Kratos Defense & Security Solutions, Inc. (KTOS) Q1 2019 Earnings Report, Transcript and Summary

Good day ladies and gentlemen and welcome to the Kratos Defense & Security Solutions First Quarter 2019 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 given at that time. [Operator Instructions] AS reminder, today's conference will be recorded. I would now like to turn the call over to Marie Mendoza, Senior Vice President and General Counsel. Ma'am, you may begin.

Thank you. Good afternoon everyone and thank you for joining us for the Kratos Defense & Security Solutions first quarter 2019 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 as a 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 to turn the call over to Eric DeMarco.

Thank you, Marie. I believe as we go through today's report, you will see that Kratos is one of the best positioned technology product and systems businesses in the defense industry, that we are uniquely aligned with the Pentagon's National Security Strategy and funding priorities, and that we are positioned for industry leading organic revenue profit and cash flow growth. Demand is strong and increasing in each of Kratos' core business areas which includes space and satellite communications, unmanned systems drones and artificial intelligence, missile defense radars and missile systems, training systems, microwave electronics and electronic warfare. We began 2019 well, exceeding our Q1 revenue, profit, operating income, EBITDA, EPS and cash flow guidance. With every Kratos business unit exceeding its financial forecast, the EBITDA we generated is particularly notable and representative of the operating leverage we expect going forward for the business. In Q1, Kratos' space and satellite communications business, our company's largest performed particularly well including a favorable program mix. The space and satellite areas of the budget are seeing some of the largest growth with the 2020 DoD request of $14.1 billion or an approximate 20% increase over 2019s $11.8 billion. Satellites and space as a funding priority is expected to continue for the foreseeable future as the US prepares for a potential war or peer confrontation, and we expect Kratos to realize future benefit from this increased funding due to our customer relationships, our past performance qualifications and our unique positioning. Certain of the largest increases in the 2020 space request include a new constellation of missile warning satellites, the next generation overhead persistent infrared, the GPS IIIS constellation of positioning navigation and timing satellites and the development of future satellite communications systems. Additionally the 2020 budget request creates a new funding line for the enterprise ground services program with EGS planned to become the primary ground command and control system for the Air Force Space Systems. We are particularly looking forward to this. Significant funding increases in reprogrammable satellites, low earth orbit and mid-orbit satellites for distributed capability with the objective of resilient uninterrupted communications are rapidly occurring, and are also expected to be a positive growth driver for Kratos. Funding for military network terminals which need to be able to access a mix of frequency bands including Ku, Ka and X and satellite architectures including GEO, MEO and LEO and terrestrial wired and wireless communications are similarly expected to drive demand for Kratos' satellite communications business. On March 12, 2019, the Pentagon established the Space Development Agency or SDA under -- excuse me -- under the under Secretary of Defense for Research and Engineering. The SDA was created to accelerate the development and fielding of new military space capabilities and emphasizes the prioritization of the long-term increased future funding expectations for the DoD space and satellite area. Commercially, numerous new large planned satellite constellations are expected to provide additional significant long-term growth opportunities for Kratos with certain of these planned constellations including Amazon or AWS with 3,236 satellites planned, OneWeb with 650 satellites, Telesat with 292 satellites, LeoSat with 108 and SpaceX with the planned 4,425. Similarly to the National Security Space opportunities, Kratos' industry leading ground command control and communication systems and our relationships with approximately 80% of the global satellite operators, we believe uniquely positions and qualifies us for this well-funded high growth industry, and today we are now already under contract, and beginning to provide product to certain of these new large commercial customers. Kratos' unique owned and operated Global Space Situational Aware business, one of our company's most valuable assets is also seeing solid performance and strong organic growth, which is being driven by the ever increasing number of and requirement to monitor satellite beams for potential interference, jamming and other anomalies in the locating and identifying of the source of these issues, so they can be mitigated or neutralized. The number of opportunities for our space and satellite business once again our company's largest and highest margin and cash flow generating business is significant, it's diverse to rapidly growing and we expect our space business to have a long-term growth trajectory for our company. In our Unmanned Systems Business, we're on track with important strategic milestones continuing to be achieved and our line of sight to significant revenue from our tactical drone business becoming much clear. On last quarter's call, I stated that we believe that 2019 will be the year that Kratos is established as the world leader in the affordable high performanced unmanned aerial drone system class which we see as a multi-billion dollar opportunity for our company. For you, the owners of the company, it is important to recognize the value that has been created in Kratos and how we expect this value to be reflected in Kratos' future P&L, our revenue, our cash flow and our profitability. As you know, over the past several years, we have invested approximately $100 million in a suite of high performance jet powered UAVs, some of which you were aware of and others we are prohibited by our customers from discussing. This investment along with our industry leading position in high performance targeted drone UAVs and the related customer relationships and credibility we have, have uniquely positioned Kratos as the industry leader and the expected to be multi-billion dollar tactical UAV market. The leadership position that Kratos has today with our tactical UAVs did not and cannot occur overnight for any company, no matter how large. It will take multiple years, hundreds of millions of dollars and unique qualifications. And we currently see no competitor even close to what Kratos is today. On March 5th, Kratos took an incredibly important step in executing this strategy, solidifying our tactical drone leadership position in the line of sight clarity to significant revenue generation, as the Kratos built AFRL XQ-58A Valkyrie successfully flew as expected for the first time over Yuma, Arizona, marking the historical achievement for both our company and for aviation history. For the owners of the business, our investors, it is important to understand strategic market leadership solidifying for Kratos of this success with the customer community and its value generation. This can be explained by highlighting the following. The successful flight of the Valkyrie demonstrated Kratos' unique capability to rapidly design, develop, demonstrate and deliver a low cost leading technology, high performance product that is of great value to the customer. The version of Valkyrie that successfully flew is designed as a long range strike and intelligence surveillance and reconnaissance UAS and it is important to keep in mind that Kratos has thus far built three XQ-58As. Two of which are Kratos assets and which have not yet been unveiled publicly. Immediately after the Valkyrie's successful March 5th flight, on March 13th, the Assistant Secretary of the Air Force for Acquisition and Technology announced publicly for the first time the Skyborne artificial intelligence drone related program, specifically mentioning pairing the sky borne program artificial intelligence with Kratos' Valkyrie and also other Kratos drones, including the BQM series which includes Kratos' UTAP-22 Mako. Each of the Kratos drones mentioned by the assistant secretary are flying today. We are the only company with drones in this class at this price point flying today. On March 15th, two days later, the formal sky borne program request for information or RFI was publicly released stating that only parties that have flying or operational systems need respond. On April 2nd, the house appropriations sub-committee on defense held a meeting which was attended by the secretary of the Air Force and the Air Force Chief of Staff among others or sky borne Loyal Wingman and affordable unmanned attritable aircraft being a key component of the future force structure was discussed. I encourage you to see the publicly available video of this hearing. On May 2nd, the House Armed Services Committee Subcommittee on Tactical Air and Land Forces held an over two hour meeting which attendees included the Assistant Secretary of the Air Force for acquisition and included General Homes, United States Air Force, Commander of the Air Force Combat Command and Major General, David Nam [ph] U.S. Air Force Director of Programs for the office of the Deputy Chief of Staff for Strategic Plans and Requirements. In this hearing, there was a lengthy discussion on Kratos' Valkyrie, its affordability, its offensive and defensive counter air measure capabilities and its ability to soak up enemy fire and to take on enemy air defenses. The hearing discussion also included missionizing the Valkyrie with certain communication systems, sensors and payloads and getting Valkyries deployed and into the hands of the war fighter as soon as possible for practical utilization and concepts of operation development. Also discussed in the hearing was fielding the Valkyrie as the Loyal Wingman for both the F-35 and the F-15 no later than fiscal 2023 which of course begins in calendar 2022, and ensuring that both the F-35 and F-15 command control and communication systems could control swarms of Loyal Wingman drones. I encourage you to also see the publicly available video of this hearing. Over the past several months, we have spent a significant amount of time on Capitol Hill including since the successful flight of the Valkyrie and we believe that there is considerable bipartisan support for this aircraft and Kratos' drone suite, which are low-cost, efficiency increasing and that protect exquisite and extremely valuable assets like the F-35 and F-15. In addition to the new Skyborne program from a funding standpoint in the 2020 DoD budget request including in the RDT and E-Program element numbers, there is currently an excess of $100 million with LCASD, LCAT or Valkyrie related programs and initiatives. Also, we are aware of significant additional planned Valkyrie and Kratos drone related funding also tied to the fiscal '20 defense budget. All of this information and data points are consistent with the customers' intention to get Valkyries fielded in the hands of the war fighters as soon as possible, so they can use them, explore their capabilities and potential and begin developing definitive concepts of operations and prepare for a 2023 fielding day. Since the successful Valkyrie flight, several additional potential customers in addition to the Air Force have reached out to Kratos regarding our affordable high performance tactical drones, certain of which we have already met with and which we are follow-up meetings schedule. All of this is why we now have a much clearer line of sight and visibility to Kratos tactical UAS revenue. As a result of all of these recent events and information, we have now announced that Valkyrie production will be performed in our new Oklahoma City manufacturing plant which is currently producing Kratos fire jet drones. The recent identification of our Oklahoma facility for Valkyrie production is consistent with the customer timetable mentioned above and whether our customer decides to begin ordering the Valkyrie either in the next three, six or nine months, we will be ready to meet their requirements. It would take Kratos approximately 15 to 20 months to begin delivering Valkyries after order placement with timing primarily driven by a certain long lead item. Over the next few months, we are scheduled to complete the Valkyrie demonstration flights with AFRL with increasing performance and capabilities all of which we expect to be successful. The Gremlins program with our prime partner Dynetics is on track, and we recently began delivering Gremlin air vehicles to the customer Dynetics, and Dynetics recently publicly unveiled a mockup of the Gremlin airborne launch and recovery system. Initial Gremlins system and demonstration flights are scheduled for late Q2 or Q3 of this year. And once the Gremlins demonstrations are successfully completed, we expect initial orders later on in 2019 or in 2020 with the order timing similar to the Valkyrie being driven by the customer. Also similar for the Valkyrie, we expect more clarity on this timing once the successful demonstration has occurred. We recently met with the Program F customer where Kratos is the prime. And we are now more confident than ever that Program F will achieve production and be fielded in large quantities as a result of customer need and the mission requirement. The next series of Program F demonstration and capability flights are scheduled for the second half of this year, and are now expected to be completed in the first half of next year. We expect to receive an initial Program F order after completion of the demonstration in capability flights. On our Thanatos Program, we work on the new and expanded secure production facility has begun and we forecast Thanatos to be a meaningful financial contributor to Kratos beginning in mid 2020. Kratos' Aethon ISR UAS which is flying today is under a funded development contract with the government agency with this program expected to be a meaningful financial contributor to Kratos beginning in the second half of 2020. Since our last report to you, we have received great news on Kratos' project Spartan which has now accelerated and moved to the left, and we now expect to be under contract with just the next few months with Spartan now expected to be a meaningful financial contributor to Kratos in the second half of 2020. On project Apollo, we expect to be under contract by the end of this year or early next year, and we expect this program to be financially meaningful to Kratos in late 2020. On Kratos' DIU Mako UAS program, we recently met with the customer at the Pentagon, we expect to receive additional funding in the next few months, with further funding received later on this year and with further funding continuing into 2020. We also continue to expect to have under contract a new Mako related customer by the end of this year. We continue to work Project A and Project Z with initial development awards expected in late 2020. Yesterday, Kratos and AeroVironment announced that we are teaming to demonstrate integrated high performance tactical UAS and tactical missile system capabilities. The strategic arrangement and collaboration between the market leaders in our respective fields will demonstrate low cost, flexible, intelligence surveillance and reconnaissance and precision strike in a near peer denied environment, we are going to demonstrate this. Under the agreement, AeroVironment tube-launched small unmanned aircraft and tactical missile systems will be integrated with Kratos' high speed, low cost attritable drones to dramatically enhance situational awareness and system effectiveness [ph] with Kratos' high speed UAS delivering small, highly autonomous systems across significant distances in denied environments at coordinated times and location. For competitive reasons, I will not be adding anything additional to what was disclosed in that press release yesterday, other than I will say that we have significant customer interest in what we are doing here. And also yesterday, again affirming the momentum that high performance unmanned jet drones are gaining for utilization in the fighting force, DARPA announced the Air Combat Evolution or ACE program to test human pilots trusting robotic wingman in a drone fight. Moving on to our Targets business. For 2019, we expect the primary growth drivers in our Unmanned Systems business will be from the Target drones with multiple programs under production contract, including programs with the United States Air Force, Navy, Army, other agencies and from a very large multi-year International Award we received last year. Our SSAT BQM-177 program with the US Navy continues to ramp up. We have now received initial operating capability, a major milestone and once again we begin -- excuse me -- and once we begin forward (ph) rate production over the next couple of years, SSAT is expected to be one of Kratos' largest system production programs. On our US Air Force AFSAT BQM-167 program, we expect the annual production rates to increase based on recently completed contract negotiations with a significant contract award expected in the next few months. We also expect our 167M and MQM-178 deliveries to the US Army under these respective programs to also increase. Additionally, a program with the confidential customer continues to ramp production and head to FRP with this also expect to become one of the largest Kratos production programs for many years to come. Very importantly, a few weeks ago and also immediately after the successful Valkyrie flight, the next generation aerial target RFI was issued by the USAF. For competitive and other reasons, I will not comment on this large new opportunity. However, I encourage you to take a look at the [indiscernible] RFI and I believe you will understand why Kratos is extremely excited about what this could mean for our company and the new large target drone opportunities that are coming, that we believe Kratos is uniquely positioned with our suite of aircraft. On Kratos' unmanned aerial target drone business, we see this business growing approximately $250 million in annual revenue over the next few years, driven by the recapitalization of strategic weapons systems by the US and our allies that need to test and exercise these weapon systems, our existing under contract programs and intellectual property ownership positions that we have. Kratos' Training Systems and Solution business had a solid Q1, also including a very favorable business mix. We are currently in production on a number of helicopter and fixed wing training systems in our US Navy FMS program in Saudi Arabia continues to be the largest contributor in this business which has been one of Kratos' fastest growing and the opportunity pipeline in Kratos' Training Systems business is one of the strongest in the company. The recapitalization of strategic weapon systems to address peer threats by the US and our allies, the training requirements related to these systems and related operations and maintenance requirements are all key macro drivers for this business. We clearly have the wind at our backs on this one. Kratos' Microwave Electronics Products business performed as expected in Q1 and we are on schedule and on budget on all of our major programs. Our Microwave business is designed in on a number of potentially very large programs including missile programs, radar programs, the F-16, F-15, Gripen, Iron Dome, BARAK and certain Guided Munition systems, each of which are expected to begin production and to ramp over the next several quarters. Once production on these designed-in programs occurs, we expect a very strong organic growth trajectory for this business which historically has generated some of the highest profit margins in the company. Kratos' C5ISR products business which supports major missiles system and radar programs including THAAD and Patriot had a very strong Q1, also including a favorable business mix. Similar to other Kratos product and systems businesses, Kratos' C5ISR business is benefiting from the recapitalization of strategic weapon systems. This businesses opportunity pipeline is one of the strongest that we have seen in years. Our rocket support, ballistic missile target and hypersonic systems business is very well positioned for a strong future which trajectory is expected to begin in the second half of '19. We are expecting our first hypersonic task order in the second half of this year. Kratos' turbine technologies which we established at the end of February with the acquisition of FTT is performing as forecast and we are focused on integration, existing business execution and the development of next generation engines for unmanned drone and tactical missile systems. The engine is the largest component of Kratos' drones bill of materials and key Kratos business plan differentiators are affordability and responsiveness both of which we intend to improve with this new internal capability overtime. Additionally, the expected future market potential for tactical missile systems, missiles which utilize a similar class of engines to Kratos' UAS is expected to be extremely large and fast growing, and we believe that if we successfully execute our strategy and plan, that KTT will be as disruptive as Kratos' unmanned systems division with similar growth and value generation potential to our company. From a capital allocation standpoint, we intend to maintain adequate cash on the balance sheet to enable us to successfully execute on our base business plan, expected growth in existing production programs and growth in newly awarded production programs we believe we are going to be successful on. We believe the company's future cash flow to continue to increase year-over-year with the current primary expectation for this increased cash flow to continue to delever the balance sheet from a net standpoint and to strengthen our balance sheet. Accordingly, we currently foresee no major acquisitions in our strategic roadmap. As the production, development programs and opportunities that we have, we believe our industry leading, significantly differentiating and have Kratos position for a long term organic revenue profit and cash flow growth trajectory. We may explore some small tuck-in acquisitions similar to FTT, which would be either exactly or substantially similar to our existing core business areas, be technology, intellectual property and product focused or would position Kratos for certain large international market opportunities. I'll now turn it over to Deanna for her financial report.

Thank you, Eric. Good afternoon. Kratos' first quarter of 2019 revenues of $160.4 million exceeded our expectations of $147 million to $157 million and increased $17.4 million or 12.2% year-over-year. Excluding the impact of the recently acquired FTT operating results which contributed $4.2 million in revenues, Kratos revenues grew organically 9.2% in the first quarter. Our adjusted EBITDA came in at $17.5 million above our expectation of $9 million to $11 million, primarily driven by a favorable mix of revenues in our space and satellite communications and training solutions businesses and due to certain execution and deliveries occurring earlier in the year than originally forecasted Our adjusted EPS of $0.08 also exceeded our forecast of $0 to $0.02 per share for the quarter. In the first quarter, KGS generated revenues of $125.5 million, up 8.9% from $115.2 million for Q1 of '18, adjusted EBITDA of $15.5 million or 12.4% of revenues up from $12 million in Q1 of '18 and operating income of $11.4 million up from $7.9 million in Q1 of '18. Operating income and adjusted EBITDA were impacted by a favorable mix of revenues with the most notable impact in our space and satellite communications training systems and C5ISR systems businesses. Revenues in our Unmanned Systems segment increased 25.5% from $27.8 million in the first quarter of '18 to $35 million -- $34.9 million and adjusted EBITDA increased from $1.7 million to $2 million in the first quarter of '19, primarily reflecting an increase in execution and production on our AFSAT 167 and SSAT 177 aerial target platforms. Our Q1 operating income was $8.2 million up from the first quarter of '18 operating income of $7 million. Included in our current quarter operating income is $1.2 million of transaction expenses related to the acquisition of FTT. Excluding these transaction expenses, operating income was $9.4 million. Our adjusted EBITDA for the quarter is from continuing operations and excludes non-cash stock compensation costs of $2.6 million, severance related costs of $100,000 and the FTT transaction costs of $1.2 million. On a GAAP basis, net income for the first quarter was $3.1 million which includes a loss from discontinued operations of $600,000 and includes a tax benefit of $1.5 million primarily reflecting the release of valuation allowance due to deferred tax liabilities related to the FTT acquisition, offset partially by foreign and state income taxes and uncertain tax position liabilities. Moving onto the balance sheet and liquidity, our cash balance was $178.4 million at March 31st. At quarter end, we had zero amount outstanding on our bank line of credit and $5.7 million of letters of credit outstanding. Debt outstanding was $294.4 million at quarter end and net debt was $116 million. Our LTM adjusted EBITDA was $64.3 million with the net leverage ratio of 1.8 to 1. Cash flow generated from continuing operations for the first quarter was $16 million. Capital expenditures were $4 million, including approximately $1.7 million related to the unmanned systems division, primarily reflecting the two LCASD Kratos owned aircraft and related equipment that we are building which are now substantially complete. Net cash of approximately $17.6 million was used to fund the FTT acquisition. As a reminder, approximately $14.5 million of the cash consideration for FTT will be payable over the next three years. Our DSOs increased from 131 to 136 days due to the continued impact of contractual milestone payments on long-term delivery projects which are not contractually due until the completion of certain milestones and or the final delivery of products. Our contract mix for the quarter with 85% of revenues from fixed price contracts, 10% from cost plus contracts and 5% from time immaterial contracts. Revenues generated from contracts with the US Federal Government during the quarter were approximately 73% including revenues generated from contracts with the DoD, non-DoD federal government agencies and FMS contracts which were approximately 10%. We generated 9% from commercial customers and 18% from foreign customers. Our book-to-bill ratio for the quarter was 0.9 to 1 and for the trailing 12 months was 1.1 to 1.0. Our bookings were $139 million for the quarter which were below our expectations due primarily to contract awards in our modular systems and space and satellite communications businesses which came in shortly after our quarter closed of approximately $20 million. Today, we are providing second quarter revenue guidance of $175 million to $185 million, adjusted EBITDA guidance of $16 million to $18 million and adjusted EPS guidance of $0.05 to $0.07 per share and our reaffirming full-year revenue guidance of $720 million to $760 million and adjusted EBITDA of $71 million to $77 million. We are also reaffirming our full-year '19 cash flow from operations guidance of $40 million to $50 million, capital expenditures of $28 million to $30 million and free cash flow guidance of $10 million to $20 million plus the expected final cash receipts of the retained working capital of the company's divested PSS business of approximately $46 million. We expect CapEx to be at elevated levels for 2019 with the most significant outlays in Q2 and Q3 of approximately $17 million and $19 million combined as we make the necessary investments for manufacturing and test equipment for our new Oklahoma facility and a new secured facility of approximately $6 million to $8 million and approximately $4 million to $6 million related to our aerial target drones the company plans to manufacture in preparation of book-billing expected customer requirement. We expect our estimated cash taxes to be approximately $2.5 million to $3.5 million for 2019, reflecting the impact of the over $300 million in net operating losses that we have.

Thank you, Deanna. We'll now turn it over to the moderator for questions.

[Operator Instructions] And our first question comes from the line of Noah Poponak with Goldman Sachs. Your line is open.

Hello.

Hello, sir.

Hello.

Good evening -- good evening and good afternoon. Deannna, maybe you can elaborate a little bit on the cash flow in the quarter, it's -- I mean I guess we don't have great history on the seasonality of your cash flow, but I would expect that it would be back end loaded. I'm just looking at other parts of the financials, but it would have to be down the rest of the year to be in your guidance range and that's especially true with the PSS item that's still to come through, assuming that wasn't in the quarter. So were you ahead of plan and could you elaborate on how and why if you were?

Yes. We were ahead of plan. There were some receipts that we expected in the second quarter that came in, in the first quarter. Included in our cash flow from discontinued operations for the quarter, there was an $1 million of cash receipts that we expected of that $4 million to $6 million, so $1 million did come in but that's not included in the cash flow from ops. It's included in the -- a discontinued cash flow generation. So as far as their is seasonality, it's more milestone driven, so it's not necessarily related to seasonality but related to milestones that we expect to achieve and deliveries based on those milestones, so it can be lumpy from quarter-to-quarter which is why we typically only guide from a cash flow perspective for the full year.

Okay.

Which is why we're maintaining -- which is why we're maintaining for the full year.

Great. That's helpful. What were the milestones related to?

It's -- there's a number in our training systems business where we are making -- we're building some very large training systems for the customer. And as we deliver each system, then we are able to bill the final billing milestone on each of those systems. But it's on a per unit basis as we deliver those large systems which we've been building for the last 18, 20 months.

Got it. On the KGS margin, perhaps you could elaborate on the strength there -- was there -- I know you have or I think you have a cyber business that can move in and out of there where -- anything like that that impacted the margin on a less recurring basis or I guess just how sustainable is that margin?

Yes. As we both commented in our prepared remarks, we had a very favorable mix during the quarter primarily in our satellite communications and space business. So that will be dependent on the type of deliveries that we make which are some may be software related which tend to carry more attractive margins.

Okay. And then, Eric, I think you've spoken before about a few ballistic missile target opportunities that are potentially sizable and could potentially be awarded this year, if you went over those in the prepared remarks I missed it. I wonder if you could update us there?

I did not, you did not miss it. It's in source selection, the first one. And we understand that contract award on the first one will -- is supposed to be in the next -- within the next 90 days. And on the second one, that is tracking RFP in the next month to eight weeks with contract awards still tracking toward the end of this year.

Okay. Is there anything from those in your revenue guidance?

We had -- there were three large opportunities that we began the year chasing. We've won the first one. We had factored the three. So depending on timing, if we win one of the second two, that could be beneficial to us this year, depending on timing that was awarded sooner rather than later. So we took the three and we factored them because they're so big in the binary and we've won the first one.

Okay. Thanks a lot.

Thank you.

Thank you. And our following question comes from Josh Sullivan from Seaport Global. Your line is open.

Good evening. Great quarter here.

Hi, Josh, thank you.

The bookings for the unmanned segment, was there any particular program that drove that backlog in the quarter or was it more broad based across them?

There was an Air Force program that we received, that was a big contributor there. And we got another big one coming that we expect to receive and like I said Q2, late Q3, -- Josh, related to that, we -- like in the last 90 or 120 days we've received orders for over 100 drones.

Great. And then just can you talk a little bit more about KTT and if you're customers are showing interest in the low cost engines yet? There, maybe I guess if any of your announced tactical aircraft have had FTT jets integrated into the platforms at this point?

The answer to the first part of your question is, yes, absolutely. We are under contract with basically the same customers that we are working with our target drones and our tactical drones with KTT, absolutely. And we are expecting later this year early next year first engine test on the first engine and then next year, first engine test on the second engine. And so, yes we have customer interest and we are working with them and the plan is, these things work out and they're successful they'll be designed in, that is how we're working up with these customers.

Okay, great. And then just one more on KTT. As far as some of these cruise missile upgrades potentially coming down the pipe, is KTT positioned well there? Do you see those as opportunities?

We have met and I'm not going -- for competitive reasons, I'm not going to get into specific customers, the answer to your question is, yes. We have met both with the spouse (ph) the government spouse, the program offices for these missile systems and we've also been meeting with the primes who build the missile, you have to work with both, the government customer who buys the missile and the prime who makes the missile for the customer and buys the motor. There is absolutely positively interest in a next generation class of engine like these turbo jets and turbo fans.

All right. Thank you.

Yes, sir.

Thank you. And our next question comes from the line of Ken Herbert with Canaccord. Your line is open.

Hi. Good afternoon, Eric and Deanna.

Hi.

Hi, Ken.

Hey, Eric, you obviously started off your prepared remarks with a discussion on the satellite business, and it clearly sounds like that business is seeing a real step-up in opportunity. Can you maybe just provide a little more quantification as to what kind of growth you're looking at for this business maybe this year and next, and anything you can say on sort of what you're seeing on order trends or backlog growth specifically on the satellite business in particular, because I know it is your largest business and one of the more profitable but it sounds like it's really positively inflicting right now?

Yes. So, thank you, Ken. So we had a -- we made some management changes at the beginning of the year. And so my personal expectations for the management team in there for this year's growth is extremely high. That's my expectation for these guys. And as I mentioned the budgets are growing 20%. And there is a little bit of a lag between you see the satellites getting ordered, the satellites go up the ground equipment typically goes out six months is deployed six months prior to the satellite going up. And so let me give you an example, you saw WGS-11 and WGS-12 as you know that's one of our major programs. So we can map when those go up and we can map when we deploy on that. Over the next three years or so, I'm looking for an average growth of 10%, over the next three or four years. It may be lumpy, but that's what I'm looking for. Here, you heard my remarks on the commercial side. We're under a big NDAs (ph), I can't get into details but we are under contract and delivering product. So we are very, very well positioned and I personally am looking for some big favorable surprises from this group later this year.

Okay. Considering the DoD budget growth of 20%, could your average of 10% especially also considering the commercial opportunities could that be a little conservative over the next few years?

I believe so. Let's get some of these constellations going up and maybe I'll increase my expectation. But yes, trying to be conservative. But as commented on this call today, the margins in the business in Q1 were very strong, and as Noah pointed out, it has to do with mix and typically toward the end of the year and we explained this on the last call, end of the federal fiscal year because funds are de-obligating and they want to obligate and spend them. We can get some significant orders in the software area or the quick turn area on command and control. We got some of those in Q1 and it has to do with the threat. So we don't plan for these, because they're hard to plan for because a lot of these customers don't tell you what's going on. But the trend looks very good because of the threat and what some of these products do, that maybe we could see some more of that this year than historically.

Thank you. Thanks for the color and if I just could one final one on the Valkyrie. You really provided a lot more detail and certainly it's become a lot more public with the hearings and press and everything else. Considering the fairly aggressive timeframe, the Air Force isn't looking at, has your thinking changed on when we could see sort of an initial production contract either through the skyborne program or through some other means and anything you can say on expectations around timing and potential size of that would be helpful.

Yes. No expectations have not changed on our side. They probably solidified or gotten firmer, because obviously the successful flight of the airplane and some of the items that I mentioned that are publicly available. These events is what drove our decision to go public and named the manufacturing site, and starting to build that out for the Valkyrie. You can see, Ken, we believe strongly, we're going to get going here on the timelines that I've said before and I mentioned again today. So we'll try to stay conservative, but directionally everything appears to be on track here.

Great. Thank you very much. Really a nice quarter.

Thank you, sir.

Thank you. And our following question comes from the line of Mark -- Mike Crawford with B. Riley. Your line is open.

Thank you. Eric, just to continue that line. So you produced the first fire jet in Oklahoma, while you're building out Oklahoma for Valkyrie. So can you talk at all about capacity there and or in your other facilities?

Yes. So we'll start on the main facility right now in Sacramento. As we have said previously, the reason why we initially started the Oklahoma facility was by the end of '19, we expected from a target drone standpoint the Sacramento facility to be at capacity, and we are tracking exactly on plan that it will be on capacity -- it will be at capacity by the end of this year, early next year. That is why we've begun delivering fire jets out of Oklahoma already and we're delivering them routinely now, and it is ramping very, very quickly. The facility is 300,000 square feet to 350,000 square feet. We have auctions on two additional 300,000 to 350,000 square foot blocks for a total of a million square feet. We did that on purpose because we wanted to have that flexibility depending on the timing of when the tactical drone orders would begin. And so now to the root of your question, so we've made this announcement and we're gonna start taking a look at the tooling different autoclave capacity that we're going to need and the facility capacity we're going to need, assuming we're going to get in order along the timelines we've talked about.

Okay. Great. And then just a clarification because you reiterated the annual guidance of $720 million to $760 million, but I believe when you issued it you said that excluded these large hypersonic opportunities you're pursuing in any one -- in the first one with Corvette and it sounds like you're expecting the task order later in the year and that -- is that just the case where you get the task order but you don't start recognizing revenue on that until 2020? Or…

Mike, I'm glad you brought that up because I probably wasn't clear. The hypersonic task order is entirely separate. It's different. It is -- I'm glad you brought it up, that is in addition to these other two opportunities, hopefully we're going to be successful in. Totally separate, since the last call that has come up and I believe we're going to have -- we're going to be under contract on that task order by the end of Q3.

Okay. Great. And then just a final question, getting back to the space segment. And talking closely with these various proposed operators -- operators have proposed LEO constellations, SpaceX with StarLink, Amazon, Telsat, OneWeb, I mean -- do you -- how many of these do you think actually get built?

Obviously, we hope that most if not all get built because obviously they all need ground equipment. Mike, I don't know and I don't know why you're asking the question, I don't know if it would be appropriate for me to comment here. I am confident that some of them will get built and some of them will be successful and our job is to be sure that on those some or all we're part of it.

All right. Thank you very much.

Okay. Thank you.

Thank you. And our following question comes from the line of Michael Ciarmoli with SunTrust. Your line is open.

Hey, good afternoon, Eric and Deanna. Thanks for taking the call or the question and nice quarter. Eric, just on -- you talked about the next gen aerial targets and there's been a lot of press out there with the capability of these targets needing to be I guess significantly enhanced and the fact that they're currently using F-22s and F-35s. How do you bridge the gap from taking one of your tactical drones like a Valkyrie to enable them to perform the same characteristics as those platforms. Is that effectively what the customer is asking for?

Great question, Mike. Let me, obviously this is going to be a competitive solicitation and it sounds like you've read that RFI very, very closely. We read that RFI and we are very happy. As you know, we took a target drone, the BQM-167 and these are my words now, we went up one notch and we converted into a tactical drone that UTAP-22 or the makeup. So instead of carrying in a target drone configuration, decoys and flares and chaff and dazzlers including lenses, it's carrying other things. All this is classified now as a tactical airplane. Hypothetically, you would take a Valkyrie which is low cost and instead of it being tactical you could go down one notch and now its target and similar to a target drone go into a tactical drone because on expanded quantities, it drives the cost down further to the customer. So they like it.

What about speed? I mean F-22 and F-35, I mean you are not the stats in fright but your Valkyrie is not going to match the speed on both of those potential...

Yes, you're absolutely correct. Yes. So, the F-22 has super cruise capability. So both the F-22 and the F-35 are supersonic. The supersonic fourth generation fighters are supersonic, and so being supersonic does not make a fifth Gen fighter. A Fifth Gen fighter, the primary distinction on a Fifth Gen fighter is radar cross section and stealth. And so if you have a Fifth Gen fighter that's heavy radar cross-section and stealth and you light up the afterburners, where now the whole world can see you on infrared. And so the -- I've to answer it carefully. Yes, you are correct. I don't think there's a problem that our drones published, don't go supersonic for this application.

Got it. Okay. Just on the guidance, I think you may have addressed this in the fourth quarter and kind of contemplated this. What do you thinking around the budget environment, if we go into a continuing resolution. I know you guys have been somewhat exposed there in prior years but I think I recall kind of you guys saying that you took some measures for that when you laid out the initial guidance. Any thoughts on how you're thinking about year end here?

Yes. We have set the year up hopefully, that our assumption is there is a continuing resolution at least for calendar Q4 of this year, not a government shutdown, that's a different [indiscernible] because as you know that impacts our export license capability. But we have just made an assumption that there is a continuing resolution.

Got it. All right. Perfect. Really nice quarter guys. Thanks and I'll jump back in the queue.

Thanks, Mike.

Thank you. And our following question comes from the line of Sheila Kahyaoglu with Jefferies. Your line is open.

Hi. This is Helen on for Sheila. When -- sorry most of my questions were taken. So when we look at the organic growth into 2021, 2022 are we still targeting an acceleration and what are the main levers for that growth?

Hi. So we haven't given formal specific guidance for '21 or '22. We typically give it year-to-year for the reasons that Michael mentioned. You know we've been having extended continuing resolutions and government shutdown. So we know those can disrupt things and can be temporary delays. However, directionally to your question, we are expecting a significant organic growth trajectory for the next several years with the programs we have or ones we expect to win primarily driven by our Target drones. Our Target drone business last year came in at like 135, and as I mentioned in the next few years we're looking to get to 250. Our ballistic missile target in our hypersonic business the [indiscernible] in there is increasing significantly and you can see that publicly in the public funding documents. Our tactical drone area as we've been talking about today, we have a number of tactical drone programs under development contract, or that are farther along in development contract that we're expecting to get into production on get initial orders in the next year. Those are the big primary needle movers. And then of course there's the satellite business, which is our biggest business and it is -- as I said I expect this new -- this group of managers that they're going to over the next three years, we're going to have significant growth there as well because the wins are at our back.

Okay. Great. Thanks.

Okay.

Thank you. And our next question comes from Joe Gomes with NOBLE Capital. Your line is open.

Nice, quarter. Good afternoon.

Hi, Joe.

Just wanted to circle back, in the first quarter you mentioned and you just did hear about how the shutdown impacted the foreign military sales and you did mention today about the large contract you have. Just wanted to see -- what the status is there? Have you seen a rebound there? Is it still somewhat working through the process? Any color you can provide on that, I'd appreciate it.

Right. As we -- yes you're correct, Joe. And as we had said at the last quarter, we thought that we would start getting through those in Q2 and Q3 and everything is on track for us to be back on track in Q2 no later than Q3.

Okay, great. And I don't know if you can comment but if you would, just curious as to how the AeroVironment's relationship came about?

So, Deanna and I have known Wahid and the CFO there for quite a while, and we have an excellent working relationship. And we've talked for quite a while about the right opportunity to team and go after something. And we're not teaming just the team and put out a press release. We are -- we have a -- as I mentioned, we have a customer, and we have a real opportunity here. And let me give you an example and you'll see where I'm going. We made our own investment along with the government on the Valkyrie. We got the contract award in July of '16 and 30 months later the plane was ready to fly and it flew. So now you have two companies that have come together with working systems, proven systems, our proven jet drones and they're very awesome unique tactical weapon systems and drones that we're going to integrate on ours and be deployed, and we're going to do it very, very rapidly. That's the differentiator here, is these two commercially minded companies -- disruptive companies, with disruptive thinking are coming together and we're going to do something because the customers has indicated interest and we're going to deliver this quickly. It's not going to be five years, if you did it with a government contract. And so that that is what we're doing here, because we believe this is where the DoD is going. This is where they're going. They want more of a commercial based model, where proven technology is leading edge not bleeding edge reduces risk, reduces schedule, reduces cost, and this -- I'm excited -- I'm really excited about this. Hopefully, the next 12 months, we're going to be able to demonstrate something that we talked about in the press release.

Great. Thank you.

Thanks, Joe.

Thank you. [Operator Instructions] Our next question comes from Seth Seifman with JP Morgan. Your line is open.

Hey, good afternoon. This is actually Ben on for Seth.

Hi.

Hi, Ben.

Hi. I guess it sounds like you have a number of irons in the fire here with a lot of the tactical drone programs that -- we might be seeing some contracts and revenue next year. Can you kind of help us think about how much of a financial contribution these might make kind of in a broad sense, maybe next year or even in 2021?

I'm thinking about how to answer this question. So on Thanatos, we've said publicly that we expect that to be meaningful financial impact next year. So I think a few tens of millions of dollars. If we -- by the end of this year, we get orders for 20 or 25 Valkyries, $3 million, $4 million each. And as I said, let's say it's a 20 month production cycle and we have to do it 100% (ph) complete, you can see how something like that would be spread. Let's say we get an order for some Gremlins end of this year first half and next year at $700,000 each. Like a 15 month build. I think that's the way, Ben you've got to look at it. You've got to put out the various ones and put some probabilities on them based on the information we give and as we move down the timeline further in the future we get more clarity, we're going to put more meat on the bone for you all, but one thing we're not going to do is we can't get ahead of the customer. I'm sorry.

Right. That makes sense. And so, I guess, not to be too nit picky here but you had the good book-to-bill and unmanned in the quarter. And if we take that let's call it like $60 million of bookings out from the overall company, you're left with maybe about $80 million of bookings are about 0.6% book-to-bill for KGS. How does that kind of square up with your expectation for strong revenue growth in space and that overall segment kind of...

Sure. So in the last six months of last year, our book-to-bill ratio on our space segment was 1.4 to 1 which is typical for that business as if the bookings come in typically around the federal fiscal year-end.

And Ben, what I think it's important to note is of the LTM book-to-bill of 1.1 to 1 for KGS which is outside of the unmanned systems business. That was a 1.1 book-to-bill for that -- for the last 12 months. So clearly for the quarter it was below that but and that's why we think it's important to look at the LTM metrics because the bookings can be lumpy from quarter-to-quarter but on an LTM basis it is over 1.1 to 1.

Okay. That's helpful. Thank you.

Sure.

Okay. Thank you.

Thank you. And our last question comes from the line of Noah Poponak with Goldman Sachs. Your line is now open.

Hi. I was hoping to make sure I fully understood or got an update on the items that slid out from 2018 on you last quarter or last year. So I know you had the DIU program slide and then there were the two services programs, if you could update us on the status of those? And then I had written down -- I know you were just asked about international but I had written down that you said what slid out of '18 you are actually not embedding in the '19 outlook and assuming it came in '20. So did I have that correct and how is it actually playing out versus that?

Right now, right. So we may be talking apples and oranges here. So to the first part of your question, items that slipped out from Q4, the DIU program, we had expected to get that in Q4. And as I mentioned we just met with the customer at the Pentagon. I think we're going to have the contract by the end of this quarter just like we said before Q2. But let's be conservative and say July but that is on track and then we're going to get additional funding by those customers before the end of the year. And then we're going to get even further customer in Q1 or Q2 or next year. So that that push out is coming back as expected. We talked about the radar program that we had won and another services contract that we had won where we had thought we would have 40 or 45 billets by the end of the year, and we did not have those billets, and we said we hope to be back on track by the middle or Q3 of next -- of this year. I don't know if we're going to get there candidly, but the business is strong enough elsewhere. We're going to make up for it. The other parts -- yes. So I don't know if we're gonna get there with those heads. And the issue there as I can see, I'm really glad we're not a services company, is because right now, with low price technically acceptable, it's very hard to get qualified people to do the billet rate and the billet job. So on those two what the numbers are increasing they're coming up from where they were last year. I do not know if we're gonna get to the 40 or 45 by Q2 or Q3. So but I'm not -- but I'm not worried about that one. On the other one you mentioned on the government shutdown and which impacted us exporting equipment, because we could not get the export licenses because those that office was impacted by the shutdown -- on those, we have shoved those out. I thought we -- I thought we said we have shut them up because no one of them is expected to go in Q3 or Q4 and the other ones in Q1. So I don't think that has changed, it's either one of them is late this year but there's definitely one that we stuck in Q1 of next year because they were doing F-35 ahead of guys like us.

Okay. Great. That's really helpful. Is it possible to quantify what's in the 2019 outlook then or what was in the original 2019 outlook for DIU and the two services programs? So we could understand the order of magnitude I respect...

Yes. So -- I don't want to -- on DIU, I don't want to say for a customer related purposes. I don't want to say. So I'd rather not give that specific on these.

All right. No problem. And one other thing I want to ask you about Eric, now that some of these hypersonics prime contractor awards are coming through, is hypersonic targets a thing that will be a business for you one day or is it already starting to be or is that too pie in the sky?

No, it is absolutely not pie in the sky, and the answer to your two questions are yes and yes.

So you already have revenue in the business for hypersonic targets?

I want to say, we already have revenue in the business from hypersonic systems, and as I said, we're expecting a meaningful task order now directly related to what you just said in the second half of this year related to a hypersonic system, and we are absolutely involved with the coming hypersonic targets, because if you want to defend against Russian or Chinese hypersonic weapon systems, you have to exercise your weapon systems against something, and so you need a target. So yes, sir. .

Okay. So but what -- with targets being separate -- systems being components that are in the prime contractors actual system versus targets being a completely separate thing. Just to make sure I have...

You're absolutely correct. We do not build a full hypersonic system. If you pull up half of the program's high fire or high cause and you look at the booster stacks on those hypersonic front ends, we are the booster stack. Those are two public ones I can mention.

Okay. Thanks so much.

Okay. Thank you.

Thank you. And I'm not showing any further questions at this time. I would like to turn the call back to Eric DeMarco for closing remarks.

Thank you very much for joining us all this afternoon. Our next regularly scheduled call will be when we report Q2 in early August. Thank you again.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone have a good day.+