Good day ladies and gentlemen and welcome to the Kratos Defense & Security Solutions First Quarter 2014 Earnings Conference Call. (Operator Instructions). I would now like to turn the call over to Deborah Butera, Senior Vice President, General Counsel, Chief Compliance Officer and Secretary. You may begin.

Good afternoon, everyone, and thank you for joining us for the Kratos Defense & Security Solutions First Quarter 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 the Kratos' corporate website at www.kratosdefense.com. It is also available on the SEC's website. 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 and the potential impact of sequestration, federal government shutdowns and the constraints on the federal budget, constitute forward-looking statements. These forward-looking statements are subject to risks and uncertainties, including those found in the Risk Factors section of our annual report on Form 10-K and our quarterly reports on Form 10-Q, 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 annual report on Form 10-K and any of our other SEC filings, for a more complete description of these risks. All forward-looking statements are qualified in their entirety by this cautionary statement, and we…

Great. Thank you Deborah. Good afternoon. Many important positive developments across the company to update you on this afternoon. We’re glad you could join us. In the first quarter we saw strength in certain of our higher technology and value added product areas including unmanned systems, electronic products, satellite communications and signal intelligence. With some delays and certain PSS new business starts which was open and us achieving the higher end of our adjusted EBITDA forecast and coming in just under the low end of our revenue range. We have now received and started work on a number of new large critical infrastructure security system deployments, many of which we have been able to publically announce over the past several weeks and we expect to see approximately 10% Q2 over Q1 sequential PSS revenue growth and 5% to 10% growth year-over-year for this business. Kratos’ Q1 book to bill ratio was one of the strongest we have seen in the past five fiscal quarters which we believe is the direct result of a DoD budget being in place for the first time since 2012 and the company’s last six months book to bill ratio is now approximately 1:1. Bookings have remained strong thus far into the second quarter as you’ve seen with the number of contract awards we have been able to publically announce including important EA-18G, P-8A Poseidon and unmanned system awards, a large amount of work is now underway, the delivery schedule beginning in Q2 and into Q3 and Q4. Additionally we just recently received a 35 million C4ISR contract award that our customer approves this week for public release and which we will be formerly announcing shortly and just yesterday we received another large Mass Transit Authority Security System Deployment Contract Award. We have also in the…

. : A number of these awards have now being received and work has commenced. Our revenues decreased year-over-year 21% from 252.8 million in the first quarter of 2013 reflecting the impact of fiscal 2013’s DoD budgetary situation which caused certain delays in orders and awards, the related impact to timing and product shipments, the expected reduction in two sizeable satellite communications project as the scope of work completed it's natural contract lifecycle resulted in net aggregate reduced revenues of 5.1 million. And the continued contraction of our legacy government services business of approximately 6.5 million or 29.3% compared to the first quarter of 2013. Operationally we continue to remain focused on cost reductions and efficiencies and in the first quarter we reduced our headcount by an additional approximate 120 personnel or another 3.1% of our total workforce down to a total headcount from year-end of 3696. This compares to a headcount of 3815 at the end of 2013. We have continued to take actions on continued cost reductions in the first quarter of 2014 including in the excess capacity and facility areas. This cost rationalization will be a continuous process which will help to enhance operating margins and efficiencies all improving our operating margins. As a result in the first quarter we have recorded charges related to excess capacity caused in part by the delays in procurements and awards, changes in accruals for our unused excess facilities, severance and contract design retrofit cost. For instance included in the first quarter is a charge of 500,000 during the first quarter related to the cost of personnel reduction actions as well as excess capacity charges of 500,000. A charge of 1 million related to contract design cost for certain of our new aerial target platforms along with an increase of 200,000…

Thank you Deanna. Operator we will turn it over to questions at this time.

(Operator Instructions). And the first question from Mike Crawford of B. Riley & Company. Your line is open. Mike Crawford - B. Riley & Company: On your unmanned platforms particularly the combat platforms, how similar are these different prototypes you’re building for these different customers and to what extent does sales plan to any of the products you’re working on?

Mike, to be clear when you ask how different are they, how different are they from what, sir? Mike Crawford - B. Riley & Company: From each other.

They are very similar to each other. The performance characteristics and the payloads are primarily are different, and they are fairly similar across the customers that I referred to as well and that’s part of the beauty of this is that they are proven systems that there is a logistics tail, there is an inventory tail and which means lower cost initially a lower cost over the long and midterm. Mike Crawford - B. Riley & Company: And for stealth when really come into the equation then for what you’re offering and what some of these will be able to--

Yes Mike on that, let me be very clear. I cannot talk about that in any shape or form. So that’s my answer I cannot talk about it. Mike Crawford - B. Riley & Company: What about ability to for mid-air refueling?

Mike, these aircrafts are designed to fly in contested airspace. Not uncontested airspace, if that helps answer your first question and these aircraft if required because of the endurance on them that may not be a requirement would be able to be refueled. Mike Crawford - B. Riley & Company: And then just switching gears, can you talk a little bit about some of these new major programs if you can but I believe Kratos will be working on such a SEWIP and AMDR?

Yes so we’re under contract on SEWIP, we’re delivering product and we’re expanding our position on that literally we’re gaining additional content on that on Block 2 as we speak that’s when I was just talking to. On Block 3, SEWIP is scheduled to be released. I think it's been delayed a bit and I think it's September or October, that will also be another very important program for us. We’re under contract and in production on APR-39 which is helicopter of fixed-wing aircraft warning system for incoming threats primarily missiles. That program, we will be ramping over the next couple of years, that program is going to be very significant to us, 10s millions of dollars over the production period. We’re NDA of AMDR and NGJ so those are what the people typically are working with, so those I cannot say too much about other than we’re working with long term strategic partners and those will also be very important for us. So they are a little bit behind SEWIP Block 2, SEWIP Block 3 and APR-39 and we’re also on the --- we are under NVA [ph] but we’re involved with AESA upgrades on F-16. Mike Crawford - B. Riley & Company: Final question relates if you were able to go banks today to refinance your balance sheet, what range might you expect to get? Thank you.

Mike, because as we have been talking about on our normal calls, we’re so close now to the no-call date falling off et cetera. That’s something I would rather not speculate on at this particular point in time.

Thank you. And the next question is from Mark Jordan of Noble Financial. Your line is open.

Eric, you seem to clearly be more positive on your UAS initiative now than you were a few months ago. What have you demonstrated and/or what has been communicated to you that gives you this enhanced senses of excitement about the program?

You sensed correctly Mark and I typically try to be reserved on these things but we have had a number of flights with the new supersonic aircraft that have just knocked it out of the park for us, knocked it out of the park for us. In addition to that what Beaman and his team are doing literally in the last 3 or 4 months we have several new customers for our aircraft, for demonstrations, for war games. It is moving far faster than I ever could have imagined because of some of those recent flight test I mentioned we’ve basically completed negotiations on a new $30 million order for aircraft the one that I mentioned. We have virtually completed the negotiations on a $70 million order for aircraft for different platform and the 30; it is a different platform as well. So it's a -- things are -- the plan that we put together is happening and it's coming together for us and that’s what you’re sensing.

You know as well as $30 million and $70 million that are both coming, would they be for 2014 deliveries and what these positive moves is -- you haven't changed the overall guidance for the year which is building conservatism into your expectations?

So based on the current expectation the $30 million, one we would start building this year and so that would be, there would be revenue events for that this year. On the $70 million one that’s expected later in this year, so that would probably not be this year but it would probably be beginning of ’15 just on timing to get going on that. And we’re as you know as Deanna mentioned we’re product based and some of our work that I just indicated is complete and a lot of the other work is based on deliveries and we try to build some conservatives, we try to build conservatism based on initial indications of production schedules and delivery schedules but in this environment and the environment is much, much better than it was in ’13, ’13 was the disaster. Six months of continuing resolutions, government shutdown for all those blah, blah, it was just terrible. So this environment is much, much better but it's still things can still move around a little bit, it's just the case. Mark I will give you an example, we’ve negotiated and we have been approved for an appropriate $40 million order for some very specialized hardware that we fully expected to get in Q1 and now it looks like it's all going to happen in Q2 and we will build it out and we will deliver it over the balance of the year. And we’re design win, we’re sole source, we have been given the documentation, the data package. It's just moved and so we haven't lost anything that’s what’s critical but things are still moving around a little bit, sir.

The air force has announced their intentions to retire the U-2 which was really the only thing that could fly on contested airspace. Also I think the capabilities of the Global Hawk was documented when I guess one was shot down over the Crimea a little bit ago. Is there any platform that is being worked on to your knowledge that could be delivered within the next 2 to 3 years that could provide UAV capabilities that would be able to fly in contested airspace other than yours?

That would be deployable in the next couple of three years.

Yes that could be within a reasonable time horizon or could be relevant to your customer.

Nothing more that -- nothing that I’m aware of, if that excludes anything that could be on the dark side.

Final question on my end, I think I read in the S&P report, and congratulations on the upgraded in the time when still things are pretty dicey. They stated that there is no intention on the company’s part to make any acquisitions for at least the next two years. Is that a firm commitment with the S&P and an understanding of the Boards?

We are. We have made that comment and commitment since we made our last acquisition in the middle of 2012. We have zero intentions of making any acquisitions of any size at all going forward. If something comes along or it's a group of engineers, 5 or 10 guys that might make sense that could add us capability and we want to bring them in with some IP they have, that might be an offshoot but acquisitions -- we have been making in the past, absolutely not. We have some incredible opportunities that we’re working on that are under contract and there are programs where we have sponsors and we would be remised if we went off and did anything to dilute these opportunities.

Thank you. And the next question is from Sheila of Jefferies. Your line is open.

It's Sheila Kahyaoglu. I just want to follow-up on the unmanned opportunity. Is that an incremental 100 million in sales Eric? So the way we should be thinking about your unmanned and missile target platforms being about potentially that 200 million next year?

Sheila, it's which part is incremental 100 million, I want to--

Sure. The two contracts you mentioned the 70 million drone order and the additional the other 20 unmanned aircraft order. So, those two contracts, would they be an incremental 100 million in sales next year the way to think about your total unmanned platform could be 200 million next year?

Sheila, depending on deliveries on the 70, that 70 will probably deliver out over ’15 and ‘16. The 30 definitely, and the potential follow-on to that 30 that will also be a ’15 event. So there are really two potential 30s in there and then the 70. The 70 would be out over 2 or 3 years.

And this is new customers?

The first two are new and the other one is an existing. Two new, one existing.

And then in terms of PSS, this is one of the first disappointing orders. Growth has been really great, do you mind elaborating on the infrastructure contract push out and what gives you confidence for the remainder of the year?

Sure. So on the confidence on the remainder of the year I will answer that first because we have now won the contracts and we have started working on them. That’s what gives us confidence and that’s been a number of the releases we put out over the past month and keep in mind most of their work we can’t disclose because of the customer side of the nature of the work et cetera. When we gave our Q1 guidance, when we reported Q4 we did indicate that Q1 would be down a little bit because we knew we’re coming off of some and we knew we had a bunch of new ones that would be starting. The reason it was off a little more than we thought, the new ones that we thought would start didn’t start as quickly as we had initially planned but as I said they are going now. It appears right now Q2 will be particularly strong for our PSS business.

And then just on the margins in that business, how do we think about that? I know you don’t provide long term targets but could we see that become 6% to 8% margin business? How should we think about that over the next 2 or 3 years?

So 6% to 8% from an EBITDA margin perspective should be the range that we expect. If we look at where PSS was operating at in 2013 they close the year just under 8% EBITDA margins and for the year they were at 7.3%. So that is clearly in the range of our expectations.

Our plan Sheila, because approximately 15% of that business is either maintaining the systems or operating the systems after you deploy them and that annuity stream my word that annuity stream that once you design then you get the maintenance to the operating contract. Those margins are typically better than the deployment contracts and so our plan all along and it's been working has been, we win the work, we get designed in, we have the schematic, and we operate and we maintain it and slowly increase that percent of operating and maintaining which is higher margin. Okay, we have had a good problem in the past year, in a quarter. The good problem is we have been winning so much deployment work -- the deployment piece is actually growing faster than the service and maintenance piece. If you what I’m saying because we’re winning it which is good but it will catch up because the vast majority is once we deploy them we maintain them. And that -- it figures into our mid and longer term margin objective.

And then I guess on EBIT margins but I understand so, the EBIT margins can be slightly better I guess.

Sheila, there is not a lot of dough in PSS so it's pretty close to EBIT.

And then one clean up item. I don’t think you mentioned the Department of Homeland Security contract in the opening remarks. Do you mind commenting on was it half quarter stand on that?

Yes. What’s happening with that is the second -- they will come out so the DHS has indicated what the next set of task orders are going to be. They are going to be between $50 million and $150 million and I think some of them are out or they are coming out right now and they are several of them. It is going to be very, very large, this is Phase II. They have already also started talking about Phase III for next year with task orders of equal size. As I think I indicated before we have or we will be bidding on virtually every one of the Phase II, task orders that are coming out now and over the next few months. So it's happening, it has begun.

Thank you. The next question is from Tyler Hojo of Sidoti & Company. Your line is open. Tyler Hojo - Sidoti & Company:

So Tyler on the first part of your question, on the milestones, there are additional significant and important flight milestones that need to be achieved over the approximate next year and along with those are technical milestones that relate to those flight milestones and performance milestones with specific objectives for the aircraft to do which it's not appropriate for me to get into publically but flight milestones. That will be for the next year into 2015. If things go according to plan starting in 2016 we could hopefully start building on this and then on 2017 we get into production and we are looking at somewhere between around 52 to a 100 aircraft a year for an extended number of years like on our ABS sat [ph] program right now Tyler. We’re finishing production in year 10 and we have just negotiated production years 11 through 13. So we’re going into the 11, 12 and 13 years of production. This would be something similar to that. It's not that -- program it something similar. Tyler Hojo - Sidoti & Company: And I was also looking for little bit more clarity in regards to the IR&D. I think you said under a certain circumstance that could track lower than you’re currently guiding and one is that the case and two what kind of downside driver could that be?

So what Eric has said in his prepared remarks is it could potentially lead to reduction in R&D spend and that applies to both ’14 and ’15 because some of the plans to develop some of these aircraft actually extend through mid-2015. But regardless of that potential reduction in R&D, we’re planning on reducing R&D in the second half of 2015. What his comments refer to is that it could potentially decrease that more than what we were expecting plus also reduce the level in ’15 as well. Tyler Hojo - Sidoti & Company: And I guess lastly Eric, I get you’re not a buyer of properties at this point but I guess I’m just curious on what your perspective is on the M&A market. We have seen some loosening up I guess you could say and are there any particular assets that are kind of part of the portfolio today that you might consider being a seller of?

So on the first part of your question Tyler, in the past three months the activity in the M&A area in small and midsized companies has increased significantly, it's just increased significantly. And I think part of it I think is Ryan-Murray and we know we have got a $496 billion spend for ’14 and ’15. We got budget, we have a ’15 request and we have a QDR. So people kind of sort of think they know what’s going to be funded. Additionally some of the big OEMs which have been buying back a significant amount of their stock and paying dividends which has been great for them and great for their shareholders but they are seeing some very significant revenue reductions and so they are coming back into the market and they are showing some interest and in particular related to specialized product companies. So, that is heating up and we’re right in the middle of it. There is -- our business as you know it's two segments, it's the defense business which is about 75% of the company and it's our critical infrastructure security business. The defense business is substantially integrated. Let me give you an example so you can understand, we build composite aircraft, we build the electronics and avionics to go in that composite aircraft. We build the ground control and flight controls equipment that fly that composite aircraft. We build the command and control shelters but that equipment is in, we build the transport shelters that they are in, we’re going to be at a show in Orlando, you’re going to see all of this down in Orlando in a few weeks. So our defense business is very heavily integrated for the most part. So there is that piece. The critical infrastructure security business, that as I talked about before, and I talked about today, that has been and will continue to be our near term organic revenue grower in the current environment. We’re very fortunate that we started building this business when the Obama administration came in and he changed those procurement rules and policies and I think this business grew 10% or 15% last year, 13% last year and I think it's going to be 10% this year. It's looking good. The book of business is very strong and so looking at those two pieces Tyler, I know there is -- I don’t see an opportunity for us to do anything like that based on our current strategy and the current environment.

Thank you. The next question is from Michael Ciarmoli of Keybanc Capital Markets. Your line is open.

Eric, maybe you could just to elaborate a little bit on not so much the M&A but you have been talking about a lot of the end markets. I don’t think you’ve really mentioned kind of the cyber market. I know you guys have some interesting products and applications. Maybe if you can sort of quantify what percent of the overall revenue streams are coming from cyber? What do you think the opportunities are there right now?

So approximately a 100 million to a 150 million of what we do is related to cyber or information assurance and that includes cyber on the satellite communication side and the terrestrial network side, all right? So our cyber includes our software products that we sell and we integrate or design into certain customers or agencies. Networks, most of which we’re not available to talk about. We do that something on the commercial side and we have software-end products on the satellite communication site. The growth area for us putting aside the DHS contract we won on those past quarters which are very binary, that’s why I’m not even assuming those in our plan, is on the satcom side, in the ground equipment side and our (indiscernible) software and NeuroStar and (indiscernible) and identifying cyber threats. They are trying to be injected into satellite networks.

And then just separately, looking at the defense business you mentioned the budget in place. Can you comment on what you’re seeing in some of your shorter cycle businesses? Whether it's spares or services some of those contracts that it really gotten delayed? I mean are you seeing a pickup in that business?

No, the services business is terrible. It has been completely commoditized, virtually everything is low price technically acceptable, virtually everything. If you do win it's protested and it's delayed for another six months. It is -- Deanna and I talk, we thank god that in our services business we don’t have any major recompetes coming up for the next few years because the incumbents win the work I think less than 20% or 10% of the time now. It's just terrible. On the shorter cycle product side, okay? We’re doing very well with Patriot right now. We’re doing well with AEGIS, we’re doing well with THAAD on the shorter cycle side, all strategic systems. The tactical systems, army and marines; command post platform, things like that have gone to zero.

Last one for me, regarding the refinancing what are the steps? I mean you’re going to have to call your bombs that are out there. I’m not sure how long the notice is but I mean we’re kind of -- what's the timeframe that that’s going to have to take, I mean if you were planning to refinance as soon as your prepaid penalties are over, I mean I would imagine the paperwork’s got to get filed pretty quickly. Am I under the right assumptions there?

You’re correct Michael. So we could either call or tender them or redeem them. So it's a couple week process so it's not as time consuming as you would think and that no call does on June 1st of this year.

Thank you. (Operator Instructions). And the next question is from David Olkovetsky of Jefferies. Your line is open.

My first one obviously relates to the refinancing, I don’t want to through (indiscernible) on the plans. I’m not quite sure exactly what you guys are looking to do in terms of structure. But you just got all this tremendous EBITDA growth coming down the pipe and ’15 and ’16. Why not do a structure or deal where something like half term loan, half bonds so that in after a year you can take out the term loan with a small repayment penalty of 1 or 2 points. I mean is that something, as you’re considering with your underwriters?

Yes. David Olkovetsky – Jefferies: And then you mentioned that there are some leases that are rolling off in ’14 and ’15? What’s the dollar amount of that?

These are corporate headquarters from some of our--

The previously acquired companies.

Previously acquired companies that have been significantly underutilized, they are not utilized at all by us and this is one was Haverstick that we acquired, this is our ballistic missile target business. Their corporate headquarter was in Indiana, that’s rolling off in the next several months and that’s relatively significant to us. It's how much annually in cash?

It's about I think 200k a month.

A month, so 2.5 million a year that will go away right there and then I think it's in the middle of ’15 another significant one--

A fairly sizeable one in Maryland.

Rolls off [ph] in Maryland.

And that was one was acquired from Integral Systems and that was the previous headquarter.

And those dollars are a couple of few million dollars a year also.

So they are fairly sizeable David. David Olkovetsky – Jefferies: That’s great to hear. This can be pretty darn accretive. So these are really just corporate headquarters. There is no production coming out of these facilities right?

These were administrative facilities where we have long since consolidated out the corporate infrastructure, the back office, all that stuff. David Olkovetsky – Jefferies: So that actually fits perfectly into my next question, on the acquisition and also maybe spin-off. I mean are there any small little business units that might have been rolled up through the various acquisitions that now you’re considering non-core and therefore to looking to start off?

No, sir. David Olkovetsky – Jefferies: Nothing? Okay.

Nothing. David Olkovetsky – Jefferies: And just to clarify your earlier comments Deanna, so the minimum call note if I believe is 30 days, so presumably you could issue that tomorrow and do I understand correctly that that is not your plan?

Well we could do it tonight. We could.

As I said David we continue to work with our financial advisors as it's very similar to what we have said in the past and so we continue those discussions.

Thank you. There are no further questions at this time. I will turn the call back over to Eric DeMarco for closing remarks.

Great. Thank you again all for joining us this afternoon. I think I believe our next scheduled quarterly call will be in July or August.

It will probably be last week of July, first week of August.

Last week of July, first week of August. Thank you very much.

Thank you.

Thank you. Ladies and gentlemen this concludes today’s conference. You may now disconnect. Good day.