Good day, ladies and gentlemen. And welcome to the Kratos Defense & Security Solutions First Quarter 2012 Earnings Conference Call. [Operator Instructions] As a reminder, this call may be recorded. I would now like to introduce your host for today's conference, Laura Siegal, Vice President and Corporate Controller. Ma’am, you may begin.

Thank you. Good afternoon, everyone. And thank you for joining us for the Kratos Defense 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 planned to discuss today. If anyone has not yet seen a copy of this press release, it is available on the Kratos corporate website at www.kratosdefense.com. Additionally, I’d like to remind our listeners that this conference call is open to the media and we are providing a simultaneous webcast of this call for the public. A replay of our discussion will be available on the company’s website later today. During this call, we will discuss some factors and matters that are likely to influence our business going forward. Any matters discussed today that are not historical facts, particularly comments regarding our future plans, objectives, and expected future performance, constitute forward-looking statements. These forward-looking statements may include comments about our plans and expectations of future performance. 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 May 3, 2012, and the company undertakes no obligation to revise or update…

Great, thank you, Laura. Good afternoon. First quarter revenues and EBITDA performance came in pretty much as expected at $215 million and $24.4 million respectively, with adjusted cash flow form ops of approximately $32 million exceeding the high end of our expectations. Accordingly, the business plan is on track and we are reaffirming our previous 2012 revenue guidance of $950 million to $1 billion, adjusted EBITDA guidance of $120 million to $130 million and adjusted free cash flow guidance of $50 million to $65 million. The integration of the critical infrastructure business that we acquired at the beginning of the first quarter is well underway with significant cost cutting actions already having them implemented, which will result in significantly greater EBITDA margins over the balance of 2012, in particular, the second half of the year. Additionally, certain back office and administrative functions during the first quarter were being provided to Kratos by the previous owner of this business under a Transition Services Agreement or TSA, which Kratos is paying for and which TSA is currently in the process of being phased out. The required services under this TSA are expected to be substantially eliminated by the second quarter or early in Q3. The elimination of the TSA and its associated costs at the end of Q3 or early -- excuse me at the end of Q2, early in Q3, is expected to further increase the overall EBITDA margins of the business and for Kratos as a whole. The bottom-line here is that the integration is going very well, it is on track and we expect the profitability of this acquired business to continue to improve throughout the remainder of the year as we had originally planned. Kratos’ Public Safety & Critical infrastructure security business had a record backlog at the…

Thank you, Eric. Good afternoon. The first quarter's financial performance remained solid in what continued to be a very difficult challenging and changing Department of Defense, National Security and overall federal government budgetary environment. Our revenues of $215 million were substantially as we had expected, which was to be at or slightly below our fourth quarter revenue levels. Our adjusted EBITDA of $24.4 million or 11.3% of revenues were impacted by less favorable mix in revenues, which can be choppy at times based upon the mix of products shipped in any given quarter as well as due to the recent acquisition of the critical infrastructure business we closed at the beginning of the quarter, which Eric touched on earlier. The recently acquired business was an asset acquisition we made to acquire the critical infrastructure business from a large multinational corporation, which continues to provide certain back-office administrative and other support services as well as providing facility lease space until we can integrate the business into our existing public safety and security business. The cost of these services provided by the seller were approximately $1 million during the first quarter, which negatively impacted the operating performance of our PSS business this quarter. As previously mentioned, we expect to transition and integrate a substantial portion of these services and facilities to our existing PSS business by the end of this quarter and in the third quarter, resulting in the reduction and elimination of certain duplicative costs. As originally planned, we substantively completed our plant integration of back-office administrative functions associated with the Integral Systems acquisition. With many of the support functions such as accounting, payroll, treasury, and contract administration being transitioned to our San Diego Shared Services organization. Also as originally planned, we are continuing our analysis and evaluation of certain underperforming…

Thank you, Deanna. Three years ago Kratos made the strategic decision to stop investing and are pursuing the non-differentiated government contracting services or support market place. And we believe that what is happening in that market right now is validating that decision. In this government services area, the government customer is making procurement decisions based on the lowest cost, technically acceptable criteria, time and time again, which is basically commoditizing the space. This is being exacerbated by the government’s increasing use in this area of multiple award in IDIQ contracts, which is further driving down cost points and accelerating this commoditization. And the government is also actively looking for ways to significantly reduce overall contract services support spending and use competition and contracting terms like MAX and IDIQ to further reduce margins and eliminate non-essential tasks. This environment has caused companies competing in this space to protest contract awards as a normal course of business, which further delays the commencement of contracted work and makes planning and forecasting virtually impossible. Related to this, just this week it was disclosed that 11 companies have now protested one ofthe air force’s largest IT contracts in that sense and the air force is now rethinking its entire award decision. Strategically, we believe that the business plan that we made the decision to pursue 3 years ago, the areas of specialized and differentiated products, is an important differentiator for Kratos in this current environment. Our strategy, identifying mission critical national security priority areas, electronic and cyber warfare, electronic attack, missile defense and targets, adversary threat representation and satellite communications. We designed in to these mission-critical, national security areas with proven, deployed products, software systems. Like Kratos’ ARAV or NeuralStar, our CyberC4 Product Suite, specialized electronic products, SATCOM products, unmanned systems products and products where…

Thank you. [Operator Instructions] Our first question comes from Mike Crawford of B. Riley and Company.

Eric, there is a lot to go over, would you start with one, you said you want to invest further in unmanned systems. Can you talk about the opportunity with unmanned combat systems and what Kratos brings to the table there?

Currently, we manufacture avionics and electronics that go in certain aircraft. And we also manufacturer electronics in the ground control stations for certain unmanned systems or unmanned drones. We have outstanding visibility into this marketplace, because of our electronic product suite and our existing customers, and this is an area, especially related to area access, area denial, that is going to be well-funded and we are positioned with the right customers, the right products, and the right technology. And so, it’s an area we're involved with.

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

Sure. So, Integral Systems has turned out just to be outstanding,an outstanding acquisition for our company. And it is just killing it. And I went through a number of the programs we’re allowed to talk about, where we are seeing significant growth areas. Approximately, 90% or 95% of that company’s business has to do with strategic satellite communication operations and 90%, 95% of that revenue has to do with the software that command and controls, the space assets, the people that are working with the customers that are command and controlling those space assets, products and software that do communications conversion from satellites to terrestrial communications, cyber-related work on the geo-location of RF interference and potential cyber threats to the fleet. So that is 90% or 95% of the business. Another small percent of the business was related to flyaway VSAT terminals for example or little antenna systems for example and there is nothing wrong with these businesses, but we are not big enough and we don’t have the resources to be the best in everything. And so in the 90% or 95%, where Integral Systems' systems software and products command and control 85% or 90% of the space segment, that’s where we are going to stay focused. And on the other small areas, we are assessing if we should make a run at it, if maybe we should go to someone else who’s primarily focused in that area and see if they’d be interested in it, we’re just making an assessment there.

Okay. And then final question about operations on this Atrix test that NASA conducted using your rockets. If you go to the NASA site, they talk about using not only the Oriole, but also Terrier, O’Ryan, and Terrier improved malemutes, which are all, I believe, Kratos rockets though earlier acquisition DTI, but are those rockets relevant to what you’re doing now or is that just getting to there with too much detail?

Those rockets are absolutely relevant to what we’re doing now. Part of that test had to do with plume analysis, if there were certain events that happened where those rockets were launched. And it is an area that is extremely well-funded and there are like 1 or 2 additional players other than Kratos, so it’s very limited competition. And we have the, we believe, the lowest cost solution that meets the customers’ requirements.

Thank you. Our next question comes from Michael Ciarmoli of KeyBanc Capital Markets.

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

No, it's, if you go back and looked at what we said at the last call, we -- it came in as I said in my prepared remarks pretty much as expected. If you take a look at the businesses that we’re in, primarily the products businesses you’re in, for what I believe is government year-end reasons of September 30, what being the government fiscal year end. Q3 and Q4 historically has been the strongest, especially with very quick procurement and purchase decisions by the government. I think it has to do with their nearing in calendar Q3, they are nearing 930. They want to either spend or obligate their funds, which then will go into Q4 to make sure that they don’t lose it, and that has caused upticks in the past, in those areas, and we’re seeing that lighting up right now again. In addition to that, we have pretty good visibility of a number of programs that we’re currently building that we are going to be delivering in Q3 and Q4 and those are in-house. And the assumption set really hasn’t changed too much. It’s pretty much on track. I'm hoping that will stay on track at least through Q3 and then we’ll see what happens with the election and maybe 2013 CRE.

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

Well said, well, yes, half of the above, well said. So, here is how we’re -- we’ve been looking at that risk. Our critical infrastructure security business is about 20% of our company right now, and this is our hedge. Other defense contractors are going into HELFITI [ph]they are going into renewalable energy, they are going into stuff like that, that’s non-DOD funded. We made a decision to stay with security and we’ve gone into the critical infrastructure business as I said in my remarks, virtually none of the revenues there is -- none of the customers there is department of defense related. The book-to-bill ratio in Q1 was 1.3. The backlog is at a record high. There were very, very few players in this space, especially players that have the critical infrastructure of the size that we have -- that we can do a national deployment of a uniform and ubiquitous security system across an agency or an entity, an enterprise or commercial enterprise, that has locations across the country. So, now with that as backdrop to answer your question. We are -- in our assumptions were assuming that things are going to flatten out in Q4 on the DoD side, but our critical infrastructure business is going to remain strong and that’s what we’re seeing right now. So, that’s what we’ve hedged for this year as far as sequestration, which is supposed to kick in January of 13, if it’s happen. We are doing all the prudent things right now that we can do to control things. We are consolidating, we are not talking about this much, we’re consolidating facilities where we have leases running off across the country. We are bodying up facilities. We are significantly reducing the G&A infrastructure in the company, Deanna talked about that relative to the PSS business, we’re doing it elsewhere in the company and battening down the hatches is probably too strong of award but we’re tightening things up in anticipation of sequestration because that’s what we can control and if were to happen and then we’re just going to have to make an assessment okay, here it is what programs did it hit, how did it impact us, and then we can make business development or customer revenue decisions from there.

Okay,. And then, just the last one, still expecting the gradual quarterly ramp, I mean looking at the public safety and security operating margins, do they gradually ramp or do we sort to see step function jump in Q2 maybe back up towards those Q3, Q4 ‘11 levels of 11%?

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

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

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

Just maybe to follow-on the Mike’s question, thanks for all the detail on the prepared remarks, but I guess what I’m trying to get my hands around is, we’re talking about all these positives for the business and one segment of the business flat to down and the other down significantly but, we look at the total organic growth and we’re down something like 18% this quarter. So, I’m just trying to understand that a little bit better. Could you maybe…

Sure. The biggest part of that and this is something we’ve talked about for the last couple of years. The last small business contract that we acquired remained an acquisition in June of 2007, excuse me, June of 2008, Digital Fusion DFI. It was -- when you look at in the surface, it was run rate $70 million or so business, but the purchase price we paid assumed a $30 million drop-off in business because they have significant small business, including one very large contract with NASA, down in Florida. That NASA contract went away this time last year. We did not and we don’t have it anymore. And so that contract has fallen away. That’s the primary driver and then in addition to that, secondarily to that, all through last year when we talked about the street routinely on the calls last year. We were working from the liquidity standpoint to drive out as much of the pass through revenue as we could in the company where we’d get a 1% or 2% material M&S material and subcontracting fee on it, but the DSO would be 90 days and that didn’t do -- that didn’t make any sense. So, we had quite a bit of that in the first-half of last year and that really went away in the second-half, and that’s the second piece.

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

No, but it was I think it was a pretty…

On an annual basis it was approximately $20 million.

Yes, it was $20 million ish.

Okay, great. Thanks for that color. And then the other question I had just in the press release, you talked about some customer milestones in the back half of the year that needed to hit in order to make the free cash flow guide, or at least that’s what I read it, could you maybe expand upon that a bit?

Sure. So, when we acquired Integral Systems, and then we’ll talk about the Critical Infrastructure Security business, we were very fortunate on Integral Systems. And one of the reasons we were very fortunate had to do with timing of milestone collections on certain of their very large contracts. And we acquired that business at the cycle point where they had built up a significant amount of receivables that could not be billed and collected until this year when we owned them. And so these are normal scheduled timing when you hit the milestone, you can build for a significant amount of work that’s been done previously and that’s that piece. The second piece has to do with the critical infrastructure business that we acquired. As Deanna mentioned, the receivables on that business, and I think when we acquired that business we talked those are going to be like $40 million revenue business or something like that. The receivables were like $25 million, the strategic that owned the company was Gigantor and they didn’t focus on these receivables, okay. We did big part of them were an unbilled and a big of them were billed, the billed ones we’ve shipped out and we collected a big part of that in Q1, we are get to more in Q2. The unbilleds, we have gone through for all the billings together shipped out all the invoices, those are now starting to come in and so this where we took advantage of a working capital aberration where we are collecting it.

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

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

Okay, all right, great and just last one from me. Again on free cash flow you, had that $2.3 million adjustment for the calculation you provided in the press release, are there any other acquisition related items in that adjusted free cash flow guidance?

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

Thank you. Our next question comes from Mark Jordan of Noble Financial.

Good afternoon, Eric and Deanna. To go back once more the sort of free flow guidance versus the opportunity and accounts receivable, it’s my understanding $50 million to $65 million that you’re talking about the free cash flow guidance for the year, is what you expect you left out of the EBITDA of $120 to $130 after paying debt -- interest payments and taxes. And that if you look at the $250 million of accounts receivable of 110 day DSOs overtime even possibly greater than a year timeframe, getting that to 90, would allow you to free up a further $47 million. So those are 2 discrete separate forms of cash, one from operations, the other one from working down DSOs. Are those correct statements?

That’s correct. So, Mark if you go through the details what I went through, so assuming the guidance of the $120 million to $130 million of EBITDA, walking through the interest - cash interest payments of 62.5 and 10 to 14 of CapEx and cash tax payment of $5 million. So, on the low end of the guidance that equates to 42.5 of free cash flow before any reduction of DSO or any type of cash stores from working capital. So, on the low end of the range of the $50 million that assumes $7.5 million of working capital source or reductions of receivables, which equates to 3 days on our DSO of 110. And then on the high end of the range of the 130 of EBITDA taken those same amounts for interest and taxes, that assumes $16.5 million of reduction in receivables or a flow from working capital, which is equivalent to a 7 days reduction of our DSOs.

Okay. And then the longer term opportunity would be going to 90 days, which would be $47 million, that’s probably a multiyear event…

Yes, that’s correct.

And that’s probably a multiyear event.

Yes, that is correct.

Okay. Starting with Eric, there are some interesting releases relative to the Oriole rocket shoot, one that I found intriguing was the one where you’re proving out the new guidance system and flight termination capabilities. Is that critical from the standpoint that it dramatically expands the addressable market for the Oriole, allowing you to do targeting testing over land and therefore, be more competitive against some of the higher-priced Lockheed and other folks who have dominated that space in the past through the Air Force?

Yes, Mark, that’s exactly right. The previous -- the current or existing targets were primarily related for Aegis-type systems and ship-based systems. Some of the threat profiles that our customers came to us and asked us to address, which is one of the reasons we felt comfortable going on this internally funded endeavor, had to do with ballistic missile threats being fired over land. And because of that, we designed and have now fired this new system, which has a different type of control system on it and it has a certain type of a self-destruct system. So, it can be used for land based or city based tax.

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

By more than that. This is very significant -- this has opened up. It’s not going to, as I mentioned, we’ve received orders already. This has opened up number of new markets for us. And this -- if you are designed in, this lowest cost technically acceptable thesis isn’t all that bad, because if you've got the lowest cost system that hits all the technical requirements of the representative threat that your customer wants you to represent. In today’s environment, you will win the work, because the money is not there. Your target is $5 million and your competitor’s is $50 million. It’s the amount of politics that will guide the customer to the $50 million is over and now they want to do 10 shots instead of 1. And modeling and simulation is wonderful on the computers, but it has been proven time and time again, including very recently, that it doesn’t take lifecycle test shots of targets into consideration, and we have seen some failures as a result of that. And so, the military wants to execute more and more live fire tests, not just in this area, but in other target areas as well. The targets area right now, in our opinion is white hot and it is going to remain that way, especially because of the threat profiles coming out of China and Russia and including fifth generation threats.

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

Right. And so, there are - the older Oriole, there were 3 variants: A, B and C. And on the A what you just said is approximately correct. For competitive reasons, we won’t get into on the B and the C, which are the ones that we are launching more and more of now, those are higher than the A.

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

Yes, Mark, we have two things going on, so there will be a step down on a steady state basis with the current revenue that we have, but there are some increases to that SG&A related to revenue, where we have some commissions built in, with somewhat -- especially on our PSS business. So, I would say that they will be at about the level that we are at today with potentially some slight increase as it function as revenue increases for certain areas.

Thank you. Our next question comes from Josephine Millward of The Benchmark Company.

So, Eric in your prepared comments you talked about the rocket support services BMD Aegis related business is one of your fastest growing areas. Can you help us quantify the annual run rate of your missile defense business and how fast do you think this business can grow in the coming years?

Okay. So, our total missile defense business, which includes Aegis and tactical missile system, so, for example the $24 million award we just announced recently that total business annually is probably somewhere $50 million to $75 million annually and that business probably combined can grow over 10%, it’s growing combined over 10% annually.

Great, can you give us an update on the Ballistic Missile Defense opportunity for short and medium range targets, I believe there might be a solicitation out there?

Yes, there is a solicitation out there, a lot of solicitations that are out there in this area right now have to do with maintaining the defense industrial base and it has to do with maintaining the solid rocket capability remaining in this country. And there are 2 solid rocket motor providers left, there’s Aerojet and there is ATK. And there is a concern and much probably a valid concern that there may not be enough business for there to be 2 healthy competitors in this space. And so there is a solicitation out there for some very large medium range MRBM medium range ballistic missile targets. That is not an area, those size targets, where we currently play. We currently play in what are called subscale targets that put off a threat profile that is representative of a full scale threat, which is one of the reasons why it’s lower cost, okay.

Okay. You don’t view this medium range target as an opportunity for Kratos then?

We do not. What we view as our opportunity in this area is declining budgets, okay is limiting the amount of funds that agencies can spend to practice and do practice shots. And so the lower the cost point you have in this areas, the more practice shots they can do and with the proliferation of what’s going on in missiles in the world, they want to be more and more practice shots, that is what is driving this and now with this new variant that we have, it is opening up new markets, hypothetically like Aegis assure, or Patriot, or FAD and potentially even GMD.

Okay. Also shifting gears, the Critical Infrastructure award you plan to announce in the coming weeks, is that one of the 2 major opportunities that you talked on the last call?

It’s not. This is a one that Dan Goodwin when his team pulled off and it’s just fantastic, but so this is the third one. It’s not one of those 2.

So, this is in addition to the other 2, can you give us an update on the other 2?

They are in the procurement process as we speak.

Thank you. Our next question comes from David Sagalov of Jefferies.

I was just wondering can you comment quickly on the S&P downgrade, one notch downgrade.

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

Yes, they were actually very clear that the cash on the balance sheet is really not take into the consideration and as you are well aware on our senior notes there is no call on that. So, cash that we’ve accumulated on the balance sheet we get no credit for, but we can’t pay the notes down. So, we’re kind of in a box from a rating perspective. The other issue that they were concerned about is just the potential budgetary concerns with sequestration. So, those were the 2 things…

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

Yes, we were certainly a little surprised by it, it seemed like a pretty positive note, and then it’s still down there and so…

Exactly.

It seems like there was kind of digging you guys for basically they have seen like just a small size kind of issue relative to leverage?

Yes.

Yes.

And then just lastly can you just clearly talk about I guess then the use of cash, I know you’ve talked about it before and we know that notes are trading pretty well, I think around 108. So, what is the intention for use of cash, is it just container building, just lower -- is net leverage targets still around 4x for the end of the year?

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

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

Just a couple of questions from me, on the public safety side, you mentioned earlier we talked about the fact that the margins went down, even if I net out the $1 million in TSA, it looks like core profitability has come down. The business you acquired earlier this year, is it profitable or how long does it take you to get that to return profitable?

Right, the costs that are coming out of that business are in addition to the TSA, so that TSA number was just one piece. So for example, there are facility costs that are coming out, there are other types of back office costs that the TSA doesn't cover. There are installation costs where there’s duplication across the company where you're on jobs in both our business and the acquired business, and it is not -- what you don’t want to do is upset a customer, so you want to run out those jobs before you make some rightsizing decisions on direct, if you know what I mean. And so, it’s not just the TSA costs, that business we believe will absolutely unequivocally in the second half of this year, be as profitable as our core PSS business prior to acquiring it. It’s the same type of work, same type of customers, same type of service and maintenance agreements that are extremely profitable, same customers. It’s the same stuff.

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

Yes. So the way - so we kind of look at it a little differently, but our critical infrastructure services business historically has made somewhere between around 12% or 15% EBITDA margin. That’s what it’s been able to do. It’s historically done gross margins of 29% to 31% or 32%, something like that historically, okay. We believe combined, the combined business because it’s not, it’s combining now. It’s, as I said, locations are combining, vehicles are combining plus all combining, the combined business in the second half of this year will achieve those high-20s, low-30 gross margins and it’ll achieve those low-teen EBITDA margins.

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

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

Thank you. Our next question comes from Jonathan Richton of Imperial Capital.

I wanted to touch on more of a, I guess 10,000 foot question maybe. Over the year, you guys have spoken about how you strategically please yourself around kind of the BRAC realignment and now that there is talk about possibly going to another BRAC process, how are you guys doing with the opportunities going forward.

That’s an interesting question, you are exactly right, so when we laid out the strategy we built our company where we believed that the BRAC would be consolidated into. So what we see happening now. San Diego, it looks like it’s going to be a huge BRAC recipient, huge. The number -- we are already the largest concentration of warships in the world, it’s going to be -- our brand is going to be going up by 25% or 30% because of the pivot -- this administration’s pivot of the Pacific Rim. We are obviously we are headquarter here, we have a huge presence here, we are extremely well-positioned for that BRAC move. As you know we have the significant presence in Huntsville, Alabama. Huntsville, Alabama is where the Missile Defense agency is now headquartered. Future BRAC moves are planning on BRACing commands into Huntsville. So, we’re extremely well-positioned there. So, we believe if this next round comes, we are not at any of the bases or commands in any material way that are looking to be BRACed and moved. We’re actually in the couple, 3 of the potential recipient locations.

Okay, great. And the just looking at some of the contracts announcements over the past couple of months with the DSP and I think -- I guess can you give us little more color on what Kratos’ participation will be and kind of what your expectations were in term of the benefit?

Right. So, those are new awards. And if you look at common threat in these awards, most of them are with SPAWAR and most of them are communication systems slanted, and in particular seaborne communications and undersea communications. And that is an area we have a very strong presence here in San Diego at SPAWAR and in the east coast in SPAWAR, and this ties into our MILSATCOM pieces, that ties into one of the reasons, one of the synergies we saw with Integral Systems and it’s an opportunity area for us. It's not like some of the other that beat that $80 million piece of business that we have that is just shrinking right now, right in front of us towards the upgrade or the consolidation of the legacy IT systems commands, that is program management, that is not doing well, while the other one is doing well.

Thank you. Our next question comes from Bhakti Pavani of C.K. Cooper & Company.

The question I just wanted to talk about your previous comment that you mention that you are focusing on gathering more cash and reducing the debt, would it be fair to assume that there are no more acquisitions lined up for the year?

Yes, it’s -- I will tell you this. We have not been actively pursuing acquisitions. And when I say that we are not -- we don’t have a list and we are saying we are going to go acquire this company or that company or this capability or that capability. We are absolutely unequivocally not in that mode, no way, okay. However, if an opportunity, let’s use the critical infrastructure business that happened at the end of calendar Q4 of the end of the calendar ‘11. If an opportunity comes to us where it’s a business that’s exactly what we are doing and extremely favorable purchase price, okay, that either one like that business had an incredible balance sheet that we can get the benefits of, which we are doing right now or two, it’s in a real growth area, a real growth area. I mean, there are like 3 real growth areas left right now, real ones. I mean, there is a lot of bologna out there, but they were like 3 real ones. If it’s in one of those 3 real areas, where there is extremely limited competition etc., you bet your boots, we are going to look at it, absolutely, bet your boots. But I will tell you literally there are dozens and dozens and dozens of assets that are for sale today and 99% of them are crap.

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

So, the pure SATCOM business right now is somewhere between $175 million and $200 million in revenue. And it is growing at approximately 10%.

Okay. Just touching base on the recent news that came out, I think a couple of weeks ago regarding the U.S. House lawmaker adding $1.1 billion to the Air Force. And they are planning to like increase investment in some of the programs that Kratos is already built in? What are you seeing -- I mean, are you seeing any business coming through or any follow-on contracts on that or it’s just the news?

That right there was to us as of right now was just news. And we haven’t seen anything there, but if the F-15 upgrade happens, that would be -- in the electronics area, that would be very significant for us. If they are talking about an F-16 electronics upgrade, that would be extremely significant for us. And -- but nothing yet and if there are additional orders placed for F-18 because of what's going on with F-35 obviously that would be huge for us, but nothing from that news yet, no.

Thank you. Our next question comes from Ania Wacht of Seix. Your line is now open.

This is Ania Wacht from Seix. Can you tell me what the pro forma LTM EBITDA was?

I don’t know something of the top of my head. I'll tell you, I don’t know that one, hold on one second.

It’s - Ania this is Deanna, it's about 126 to 127.

Sounds great. And then do you remember what it was for the full year last year?

Yes, for last year, it was roughly about 130.

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

Right. So, we made one prior acquisition in this area before and that was Henry Brothers which we acquired at the end of 2010. That was a standalone company, so it had its own discrete systems, it has its own discreet benefit plans, it has its own discreet facilities that people have their own discreet IT, etcetera, etcetera. So, okay this business we bought and if you go look at filings you can see name of the company that owned it, it’s the reason why we call the critical infrastructure business is even though it’s out there we’re under on NDA on it. This was part of a company. So, it’s stealing some of the company’s facilities and we are paying a lot of money and so we can move out. It is still using this company’s IT infrastructure. We are paying a lot of money for TSA, and so, we can transition ours. And so, we’ve started the transition program as we said we think that all be done by the end of Q2, no way than early Q3 and it’s a lot of money. And we knew this when we acquired it and it’s easy to buy a company, that hard part’s integrating it. We just want to rip everything out and impact the business.

Yes. So, would you say that most of that margin decline was due to the duplicate call, or is it something within the product mix kind of…

Primarily due to that acquisition and now the integration and elimination of the cost element.

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

So, you’re exactly right. So at the end of our third quarter last year in '11, we came out and we detailed on the call. And we identified certain programs where we were going to be making a greater than normal we internally funded research and development spend this year. That is the primary reason the EBITDA dollars are staying kind of flat because we’re really upping that this year. In certain areas some of which I talked about today where we already have the customer relationship. We’re on the platform and we need to build the next best thing for the technology refresh, okay. So, as of right now, this can change but as of right now this year’s R&D spend is currently planned to be stronger than say ‘13 because of the reset you know what I’m saying is kind of the refresh. So as of right now, based on the opportunities that we see and we’re trying to be a rightful. We’re not a huge company, $20 million on R&D spend is a big number for us, but we believe like writing this assessment vehicle we’re really just successful on that internal effort. We’ve got a handful of other ones that for successful. It can really further us going forward and as you know that’s the differentiator of us right now, is being in a niche, being on a platform and exploiting it.

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

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

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