanna. I would say they gradually ramp in Q2 and then a step function thereafter as we complete those integration efforts.

Okay, perfect. Thanks a lot, guys.

Yes and, Michael, in the first part of your question, we do -- right now we see sequential organic revenue growth from Q1 to Q2 and then that accelerating into Q3 and into Q4.

Perfect. All right, great. Thanks, guys.

Okey-doke.

Thank you. Our next question comes from Tyler Hojo of Sidoti. Your line is now opened.

Yes, hi. Good evening, everyone.

Just, maybe, to follow on to Mike's question, thanks for all the detail in the prepared remarks, but I guess what I'm trying to get my hands around is we're talking about all these positives for the business and one segment of the business flat to down and the other down significantly, but we look at total organic growth and we were down something like 18% this quarter.

So, I'm just trying to understand that a little bit better.

Sure.

Could you maybe --

The biggest part of that and this is something we've talked about for the last couple of years, the last small business contract that we acquired, we made an acquisition in June of 2007 -- excuse me, June of 2008, Digital Fusion, DFI. It was a -- when you looked at it on the surface, it was a run rate $70 million or so business, but the purchase price we paid assumed a $30 million dropoff in business because they had significant small business including one very large contract with NASA down in Florida.

That NASA contract went away this time last year. We did not -- we don't have it any more. And so that contract has fallen away. That is -- that is the primary driver and then in addition to that, secondarily to that, all through last year and we talked about this pretty routinely on the calls last year, we were working from a liquidity standpoint to drive out as much of the pass-through revenue as we could in the Company where we'd get a 1% or 2% M&S, material and subcontracting, fee on it, but a DSO would be 90 days and that didn't do -- that didn't make any sense.

So, we had quite a bit of that in the first half of last year and then that really went away in the second half and that's the second piece.

Okay. Just for clarification here, in regards to the NASA contract with Digital Fusion, was that the delta, was that a $40 million contract on an annualized basis?

No, but it was a -- on -- it was a pretty --

On an annual basis, it was approximately $20 million.

Yes. It was $20 million-ish.

Okay, great. Thanks for that color.

And then, the other question I had, just in the press release you talked about some customer milestones in the back half of the year that needed to hit in order to make the free cash flow guide -- or, at least, that's how I read it. Could you maybe expand upon that a bit?

Sure. So, when we acquired Integral Systems and then we'll talk about the Critical Infrastructure business, we were very fortunate on Integral Systems and one of the reasons we were very fortunate had to do with timing of milestone collections on certain of their very large contracts. And we acquired that business at the cycle point where they were -- they had built up a significant amount of receivables that could not be billed and collected until this year, when we owned them.

And so, these are normal scheduled timing. When you hit the milestone, you can bill for a significant amount of work that's been done previously and that's that piece.

The second piece has to do with that Critical Infrastructure business that we acquired. As Deanna mentioned, the receivables on that business -- and I think when we acquired that business, we talked it was going to be like a $40 million revenue business or something like that. The receivables were like $25 million.

The strategic that owned that company was Gigantor and they didn't focus on these receivables. Okay? We -- a big part of them were in unbilled and a big part of them were in billed. The billed ones we've shipped out and we collected a big part of that in Q1. We're going to get more in Q2.

The unbilleds we've gone through, put all the billings together, shipped out all the invoices. Those are now starting to come in. And so, this is where we took advantage of a working capital aberration where we are collecting it.

Okay, great. And just in regards to the customer milestones, how much cash inflow are you expecting from those? Just ballpark?

The customer milestones are north of $5 million to $7 million that we're expecting on those.

Okay. All right, great.

And just last one for me. Again on free cash flow, you had the $2.3 million adjustment for the calculation you provided in the press release. Are there any other acquisition-related items in that adjusted free cash flow guidance?

The free cash flow guidance assumes the exclusion of any type of acquisition-related expenses, so the bulk of those have already been paid, thus far, of what we have estimated.

Okay, great. Thanks a lot.

You're welcome.

Thanks.

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

Good afternoon, Eric, Deanna. To go back once more at sort of the free cash flow guidance versus the opportunity in accounts receivable. It's my understanding that the $50 million to $65 million that you're talking about in free cash flow guidance for the year is what you expect to be left out of the EBITDA of $120 million to $130 million after paying debt -- or, excuse me, interest payments and taxes.

And that, if you look at the $250 million in accounts receivable at 110 day DSOs, over time, be it even possibly greater than a year timeframe, getting that to 90 would allow you to free up a further $47 million.

So, those are two discrete, separate forms of cash, one from operations, the other one from working down DSOs. Are those correct statements?

That's correct. So, Mark, if you go through the detail of what I went through, so assuming the guidance of $120 million to $130 million of EBITDA and walking through the interest -- cash interest payments of $62.5 million and $10 million to $14 million of CapEx and cash tax payments of $5 million, so on the low end of the guidance, that equates to $42.5 million of free cash flow, before any reduction of DSO or any type of cash source from working capital.

So, on the low end of the range of the $50 million, that assumes $7.5 million of working capital source or reductions of receivables, which equates to 3 days on our DSO of 110. And then on the high end of the range, the $130 million of EBITDA is taking those same amounts for interest and taxes. That assumes $16.5 million of reduction in receivables or flow from working capital, which is equivalent to a 7 days reduction of our DSOs.

Okay. And then the longer term opportunity would be going to 90 days, which would be $47 million.

That's correct.

That's probably a multi-year event. And that's probably a multi-year event?

Yes, that is correct.

Okay. Secondly, Eric, there are some interesting releases relative to the [Oracle] rocket shoot. One that I found intriguing was the one where you were proving out the new guidance system and flight termination capabilities.

Is that critical from the standpoint that it dramatically expands the addressable market for the Oriole, allowing you to do targeting testing over land and, therefore, being more competitive against some of the higher-priced Lockheed and other folks who have dominated that space in the past through the Air Force?

Yes, Mark, that's exactly right. The previous -- the current or existing targets were primarily related for Aegis-type systems and ship-based systems.

Some of the threat profiles that our customers came to us and asked us to address, which is one of the reasons we felt comfortable going on this internally funded endeavor, had to do with ballistic missile threats being fired over land.

And because of that, we designed and have now fired this new system, which has a different type of control system on it and it has a certain type of a self-destruct system, so it can be used for land-based or city-based attacks.

And would this, conceivably, expand the potential Oriole market by a factor of 2 or 3?

By more than that. This is very significant. This is -- this has opened up. It's not "going to." As I mentioned, we've received orders already. This has opened up a number of new markets for us and this -- if you're designed in, this lowest-cost, technically acceptable thesis isn't all that bad. Because if you've got the lowest-cost system that hits all the technical requirements of the representative threat that your customer wants you to represent, in today's environment, you will win the work, because the money is not there.

If your target is $5 million and your competitor's is $50 million, it's -- the amount of politics that'll guide the customer to the $50 million is over and now they want to do 10 shots instead of 1.

And modeling and simulation is wonderful on the computers, but it has been proven time and time again, including very recently, that it doesn't take life-cycle test shots of targets into consideration and we've seen some failures as a result of that.

And so the military wants to execute more and more live-fire tests, not just in this area, but in other target areas, as well. The targets are right now, in our opinion, is white hot and it is going to remain that way, especially because of the threat profiles coming out of China and Russia and -- including fifth generation threats.

Yes. When you throw out the $5 million shot cost, what would be the net realization for you? I thought that the old Oriole was about a $0.5 million billing and where would you be with the enhanced version?

Right and so there are -- the old Oriole there were three variants, an A, B, and a C. And on the A, what you just said is approximately correct. For competitive reasons, we won't get into on the B and the C, which are the ones that we are launching more and more of now. Those are higher than the A.

Okay. A final question for Deanna, relative to SG&A, because you have the -- still are in a consolidation mode and you've got the transitional support contract for the critical -- for the acquisition this year, should we look at the $33 million SG&A as a high-water mark for the year and expect a step down in the second half? And where might that go?

Yes, Mark, the -- we have two things going on. So, there will be a step down on a steady-state basis with the current revenue that we have, but there are some increases to that SG&A related to revenue where we have some commissions built in, with some of -- especially on our PSS business.

So, there -- I would say that they will be at about the level that we're at today with, potentially, some slight increase as a function as revenue increases for certain areas.

Okay. Thank you very much.

You're welcome.

Great. Thanks.

Thank you. Our next question comes from Josephine Millward of The Benchmark Company. Your line is now opened.

Hi, Deanna.

Hi, Josephine.

So, Eric, in your prepared comments, you talked about Rocket Support Services, BMD, Aegis related business as one of our fastest-growing areas. Can you help us quantify the annual run rate of this -- of your missile defense business? And how fast do you think this business can grow in the coming years?

Okay. So, our total missile defense business, which includes Aegis and tactical missile systems, so, for example, the $24 million award we just announced recently, that total business annually is probably somewhere $50 million to $75 million annually.

And that business, probably combined, can grow over 10%. It's growing, combined, over 10% annually.

Great. Can you give us an update on the ballistic missile defense opportunity for short and medium-range targets? I believe there might be a solicitation out there.

Yes, there is a solicitation out there. A lot of solicitations that are out there in this area right now have to do with maintaining the defense industrial base and it has to do with maintaining the solid rocket capability remaining in this country.

And there are two solid rocket motor providers left. There's Aerojet and there's ATK. And there is a concern and it's probably a valid concern that there may not be enough business for there to be two healthy competitors in this space.

And so there is a solicitation out there for some very large medium-range, MRBM, medium-range ballistic missile, targets. That is not an area, those size targets, where we currently play.

We currently play in what are called sub-scale targets that put off a threat profile that is representative of a full-scale threat, which is one of the reasons why it's lower cost. Okay?

Okay. So, you don't view this medium-range target as an opportunity for Kratos, then?

We do not.

Okay.

What we view as our opportunity in this area is declining budgets, okay, is limiting the amount of funds that agencies can spend to practice and do practice shots. And so, the lower the cost point you have in this area, the more practice shots they can do and with the proliferation of what's going on in missiles in the world, they want to do more and more practice shots.

That is what is driving this and now, with this new variant that we have, it is opening up new markets, hypothetically like Aegis Ashore or Patriot or THAAD and, potentially even, GMD.

Okay. Also, shifting gears the Critical Infrastructure award you plan to announce in the coming weeks, is that one of the two major opportunities that you talked about on the last call?

It's not. This is one that Ben Goodwin and his team pulled off and it's just fantastic. So, this is a third one. It's not one of those two.

So, this is in addition to the other two. Can you give us an update on the other two?

They're in the procurement process as we speak.

Great. Thank you, Eric.

You're welcome.

Thank you. Our next question comes from David Sagalov of Jefferies. Your line is now opened.

Hi. Thanks for taking the question. I'm just wondering, can you comment quickly on the S&P downgrade, one notch downgrade?

Well, my comment is that we have a significant amount of cash on the balance sheet and they don't net off debt against cash. So, if we build our cash balance as we generate $50 million or $60 million of free cash flow a year and we build our cash balance, it doesn't -- it won't favorably impact the credit. That's what they said.

Right.

That's my takeaway.

Yes, they were actually very clear that the cash on the balance sheet is really not taken into consideration and, as you're well aware, on our senior notes there is no call on that, so the cash that we've accumulated on the balance sheet we get on credit for, but we can't pay the notes down. So, we're kind of in a box from a rating perspective.

The other issue that they were concerned about is just the potential budgetary concerns with sequestration. So, that's -- those were the two things they outlined for us.

It was an interesting note and I'm sure you read the whole thing. It said as a company they think we're better positioned than most in this space. They said our -- they had done -- clearly, when we spoke to them, they had done their work. They knew our programs. They said your programs are extremely well positioned. We think you're better positioned than most, however, you haven't spent your cash and bought more EBITDA and we don't net the cash off and so down goes the rating.

Yes, we were certainly a little surprised by it. It was -- it seemed like a pretty positive note and they still downgraded. So --

Exactly.

It seemed like they were just kind of dinging you guys for -- basically, they seemed like it was just a small size issue relative to the leverage.

Yes.

Yes, sir.

And then, just lastly, can you just quickly talk about, I guess, then the use of cash? I know you've talked about before and we know the notes are trading pretty well, I think, around 108. So, what is the intention for use of cash? Is it just to continue to build and just lower -- is the net leverage target still around 4 times for end of year?

Our -- absolutely, our plan, operationally, is continue to generate the plan, generate the cash, net down the debt. That is the tactical operational plan right now. And, as I've said before, if something happens where there's a dislocation in the market, in the debt market, where the bonds come off their 108 and they drop precipitously and there's an opportunity for us to buy a bunch of them back on the open market, we would absolutely consider doing that, because that would, obviously, mathematically make smart corporate finance sense.

Great. Thank you very much, guys.

You're welcome.

Thanks.

Thank you. Our next question comes from Yair Reiner of Oppenheimer & Company. Your line is now opened.

Yes, thank you. Just a couple of questions for me. On the Public Safety side, you mentioned earlier, we talked about the fact that the margins went down. Even if I net out the $1 million in TSA, it looks like core profitability has come down. Is -- the business that you acquired earlier this year, is it profitable or how long does it take you to get that to turn profitable?

Right. The costs that are coming out of that business are in addition to the TSA. So, that TSA number was just one piece.

So, for example, there are facility costs that are coming out. There are other types of back office costs that the TSA doesn't cover. There are installations costs where there's duplication across the Company where you're on jobs in both our business and the acquired business and you -- what you don't want to do is upset a customer, so you want to run out those jobs before you make some right-sizing decisions on directs, if you know what I mean.

And so, it's not just the TSA costs. That business, we believe, will absolutely, unequivocally, in the second half of this year be as profitable as our core PSS business prior to acquiring it. It's the same type of work, same type of customers, same type of service and maintenance agreements that are extremely profitable. Same customers. It's the same stuff.

So, as you look across your businesses and you've identified these places to remove costs, what are we looking at in terms of a quarterly run rate of cost savings, exclusive of that $1 million in TSA? How much is there to kind of strip out?

Yes, so the way -- so, we kind of look at it a little differently. Our Critical Infrastructure Services business, historically, has made somewhere around a 12% or a 15% EBITDA margin. That's what it's been able to do. It's historically done gross margins of 29% to 31% or 32%, something like that, historically. Okay?

We believe combined, the combined business, because it's not -- it's combining now. It's -- as I said, locations are combining, vehicles are combining, so it's all combining. The combined business in the second half of this year will achieve those high 20s, low 30, gross margins and it'll achieve those low-teen EBITDA margins.

Okay, great. And then just one other question on the expense side. You had said, I think, in the last call that you expected R&D investment to go up during the year. It was actually flat in the first quarter. You've wound up some R&D that you spoke about earlier. What should we think about that kind of going forward through the year? Are we still looking at something around in $20 million in R&D investment or should we be thinking about a number that's lower than that?

Yes, Yair, that's about right for the full year expectation for R&D. We do expect there to be a slight ramp from where we were at in the first quarter.

Thank you.

Thank you.

Thank you. Our next question comes from Jonathan Richton of Imperial Capital. Your line is now opened.

Good afternoon.

Good afternoon.

I wanted to touch on more of a, I guess, 10,000-foot question, maybe. Over the years, you guys have spoken about how you strategically placed yourselves around kind of the BRAC realignment. And now that there's talk about possibly going through another BRAC process, how are you guys viewing the opportunities going forward?

That's an interesting question. You're exactly right. So, when we laid out the strategy, we built our Company where we believed that the BRAC would be consolidated into.

So, what we see happening now, San Diego, it looks like, is going to be a huge BRAC recipient, huge. The number -- we're already the largest concentration of warships in the world. It's going to be -- I've read it's going to be going up by 25% or 30% because of the pivot, this administration's pivot to the Pacific Rim.

We are -- obviously, we're headquartered here. We have a huge presence here. We are extremely well positioned for that BRAC move.

As you know, we have a significant presence in Huntsville, Alabama. Huntsville, Alabama, is where the Missile Defense Agency is now headquartered. Future BRAC moves are planning on BRAC'ing commands into Huntsville. So, we're extremely well positioned there.

So, we believe, if this next round comes, we are not at any of the bases or commands in any material way that are looking to be BRAC'ed and moved. We're actually in a couple three of the potential recipient locations.

Okay, great. Thanks. And then, just looking at some of the contract announcements over the past couple of months with DSP and I think one is SAIC. I guess, can you give us a little more color on what Kratos' participation will be and kind of what your expectations were in terms of benefit?

Right. So, those are both -- those are new awards. And if you look at a common thread in these awards, most of them are with SPAWAR and most of them are communications systems slanted and, in particular, seaborne communications and undersea communications.

And that is an area -- we have a very strong presence here in San Diego at SPAWAR and in the East Coast at SPAWAR and this ties into our milsat com thesis. It ties into one of the reasons, one of the synergies we saw with Integral Systems. And it's an opportunity area for us. It's not like some of the other -- that $80 million piece of business that we have that is just shrinking right now right in front of us where it's the upgrade or the consolidation of the legacy IT systems at commands. That is program management. That is not doing well, where that other one is doing well.

Okay, great. Thank you very much.

Okay.

Thank you. Our next question comes from Bhakti Pavani of C.K. Cooper & Company. Your line is now opened.

Hi, Eric. Hi, Deanna.

Good morning.

Hello.

Yes, good morning.

Good afternoon.

The question -- I just wanted to talk about your previous comment that you mentioned that you are focusing on gathering more cash and reducing the debt. Would it be fair to assume that there are no more acquisitions lined up over the year?

Yes. It's -- I will tell you this. We have not been actively pursuing acquisitions. When I say that, we are not -- we don't have a list and we're saying, we're going to go acquire this company or that company or this capability or that capability.

We are absolutely, unequivocally, not in that mode. No way.

Okay, however, if an opportunity -- let's use the Critical Infrastructure business that happened at the end of calendar Q4, the end of calendar '11. If an opportunity comes to us where it's a business that's exactly what we're doing and extremely favorable purchase price, okay, that either, one, like that business had an incredible balance sheet that we can get the benefits of, which we're doing right now, or, two, it's in a real growth area, a real growth area. I mean, there are like three real growth areas left right now, real ones. I mean, there's a lot of baloney out there, but there are like three real ones.

If it's in one of those three real areas where there's extremely limited competition, et cetera, you bet your boots we're going to look at it. Absolutely. Bet your boots.

But I will tell you, literally, there are dozens and dozens and dozens of assets that are for sale today. And 99% of them are crap.

Okay. And just -- hello?

Hello.

Yes, just talking about the SATCOM business, that seems to be growing at a pretty attractive rate, so if you would want to quantify it like in terms of numbers, then how much that business contributes to your entire business?

So, the pure SATCOM business right now is somewhere between $175 million and $200 million in revenue.

Okay.

And it is growing at approximately 10%.

Okay. Just, I think, based on the recent news that came out, I think, a couple of weeks ago regarding the US House lawmakers adding $1.1 billion to the Air Force and they are planning to increase investment in some of the programs that Kratos is already built in. What are you seeing? I mean, are you seeing any business coming through or any follow-on contracts on that? Or it's just the news?

That right there was, to us, as of right now was just news.

Okay.

And we haven't seen anything there, but if the F-15 upgrade happens, that would be very -- in the electronics area, that would be very significant for us.

Right.

If they're talking about an F-16 electronics upgrade, that would be extremely significant for us. And -- but nothing yet and if there are additional orders place for F/A-18 because of what's going on with F-35, obviously that would be huge for us. But nothing from that news yet, no.

Okay. Fair enough. That's it from my side. Thank you.

Thank you.

Thank you. Our next question comes from [Anya Wacht] from [Sykes]. Your line is now opened.

Hi, this is Anya Wacht from Sykes. Can you tell me what the pro forma LTM EBITDA was?

I don't -- when I don't know something off the top of my head, I'll tell you. I don't know that one. Hold on one sec.

Anya, this is Deanna. It's about 126 to 127.

Sounds great. And then, do you remember what it was for the full year last year? For some reason I can't find it in my notes. Sorry about that.

Yes. For last year it was roughly about 130.

Sounds great. And then, on the Public Security segment, you spent a lot of time on the margins. They were obviously down. How much of that was the whole TSA, the double cost and all that, and how different is it from your prior acquisitions? I do not seem to recall this being such a big issue in terms of margins.

Right. So, we made one prior acquisition in this area before and that was Henry Brothers, which we acquired at the end of 2010. That was a stand-alone company. So, it had its own discrete systems. It had its own discrete benefit plans. It had its own discrete facilities. The people had their own discrete IT, et cetera, et cetera.

Got you.

Okay? This business you bought and if you go look at the filings you can see the name of the company that owned it. We're under -- the reason why we call it the Critical Infrastructure business is even though it's been -- it's out there, we're under an NDA on it. This was part of a company.

Oh, I see. Okay, I see what -- Okay.

Okay? So, it's still in some of this company's facilities and we are paying a lot of money until we can move out. It is still using this company's IT infrastructure. We are paying a lot of money people a TSA until we can transition to ours.

And so we've started that transition program. As we said, we think it will be done by the end of Q2, no later than early Q3, and it's a lot of money. And we knew this when we acquired it. It's easy to buy a company, the hard part is integrating it and we just didn't want to rip everything out and impact the business.

Yes. So, would you say that most of that margin decline was due to that duplicate cost or is there something within the product mix? Kind of on an --

No. Primarily due to that acquisition and now the integration and the elimination of the cost element.

I see. Okay. So, then, looking at that 126 or so pro forma EBITDA and looking at your guidance, so the business is going to be essentially flat in terms of EBITDA. Would you say that, in terms of R&D costs for this year, you were guiding $20 million or so, that's -- if we look beyond 2012, is that kind of a run rate and we should expect this a bigger part of the business?

At the -- you're exactly right. So, at the end of our third quarter last year, in '11, we came out and we detailed on the call and we identified certain programs where we were going to be making a greater-than-normal internally funded research and development spend this year.

Yes.

That is the primary reason the EBITDA dollars are staying kind of sort of flat, because we are really upping that this year in certain areas, some of which I talked about today where we already have the customer relationship, we're on the platform, and we need to build the next best thing for the technology refresh. Okay?

So, as of right now -- this can change -- but as of right now, this year's R&D spend is currently planned to be stronger than, say, '13's because of the refresh.

Got you.

You know what I'm saying? Because of the refresh. So as of right now, based on the opportunities that we see and we're trying to be a rifle. We're not a huge company. $20 million in R&D spend is a big number for us, but we believe, like the Aegis Readiness Assessment Vehicle where we were just successful on that internal effort, we've got a handful of other ones that if we're successful it can really further us going forward and, as you know, that's the differentiator of us right now is being in a niche, being on a platform, and exploiting it.

Okay. Sounds good. That's all I had. Thank you so much.

Okey-doke.

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

I'm sorry. I had a follow up, but it was asked. I thought I'd withdrawn.

Thank you, sir.

Thanks, Mark.

Thank you. At this time I'm not showing any further questions. I'd like to turn the call back to Mr. DeMarco for any further remarks.

Very good. Thank you for joining us this afternoon or this evening and we'll be circling up again with you during the end of Q2. Thank you.

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