Good day, ladies and gentlemen, and welcome to the Kratos Defense & Security Solutions First Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be provided at that time. [Operator Instructions]. As a reminder, this conference maybe recorded. I would now like to turn the conference for your host Mr. Marie Mendoza, Senior Vice President and General Council. Ma’am, you may begin.

Thank you. Good afternoon, everyone and thank you for joining us for the Kratos Defense & Security Solutions first quarter 2018 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 everyone to please take note of the Safe Harbor paragraph that is included at the end of today’s press release. This paragraph emphasizes the major uncertainties and risks inherent in the forward-looking statements we will make this afternoon. Please keep these uncertainties and risks in mind as we discuss future strategic initiatives, potential market opportunities, operational outlook and financial guidance during today’s call. Today’s call will also include a discussion of non-GAAP financial measures, as that term is defined in Regulation G. Non-GAAP financial measures should not be considered in isolation from or the substitute for financial information presented in compliance with GAAP. Accordingly, at the end of today’s press release, we have provided a reconciliation of these non-GAAP financial measures to the company’s financial results prepared in accordance with GAAP. With that, I will now turn the call over to Eric DeMarco.

Thank you, Marie. Good afternoon, everyone. Revenues for Kratos’ Unmanned Systems business grow organically 78% from Q1 ’18 over Q1 2017. Virtually all of these revenues being generated by Kratos’ higher performance target drone related business. We are seeing significant demand for Kratos’ target drones in the United States and also globally. As a recapitalization of strategic weapon systems to address nation state adverse areas is underway. With not only United States DoD, but every NATO ally increasing its defense spending this year with 15 NATO countries increasing their defense budgets as a percent of their GDP. These strategic systems being deployed need to be exercise against the highest performance and most realistic [targets] to the world, which are Kratos’ targets and where Kratos’ is the undisputed industry leader. Directly related to the strong global demand that we are seeing. Kratos’ Unmanned Systems division booked in excess of 200 million in sole source or single award contracts in the first quarter of ’18, all of which we expect to convert to revenue over the respective contracts period of performance. The book-to-bill ratio for Unmanned Systems division was 2.6 to 1 for the first quarter. We are currently executing on low rate initial production contract year one, which we received in 2017 under the U.S. Navy SSAT program for Kratos’ BQM-177 target drone. In Q1 2018, we received a sole source contract award of approximately 24 million from the U.S. Navy for low rate initial production year two and we expect to begin to see meaningful revenue, EBITDA and cash flow generation from this SSAT LRIP2 in the third quarter of this year. In addition to SSAT LRIP2 we now expect to receive an SSAT LRIP3 production quarter later this year at a significantly increased value. The combined value to Kratos’…

Thank you, Eric, good afternoon. Kratos first quarter 2018 revenue is 143 million were in the range of our forecasting 140 to 150 million for the quarter and our adjusted EBITDA have 13.7 million exceeded our forecasted 9 million to 11 million, primarily due to a favorable mix of revenues in our satellite communications, training systems and microwave products businesses. Kratos adjusted EPS of $0.05 exceeded our forecast of breakeven to $0.01 for the quarter. First quarter year-over-year consolidated organic revenue growth of 8.3% which driven by growth of 78.2% in our unmanned systems business including low rated initial production one of our 177 or SSAT aerial target. Revenues in our largest segment KGS increased approximately 7.3% year-over-year for the first quarter of 2018 excluding a reduction of 8.1 million in our legacy government services business that we have previously deemphasized. Including our legacy government services business which annual revenues are now down to approximately 60 to 70 million, KGS revenues declined slightly by 1%. As mentioned earlier, we expect the PSS divestiture to close during the second quarter, and accordingly have recast all current year and prior year financial data to reflect the PSS business as a discontinued operation. As also previously mentioned Kratos' corporate overhead and public company cost of approximately 2.5 million, which was historically allocated to the PSS business has now been allocated to our remaining business segment for KGS and unmanned systems, and we have laid out a detailed plan to reduce these costs by as much as possible by the end of this year in order to increase our margins and cash flow. From an accounting standpoint Kratos' was required to adopt a new revenue recognition practice beginning January 1 of this year, which can affect the timing of the revenue recognition for certain…

Great, thank you, Deanna. We will now turn it over to moderator for questions.

[Operator Instructions] Our first question comes from Ken Herbert of Canaccord. Your line is open.

Yes, I just wanted to first ask on the target drone business it currently looks you are seeing a nice inflection in the third quarter not only you have the budget and you've got visibility there. What is the guidance implies for margins for that business in the second half of this year and into 2019 on sort of that 150ish business which we see this year?

For the second quarter half of the year compared to the first half we are expecting margins to increase as we ramp. definitely we are expecting them to increase. Right now, for 2019 we're expecting them to continue to increase and expand as we continue to ramp, and we get leverage off of our fixed overhead, our fixed manufacturing cost. And in addition to that we're working on a number of international opportunities, we're hoping to pass some of those to book in the second half of this year and those international opportunities they typically bring significantly higher profit margins to the company because we're not dealing with that [teenier] issues because we own the data packages on the drones.

So just to clarify the target drone business this year the mix is largely for the United States correct there is way for little international in there?

There is some and there but it is the majority the vast maximum majority of the United States but there is we have a number of international customers. But the largest target drone users in the world are the United States Navy, United States Air Force, United States Army, we are sole source with each of them, then the UK Ministry of Defense we are with them and then there is the fifth one is coming and we're in solicitation on that one right now. And that drops off precipitously from a funding standpoint.

And if I could just one final question on the international opportunity, you've talked about obviously couple of your tactical vehicles getting approval from the Department of State, can you provide any more detail on timing around when these international opportunities could start to hit and any insight on relative size or quantifying the opportunities there?

My expectation is before the end of the year on the tactical side we are going to book some Mako sales. I have the full expectation of that and I rather not get into slices right now but there will be meaningful -- they will additive to '19 and for successful in getting them book by the end of this year. I definitely expect quarters internationally to increase in '19 because obviously internationally it takes time, it's a process it's not an event, but we do have an advantage that a number of these customers to the state department approve for a specifically related to the Mako they are already our target drone customers so we know them, we have access and we know how to work it.

With the second quarter guidance you provided do we see sort of a similar profile for free cash flow in the second quarter as we've seen in the first quarter or is there anything you would highlight specifically we should keep in mind about the second quarter?

Sure, what I would highlight specifically about the second quarter is our interest payment is due at the end of the May and that’s roughly 9.5 to 10 million so that will be something an additional cash outlay in the second quarter that we did not see in the first quarter.

Our next question comes from Mike Crawford at B. Riley FBR. Your line is open.

When you said that you expect to be, so with your current capacity by the end of ’19 is that including the Oklahoma facility? And what is the expected capacity of that Oklahoma facility versus what you have now in California?

I’m glad you ask the question, Mike so I can clarify. No, that did not include the Oklahoma facility to be clear. our sacramental facility we expect to be at full capacity by the end of 2019. And that full capacity is going to be primarily dedicated to the U.S. Air force 167, the U.S. Army derivative 167, the United States Navy 177 and some other things. We are looking right now -- right now we’re building Firejets there. It is highly likely that we’re going to be transitioning Firejets by the end of this year. And then all tactical planes right now are contemplated to be manufactured in Oklahoma. And the capacity that we’re looking for in Oklahoma, we want to be able to have a capacity to build at least a few hundred drones a year there.

There was an article that quoted. I think you or Stephen mentioning that the Gremlins was kind of the hybrid between Firejet and asset, is that true? And then also you still continuing development of the Gremlins concept, a separate concept that you had developed as a prime and Phase 1 in that competition?

On the first question. Mike, I would say that, there are definitely similarities from a design and integration standpoint between the 167 and the 178 absolutely. And related to our Gremlin we absolutely took our Gremlin UAS. We absolute took our techniques, our production methodology, our auto play methodology and how we came up with our Gremlin and also very candidly with the [indiscernible]. And we believe that’s a winning combination for us in all areas because it’s a low cost high performance methodology that we have perfected. On your second question Mike, relative to Kratos’ Gremlin, I really -- I apologize, I cannot talk about that right now at this time.

And then final question is with all these good things going on and [countering] with the fact that we just maintained guidance. What were the puts we’ve seen that would counter balance obviously get things?

The primary put, that we have right now is when we gave our guidance, we gave ranges and we have an extended continue resolution that one all the way, it literally went six months. So, the primary put is us being able to execute on all the programs that we have. And we want to be conservative in what we are saying to make sure that we can meet what we are saying from a financial standpoint. This is not a question on the guidance of a book stuff, we need to execute and we need to do a good job. We have a great reputation with our customers right now that we do what we say, we do it on time on schedule on budget affordably and we cannot mess that up. So those were the primary thinking in estimating and maintaining our guidance at this time, we have a lot of wood to chop that we booked.

Thank you. Our next question comes from Michael Ciarmoli of SunTrust. Your line is now open.

Maybe just to say questioning on the guidance, can you give us a sense of how much of the ’18 revenue plan is already in backlog or booked for the clean line of sight to versus what we might need to go out there and get some book ship business if you would.

The vast majority of our guidance in ‘18 is in backlog, the vast majority. And now with the '18 budget its getting funded as we speak.

Got it and then just back to the margins, you mentioned opportunities to cut some of that that corporate overhead. I guess could you maybe elaborate there and you know, similarly I guess if your current capacity in Sacramento gets up to -- if you get to full capacity what sort of leverage should we expect you guys to whether its incremental margins or can you give us a sense of what that business could look like that sort of a run rate when you are operating at full capacity?

Michael this is Deanna, on the first part of your question far as what type of steps we are taking to reduce overall infrastructure cost, we’re negotiating reduced terms with certain of our large service providers such as our external auditors, IT service providers, and we’re looking at other internal costs as well to reduce those costs. We will be moving our facility later this year, the corporate facility which should maintains some of those costs as well. So, we’re looking at all aspects of corporate overhead infrastructure perspective.

And Mike let me add one more to that, when we identified from the public safety businesses non-core about a year ago a little a more than a year ago, we made the conscious decision at the corporate cost level that if people retired or they went to other companies that we would not replace them. And we have continued that aggressively and that can be significant at this level as well. And so that's another one. on the first part of your question, Oklahoma, one of the primary reasons we elected Oklahoma is because of the cost structure and the cost structure of manufacturing drones in Oklahoma is significantly less than in California for all the reasons you can think of. So, we have a [two for and a three for] coming that we see over the next couple of years in our margins. The most immediate one as our business continues to ramp in Sacramento on the target drones we are going to be levering off that fixed manufacturing costs and margins are going to increase. I'll give you some estimated rates in a minute. Then as we start selling more drones internationally, those margins are inherently higher for the reasons I stated, but as I went through before the predominant of our business will always be, I believe the United States government. And then thirdly we start manufacturing drones in Oklahoma which as I indicated it's going to be in the first half of 2019 that cost structure is going to be less the margins they are going to be are going to be higher. We're looking at this business, we're going to get the 10% and then we're going to go into the low teens and ultimately at high rate we would like to get to the mid-teens.

And I was going to say I mean you've got probably disproportionately higher amount of your revenues at fixed-price contracts versus some of your peers so that should enable you to get up to that teen rate so it sounds like that's in plan?

So, this vast majority of our contracts in unmanned is our fixed price, there is only one that comes to mind is [Indiscernible] that's of any significance that's cost plus.

How should we think about any CapEx going forward as you sort of build out Oklahoma?

Right. So, we are literally finalizing the negotiations on that plan right now. But rest assured, because of the commitments that we are making as to the number of jobs we are going to place there and the pay structure of the number of jobs that we are going to place there. Oklahoma is being the state, the city and the county is being very generous with us right now relative to say leases and credits that they've committed to give us etcetera. All that means we are looking at a very low or limited capital out related to that very low or limited not material.

Our next question comes from Brian Ruttenbur of Drexel Hamilton. Your line is open.

Couple of housekeeping questions, maybe less housekeeping but in terms of cash, your plans so you have 128 million right now, you are going to be getting the inflow of cash from PSS. Could you give us any light on what your plans are with that cash?

So, as you're alluding to our net debt position pro forma post the PSS sale is going to be approximately 2:1. So we have significantly delevered and we have no intention at all of relevering up for any reason. As we talked in our prepared remarks, we've got a number of programs that we spoke about on the drone side that are beginning to ramp, we've got some opportunities that are very real, that we have not got into detail with you, that we could hit by the end of year, that would be very significant and could change the paradigm for us. It's important to us for a number of reasons until we see how this works up and we maintain a significant liquidity position on our balance sheet. So, A, there is no question in these customers minds based on the size, the potential programs they are thinking about giving us that we can execute the production on them. And we want to be able to easily handle any working capital requirements related to those without significantly impacting our net leverage position. So that’s a long way of saying for right now, we’re going to sit tight as we continue to pursue these new very large potential opportunities. We’ll see what we come out on that and if they don’t come to where I think they’re going to come out at the beginning of next year then we’ll make some decisions. As you probably know relative to our bonds, if we do not deploy that cash in 12 months depending on some characteristics in venture. We can call the bonds at par.

And then my second question was SG&A. Can you talk about it from first quarter or second quarter kind of on a sequential move expecting to be flat and maybe talk about it as a total dollar amount on the year?

Sure. So, Brian, it should be about consistent that SG&A from Q1 to Q2 sequentially. And they really should be a lot of movement throughout the year except for probably in the fourth quarter typically that’s when we have more accrual, audit fees et cetera. But otherwise it should be about the same rate, it’s been at in the current quarter.

Our next question comes from [indiscernible] with Noble Capital Markets. Your line is open.

Just one kind of bigger picture question for me today. I’m curious about the impact of the one year versus the two-year budget as it pertains to the various UAS programs that you discussed that are comes in early stages of capture negotiation. I’m curious, what do you think the timeline from negotiation to development of these programs could be accelerated given the two years of visibility we have as compared to the programs that we all know about, that came into development amidst constant budget pressure?

Absolutely, yes. Absolutely, correct. And the Secretary of Defense is actually alluded to that relative to the rapid innovation offices and the science and technology agencies most of these as you know that we’re working directly with on a number of these programs. The Secretary of Defense either this morning or just yesterday, he addressed the [indiscernible] and he is specially talked about that over the next two or three years, they are focused on the rapid identification, development, demonstration and fielding of high performance systems that have got to be in affordable costs and that is exactly how we position the company. Because we positioned ourselves for what you’re alluding to, that irrespective that we have $700 billion defense budget this year and with the bipartisan spending bill we’re going to have another $700 billion defense budget next year. Affordability is still going to be paramount, and deploying quantities is going to be equally is important the quality. And we believe because of our size small and the nature of the program we’re going after that is a very important competitive differentiator for us to our customers.

[Operator Instructions]. Our next question comes from Seth Seifman of JPMorgan. Your line is now open.

It’s actually Ben on for Seth. I wanted to ask about cash from ops kind of thinking beyond 2018. The guidance this year right at the midpoint, 40 million I mean that as a percentage of EBITDA that's about 70% and there are obviously some investments going on this year on unmanned, the falloff is that a good starting point for thinking about your cash generation as we go in the year ahead. is there any reason why couldn't be worse than like 70% of adjusted EBITDA?

Year to year that is an absolute good starting point. And there is nothing that comes to mind right now that would indicate that it would be any worse. The only practical thing I could see that could impact that and it would not be significantly for a very long period of time is if in the next six or nine months we received an order for 300 drones. We have to deliver them in 24 months. And just depending on the milestones structure and the payments it might split 12 months to a 15 month but that’s the only thing I could see.

That, a bad problem to have I guess.

No, but that ties directly into the question on maintaining cash on the balance sheet as we’re working on some stuff.

And then maybe just kind of on space. I mean there is lot going on right now in the space market, you are kind of well positioned in satcom world. Can you talk a little bit about some of the trends that you’re seeing and how you feel about your opportunity to grow and whether or not you think your satcom business can be the fastest-growing part of KGS once we get out beyond the training awards?

The high-level line item right now is the amount of restricted or classified works is increasing rapidly, that's number one. Number two, I mentioned WGS, the two additional WGS satellites. You may have seen it just came out this morning on the next-generation's space-based infrared surveillance. We're involved in all of these. So new satellites that go up, we are involved in the ground segment on these. as I said we involved 85% US space missions we're in. what is happening right now is distributed communications. So instead of having exquisite $1 billion, $2 billion, $3 billion geostationary orbit satellites that make potentially nice UC targets for advisory is being distributed to hundreds if not thousands of Leos. So, these satellites are much less capable, but there's a lot more of them that means that they require an entire new generation of ground equipment and we’re directly involved in that as we speak. In addition, as you know we own and operate the only commercial and global network, our spectrum services business where we’re routinely monitoring hundreds of beams for our customers. This is expanding rapidly right now because of I'll use words like interference or interception that is happening with beans and people our customers want to know what's getting interfered with how it is being done and then we geo locate specifically where it's coming from so we can be mapped and neutralized those are the direct sourcing that those would be the drivers for same.

Thank you. I'm no further questions at this time. I like to turn the call back over to Eric DeMarco for any closing remarks.

Outstanding. Thank you very much for joining us. The next news that you'll probably see from us hopefully is the close of the PSS sales in the very near future and then will be chatting with you again at the end of Q2. Thank you.

Thank you, ladies and gentlemen, this does conclude today's conference. Thank you for your participation. Have a wonderful day. You may all disconnect.