WSR: Good day from Wall Street this is Juan Costello, Senior Analyst at the Wall Street Reporter and joining us today is Eric DeMarco the CEO for Kratos Defense & Security Solutions. The company trades on NASDAQ and their Ticker Symbol is KTOS. Thanks for joining us today there Eric.
Eric DeMarco: Thank you Juan and good morning, sir.
WSR: Good morning and so starting off, give us a brief history and overview there of the company for some of our listeners that are new to the story?
Eric DeMarco: Very good, sir. Kratos Defense is a pure play national security firm, approximately a billion in revenue and we are focused primarily on unmanned aerial systems, satellite communications, the ground equipment that actually flies and controls the satellites, electronic warfare and electronic attack products and the electronics and ground equipment that supports missile systems and the radars for missile systems.
WSR: Great and so talk about some of the recent contracts there, you were recently awarded a contract over $1.3 million for the Navy Training Development and also earlier in the month to provide IT services to TRICARE Management.
Eric DeMarco: Yes, we have a very large training business here at Kratos. We build maintenance and operational trainers for various strategic platforms like Black Hawk helicopters and Chinook helicopters, the M1 Tank and the Bradley Fighting Vehicle just to name a few and certain unmanned aerial vehicle systems. And these training systems are so the operators or the war fighter can operate and maintain them with technology constantly training, these systems are constantly being upgraded with technology and training the war fighter on staying up to speed and state of the art on these systems is a critical element of our nation’s national security. And that is an area we are involved in with most of the work being sole source.
Another recent contract award we just announced in the last few weeks, was a contract award with Sweden where we are providing them unmanned aerial drone target systems, these are aerial drones that represent state of the art threats, jet aircraft or missile systems of potential adversaries and they use these in Air Force and their aircraft can practice against them. We are one of the preeminent providers in the world of aerial targets and aerial drones that are unmanned.
WSR: Great. And so what were some of the drivers there behind the company’s recently announced Q3 results?
Eric DeMarco: Yes sir. We had a very strong 3rd quarter. Our organic growth was over 10% from the 2nd quarter to the 3rd quarter organically. One of the primary drivers is, we are one of the largest integrators of critical infrastructure security systems; these are video cameras, thermal imaging cameras, access control equipment, CBRNE, Chemical, Biological, Radiation, Nuclear and High Explosive sensors, we are installing these elements in critical infrastructure in the United States power plants, power transport, pipelines, subways, that business grew 20% for us organically from the 2nd quarter to the 3rd quarter. Additionally, our Aerial Drone and Target business is doing very, very nicely and Intelligence, Surveillance and Reconnaissance business primarily related to satellite communications is also going very well in this environment.
WSR: Great. And so what are some of the other trends right now that you are seeing in the sector and how well are you positioned in the company to capitalize on them?
Eric DeMarco: One of the major macro trends in the sector right now is a strategic shift from tactical systems, these are related to the Forces in Afghanistan and Iraq so think Army and Marines these are being deemphasized or defunded, funding is coming down, and the strategic pivot to the Pacific that the President announced, there was a formal paper that came out on this in January to the Pacific for the potential China threat Air Force and Navy and strategic systems that is what is happening at a macro level right now and we are very fortunate, the vast majority of the work we are involved in are strategic systems, strategic satellite communications, strategic unmanned systems not the unmanned systems the small ones that Army or Marine war fighters use but big strategic ones and the command and control and the ISR that those have and electronic warfare and electronic attack products that are strategic in nature to defeat a strategic adversary not an asymmetrical threat like a terrorist.
And in addition to that of course, there is a continuing stalemate in politically rationally, now we have a President that’s good, hopefully now we can get through the year end knuckle off the fiscal cliff and avoid sequestration. And then hopefully, we are currently under a Continuing Resolution Authorization, a CRA, so there is no 2013 federal budget right now for the DOD that CRA goes through March 26 I believe and hopefully all of this will be resolved by the 2nd quarter and will get the budget clarity and then I think all defense stocks are going to lift just because of clarity.
WSR: Certainly and so what would you say are some of the factors that makes Kratos unique from some of the other players in the sector?
Eric DeMarco: I think two things make us unique; number 1 is, we are laser focused on the strategic programs and strategic platforms, so strategic MILSATCOM, strategic unmanned systems, strategic missile systems we are laser focused; number 2, we are product focused, virtually all the work we do in this area is delivering, there is manufacturing and delivering state of the art products where are designed in and if you are designed in, in today’s environment, you are going to be there for many, many years to come because there is less and less new money for new systems and so we are single source or dual source on virtually all the work that we do.
WSR: Certainly and perhaps you could walk us through your background experience there Eric and talk a little bit about the management team on KTOS?
Eric DeMarco: Yes so prior to Kratos, I was the President of the Titan Corporation which is another national security company Tom Tom Nancy (TTN) on the New York. It was sold to L-3, so we built it from about a $100 million in 1996 to about $2 billion or so in 2005 and it was sold to L-3. Myself and a number of the executives, the managers at Titan came over to Kratos in the 04-05 timeframe. And where we were, before Kratos wireless facilities, we were commercial wireless company, we sold all the wireless business that is where we received the $300 million in net operating losses we have that wireless business was losing a lot of money and we have $300 million in NOLs that are protecting us from paying cash taxes. And we starting building this business in the areas we had been talking about today with many of the same players that were at the Titan Corporation.
WSR: And what are some of the goals and milestones that the team is hoping to accomplish over the course of the next 12 months?
Eric DeMarco: So over the next 12 months, we are focused on operational excellence we are not focused on any additional acquisitions at all, we have an outstanding portfolio of business right now, we are in most, in many of the key strategic areas that are going to be funded. So we are focused on operational excellence which means that driving our profit margins, our EBITDA earnings before interest, taxes and depreciation margins to the 12% and 13% range and I think we just did 13% in the 3rd quarter and generating cash and putting that cash no our balance sheet and de-levering we do think the debt, the next debt of the company, we all believe that is the best thing for us to do to generate shareholder and stakeholder value over the next 12 months.
WSR: And so when it comes to investors and the financial community Eric do you believe that the Kratos story and your message and upside and some of the points that you just made are completely understood and appreciated by them and if not what do you wish investors better understood about the company or your sector?
Eric DeMarco: Yes I think right now there is a dark cloud over the defense or national security sector and it has to do with what’s going on in Washington and budgetary issues. In August of 2011 the Budget Control Act was put into place which reduces defense spending by $500 billion over 10 years about $50 billion a year, that’s already baked into the budgets. Then the Super Committee which was supposed to come up with $1.3 trillion in additional cut, failed in November of 2011 which is why we’ve this threat of sequestration coming in 2013 which is another $450 billion in defense cuts over 10 years, which I don’t believe anyone thinks is going to happen but it’s put this dark cloud over the industry. And so, I believe Kratos is thrown in with all the other defense companies which are all down today.
I believe from a programmatic standpoint and a strategic positioning, from where the national security strategy is heading for the Pentagon and for the President, of pivot to the Pacific, strategic systems, satellite communications, unmanned aerial vehicles, electronic warfare and electronic products we are very nicely positioned for all of that, we are on some of the longest lasting and most important programs in the United States National Security Posture and I as I mentioned a second ago, Juan, I believe about middle of next year we are going to have clarity one way or another on the budgets and I believe that clarity is going to let investors say this company is worth 7 times EBITDA and enterprise value this one is worth 8, this one is worth 9 and I just believe Kratos is going to be on the high-end of that, because of our strategic positioning.
WSR: Well good and so once again joining us today is Eric DeMarco the CEO and President for Kratos Defense & Security Solutions. The company trades on NASDAQ, Ticker Symbol is KTOS currently trading at $4.36 a share the Market Cap is north of $2047 million. And before we conclude here Eric to briefly recap some of you key points why do you believe investor should consider the company as a good investment opportunity today?
Eric DeMarco: I believe that defense companies today especially small and mid caps like Kratos are in a trough, we’ve been hammered and we have been hammered for these macro trends and issues we have been talking about today. We are prolific cash flow generators, defense companies are, we’ve been forecasting and we are sticking by that we are going to generate at least $50 million of free cash flow a year about a $1 a share. And that will accredit to the equity value so fundamentally from an execution standpoint we are going to generate cash that’s going to go on the balance sheet that’ll accrete to the equity value. And I believe over the next 6 or 9 months as we clarity on defense budget multiples are going to expand which I believe is going to be a double positive for Kratos evaluation.
WSR: Well, we certainly look forward to continue to track the company’s growth and report on your upcoming progress and we would like to thank you for taking the time to join us today Eric and update our investor audience on Kratos it’s always good to have you on.
Eric DeMarco: Great, Juan and I appreciate you checking back in and following up on us, my entire team appreciates it, thank you for your interest sir.