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Kratos Defense & Security

Kratos Defense & Security Solutions, Inc. (Nasdaq:KTOS) is a specialized National Security technology business providing mission critical products, services and solutions for United States National Security priorities. Kratos' core capabilities are sophisticated engineering, manufacturing and system integration offerings for National Security platforms and programs. Kratos' areas of expertise include Command, Control, Communications, Computing, Combat Systems, Intelligence, Surveillance and Reconnaissance (C5ISR), satellite communication systems, unmanned systems, cyber warfare, cyber security, information assurance, critical infrastructure security and weapons systems sustainment.

Kratos has primarily an engineering and technical oriented work force of approximately 4,100, many of whom hold an active National Security clearance, including Secret, Top Secret and higher. The vast majority of Kratos' work is performed on a military base, in a secure facility or at a critical infrastructure location. Kratos' primary end customers are United States Federal Government agencies, including the Department of Defense, classified agencies, intelligence agencies and Homeland Security related agencies.

In Greek mythology, Kratos is the divine personification of strength. He is the son of Pallas and Styx; he and his siblings Nike (Victory), Bia (Force), and Zelus (Zeal) are all essentially personifications. Kratos is first mentioned alongside his siblings in Hesiod's Theogony. Styx took her sons and helped the new The first king of Olympus in his war against the Titans, after which they became his constant attendants. In Prometheus by Aeschylus, Zeus symbolising lawless power and irresponsible omnipotence is fittingly represented by his ministers, Kratos and Bia, with their appropriate implements of brazen chains.

On 08 May 2012 Kratos Defense & Security Solutions Inc. agreed to buy Composite Engineering Inc. (CEI) in a deal that provided CEIs owners with $20 million in Kratos stock and $135 million in cash. Composite Engineering is a vertically integrated manufacturer and developer of unmanned aerial target systems and composite structures used for National Security programs. Kratos provided electronics and avionics that are on board CEI aircraft and Kratos also provides ground flight control stations and electronics for the command and control of CEI aerial systems. CEI aircraft are made from composite materials in a secure, state-of-the-art manufacturing facility and as a result have industry leading flight and representation characteristics. CEI's market leading drones are designed to replicate some of the most lethal aerial threats facing this nation's Warfighters and strategic assets.

CEI domestic programs as a prime contractor include the U.S. Air Force AFSAT, U.S. Navy SSAT and as a Major sub-contractor include the U.S. Air Force Miniature Air Launched Decoy (MALD) and the U.S. Navy Multi-Stage Supersonic Target (MSST). The CEI suite of unmanned drones includes the BQM-167A/I, the BQM-177A/I and the Firejet. They are all jet engine powered, have advanced threat representative flight performance characteristics, including subsonic and sustained supersonic airspeed capability for the BQM-177A/i, external and internal payload capability and demonstrated altitudes from sea skimming to 50,000 ft.

In calendar 2011, CEI generated revenue of $94 million and Adjusted EBITDA of approximately $16 million, generating an annual organic growth rate in excess of 25 percent over 2010. CEI's primary customers were the United States Air Force, the United States Navy, other National Security related organizations and certain International National Security related agencies. The vast majority of CEI's contracts are sole source in nature, and CEI has developed critical intellectual property for its aircraft which provide significant barriers to entry into CEI markets. As a result of CEI's advanced composite aircraft and products having performance characteristics exceeding that of its competitors as related to current threat environment requirements, CEI's contract win rate is industry leading in competitive procurements.

The largest CEI disclosable were in full rate production, which is expected to continue for several years into the future, with a number of additional recent contract awards scheduled to achieve full rate production over the next two years. CEI's current backlog was approximately $160 million, with a qualified bid pipeline in excess of $1 billion. CEI's expected future organic growth rate was expected to be at least 20 percent.

The transaction was structured as a 338(h) (10) for income tax purposes, which will result in Kratos receiving approximately $130 million in federal and California state income tax deductions over a 15-year period. This tax structure and resulting income tax deductions will substantially reduce the cash paid for income taxes on CEI's taxable income and significantly increase CEI's Free Cash Flow generation for the foreseeable future. CEI personnel, including Mike Fournier have entered into long term employment agreements with Kratos. Accordingly, $10 million of Kratos restricted stock units will cliff vest in four years to certain members of the CEI management team, serving as an inducement to them to continue employment with Kratos after the acquisition and as a long term retention incentive.



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