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Rating Action:

Moody's affirms Kratos' B3 CFR; outlook stable

22 Nov 2013

$675 million of 2nd lien notes rated B3

New York, November 22, 2013 -- Moody's Investors Service affirmed Kratos Defense & Security Solutions, Inc.'s (Kratos) Corporate Family and Probability of Default ratings (CFR and PDR) of B3 and B3-PD respectively. At the same time the rating agency assigned a rating of B3 (LGD-4, 54%) on the company's proposed issue of $675 million of second lien notes due in 2020. Proceeds from the issuance along with cash on hand and revolving credit borrowings will be used to refinance the company's $625 million first lien notes and pay associated premiums and expenses. Upon full redemption of the existing notes the rating on those obligations would be withdrawn. The company's Speculative Grade Liquidity rating (SGL) was lowered to SGL-3 (adequate) from SGL-2 (good). The rating outlook is stable.

As a result of the transaction, Kratos will have higher debt and significantly lower balance sheet liquidity. Offsetting this will be lower interest expense and an extended debt maturity as the 10% existing notes due in 2017 are repaid. Kratos will also have greater flexibility to address its capital structure consistent with its recently espoused policy of debt reduction. This arises from redemption options included in the proposed indenture for the second lien notes. The reduction in interest expense also improves prospects for free cash flow available for debt repayment going forward.

The affirmation of the B3 CFR and B3-PD PDR ratings balances this higher financial leverage with improved coverage metrics and an assumption that Kratos will deploy a substantial portion of future cash flow towards lowering its debt burden. The lower liquidity rating considers the reduction in cash balance and the utilization of the company's asset-backed revolving credit facility (not rated) to fund the cost of the refinancing. The stable outlook recognizes that despite business pressures that could constrain the pace of potential debt reduction, interest coverage and cash flow should strengthen as a result of lower borrowing costs and provide support for the B3 CFR.

RATINGS RATIONALE

The B3 CFR considers Kratos' moderate size, high financial leverage and a declining U.S. defense spending environment. But it also recognizes Kratos' product portfolio is positioned in areas where funding levels are less vulnerable -- such as equipment used in unmanned aerial & missile systems, satellite communications, electronic warfare, radar and signals processing. Moreover, the company's infrastructure security business, which is driven by demand from commercial end-markets, should experience steady-to-firmer volumes. While competitive pressure within the defense services contracting environment has escalated over the past year, Kratos' service businesses now constitute a minor portion of its revenue mix (about a tenth). Free cash flow to debt should be in the low single digit percentage range in 2014, and will benefit from the refinancing transaction as well as provide flexibility to navigate through a period when sequestration budget caps in 2014 and beyond more broadly affect the sector.

The stable rating outlook considers that although the U.S. defense spending environment constrains revenue opportunities and limits prospects for margin improvement, Kratos' performance is sustainable with several coverage ratios benefiting from the refinancing transaction and that a substantial portion of free cash flow will be applied to reduce indebtedness over the intermediate term.

A rating downgrade would likely follow expectation of debt to EBITDA rising and remaining above the 7 times level and/or if liquidity were to weaken further. A positive outlook or higher rating is unlikely at this time but would require an expectation of debt to EBITDA sustained in the low 5x range with EBIT to interest approaching 1.5x.

Ratings assigned:

$675 million second lien notes, B3, LGD-4 , 54%

Ratings affirmed:

Corporate Family, B3

Probability of Default, B3-PD

$625 million first lien notes, B3, LGD-4 , 52% (to be withdrawn upon completion of refinancing)

Ratings lowered:

Speculative Grade Liquidity to SGL-3 from SGL-2

The last rating action was on April 19, 2013 at which time the company's CFR and PDR were affirmed, the rating outlook was changed to stable from positive and the SGL rating was upgraded to SGL-2 from SGL-3.

The principal methodology used in this rating was the Global Aerospace and Defense Industry Methodology published in June 2010. Other methodologies used include Loss Given Default for Speculative-Grade Non-Financial Companies in the U.S., Canada and EMEA published in June 2009. Please see the Credit Policy page on www.moodys.com for a copy of these methodologies.

Kratos Defense & Solutions, Inc., headquartered in San Diego, CA, operates in two sectors; Kratos Government Solutions (81% of 2012 revenues) and Public Safety and Security (19%). Revenue for the twelve months ending September 30, 2013 were $978 million.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the rating action on the support provider and in relation to each particular rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

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Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Bruce Herskovics
Vice President - Senior Analyst
Corporate Finance Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Michael J Mulvaney
MD - Corporate Finance
Corporate Finance Group
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Releasing Office:
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Moody's affirms Kratos' B3 CFR; outlook stable
No Related Data.
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