Description
Filed with the SEC from Dec 01 to Dec 07:
Kratos Defense & Security (KTOS)
Hedge fund MMI Investments reduced its stake to 399,400 shares (1.2%) with its sale of 2,965,400 from Nov. 14 through Dec. 1 at prices that ranged from $4.99 to $5.49.
BUSINESS OVERVIEW
Overview
We are a specialized national security business providing mission critical products, services and solutions for United States national security priorities. Our core capabilities are sophisticated engineering, manufacturing and system integration offerings for national security platforms and programs. Our principal services are related to, but are not limited to, Command, Control, Communications, Computing, Combat Systems, Intelligence, Surveillance and Reconnaissance ("C5ISR"); related cybersecurity; cyberwarfare; information assurance and situational awareness solutions; weapons systems lifecycle support and sustainment; military weapon range operations and technical services; missile, rocket and weapons system testing and evaluation; missile and rocket mission launch services, primarily for Ballistic Missile Defense; public safety, critical infrastructure security and surveillance systems; modeling and simulation; unmanned aerial vehicle systems ("UAVs"); and advanced network engineering and information technology services. We offer our customers products, solutions, services and expertise to support their mission-critical needs by leveraging our skills across our core offering areas.
Our primary end customers are United States Federal Government agencies, including the Department of Defense ("DoD"), classified agencies, intelligence agencies, other National Security agencies and Homeland Security related agencies. We believe our stable client base, strong client relationships, broad array of contract vehicles, considerable employee base possessing national security clearances, extensive list of past performance qualifications, and significant management and operational capabilities position us for continued growth.
We provide products, solutions and services for a wide range of established, deployed and operating national security platforms, including, but not limited to: Aegis Ballistic Missile Defense systems, M1 Abrams tanks, Bradley fighting vehicles, F-5 Tiger, HiMARS, Chaparral and Hawk missile systems, Kiowa AH-60 helicopters, DDG-1000 Zumwalt destroyers, attack and missile submarines, certain intelligence surveillance and reconnaissance systems and various unmanned systems.
Prior to 2008, we were also an independent provider of outsourced engineering and network deployment services, security systems engineering and integration services and other technical services for the wireless communications industry, the U.S. Government and enterprise customers. In 2006 and 2007, we undertook a transformation strategy whereby we divested our commercial wireless-related businesses and chose to pursue business with the federal government, primarily the DoD, through strategic acquisitions. On September 12, 2007, we changed our name from Wireless Facilities, Inc. to Kratos Defense & Security Solutions, Inc. Our new name reflects our revised focus as a defense contractor and security systems integrator for the federal government and for state and local agencies. In connection with our name change, we changed our NASDAQ Global Select Market trading symbol to "KTOS".
We were incorporated in the state of New York on December 19, 1994 and began operations in March 1995. We reincorporated in the state of Delaware in 1998.
Current Reporting Segments
We operate in two principal business segments: Kratos Government Solutions and Public Safety and Security. We organize our business segments based on the nature of the services offered. Transactions between segments are generally negotiated and accounted for under terms and conditions similar to other government and commercial contracts and these intercompany transactions are eliminated in consolidation. The financial statements in this Annual Report are presented in a manner consistent with our operating structure. For additional information regarding our operating segments, see Note 14 of the Notes to the Consolidated Financial Statements. From a customer and solutions perspective, we view our business as an integrated whole, leveraging skills and assets wherever possible.
Kratos Government Solutions ("KGS") Segment
The KGS segment provides products, solutions and services primarily for mission critical National Security priorities. KGS customers primarily include National Security related agencies, the Department of Defense, intelligence agencies and classified agencies. Our work includes weapon systems sustainment, lifecycle support and extension; C5ISR services, including related cybersecurity, cyberwarfare, information assurance and situational awareness solutions; military range operations and technical services; missile, rocket, and weapons systems test and evaluation; mission launch services; modeling and simulation, UAV products and technology, and advanced network engineering and information technology services; and public safety, security and surveillance systems integration. We produce products, solutions and services related to certain C5ISR platforms, unmanned system platforms, weapons systems, national security related assets and warfighter systems.
Public Safety and Security ("PSS") Segment
Our PSS segment provides independent integrated solutions for advanced homeland security, public safety, critical information, security and surveillance systems for government and commercial applications. Our solutions include designing, installing and servicing building technologies that protect people, critical infrastructure, assets, information and property and make facilities more secure and efficient. We provide solutions in such areas as the design, engineering and operation of command and control centers; the design, engineering, deployment and integration of access control; building automation and control; communications; digital and closed circuit television security and surveillance; fire and life safety; maintenance and services and product support services.
We provide solutions for customers in the critical infrastructure, power generation, power transport, nuclear energy, financial, information technology, healthcare, education, transportation and petro-chemical industries, as well as certain government and military customers. For example, we provide biometrics and other access control technologies to customers such as pipelines, electrical grids, municipal port authorities, power plants, communication centers, large data centers, government installations and other commercial enterprises.
Competitive Strengths
We believe we have robust capabilities and past performance qualifications in our respective business areas, including a work force that is experienced with the various programs we service and the customers we serve. Additionally, the majority of our employees have national security clearances specifically related to the customers they work for and the contracts which they work on. We believe the following key strengths distinguish us competitively:
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Significant and highly specialized experience. Through existing customer engagements and the government-focused acquisitions we have completed over the past several years, we have amassed significant and highly specialized experience in areas directly related to C5ISR weapon system life-cycle extension and sustainment; missile, rocket and weapons system testing and evaluation; military range operations and technical services, and other highly differentiated services and solutions. This collective experience, or past performance qualifications, is a requirement for the majority of our contract vehicles and customer engagements. Further enhancing our specialized expertise, a majority of our approximately 2,900 employees have national security clearances, including top secret and higher. We believe these characteristics represent a significant competitive strength and position us to win renewal or follow-on business.
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Specialized national security focus aligned with mission-critical national security priorities. Continued concerns related to the threat posed by certain foreign nations and terrorists have caused the U.S. Government to identify national security as an area of functional and spending priority. Budget pressures, particularly related to DoD spending, have placed a premium on developing and fielding relatively low-cost, high-technology solutions to assist in national security missions. Our primary capabilities and areas of focus, listed below, are strongly aligned with the objectives of the U.S. Government:
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Intelligence, surveillance and reconnaissance
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Command, control and combat systems
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Unmanned systems
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Ballistic missile defense
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Cyber security and information assurance
We believe our strategy has been confirmed through our established positions on 11 of the top 15 DoD programs in terms of total procurement and research, development, testing and evaluation spending, including the F-35 Lightning II, multiple missile defense programs, Bridge Combat Team, multiple unmanned aerial vehicle ("UAV") programs, Blackhawk helicopter and related variants, CVN-21 Carrier Replacement, DDG-51 Aegis Destroyer, Littoral Combat Ship and others.
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Strategic geographic locations and base realignment and closure. The U.S. Base Realignment and Closure Act of 2005 ("BRAC") is the congressionally authorized process the DoD has implemented to reorganize its base structure to fewer, larger bases in order to support U.S. armed forces more efficiently and effectively, increase operational readiness and facilitate new ways of doing business. As a result of the DoD's BRAC transformation, we have concentrated part of our business strategy on building a significant presence in key BRAC receiving locations where the U.S. Federal Government is relocating its personnel and related technical and professional services. We believe our focus on increasing our strategic presence in key BRAC receiving locations will provide us with a significant competitive advantage.
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Diverse base of key contracts with low concentration. As a result of our business development focus on securing key contracts, we are a preferred contractor on numerous multi-year, government-wide acquisition contracts ("GWACs") and multiple award contracts. Our preferred contractor status provides us with the opportunity to bid on hundreds of millions of dollars of business each year against a discrete number of other pre-qualified companies. We have a highly diverse base of contracts with no contract representing more than 5% of 2010 revenue. Our fixed-price contracts, almost all of which are production contracts, represent approximately 57% of our 2010 revenue. Our cost-plus-fee contracts and time and materials contracts represent approximately 22% and 21%, respectively, of our 2010 revenue. We believe our diverse base of key contracts and low reliance on any one contract provides us with a stable, balanced revenue stream.
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In-depth understanding of client missions. We have a reputation for providing mission-critical services and solutions to our clients. Our relationships with our U.S. Army, U.S. Navy and U.S. Air Force customers generally exceed 10 years, enabling us to develop an in-depth understanding of their missions and technical needs. In addition, we have employees located at customer sites, providing us valuable strategic insights into our clients' ongoing and future program requirements. Our in-depth understanding of our clients' missions, in conjunction with the strategic location of our employees, enables us to offer technical solutions tailored to our clients' specific requirements and evolving mission objectives. In addition, once we are on-site with a customer, we have historically been successful in winning recompete business in the vast majority of cases.
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Significant cash flow visibility driven by stable backlog. As of December 26, 2010, our total backlog was approximately $674 million, of which approximately $292 million was funded backlog. The majority of our sales are from orders issued under long-term contracts, typically three to five years in duration. Our contract backlog provides visibility into stable future revenue and cash flow over a diverse set of contracts.
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Highly skilled employees and an experienced management team. We deliver our services through a skilled workforce of approximately 2,900 employees. Our senior managers have significant experience with U.S. Federal Government agencies, the U.S. military and federal government contractors. Members of our management team have experience growing businesses both organically and through acquisitions. We believe that the cumulative experience and differentiated expertise of our personnel in our core focus areas, coupled with our sizable employee base, the majority of which hold national security clearances, allows us to qualify for and bid on larger projects in a prime contracting role.
Services and Solutions
We provide a range of integrated engineering, war fighter, security and information technology services, solutions, and products by leveraging our core service offerings: C5ISR weapons systems lifecycle sustainment, support, and extension; military range operations and technical services; missile and rocket test and evaluation; security systems integration; manufacturing of tactical combat vehicle shelters for C5ISR systems, weapon systems and warfighters; and learning, performance and training solutions.
C5ISR (Command, Control, Communications, Computing, Combat Systems, Intelligence, Surveillance and Reconnaissance)
In the area of C5ISR, we are involved in a wide range of services, including installation, upgrade and maintenance of command, control, computing, and surveillance systems for customers such as the Joint Inter Agency Task Force- south ("JIATF"), the Naval Undersea Warfare Center (NUWC) and the Space and Naval Warfare Systems Center (SPAWAR). We are also involved in the study, research and development of exotic sensors, including Electrical-Optical/Infrar ed ("EO/IR") sensors, for our customers.
Weapon Systems Lifecycle Sustainment, Support and Extension
We provide weapons systems life cycle sustainment, support, and extension services for the DoD and foreign governments. These services focus on maintaining, testing and repairing certain weapons systems for the war fighter.
Manufacturing of tactical combat vehicle shelters for C5ISR systems, unmanned aerial systems, weapon systems and warfighters
We provide tactical combat vehicle shelters for C5ISR systems, weapon systems and warfighters. Our tactical military facilities and products include lightweight, high-strength enclosures for widely recognized military programs and platforms, as well as ruggedized and readily transported enclosures. Many of our products include High Altitude Electromagnetic Pulse ("HEMP") protection, and other types of electromagnetic, electronic warfare and other protections. Our product design approach focuses on highly engineered enclosures and facilities that have the flexibility to be modified to customer specifications. We routinely design, integrate and install components into our standard products, such as command, control and communication systems infrastructure, racks and cabinets and power distribution and lighting, among others.
Missile and Rocket Test and Evaluation
We have expertise in the area of ballistic missile and rocket test and evaluation services, which are primarily dedicated to United States Ballistic Missile Defense (BMD) missions. This includes exclusive rights to the design and manufacture of the motor on the Oriole Rocket System and ancillary hardware for sounding rockets, suborbital research and target services together with both intellectual property and subject matter expertise in sensors and modeling and simulation associated with a wide range of missile technologies. Additionally, this area of our business develops and produces low-cost ballistic missile defense targets. These ballistic missile targets or AEGIS Readiness Assessment Vehicles (ARAVs) are a key element in U.S. AEGIS based Ballistic Missile Defense forces.
Security Systems Integration
We have broad experience integrating security services and solutions across a number of network and communications platforms. In particular, our non-federal business has extensive experience and has developed significant customer relationships by providing best-in-class systems integration services on a variety of platforms including digital (IP) surveillance and security, building automation systems and controls, fire and life safety systems, access control and perimeter protection, and service and maintenance of the aforementioned systems.
We have comprehensive experience providing engineering services at any phase of a project lifecycle including program management, engineering design, system engineering, operations and maintenance, integrated telecommunications, and warfare systems training.
We also develop and produce network management and protection proprietary products—NeuralStar and dopplerVUE.
Missile Range Operations and Technical Services
A key area of differentiation for us is within the missile range and technical service areas. We have resources stationed at many major weapons and targets range locations throughout the United States, including Naval Air Warfare Center Pt. Mugu, Hawaii Pacific Missile Range, Fort Bliss, Texas, and White Sands Missile Range, New Mexico. Our services include aerial target operations and maintenance, surface target operations and maintenance, missile systems operations and maintenance, range operations planning and support, hazardous materials management, supply and logistics support, and manufacturing.
Learning, Performance and Training Solutions
Our learning, performance and training solutions consist of a broad range of products and service capabilities to deliver training solutions and web-enabled or satellite based interactive distance learning for customers in the DoD, other government agencies, universities and commercial organizations. Our training solutions include services, product development, and tools addressing a wide range of related disciplines that include human performance factors, job and task analysis, competencies definitions, skills and knowledge building via multiple delivery mediums, tracking, assessment, evaluation, and trend analysis. In addition, we develop and provide classroom based and e-learning training and education programs and Net-Centric Human Systems Integration (HSI) solutions.
We offer a range of IT services and solutions from conceptual network planning to system service and maintenance. We also offer our proprietary software based network management products via software license and maintenance sales which also serve as a platform for incremental network based services work. We have extensive experience building complex and secure networks for the federal government, and we possess in-depth experience with network operations centers. Our services include network operations centers, help desks, system maintenance, system upgrades, configuration management, data warehousing, commercial off the self ("COTS") selection and integration, and high performance computing.
Our Strategy
Our strategy is to aggressively grow our business as a leading provider of highly differentiated products, solutions and services in our core areas of focus as noted above by delivering comprehensive, high-end engineering services, technical solutions, product manufacturing, and information technology solutions to federal government agencies, while improving our margin rates and overall profitability. To achieve our objective, we intend to accelerate internal growth and pursue strategic acquisitions.
Accelerate Internal Growth
We are focused on accelerating our internal growth rate by capitalizing on our current contract base and customer relationships, expanding product, solution and service offerings provided to our existing clients, expanding our client and contract base, improving our operating margins, capitalizing on corporate infrastructure investments and concentrating on high value-added contracts.
Capitalize on Current Contract Base. We are pursuing new program and contract opportunities and awards, as we build the business, with our expanding customer base, contract portfolio, and product, solution and service offerings. We are aggressively pursuing task orders under existing contract vehicles to maximize our revenue and strengthen our client relationships, though there is no assurance that the federal government will make awards up to the ceiling amounts or that we will be awarded any task orders under these vehicles. We have developed several internal tools that facilitate our ability to track, prioritize and win task orders under these vehicles. Combining these tools with our technical expertise, our strong past performance record and our knowledge of our clients' needs, should position us to win additional task orders.
Expand Product, Solution and Service Offerings Provided to Existing Clients. We are focused on expanding the products, solutions and services we provide to our current clients by leveraging our strong relationships, technical capabilities and past performance record, and by offering a wider range of comprehensive solutions as we continue to acquire companies with new areas of specialization. In regard to new areas of specialization, two of our recent acquisitions have expanded our service offerings to include manufacturing of tactical combat vehicle shelters for C5ISR systems, unmanned systems, weapon systems and warfighters. We believe our understanding of client missions, processes and needs, in conjunction with our full lifecycle IT offerings, including cybersecurity, cyberwarfare and situational awareness, positions us to capture new work from existing clients as the federal government continues to increase the volume of IT services contracted to professional services providers. Moreover, we believe our strong past performance record positions us to expand the level of services we provide to our clients as the federal government places greater emphasis on past performance as a criterion for awarding contracts.
Expand Client and Contract Base. We are also focused on expanding our client base into areas with significant growth opportunities by leveraging our capabilities, industry reputation, long-term client relationships and diverse contract base. We anticipate that this expansion will enable us both to pursue additional higher value work and to further diversify our revenue base across the federal government. Our long-term relationships with federal government agencies, together with our GWAC vehicles, give us opportunities to win contracts with new clients within these agencies.
Improve Operating Margins. We believe that we have opportunities to increase our operating margins and improve profitability by capitalizing on our corporate infrastructure investments and internally developed tools, improving efficiencies and reducing costs, and concentrating our efforts on increasing the percentage of revenues generated from high value-added contracts.
Capitalize on Corporate Infrastructure Investments. In recent periods, we have made significant investments in our senior management and corporate infrastructure in anticipation of future revenue growth. These investments included hiring senior executives with significant experience in the national security business, strengthening our internal controls over financial reporting and accounting staff in support of public company reporting requirements, expanding our Sensitive Compartmented Information Facilities and other corporate facilities, and expanding our backlog and bid and proposal pipeline. We will be allocating additional resources in our pursuit of new and larger contract opportunities, leveraging our increased scale and robust past performance qualifications. We believe our management experience and corporate infrastructure are more typical of a company with a much larger revenue base than ours. We therefore anticipate that, to the extent our revenue grows, we will be able to leverage this infrastructure base and increase our operating margins.
CEO BACKGROUND
Scott Anderson
Scott Anderson has been a director since March 1997. Mr. Anderson has been a principal of Cedar Grove Partners, LLC, an investment and advisory concern since 1997, and a principal of Cedar Grove Investments, LLC, a private seed capital firm since 1998. Mr. Anderson was with McCaw Cellular/AT&T Wireless, most recently as Senior Vice President of the Acquisitions and Development group, from 1986 until 1997. Before joining McCaw Cellular in 1986, Mr. Anderson was engaged in private law practice. Mr. Anderson has been a director of TC Global, Inc., a public registrant, since July 2010. More recently, Mr. Anderson served on the board of directors and was Audit Committee Chairman of SunCom Wireless Holdings, Inc. until its acquisition by T-Mobile USA, Inc. in February 2008. In addition, Mr. Anderson served on other public company boards prior to 2002. He currently serves on the board of directors of several private companies, including mInfo, Inc., CosComm International, Inc., Globys, Inc., Alcis Health, Inc., Root Wireless, Inc., and Anvil Corp. Mr. Anderson is a member of the control group of Savary Island Wireless, LLC, a wireless license holder. He holds a B.A. in History from the University of Washington, magna cum laude , and a J.D. from the University of Washington Law School, with highest honors. Mr. Anderson's formal legal training, extensive experience in mergers and acquisitions, experience with litigation matters, and experience on public company boards and audit committees provide important resources in his service on our Board of Directors and in his capacity as the chairman of our Audit Committee.
Bandel Carano
Bandel Carano originally served as a director from August 1998 to June 2001 and re-joined our Board of Directors in October 2001. Since 1987, he has been a managing partner of Oak Investment Partners, a multi-stage venture capital firm. Mr. Carano also serves on the Investment Advisory Board of the Stanford Engineering Venture Fund, the board of directors of Airspan Networks, Inc. and NeoPhotonics Corporation, and the board of directors of numerous private companies, including Boston Power, Inc., Good Technologies Inc., MobiTV, Inc., nLight Photonics Corporation, Protean Electric Ltd., Plastic Logic Limited, Solarflare Communications, Inc., Stretch, Inc., and Sundrop Fuels, Inc. Mr. Carano holds a B.S. and an M.S. in Electrical Engineering from Stanford University. Mr. Carano was nominated and elected as one of Kratos' directors pursuant to the terms of a purchase agreement among Kratos and certain of its stockholders in connection with the sale of our Series A Convertible Preferred Stock in October 2001. Mr. Carano's technical engineering background and experience with several companies in the defense electronics industry is particularly relevant to his understanding of our current service and product offerings and overall long-term strategy of future offerings. He also has significant expertise in evaluating various merger and acquisition targets for synergistic technical platforms.
Eric DeMarco
Eric DeMarco joined Kratos in November 2003 as President and Chief Operating Officer. Mr. DeMarco was appointed a director and assumed the role of Chief Executive Officer effective April 1, 2004. Prior to coming to Kratos, Mr. DeMarco most recently served as President and Chief Operating Officer of The Titan Corporation ("Titan"), then a NYSE-listed corporation, prior to its acquisition by L-3 Communications. Prior to his being named President and Chief Operating Officer, Mr. DeMarco served as Executive Vice President and Chief Financial Officer of Titan. Prior to joining Titan, Mr. DeMarco served in a variety of public accounting positions primarily focusing on large multi-national corporations and publicly traded companies. Mr. DeMarco holds a B.S. in Business Administration and Finance, summa cum laude , from the University of New Hampshire. Under Mr. DeMarco, we successfully transitioned from a wireless communications company to a national defense and homeland security solutions business, through both organic growth and strategic acquisitions. Mr. DeMarco's in-depth knowledge of our business and operations, his experience in the defense contracting industry, and his experience with publicly traded companies position him well to serve as our Chief Executive Officer and a member of our Board of Directors.
William Hoglund
William Hoglund has been a director since February 2001 and Chairman of the Board of Directors since June 2009. Mr. Hoglund is also a member and owner of SAFE Boats International, a leading manufacturer of vessels for military, law enforcement, and commercial purposes. From 1994 to 2000, Mr. Hoglund served as Vice President and Chief Financial Officer of Eagle River, LLC, a private investment company. During his tenure at Eagle River, Mr. Hoglund was also a director of Nextel Communications, Inc. and Nextlink Communications, Inc. From 1977 to 1994, Mr. Hoglund worked for J.P. Morgan & Co. and several of its subsidiaries. Mr. Hoglund held a variety of positions in J.P. Morgan's commercial and investment banking operations. Mr. Hoglund holds a B.A. in Management Science and German Literature, cum laude , from Duke University and an MBA from the University of Chicago. Mr. Hoglund's financial experience and expertise in both the public and private marketplace is well suited for his role as a member of the Audit Committee. He also brings significant experience in the defense contracting industry. He has served on various independent committees of the Board of Directors and has taken an active leadership role, and is well qualified to serve as the Chairman of the Board of Directors.
Scot Jarvis
Scot Jarvis joined our Board of Directors in February 1997. Mr. Jarvis co-founded Cedar Grove Partners, LLC in 1997, an investment and consulting/advisory partnership with a focus on wireless communications investments. He is a member of the control groups of Toba Inlet PCS, LLC and Savary Island Wireless, LLC, both wireless licensees. In addition, Mr. Jarvis was one of the cofounders of Cricket Communications, Inc., the low cost wireless provider owned by Leap Wireless International, Inc. (NASDAQGS: LEAP) and was a member of Leap's board of directors from 1998 to 2002. Prior to co-founding Cedar Grove, Mr. Jarvis served as a senior executive of Eagle River, Inc., an investment firm owned by Craig McCaw. While at Eagle River he founded Nextlink Communications on behalf of McCaw and served on its board of directors. He has also served on the board of directors of Nextel Communications, NextG Networks, Inc., Wavelink Communications, Inc., NextWeb, Inc., and Cantata Technologies, Inc. From 1985 to 1994, Mr. Jarvis served in several executive capacities at McCaw Cellular Communications until it was sold to AT&T. Mr. Jarvis currently serves on the board of directors of Good Technologies (since 2003), Airspan Networks (since February 2011), and Slingshot Sports (since 1999). Mr. Jarvis is a venture partner with Oak Investment Partners, a venture capital firm. Mr. Jarvis holds a B.A. in Business Administration from the University of Washington. Mr. Jarvis has extensive experience with mergers and acquisitions transactions, which is of particular significance to the Board of Directors as we continue to pursue growth strategies through mergers and acquisitions.
Jane Judd
Jane Judd joined our Board of Directors in January 2011. Prior to her retirement in 2006, Ms. Judd served as Senior Vice President, Chief Financial Officer, and a member of the board of directors of Telisimo International, a communications company, from May 1996 to November 2006. Telisimo International voluntarily filed for Chapter 11 bankruptcy in March 2003 and emerged from the bankruptcy proceedings in September 2003. Prior to that, Ms. Judd was Vice President and Corporate Controller of The Titan Corporation from April 1986 to May 1996. Titan was a publicly traded major national defense services and solutions provider before its acquisition by L3 Communications in 2005. Ms. Judd is a Certified Public Accountant and she received a B.S. from the University of Utah in 1976. Ms. Judd brings financial experience and expertise to the Board of Directors with her background in public accounting and financial leadership roles, which includes experience in the defense services industry. With these skills, Ms. Judd is well qualified to serve as the Designated Financial Expert for our Board of Directors.
Samuel Liberatore
Samuel Liberatore joined our Board of Directors in January 2009. Prior to that time, Mr. Liberatore was the Chief Operating Officer for Madison Research Corporation, building it from approximately $3 million in annual revenue to $64 million, until its acquisition by Kratos in 2006, and was President of Kratos' Weapon Systems Solutions (Madison Research) division until he retired in December 2008. Beginning in July 1994 and until June 2001, Mr. Liberatore served as Program Manager and lead engineer in support of the PAC-3 missile program for Madison Research Corporation. From 1989 to 1994, he served as Director of Ballistic Missile Defense of BDM International. Mr. Liberatore served for 30 years in the U.S. Army where he held a variety of positions related to weapons system operations, research, development and acquisition before retiring as a Colonel in 1989. He holds a B.S. in Mathematics from Loyola College, Baltimore and an M.S. in Guided Missile Engineering from the University of Texas, El Paso. In addition to normal operational and command assignments, Mr. Liberatore was the Project Manager for the HAWK missile system and Chief of Missiles and Air Defense Systems at Headquarters Department of the Army for the research, development and acquisition of all U.S. Army missile and air defense systems. Mr. Liberatore brings to the Board of Directors prior experience as a military officer, extensive experience and expertise working in the missile defense industry, and recent experience working in the defense contracting industry. Mr. Liberatore provides our Board of Directors with important insight into our key markets and customers, as well as insight into the potential market for any service and product offerings we may contemplate targeting.
MANAGEMENT DISCUSSION FROM LATEST 10K
Overview
We are a specialized national security business providing mission critical products, services and solutions for United States national security priorities. Our core capabilities are sophisticated engineering, manufacturing and system integration offerings for national security platforms and programs. Our principal services are related to, but are not limited to, Command, Control, Communications, Computing, Combat Systems, Intelligence, Surveillance and Reconnaissance ("C5ISR"); related cybersecurity, cyberwarfare, information assurance and situational awareness solutions; weapons systems lifecycle support and sustainment; military weapon range operations and technical services; missile, rocket and weapons system testing and evaluation; missile and rocket mission launch services, primarily for Ballistic Missile Defense; public safety, critical infrastructure security and surveillance systems; modeling and simulation; unmanned aerial vehicle systems; and advanced network engineering and information technology services. We offer our customers products, solutions, services and expertise to support their mission-critical needs by leveraging our skills across our core offering areas.
Our primary end customers are United States Federal Government agencies, including the Department of Defense, classified agencies, intelligence agencies, other National Security agencies and Homeland Security related agencies. We believe our stable client base, strong client relationships, broad array of contract vehicles, considerable employee base possessing national security clearances, extensive list of past performance qualifications, and significant management and operational capabilities position us for continued growth.
We provide products, solutions and services for a wide range of established, deployed and operating national security platforms, including, but not limited to: Aegis Ballistic Missile Defense systems, M1 Abrams tanks, Bradley fighting vehicles, F-5 Tiger, HiMARS, Chaparral and Hawk missile systems, Kiowa AH-60 helicopters, DDG-1000 Zumwalt destroyers, attack and missile submarines, certain intelligence surveillance and reconnaissance systems and various unmanned systems.
Industry Background
Department of Defense Drives Strategic Priorities for the Company
The delivery and execution of our mission-critical engineering and support services are driven by the priorities of the U.S. Federal Government and primarily the DoD. The strategic priorities of the DoD are based in large part on the Quadrennial Defense Review ("QDR"), a legislatively-mandated review of DoD strategy and priorities. These priorities are currently focused on mission critical capabilities of the U.S. armed forces and providing the support infrastructure necessary to sustain these forces in a time of heightened warfare readiness and deployment.
The DoD's budget for the 2012 fiscal year is $671 billion, a decrease of 5% from fiscal year 2011. The top 28 programs account for approximately $64 billion in funding and require aggregate funding that is nearly 14% higher than what was set aside for them in the fiscal year 2010 budget which closed on September 30, 2010. The increase in the top 28 programs represents a significant opportunity to key federal government contractors in support of the DoD's war fighter, information technology, and other operational priorities. We believe there will be significant market opportunities for providers of system sustainment, IT and engineering services and solutions to federal government agencies over the next several years, particularly those in the defense and homeland security communities.
As of February 25, 2011, the Congress has not approved the President's fiscal year ("FY") 2011 budget request. Consequently, the U.S. government, including the Department of Defense, is operating under a continuing resolution ("CR"), which funds the Pentagon at FY 2010 funding levels through early March 2011. We anticipate that Congress will further consider the FY 2011 defense spending bill in conjunction with the expiration of the current CR. This consideration would likely result in either an extension of the CR, thereby keeping FY 2011 funding at FY 2010 levels, or the passage of a 2011 funding bill.
Focus on Federal Government Transformation
The federal government and the DoD in particular, is in the midst of a significant transformation that is driven by the federal government's need to address the changing nature of global threats. A significant aspect of this transformation is the use of C5ISR, and information technology to increase the federal government's effectiveness and efficiency. The result is increased federal government spending on information technology to upgrade networks and transform the federal government from separate, isolated organizations into larger, enterprise level, network-centric organizations capable of sharing information broadly and quickly. While the transformation initiative is driven by the need to prepare for new world threats, adopting these IT transformation initiatives will also improve efficiency and reduce infrastructure costs across all federal government agencies.
An additional aspect of the military transformation includes significantly enhancing military readiness in areas such as missile defense, weapons system sustainment and extension, and the overall strengthening of intelligence and security. For example, the objective of the DoD as it relates to missile defense is to continue to develop, test, and field missile defense systems to protect America, its allies and deployed forces.
While the real rate of growth in the top line defense budget may be slowing for the first time since September 11, 2001, the U.S. Government's budgetary process continues to give us good visibility with respect to future spending and the threat areas that the government is addressing. We believe that our business is aligned with mission critical national security priorities particularly in the area of missile defense, C5ISR, cyber security and information assurance and that our current contracts and strong backlog provide us with good insight regarding our future cash flows.
Current Reporting Segments
We operate in two principal business segments: Kratos Government Solutions and Public Safety & Security. We organize our business segments based on the nature of the services offered. Transactions between segments are generally negotiated and accounted for under terms and conditions similar to other government and commercial contracts and these intercompany transactions are eliminated in consolidation. The consolidated financial statements in this Annual Report are presented in a manner consistent with our operating structure. For additional information regarding our operating segments, see Note 14 of Notes to Consolidated Financial Statements. From a customer and solutions perspective, we view our business as an integrated whole, leveraging skills and assets wherever possible.
Kratos Government Solutions Segment
Our KGS segment provides products, solutions and services primarily for mission critical National Security priorities. KGS customers primarily include National Security related agencies, the Department of Defense, intelligence agencies and classified agencies. Our work includes weapon systems sustainment, lifecycle support and extension; C5ISR services, including related cybersecurity, cyberwarfare, information assurance and situational awareness solutions; military range operations and technical services; missile, rocket, and weapons systems test and evaluation; mission launch services; modeling and simulation; UAV products and technology; advanced network engineering and information technology services; and public safety, security and surveillance systems integration. We produce products, solutions and services related to certain C5ISR platforms, unmanned system platforms, weapons systems, national security related assets and warfighter systems. The results of our recent acquisitions of Southside, DEI and Gichner are included in this segment.
Public Safety & Security Segment
Our PSS segment provides independent integrated solutions for advanced homeland security, public safety, critical information, security and surveillance systems for government and commercial applications. Our solutions include designing, installing and servicing building technologies that protect people, critical infrastructure, assets, information and property and make facilities more secure and efficient. We provide solutions in such areas as the design, engineering and operation of command and control centers, the design, engineering, deployment and integration of access control, building automation and control, communications, digital and closed circuit television security and surveillance, fire and life safety, maintenance and services and product support services. We provide solutions for customers in the critical infrastructure, power generation, power transport, nuclear energy, financial, information technology, healthcare, education, transportation and petro-chemical industries, as well as certain government and military customers. For example, we provide biometrics and other access control technologies to customers such as pipelines, electrical grids, municipal port authorities, power plants, communication centers, large data centers, government installations and other commercial enterprises. The results of our recent acquisition of HBE are included in this segment.
On June 24, 2009, as a result of the continued operating losses in the Southeast division of the PSS segment (the "Southeast Division"), our board of directors approved a plan to sell and dispose of the Southeast Division. In accordance with ASC Topic 205, Presentation of Financial Statements ("Topic 205") , this business unit was classified as held for sale and reported in discontinued operations in the accompanying consolidated financial statements. We recorded a $2.0 million impairment charge in the second quarter of 2009 and an additional $0.2 million in the second quarter of 2010 related to management's estimate of the fair value of the business. On August 2, 2010, we divested this division for approximately $0.1 million cash consideration and the assumption of certain liabilities.
Strategic Acquisitions
Henry Bros. Electronics, Inc .
On December 15, 2010, we acquired Henry Bros. Electronics, Inc. in a cash merger for a purchase price of $56.6 million, of which $54.9 million was paid in cash and $1.7 million reflects the fair value of options to purchase common stock of HBE that were assumed by us and converted into options to purchase our common stock upon completion of the merger. Upon completion of the merger, holders of HBE common stock received $8.20 in cash for each share of HBE common stock held by them immediately prior to the closing of the merger. In addition, upon completion of the merger, all options to purchase HBE common stock were assumed by us (the "Assumed Options") and converted into options to purchase our common stock, entitling the holders thereof to receive 0.7715 shares of our common stock for each share of HBE common stock underlying the Assumed Options. The Assumed Options will be exerciseable for an aggregate of approximately 0.4 million shares of our common stock.
HBE is a leading provider of homeland security solutions, products, and system integration services, including the design, engineering and operation of command, control and surveillance systems for the protection of strategic assets and critical infrastructure in the U.S. HBE also has particular expertise in the design, engineering, deployment and operation of specialized surveillance, thermal imaging, analytics, radar, and biometrics technology based security systems. Representative HBE programs and customers include DoD agencies, nuclear power generation facilities, state government and municipality related agencies, major national airports, major harbors, railways, tunnel systems, energy centers, power plants, and related infrastructure.
Southside Container & Trailer, LLC.
On December 7, 2010, we acquired Southside for $13.7 million of which $12.2 million in cash was paid at closing, $0.3 million is being held as security for SCT's indemnification obligations as set forth in the Purchase Agreement and approximately $1.2 million of which represents the acquisition date fair value of additional performance based consideration. The potential undiscounted amount of all future contingent consideration that may be payable by us under the Purchase Agreement is $3.5 million. Southside is a privately-held provider of national security related command and control center, law enforcement, military aviation and data center products, shelters and solutions for the United States Department of Defense, National Security agencies and related customers. Southside also provides products and solutions for specialized war fighter and critical asymmetric warfare related missions.
DEI Services Corporation
On August 9, 2010, we acquired DEI Services Corporation, in a cash merger valued at approximately $14.0 million, of which $9.0 million was paid in cash at closing and approximately $5.0 million of which represented the acquisition date fair value of additional performance-based consideration, of which $0.4 million was achieved and paid in September 2010. Pursuant to the terms of the DEI Agreement upon achievement of certain cash receipts, revenue, earnings before interest, taxes, depreciation, and amortization ("EBITDA") and backlog amounts in 2010, 2011 and 2012, we will be obligated to pay the former stockholders of DEI certain additional contingent consideration. The potential undiscounted amount of all future contingent consideration that may be payable by us under the DEI Agreement, subsequent to December 26, 2010, is between zero and $8.0 million. The contingent consideration will be reduced in the event certain anticipated cash receipts are not collected within agreed upon time periods, which could decrease the future payments by approximately $6.0 million.
Founded in 1996 and headquartered in Orlando, Florida, DEI designs, manufactures and markets full-scale training simulation products. In addition to the engineering and construction of physical simulators for air and ground military vehicles, DEI provides instructional design, courseware creation, learning application programming and other supporting services. Among DEI's most successful products are training and simulation solutions for fixed-wing aircraft (including the Tiger, Harrier and Prowler aircraft), rotor-wing aircraft (including Blackhawk, Chinook and Sea Stallion helicopters) and Ground Combat Vehicles (including M1 Abrams Main Battle Tank and M2 Bradley Fighting Vehicle).
Gichner Holdings, Inc.
On May 19, 2010, we acquired Gichner pursuant to the Stock Purchase Agreement, dated as of April 12, 2010, by and between us and the stockholders of Gichner (the "Purchase Agreement"), in a cash for stock transaction valued at approximately $133.0 million. Gichner has manufacturing and operating facilities in Dallastown and York, Pennsylvania and Charleston, South Carolina, and is a manufacturer of tactical military products, combat support facilities, subsystems, modular systems and shelters primarily for the DoD and leading defense system providers. Representative programs for which Gichner provides products and solutions include the MQ—1C Sky Warrior, Gorgon Stare, MQ—8B Fire Scout and RQ—7 Shadow Unmanned Aerial Vehicles, the Command Post Platform and Joint Light Tactical Vehicles, Combat Tactical Vehicles, DDG-1000 Modular C5 Compartments and the Persistent Threat Detection System ISR Platform.
Upon completion of the acquisition, we deposited $8.1 million of the purchase price into an escrow account as security for Gichner's indemnification obligations as set forth in the Purchase Agreement. In addition, the Purchase Agreement provides that the purchase price will be (i) increased on a dollar for dollar basis if the working capital on the closing date (as defined in the Purchase Agreement) exceeds $17.5 million or (ii) decreased on a dollar for dollar basis if the working capital is less than $17.1 million. Kratos and Altus Capital Partners, Inc., the seller's representative under the Purchase Agreement (the "Seller's Representative") have agreed to a working capital adjustment of $0.3 million owed to us. The Seller's Representative is disputing an additional working capital adjustment of $0.9 million to which we believe we are entitled.
Digital Fusion, Inc.
On December 24, 2008, we acquired DFI. DFI provides C4ISR and technical engineering services, UAV products and technology and has significant engineering, modeling and simulation capabilities. The acquisition of DFI provided us with new customers and an expanded contract vehicle portfolio, in addition to expanding the range of service offerings to our existing customers. Principal customers of DFI include the Army Aviation and Missile Research, Development and Engineering Center (AMRDEC), Army Space and Missile Defense Command/Army Forces Strategic Command (ARSTRAT), NASA Marshall Space Flight Center, and certain classified customers.
We acquired DFI in a stock for stock transaction valued at approximately $37.0 million, including transaction costs of $0.9 million. We issued 2.3 million shares to DFI shareholders and assumed outstanding DFI options, which resulted in the assumption of options to acquire approximately 1.0 million shares of our common stock. The value of the purchase price related to the common stock issued was derived from the number of shares of our common stock issued of 2.3 million, based on 12.8 million shares of DFI common stock outstanding and the exchange ratio of 0.17933 for each DFI share, at a price of $12.70 per share, the average closing price of our common stock for the two days prior to, including, and the two days subsequent to the public announcement of the merger on November 24, 2008. The fair value of the options assumed that were allocated to goodwill based upon the Black-Scholes pricing model was $7.0 million. The fair value of unvested options which are related to future service will be expensed as the service is performed.
SYS Technologies
On June 28, 2008, we acquired SYS. SYS provided a range of C4ISR and net-centric solutions to federal, state, and local governments as well as other customers. The combination of SYS and Kratos created a broad, complementary set of offerings, and positioned the organization to deliver proven capabilities to a wider spectrum of customers in the areas of highly-specialized engineering and IT solutions and services, specifically in the areas of weapon systems life cycle support and extension, military range operations, missile and weapon system testing, and C4ISR.
The purchase price of $55.9 million included direct transaction costs of $2.4 million and restructuring costs of $2.6 million to be paid by us. The value of the purchase price related to the common stock issued was derived from the number of shares of our common stock issued of 2.5 million, based on 20.1 million shares of SYS common stock outstanding and the exchange ratio of 0.12582 for each SYS share, at a price of $20.22 per share, the average closing price of our common stock on the announcement date and for the two days prior to and two days subsequent to the public announcement of the merger on February 21, 2008.
During the due diligence process related to the acquisition of SYS, senior management identified three business units of SYS which were non-core to Kratos' base national PSS businesses. In accordance with Topic 205 , these business units were classified as held for sale and reported in discontinued operations. In the quarter ended March 29, 2009, all three of the businesses were sold for an aggregate cash consideration of approximately $0.4 million.
Key Financial Statement Concepts
As of December 26, 2010, we consider the following factors to be important in understanding our financial statements.
KGS' business with the U.S. Government and prime contractors is generally performed under cost reimbursable, fixed-price or time and materials contracts. Cost reimbursable contracts for the government provide for reimbursement of costs plus the payment of a fee. Some cost reimbursable contracts include incentive fees that are awarded based on performance on the contract. Under time and materials contracts, we are reimbursed for labor hours at negotiated hourly billing rates and reimbursed for travel and other direct expenses at actual costs plus applied general and administrative expenses. In accounting for our long-term contracts for production of products and services provided to the federal government and provided to our PSS customers under fixed price contracts, we utilize both cost-to-cost and units produced measures under the percentage-of-completion method of accounting under the provisions of FASB ASC Topic 605, Revenue Recognition ("Topic 605") . Under the units produced measure of the percentage-of-completion method of accounting, sales are recognized as the units are accepted by the customer generally using sales values for units in accordance with the contract terms. We estimate profit as the difference between total estimated revenue and total estimated cost of a contract and recognize that profit over the life of the contract based on deliveries or as computed on the basis of the estimated final average unit costs plus profit. We classify contract revenues as product sales or service revenues depending upon the predominant attributes of the relevant underlying contracts.
We consider the following factors when determining if collection of a receivable is reasonably assured: comprehensive collection history; results of our communications with customers; the current financial position of the customer; and the relevant economic conditions in the customer's country. If we have had no prior experience with the customer, we review reports from various credit organizations to ensure that the customer has a history of paying its creditors in a reliable and effective manner. If the financial condition of our customers were to deteriorate, and adversely affect their financial ability to make payments, additional allowances would be required. Additionally, on certain contracts whereby we perform services for a prime/general contractor, a specified percentage of the invoiced trade accounts receivable may be retained by the customer until we complete the project. We periodically review all retainages for collectability and record allowances for doubtful accounts when deemed appropriate, based on our assessment of the associated risks.
We monitor our policies and procedures with respect to our contracts on a regular basis to ensure consistent application under similar terms and conditions as well as compliance with all applicable government regulations. In addition, costs incurred and allocated to contracts with the U.S. Government are routinely audited by the Defense Contract Audit Agency.
We manage and assess the performance of our businesses based on our performance on individual contracts and programs obtained generally from government organizations with consideration given to the Critical Accounting Principles and Estimates. Due to the Federal Acquisition Regulation rules that govern our business, most types of costs are allowable, and we do not focus on individual cost groupings (such as cost of sales or general and administrative costs) as much as we do on total contract costs, which are a key factor in determining contract operating income. As a result, in evaluating our operating performance, we look primarily at changes in sales and service revenues, and operating income, including the effects of significant changes in operating income. Changes in contract estimates are reviewed on a contract-by-contract basis, and are revised periodically throughout the life of the contract such that adjustments to profit resulting from revisions are made cumulative to the date of the revision in accordance with GAAP. Significant management judgments and estimates, including the estimated costs to complete the project, which determine the project's percent complete, must be made and used in connection with the revenue recognized in any accounting period. Material differences may result in the amount and timing of our revenue for any period if management makes different judgments or utilizes different estimates.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
Overview
We are a specialized national security technology business providing mission critical products, services and solutions for U.S. national security priorities. Our core capabilities are sophisticated engineering, manufacturing and system integration offerings for national security platforms and programs. Our principal services are related to, but are not limited to: electronic attack and electronic warfare platforms, tactical missile systems, strategic deterrence systems, Command, Control, Communications, Computing, Combat Systems, Intelligence, Surveillance and Reconnaissance (“C5ISR”); related cybersecurity, cyberwarfare, information assurance and situational awareness solutions; satellite communication systems and radio frequency interference detection and prevention; weapons systems lifecycle support and sustainment; military weapon range operations and technical services; missile, rocket and weapons system testing and evaluation; missile and rocket mission launch services, primarily for ballistic missile defense; public safety, critical infrastructure security and surveillance systems; modeling and simulation; unmanned aerial vehicle systems; and advanced network engineering and information technology services. We offer our customers products, solutions, services and expertise to support their mission-critical needs by leveraging our skills across our core offering areas.
Our primary end customers are U.S. Federal Government agencies, including the Department of Defense (“DoD”), classified agencies, intelligence agencies, other national security agencies and homeland security related agencies. We believe our stable client base, strong client relationships, broad array of contract vehicles, considerable employee base possessing national security clearances, extensive list of past performance qualifications, and significant management and operational capabilities position us for continued growth.
We provide products, solutions and services for a wide range of established, deployed and operating national security platforms, including, but not limited to: Aegis Ballistic Missile Defense systems, various unmanned aerial systems, certain intelligence surveillance and reconnaissance systems, M1 Abrams tanks, Bradley fighting vehicles, EA-18G, electronic warfare and electronic attack aircraft, HiMARS, Chaparral and HAWK missile systems, Kiowa AH-60 helicopters, DDG-1000 Zumwalt destroyers, attack and missile submarines, certain intelligence surveillance and reconnaissance systems and various unmanned systems.
Industry Update
In August 2011, Congress and the Administration enacted the Budget Control Act of 2011 (the “Budget Act”) in order to permit an increase in the federal government’s borrowing limit while reducing projected net government spending over the next 10 years. The Budget Act contains $900 billion in immediate cuts to discretionary spending for 2012-2021. It also establishes a bi-partisan congressional Joint Select Committee on Deficit Reduction, sometimes referred to as the Super Committee, which is charged with recommending legislation by November 23, 2011, that would reduce net government spending by at least $1.2 trillion over the next 10 years, in addition to the $900 billion in immediate discretionary spending reductions referenced above. In the event that the Super Committee fails to recommend legislation, Congress fails to approve that legislation by late December 2011, or the President fails to sign the legislation into law, an automatic sequestration of discretionary appropriations would be triggered, which would make up any shortfall necessary to achieve the $1.2 trillion target. Under the Budget Act, 50% of any shortfall from the $1.2 trillion target would automatically be applied as a reduction to discretionary appropriations for national security programs. Any of these reductions could have a significant impact on our business and financial results.
In October 2011, Congress passed a continuing resolution funding measure for fiscal year 2012 to finance all U.S. Government activities through November 18, 2011. Under this continuing resolution, partial-year funding at amounts consistent with appropriated levels for fiscal year 2011 are available, subject to certain restrictions, but new spending initiatives are not authorized. Our key programs continue to be supported and funded despite the continuing resolution financing mechanism. However, during periods covered by continuing resolutions (or until the regular appropriation bills are passed), we may experience delays in procurement of products and services due to lack of funding, and those delays may affect our results of operations.
This process and the spending reductions to defense programs have the potential to significantly impact our portfolio of business, which is heavily dependent upon discretionary appropriations for defense programs. Although we believe that our programs are well aligned with national defense and other priorities, shifts in domestic and international spending and tax policy, changes in security, defense and intelligence priorities, the affordability of our products and services, general economic conditions and developments, and other factors may affect the level of funding for existing or proposed programs. We cannot predict the outcome of Budget Act deliberations, actions of the Super Committee or continuing resolution or the extent to which any reductions would impact total funding and/or individual funding for programs in which we participate and the impact on our business and financial results.
Current Reporting Segments
We operate in two principal business segments: Kratos Government Solutions (“KGS”) and Public Safety and Security (“PSS”). We organize our business segments based on the nature of the services offered. Transactions between segments are generally negotiated and accounted for under terms and conditions similar to other government and commercial contracts and these intercompany transactions are eliminated in consolidation. The condensed consolidated financial statements in this Form 10-Q are presented in a manner consistent with our operating structure. For additional information regarding our operating segments, see Note 13 of the notes to the condensed consolidated financial statements. From a customer and solutions perspective, we view our business as an integrated whole, leveraging skills and assets wherever possible.
Strategic Acquisitions
We intend to supplement our organic growth by identifying, acquiring and integrating businesses that meet our primary objective of providing us with enhanced capabilities to pursue a broader cross section of the DoD, Department of Homeland Security and other government markets, complement and broaden our existing client base and expand our primary service offerings. Our senior management team has significant acquisition experience. Since May 2010, we have acquired six companies, each as discussed below.
Integral Systems, Inc.
On July 27, 2011, we completed the merger (the “Integral Merger”) of IRIS Merger Sub Inc., a Maryland corporation and our wholly owned subsidiary (“Integral Merger Sub”), with and into Integral Systems, Inc., a Maryland corporation (“Integral”), whereby Integral became our wholly owned subsidiary. The Integral Merger was effected pursuant to an Agreement and Plan of Merger, dated as of May 15, 2011, by and among Kratos, Integral Merger Sub, IRIS Acquisition Sub LLC, a single member Maryland limited liability company and a our direct wholly owned subsidiary, and Integral (the “Integral Merger Agreement”).
Pursuant to the terms of the Integral Merger Agreement, at the effective time of the Merger (the “Effective Time”), each outstanding share of Integral common stock (other than shares of Integral common stock owned by us, Merger Sub, any of our wholly owned subsidiary or Integral stockholders, if any, who had perfected statutory dissenters’ rights under Maryland law) was cancelled and converted into the right to receive (i) $5.00, in cash, without interest, and (ii) the issuance of 0.588 shares of our common stock. In addition, at the Effective Time (A) each outstanding Integral stock option with an exercise price less than $13.00 per share was, if the holder thereof had so elected in writing, cancelled in exchange for an amount in cash equal to the product of the total number of shares of Integral common stock subject to such in-the-money option, multiplied by the aggregate value of the excess, if any, of $13.00 over the exercise price per share subject to such option, less the amount of any tax withholding, (B) each outstanding Integral stock option with an exercise price equal to or greater than $13.00 per share and each Integral in-the-money option the holder of which had not made the election described in (A) above, was converted into an option to purchase our common stock, with (1) the number of shares subject to such option adjusted to equal the number of shares of Integral common stock subject to such out-of-the-money option multiplied by 0.9559, rounded up to the nearest whole share, and (2) the per share exercise price under each such option adjusted by dividing the per share exercise price under such option by 0.9559, rounded up to the nearest whole cent, and (C) each outstanding share of restricted stock granted under an Integral equity plan or otherwise, whether vested or unvested, was cancelled and converted into the right to receive $13.00, less the amount of any tax withholding.
The acquisition of Integral was completed by issuing approximately 10.4 million shares of Kratos common stock valued at $108.7 million. To fund the cash portion of the acquisition of Integral we issued $115.0 million aggregate principal amount of 10% Senior Secured Notes due 2017. We received approximately $120.8 million in gross cash proceeds from the issuance of the notes, which includes an approximate $5.8 million of issuance premiums, which proceeds were used to finance, in part, the cash portion of the purchase price for the acquisition of Integral, to refinance existing indebtedness of Integral, to pay certain severance payments in connection with the acquisition of Integral and to pay related fees and expenses.
Including the value of the common shares issued, cash paid to the stockholders of Integral, Integral debt paid at closing and the fair value of stock options not exercised of $1.0 million, the total purchase price paid for Integral was $241.0 million. In addition, we assumed change in control obligations of $2.8 million related to the transaction, the majority of which will be paid in 2011.
Integral is a global provider of products, systems and services for satellite command and control, telemetry and digital signal processing, data communications, enterprise network management and communications information assurance. Integral specializes in developing, managing and operating secure communications networks, both satellite and terrestrial, as well as systems and services to detect, characterize and geolocate sources of RF interference. Integral’s customers include U.S. and foreign commercial, government, military and intelligence organizations. For almost 30 years, customers have relied on Integral to design and deliver innovative commercial-based products, solutions and services that are cost-effective and reduce delivery schedules and risk.
Herley Industries, Inc.
On March 25, 2011, pursuant to an Agreement and Plan of Merger dated as of February 7, 2011 (the “Herley Merger Agreement”), by and among us, Lanza Acquisition Co. (“Herley Acquisition Sub”) and Herley Industries, Inc. (“Herley”), Herley Merger Sub acquired approximately 13.2 million shares of Herley common stock representing approximately 94% of the total outstanding shares of Herley common stock in a tender offer to purchase all of the outstanding shares of Herley common stock. On March 30, 2011, following purchases in a subsequent offering period, Herley Merger Sub was merged with and into Herley, with Herley continuing as a wholly owned subsidiary of ours. The shares of Herley common stock were purchased at a price of $19.00 per share. Accordingly, we paid approximately $245.5 million in cash consideration as of March 27, 2011 and as of April 15, 2011 had paid total aggregate cash consideration of $270.7 million in respect of the shares of Herley common stock and certain in-the-money options which were exercised upon the change in control. In addition, upon completion of the merger, all unexercised options to purchase Herley common stock were assumed by us and converted into options to purchase our common stock, entitling the holders thereof to receive 1.3495 shares of our common stock for each share of Herley common stock underlying the options (the “Herley Options”). We assumed each Herley Option in accordance with the terms (as in effect as of the date of the Herley Merger Agreement) of the applicable Herley equity plan and the option agreement pursuant to which such Herley Option was granted. The options are exercisable for an aggregate of approximately 0.8 million shares of our common stock. All options were fully vested upon the change in control and the fair value of the options assumed was $1.9 million. The total aggregate consideration for the purchase of Herley was $272.6 million. In addition, we assumed change in control obligations of $4.0 million related to the transaction, the majority of which will be paid in 2011, and combined transaction expenses of $11.1 million.
On February 11, 2011, we completed the sale of approximately 4.9 million shares of our common stock at a purchase price of $13.25 per share in an underwritten public offering, and on March 25, 2011, Acquisition Co. Lanza Parent, our wholly owned subsidiary (the “Stage I Issuer”), issued 10% Senior Secured Notes due 2017 in the aggregate principal amount of $285.0 million (the “Stage I Notes”). The proceeds of the underwritten public offering and sale and issuance of the Stage I Notes were used to fund the acquisition of Herley. We received gross proceeds from the equity offering of approximately $64.8 million and after deducting underwriting and other offering expenses received approximately $61.1 million in net proceeds. The Stage I Notes were offered at a premium of 107%, for an effective interest rate of 8.5% and the gross proceeds were approximately $314.0 million, which includes approximately $20.0 million of issuance premium and $9.0 million of accrued interest.
Herley is a leading provider of microwave technologies for use in command and control systems, flight instrumentation, weapons sensors, radar, communication systems, and electronic warfare systems. Herley has served the defense industry for approximately 45 years by designing and manufacturing microwave devices for use in high-technology defense electronics applications.
Henry Bros. Electronics, Inc.
On December 15, 2010, we acquired Henry Bros. Electronics, Inc. (“HBE”) in a cash merger for a purchase price of $56.6 million, of which $54.9 million was paid in cash and $1.7 million reflects the fair value of options to purchase common stock of HBE that were assumed by us and converted into options to purchase our common stock. Upon completion of the merger, holders of HBE common stock received $8.20 in cash for each share of HBE common stock held by them immediately prior to the closing of the merger. In addition, upon completion of the merger, all options to purchase HBE common stock (the “HBE Options”) were assumed by us and converted into options to purchase our common stock, entitling the holders thereof to receive 0.7715 shares of our common stock for each share of HBE common stock underlying the HBE Options. The HBE Options will be exercisable for an aggregate of approximately 0.4 million shares of our common stock. The fair value of unvested options which are related to future service will be expensed as the service is performed over the weighted average vesting period of 2.5 years.
HBE is a leading provider of homeland security solutions, products, and system integration services, including the design, engineering and operation of command, control and surveillance systems for the protection of strategic assets and critical infrastructure in the U.S. HBE also has particular expertise in the design, engineering, deployment and operation of specialized surveillance, thermal imaging, analytics, radar, and biometrics technology based security systems. Representative HBE programs and customers include DoD agencies, nuclear power generation facilities, state government and municipality related agencies, major national airports, major harbors, railways, tunnel systems, energy centers, power plants, and related infrastructure.
HBE has been in business for over 50 years and has established relationships with manufacturing partners, industry colleagues, and customers demanding some of the most sophisticated security solutions available. HBE has a national footprint that includes offices in New York, New Jersey, Virginia, Maryland, Texas, Arizona, Colorado and California. The combination of our existing PSS businesses with one of the leading homeland security solutions and high end security system design and engineering services providers in the industry today strategically strengthens our overall capabilities and enhances its customer offerings and overall contract portfolio.
Southside Container & Trailer, LLC
On December 7, 2010, we acquired Southside Container & Trailer, LLC (“SCT”) for $13.7 million of which $12.2 million in cash was paid at closing, $0.3 million was paid in March 2011, as SCT’s indemnification obligations as set forth in the applicable acquisition agreement (the “SCT Agreement”) were met, and approximately $1.2 million of which represents the acquisition date fair value of additional performance based consideration. Pursuant to the terms of the SCT Agreement, upon achievement of certain earnings before interest, taxes, depreciation, and amortization (“EBITDA”) amounts in 2011, 2012 and 2013, we will pay the former stockholders of SCT certain additional performance-based consideration (the “SCT Contingent Consideration”). The potential undiscounted amount of all future SCT Contingent Consideration that may be payable by us under the SCT Agreement is between zero and $3.5 million.
CONF CALL
Laura Siegal
Good afternoon, everyone. And thank you for joining us on the Kratos Defense and Security Solutions first quarter earnings conference call. With me today is Eric DeMarco, Kratos’ President and Chief Executive Officer; and Deanna Lund, Kratos’ Executive Vice President and Chief Financial officer.
Before we begin the substance of today’s call, I’d like to make some brief introductory comments. Earlier this afternoon, we issued a press release which outlines the topics we plan to discuss today. If anyone has not yet seen a copy of this press release, it is available on 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 April 29, 2010 and the company undertakes no obligation to revise or update publicly any of the forward-looking statements contained herein, whether as a result of new information, future events, changes in expectations or otherwise for any reason.
This conference call will include a discussion of non-GAAP financial measures, as that term is defined in Regulation G. Certain of the information discussed, including EBITDA, pro forma EBITDA and the associated margin rates, and pro forma EPS from continuing operations, excluding the differed financing costs and interest charges 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 and capital resources and cash flow.
Non-GAAP financial measures should not be considered in isolation from, or as a substitute for, financial information presented in compliance with GAAP. And non-financial measures, as reported by the company may not be comparable to similarly titled amounts reported by other companies.
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 2010. He will then turn the call over to Ms. Lund to discuss the specifics related to our first quarter 2010 financial results. Eric will then make some concluding remarks about the business and we will then open the call to your questions.
With that said, it is my pleasure to turn the call over to Mr. DeMarco.
Eric DeMarco
Thank you, Laura. Good afternoon. As we provided a preliminary report of our first quarter results a couple of weeks ago when we announced the pending acquisition of the Gichner Holdings, Inc., today, I’m just going to provide a brief summary of the quarter operating results, get into some recent events and talk about operations and programmatics. Deanna’s going to give a complete detail of all the financials, including all the GAAP numbers and then I’ll wrap it up.
Today Kratos reported first quarter 2010 revenue of $68.7 million, inline with what we communicated just a few weeks ago.
First quarter EBITDA increased once again to 8.6% of revenues or $5.9 million, up sequentially from our fourth quarter 2009 EBITDA of 8%, and surpassing our expectations as a result of favorable program mix and continued intentional reduction of some low margin and non-value-add pass-through work.
Additionally, Kratos’ Government Solutions segment EBITDA, which comprises about 90% of our business and where we perform our Department of Defense and National Security work increased to 9.3%.
For the first quarter Kratos’ Public Security and Safety business continued to improve its profitability, with a sequential increase in contribution to the corporation after its return to profitability in the fourth quarter of 2009. Overall, Kratos’ first quarter EBITDA margin increased 18% over the first quarter of last year.
Today we reported pro forma EPS from operations of $0.11 for Q1, excluding the interest charge of $2.2 million related to our recent refinancing. As Deanna will discuss in some detail, since we last communicated with you and as a result of certain very recent changes in Kratos’ shareholder base, our NOLs are no longer completely unlimited from a technical standpoint.
However, as the result of the timing of this recent change, which worked out very well for our company even with the limitation Kratos can still utilize over $20 million of its NOLs each year over the next five years to shield all or substantially all, of our currently forecasted pre-tax income from income taxes. And we also believe that we will be able to utilize all $200 million of our NOLs well within their expiration period.
We’ve verified the ability to utilize our NOLs in this manner with our independent tax advisors. Accordingly, Kratos’ NOLs remain intact and are still an extremely valuable asset to our company, which is very important to our free cash flow. And now that this change has occurred, it is unlikely that another inadvertent limitation can occur.
Accordingly, all of our previously communicated financial accretion and ROI models for Gichner remain unchanged. And we believe we will also still be able to shield substantially all of Gichner’s pre-tax income as well. I will talk more about the pending Gichner acquisition a little later on.
From a programmatic standpoint, during the first quarter, Kratos was awarded a fully-funded foreign military sales weapon systems sustainment prime contract valued at over $48 million for the overhaul, upgrade and sustainment of air defense weapon system munitions in support of U.S. allied nations under United States Foreign Military Sales Program.
We were awarded a $9 million modeling and simulation prime contract for the development and maintenance of phenomenology and lethality models supporting the United States Missile Defense efforts.
Related to this, a key Kratos differentiator continues to be modeling, simulation and other work related to the weaponization of unmanned systems. And we’re now getting involved in the defense against identification, tracking and destruction of our potential enemies’ unmanned systems.
During the first quarter we were awarded approximately $7.1 million in Aegis Ballistic Missile Defense task orders under a prime contract vehicle to provide ballistic missile defense related products and services and to support engineering, integration and flight tests for a family of suborbital rockets used as diagnostic tracking vehicles that simulate a variety of potential enemy ballistic missile threats.
We received tasking under our Consolidated Professional Services or CPS, prime contract vehicle for support of predator and reaper unmanned aerial vehicle operations out of Wright-Patterson Air Force Base. We provided systems modification services for the upgrade of certain platforms, communications and C5 systems in support of a certain foreign military sales effort.
Our Information Assurance, Networking and Cyber Security practice has begun work on a network management and protection program for certain Department of Defense communications and satellite networks. And we continue to provide network management, assurance and protection solutions and products to certain national security agencies. We received $3.2 million in United States Navy Workforce Learning and Performance work related to our Navy customer and next-generation information technology capabilities.
Kratos’ Workforce, Learning and Performance Management business, including for the United States Navy and other government agencies and customers is one of Kratos’ fastest growing business areas today and an area that we believe will continue to grow as the federal government workforce expands.
During the first quarter Kratos’ Public Security and Safety division received $9.5 million in new contract awards for security system design, deployment, integration, operation and maintenance for certain strategically important assets and infrastructure here in the United States.
Additionally, our Public and Homeland Security business thus far in the second quarter has continued to rebound with approximately $5 million in new Public Safety and Homeland Security related contract awards thus far in Q2, including security system design work for a large national oil company.
On the Gichner acquisition, we have received early termination of the HSR waiting period, which was great news and ahead of our expectations. We also have some additional good news from Gichner, with first quarter bookings for their business of approximately $50 million for the three months ended March 31, which was stronger than we had originally anticipated and which provides us additional comfort for the business for the second half of this year. We believe all other aspects of the transactions are on track and we currently expect to close the acquisition in May. Deanna?
Deanna Lund
Thank you, Eric. Good afternoon. Today we reported quarterly revenues of $68.7 million, compared to first quarter 2009 revenues of $82.6 million, which reflects a reduction in our Government Solutions segment revenues from $74.4 million in the first quarter of ‘09 to $61.5 million in the first quarter of 2010, reflecting our continued reduction of lower margin pass-through revenues and efforts to enhance operating margins, the impact of government in-sourcing and certain of our Government Solutions contract, as well as, the impact of delays and contract awards, which include certain work that has been extended on bridge contracts but at a reduced operational pace.
Although one of the delayed contract awards, the $48 million military sales contract was awarded in March, we were unable to ramp up the production on the program in the first quarter that we had originally anticipated.
In addition, our Public Safety business though it has returned profitability continued to be impacted by the macroeconomic conditions. Revenues decreased from $8.2 million in the first quarter of ‘09 to $7.2 million in the first quarter of 2010.
Kratos’ gross margins increased for the first quarter of 2010 to 24% from 20.8% in the first quarter of ‘09, and sequentially from 22.6% in the fourth quarter of ‘09, as a result of the favorable mix of revenues comprised of our higher margin, Ballistic Missile Defense, Information Assurance and Cyber Security business areas.
SG&A decreased from $11.4 million in the first quarter of ‘09 to $10.6 million in the first quarter of ‘10, primarily due to cost reduction actions we have taken. Our EBITDA for the first quarter of 2010 was $5.9 million or 8.6%, up sequentially from an EBITDA margin standpoint of $6.6 million or 8% in the fourth quarter of ‘09, and up year-over-year from an EBITDA of $6 million or 7.3% in the first quarter of ‘09.
From an operating segment standpoint, our Government Solutions segment generated $4 million of operating income in the first quarter of 2010, down from $4.2 million, compared to the same quarter last year, which excluded the $41.3 million impairment for goodwill.
However, operating margins for the Government Solutions segment increased 16% from 5.6% in Q1 ‘09 up to 6.5% in 2010. Again, the ‘09 operating income excludes a goodwill impairment charge in that period.
Our Public Safety and Security segment was slightly profitable in the first quarter of 2010, up from a loss of $400,000 in the first quarter of ‘09, reflecting the impact of the cost reduction actions that we’ve taken in 2009 and the core responding improvement to operating margins in those businesses.
From an operational pro forma EBITDA metric, our Government Solutions segment generated $5.7 million of EBITDA or 9.3% of revenues and our PSS segment generated EBITDA of $200,000, which continues to show improvement in its operating margins and contribution to the corporation.
From an operating income standpoint, on a GAAP basis, our Government Solutions segment increased from a loss of $37 million, which includes a goodwill impairment to $4 million in 2010 and our PSS business improved from an operating loss of $400,000 to breakeven in 2010.
Our consolidated EBITDA for the first quarter, again was 8.6%, now in the range of our comparable peer group as a result of our continued cost reduction efforts, as well as, the reduction of lower margin revenues and efforts to enhance our operating margins.
On a GAAP basis, net income for the first quarter was $200,000, which included the income from our discontinued operations of $600,000 and an interest charge of $2.2 million related to the write-off of differed financing costs related to our recent refinancing with a net of tax impact of approximately $2.1 million.
On a pro forma basis, EPS from continuing operations without this charge and utilized in an expected cash paying income tax provision was approximately $0.11 per share. Our income tax provision was approximately $300,000 on a pre-tax loss of $100,000, which reflects a $2.2 million interest charge related to the refinancing.
As we discussed on our last call, our tax provision primarily reflects the cash payments we expect to pay for AMT and certain states that we’re not able to file on a combined basis and therefore cannot utilize our net operating losses.
As we’ve discussed previously, we monitor ownership changes in our stock very closely to determine if an ownership change under Regulation 382 has occurred, which would result in an annual limitation of our NOLs.
As a result of the 13D that was filed a few weeks ago by our new 5% shareholder, an ownership change as defined by the Income Tax Code has been triggered and therefore, a computation of the corresponding annual limitation of our NOLs going forward was required. We have worked very closely with our tax consultants and valuation specialists to compute this new annual limitation.
As you can imagine, this is a very complex computation and we currently estimate that the annual limitation for usage for the next five years will be over $20 million per year, which we believe will shield or substantially -- will shield all or substantially all of our taxable income on a standalone basis in the next five years and will also shield a vast majority of the estimated combined taxable income with Gichner.
As a reminder, our current federal NOLs of over $200 million expire through periods of 2028, so we believe even with this new annual limitation we will be able to utilize all of the NOLs before they expire.
Moving to the balance sheet and liquidity, our cash balance was approximately $6.3 million at March 28th, plus $400,000 in restricted cash or total cash on the balance sheet of $6.7 million. Our cash flow used from operations was $700,000 in the first quarter, a few million better than we had originally forecasted. We expect that cash flow generated from operations will be positive for the balance of the year with approximately $10 million of cash flow from operations expected with the second quarter.
As we discussed on our last call, in conjunction with the financing for the Gichner transaction, we also expect to enter a new $25 million revolver, primarily for performance bonds and letters of credit requirements that we have.
We’re currently with our bank -- working with our bank group to place the revolver secured by our receivables and inventory balances and we’ve received a term sheet and commitment letter from our lead lender for the facility. The terms and conditions in this terms sheet, we believe are very favorable for the company and includes an interest rate substantially lower than our existing facility.
As we stated on our last call, when we closed the financing of the notes and the new revolver we expect to take an additional interest charge of approximately $1.9 million in the second quarter related to differed financing costs of our current credit facility. In addition, we expect to take a charge for acquisition related expenses of approximately $1 million for the estimated transaction expenses we expect to incur to close the transaction.
Other key balance sheet and capital structure elements at March 28th are as follows. Accounts receivable, primarily from the U.S. government and other agencies was $93.6 million. Accounts receivable days sales outstanding, or DSOs were at 124 days, which we flexed the timing of milestone payments on a weapon systems contract which increased our DSOs by 22 days in Q1.
However, thus far in the second quarter we’ve received payments under this contract of approximately $16 million as the milestones were billed and collected within 30 days of billing, which we reflects very favorable payment milestones we were able to negotiate on this large multi-year contract.
Bank debt at March 28th was approximately $53.5 million, including $35 million on our senior term note and $18.5 million on our line of credit. Total net debt, net of the $6.3 million in unrestricted cash at March 28th was $48.2 million.
Moving on to backlog. Our total backlog at the end of the quarter was approximately $583 million, including approximately $183 million in funded backlog. Our contract mix for the first quarter was 30.9% of revenues on fixed-price contracts, 37.6% from CPFF contracts and 31.5% on time and materials contracts.
For our first quarter government revenues, approximately 60.4% are performed as a prime, with the remaining 39.6% performed as a team member or as a subcontractor. We expect these ratios will change once the Gichner transaction closes as a significant amount of work Gichner performs is directly for the OEMs and their specific systems, platforms or applications.
Revenues generated from contracts with the federal government were approximately 84.9%, including revenues with the DOD of 75.7% and revenues with non-DOD federal government agencies of 9.2%. We also generated 3.9% of our revenues from state and local governments and 11.2% from commercial customers.
Finally, as I mentioned on our call a few weeks ago, going forward we will be reporting a pro forma EPS number which will reflect EPS utilizing the actual cash taxes Kratos expects to pay. We will be reporting this pro forma EPS as a result of the significant benefit we will be receiving from Kratos’ NOLs for the next several years and that Kratos’ cash paid for income taxes is substantially below that of other tax-paying entities.
At times our GAAP income tax provision may approximate the actual cash for income taxes that we expect to pay but at other times it may not, due to non-economic reasons and items which can impact a GAAP income tax provision. We believe that a pro forma EPS, as we’re defining it here, based on the expected cash paid income taxes reflects the true economics of Kratos’ earnings and cash flows.
With that, I’ll turn the call back over to Eric for his final remarks.
Eric DeMarco
Thank you, Deanna. So, in summary, Kratos had a very solid first quarter, taking into consideration the current government contracting environment, including the slow government procurement process, contract award delays and contract protests continuing to impact the industry.
We believe that Kratos is very well positioned in the areas of national security priority. These include ballistic missile defense, including Aegis and FAD. Unmanned aerial vehicles and unmanned systems, including the weaponization of unmanned systems, modeling, simulation and design work. C5 ISR, including electro-optical, infrared, photonic and other exotic types of sensors, including sensors related to unmanned systems and ISR applications. Information assurance, network management and cyber security, including in support and protection of Department of Defense and three-letter and classified agencies. Public Safety and Homeland Security and the protection of important strategic assets and infrastructure here in the United States. And finally, weapon systems sustainment and lifecycle extension, including related C5 ISR systems and the large FMS market.
Kratos had a very strong first quarter of bookings, with a book-to-bill ratio of approximate 1.3 to 1. Kratos’ PSS business has returned to sustained profitability. It had a solid first quarter’s bookings, which has continued thus far into Q2 and we are pursuing several new Homeland Security type opportunities in our capture process at this time.
We’re also taking a very close look at funding trends in this area from a strategic standpoint and is specifically related to the recently released Quadrennial Homeland Security Review. And as I mentioned before, preliminary first quarter new contract bookings for Gichner came in very strong at approximate $50 million.
Finally, we just received word today that one of our major range prime contracts, which we have been performing under a bridge for the past several months has now been awarded with a five-year contract term and a significant scope of work increase. We will be more formally announcing this award shortly. Accordingly, we fully expect revenues to ramp throughout 2010, starting in Q2 as we start to perform in increased work on some of our recent large and other contract awards.
We are also reaffirming our previously stated 2010 profitability targets, EBITDA and EBITDA margin rates and we expect to generate a significant amount of cash flow from operations for the fiscal year, including approximate $10 million of cash flow from ops in Q2 alone.
With that, we’ll turn it over to questions.
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