Kratos has entered into a definitive agreement to acquire 100 percent of the stock of Composite Engineering Inc, a vertically integrated manufacturer and developer of unmanned aerial target systems and composite structures used for US National Security programs.
Kratos currently provides electronics and avionics that are on board Composite Engineerings drone aircraft which are made using Composite materials, they also provide the ground flight control stations and electronics for the command and control of CEI aerial systems.
The range of unmanned drones from Composite Engineering 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 2011, Composite Engineering 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 are the United States Air Force, the United States Navy, other National Security related organisations 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. The largest current CEI disclosable contracts are currently 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. Composite Engineering’s current backlog is approximately $160 million, with a qualified bid pipeline in excess of $1 billion. The company expected future organic growth rate is expected to be at least 20 percent.
Eric DeMarco, Kratos’ President and CEO, said;
CEI is clearly a world leader in the design, engineering, development, manufacturing and production of leading edge unmanned aerial targets and airframe structures. Similar to the Kratos Aegis Readiness Assessment Vehicles, or ARAVs, certain of CEI’s products are also designed to replicate some of the most advanced aerial threats and potential adversary fighter aircraft in the world today, including next generation threats. Additionally, certain CEI products and aerial systems support leading edge electronic warfare programs, another area where Kratos is particularly well positioned.
The purchase consideration to be paid by Kratos for Composite Engineerings Inc is $135 million in cash and $20 million in Kratos’ stock, or $155 million. Additionally, the transaction is expected to be 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.