Kratos Defense and Security Solutions Inc (KTOS) 2016 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Kratos Defense and Security Solutions first quarter 2016 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will host a question-and-answer session, and instructions will follow at that time. (Operator Instructions) As a reminder, this conference is being recorded over the webcast.

Now, I would like to hand this call over to Ms. Marie Mendoza, Vice President and General Counsel. Ma'am, please proceed.

Thank you. Good afternoon, everyone, and thank you for joining us for the Kratos Defense and Security Solutions first quarter 2016 conference call. With me today is Eric DeMarco, Kratos's President and Chief Executive Officer, and Deanna Lund, Kratos's 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, 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 turn the call over to Eric DeMarco.

Thank you, Marie. Good afternoon. Today, we announced that Kratos has successfully received a Phase 1 contract on DARPA's Gremlins program, a very important strategic win for our Company, furthering Kratos's entry into the tactical unmanned combat aerial system market.

Gremlins Phase 1 is to explore different systems approaches to launch and recover in-flight multiple low-cost, high-performance unmanned tactical aerial systems that will be networked and cooperating for electronic attack and reconnaissance missions from standoff ranges. This exploration phase is designed to pave the way for a proof-of-concept flight demonstration. An important objective of the Gremlins program is for relatively inexpensive unmanned aerial vehicles that are reusable to be used in mass quantities to saturate enemy air defenses.

There were four announced winners to Gremlins Phase 1, including Kratos, and the others being Lockheed Martin, General Atomics and Dynetics. Phase 1 is currently scheduled to lead to a systems requirements review at the end of the first quarter of 2017, at which time DARPA plans to down-select two teams, issuing contracts of approximately $20 million each for a Phase 2 preliminary system design.

In the second quarter of 2018, DARPA will hold a preliminary design review, and one team will be selected for Phase 3 at an estimated $35 million contract, concluding with the flight test in 2020. The estimated price target for the Gremlin UAS is approximately $700,000 per aircraft, excluding payloads, for 1000-unit order quantities once in production.

Additionally, we have also just recently received and are now under contract for a second high-performance tactical UAS opportunity. We are unable to provide additional information as to this new UAS contract award at this time due to specific customer confidentiality obligations, though we anticipate being able to do so in the future.

We believe that the selection of Kratos for the Gremlin 1 Phase contract award and the second new high-performance tactical unmanned aerial system award demonstrates our Company's tactical unmanned aerial system qualifications and capabilities, our proven ability to provide high-performance unmanned aerial systems that are reusable at a low cost, and represents an important milestone for our Company and our strategy to successfully enter this new market space.

On the Gremlins program award, due to the nature of the contract and existing Kratos intellectual property positioned, no significant Kratos discretionary investment is expected. Also, no significant Kratos discretionary investment is required or expected on the second new tactical UAS award we recently received.

Additionally, the resources we have been maintaining related to the hoped for successful award of these new opportunities are now, beginning with our second quarter, under contract and will not adversely impact Kratos's EBITDA going forward as they did in our first quarter.

We do believe that the significant discretionary investments we have made over the past two years to develop our UTAP-22 Tornado UCAS successfully positioned us for the Gremlins solicitation and this second UAS contract award we received, as the UTAP-22 demonstrated our ability to quickly develop and produce high-performance, low-cost unmanned tactical systems, leveraging off of our existing high-performance unmanned aerial drone system aircraft.

As I just mentioned and as Deanna will discuss in detail, we have been maintaining resources in anticipation of winning these awards, which related costs impacted our Q1 2016 financial performance, and we will continue to maintain the resources related to the third new UAS opportunity in anticipation of successfully receiving a contract award in the very near future.

In the first quarter, Kratos continued to make progress in the customer and congressional community with our UTAP-22 Tornado initiative, which is Kratos's initial tactical platform related to the unmanned combat aerial system market space. Due to competitive considerations, which are increasing, I will not be providing additional information related to Kratos's UTAP-22 at this time. However, we are making no significant additional investment in the Tornado aircraft at this time.

During the first quarter, we continued to support certain US government agencies related to the command and control of swarms of unmanned aerial vehicles, related mission capabilities, tactics and also defensive capabilities against swarms of UAVs, including the use of high-powered directed energy and laser weapons systems.

In unmanned ground systems, today we announced that Kratos and our strategic partner, Royal Truck and Equipment, Inc., will be deploying Kratos's unmanned ground system technology in an autonomous impact protection vehicle program in collaboration with Colas, a UK transportation infrastructure enterprise.

The autonomous IPV, equipped with an electromechanical system and completely integrated sensor sweep, has leader-follower capabilities that allow the autonomous unmanned vehicle to follow a manned lead vehicle. This unmanned drone system technology was initially deployed for the United States military and is now being customized by Kratos and Royal for the commercial highway industry and related applications, including here in the United States.

Royal provided America with the first driverless, unmanned TMA truck and is an industry leader in unmanned and autonomous vehicles and trucks. If successful, this technology would be deployed across the UK and Europe.

There are few unmanned ground vehicles currently in production. However, the number of tactical UGVs will grow in the future, and certain militaries are currently working on UGVs capable of carrying armaments, rockets, grenade launchers and other weapons systems. With our customers, technology and contractual relationships, we expect Kratos to be a significant player in this new and growing marketplace.

Important additional Kratos first quarter bookings in our unmanned business included a $37 million firm, fixed-price contract on the Air Force Subscale Aerial Target program related to AFSAT operations at Tyndall Air Force base in Florida and the Utah test and training range.

We also received an $18.7 million contract award for the Lot 12 option on the previously-awarded AFSAT Lots 11 through 13 production contract. Both of these contract awards are expected to contribute to our unmanned systems 2016 over 2015 growth and expected 2017 over 2016 growth.

From a business development standpoint at our unmanned systems division, we are currently in contract negotiations on a large, new unmanned target drone opportunity we expect to be under contract on in the next few months. We are also in discussions on a new sole-source unmanned target drone system opportunity we currently expect to be under contract on in the fourth quarter of this year.

Additionally, we are in pursuit of a large, new unmanned aerial drone system program opportunity with a certain government agency, where we understand that tens of millions of funding is allocated over the next couple of years. This opportunity is currently expected to be awarded in late 2016 or early next year.

In Q1, Kratos's unmanned systems division generated a book-to-bill ratio of approximately 2.5 to 1. Operationally, in Q1, our unmanned systems division came in on track, and we continue to expect sequential 2016 to 2015 year-over-year growth, including growth generated by an increased number of unmanned aerial target drone systems, which are currently under contract and expected new awards.

In Q1, Kratos also remained on track to commence LRIP on the SSAT program later this year or in early 2017, depending on the length of any potential federal fiscal CRA, and we remain under contract on a confidential program, also currently estimated to begin production in early 2017.

In Q1, Kratos's satellite communication technology and training business, the largest and most profitable business of our Company, had a particularly strong quarter driven by increased demand for protected satellite communications, unmanned systems communications, overall increasing bandwidth requirements, and a recently publicly disclosed space war game where US satellites and space assets were effectively neutralized.

Our satellite business is expected to continue to be strong throughout 2016 as our backlog and big pipeline continues to strengthen. In this business, we are currently in pursuit of a new approximate $100-million opportunity and a separate new approximate $65-million opportunity, where if we are successful, these could provide us an additional growth step function beginning next year.

And on the training side, we are now designed in and under contract on a new combat rescue helicopter program for multiple training system units, which will be an important growth driver going forward. Kratos's satellite technology and training business is one of the crown jewels of our Company, and the future looks extremely promising for our largest business unit.

In Q1, Kratos's microwave electronics business had a very strong quarter, including strength in the missile system, radar and communications systems area. Kratos's Israeli-based microwave business is one of the most technologically advanced in our Company, and this business is also expected to continue to be strong throughout 2016, driven in part by a first quarter book-to-bill ratio of approximately 1.2 to 1 and a current near record backlog.

Related to this business, the House Armed Services Committee has requested an approximate $200-million funding increase for various Israeli missile defense programs, which, if sustained, would be an additional positive for our business.

Also, a few weeks ago, it was reported that Airbus has been awarded an approximate $9-billion Kuwait fighter jet deal for Eurofighter Typhoons, which is a multi-million dollar opportunity for Kratos based on our current design in position on the Typhoon and our ship set value, and it has recently been reported that Saudi Arabia and Oman are also in discussions to acquire additional Typhoons.

Microwave electronics is also in pursuit of certain potential needle-mover opportunities, one of which is a missile system, which is currently expected to be awarded later this year.

In Q1, Kratos's ballistic missile targets business had a solid quarter, and we are just beginning a large, multi-BMD target system production run we are now under contract on, which is expected to continue into 2017 and should be a key driver of 2016 over 2015 year-over-year organic growth for this business.

In Q1, our government services business came in on track, and based on this business's current backlog and bid pipeline, it is expected to remain stable throughout 2016.

As we informed you in Kratos's fiscal 2015 year-end report, in the first quarter of 2016, we executed a restructuring, a facility consolidation and a major cost reduction in our modular systems and public safety and security business areas. These actions are expected to position these businesses for significantly improved profitability and cash flow generation beginning in the second or third quarter of 2016 on an expected reduced business and revenue base.

We are affirming the full-year 2016 base case financial guidance and trajectory that we previously provided, with 2016's financial trajectory expected to be similar to 2015, with both second quarter 2016 revenue and EBITDA expected to sequentially increase over Q1 of 2016. Kratos's Q2 2016 adjusted EBITDA, though expected to increase above Q1's, will, however, continue to be adversely impacted by the significant resources we are maintaining related to the third tactical UAS opportunity we are awaiting word on and excluding any future investments we may make related to the third new UAS opportunity if we're successful.

We will update our guidance once this third UAS opportunity award is made, the timing of the award, if Kratos is successful, and, if we are successful, the definitized contract structure. If we are unsuccessful, we will update our guidance for the significant cost reduction we will immediately make related to the significant resources we have been maintaining in anticipation of successfully winning this opportunity.

Deanna?

Good afternoon. Thank you, Eric. Our first quarter 2016 revenues were as expected at $153 million, with year-over-year organic revenue growth of 23.4% in our microwave products business, 14.5% in our unmanned systems business and 11.3% in our satellite communications business offset by year-over-year reductions in revenue generated by our modular systems and public safety businesses of 30% and 19.5%, respectively.

Modular systems and public safety declines were primarily the result of reduced shipments of hardened mobile tactical facilities and our change in strategic focus in our PSS business to pursue primarily smaller size, higher margin security system deployment projects rather than larger size projects, which typically have lower-margin projects.

Our Q1 adjusted EBITDA of $4.6 million was positively impacted by stronger than expected performance in our core satellite communications, microwave products and defense and rocket support businesses offset partially by a weaker than expected performance in our modular systems, public safety and unmanned systems businesses.

Additionally, as Eric briefly mentioned and as we communicated with the Company's fiscal 2015 year-end financial report in March of 2016, during the first quarter of 2016, Kratos continued to maintain significant engineering, technical, management and other unmanned aerial system-related resources in anticipation of successfully being awarded three new high-performance tactical UAS program opportunities, which the Company was competitively pursuing.

The maintenance of these resources and the associated costs related to the pursuit of these new UAS opportunities significantly adversely impacted Kratos's first quarter 2016 adjusted EBITDA. As Eric mentioned, Kratos was recently successfully awarded and is now under contract for two of the three new opportunities, with the third UAS opportunity not yet being formally awarded. We will continue to maintain the resources related to the third new UAS opportunity in anticipation of successfully receiving a contract award in the near future.

Also, as we informed you with our FY15 report in March and Eric also mentioned, in the first quarter of 2016, Kratos executed significant cost reductions and a related facility consolidation in its modular systems division and a restructuring move, which resulted in the closing of Kratos's Charleston marine container manufacturing plant in April 2016 and the transfer of associated work to other MSD facilities. The facility consolidation was driven by the need to improve MSD manufacturing efficiencies, operational performance, profit margins and cash flow.

Additionally, in the first quarter of 2016, we executed a significant cost reduction action and reorganization in our public safety and security business, with the objective also of improving operational performance, profit margins and cash flow. The majority of the actions related to these restructuring activities, facility consolidation, headcount and other cost reductions were completed by the end of Kratos's first fiscal quarter. These restructuring activities in our modular systems and public safety businesses resulted in an aggregate headcount reduction of over 120 personnel.

Accordingly, our adjusted EBITDA for the first quarter is from continuing operations and excludes the following charges, which have been reflected as adjustments consistent with our prior presentations, since we either believe the items are non-operational or nonrecurring in nature or meaningful for investors to understand our financial performance -- restructuring-related items and other of $4.9 million, which includes the following -- $3 million of a non-cash charge to impair the carrying value of inventory as a result of exiting a lower-margin shelter business at our recently closed modular systems facility, excess capacity and restructuring costs of $1.9 million, reflecting $600,000 of employee termination costs and $1.3 million of unabsorbed manufacturing overhead costs due to reduced sales volume resulting from the delays in anticipated contract awards in our modular systems and unmanned systems businesses.

Also excluded from our adjusted EBITDA are $1.9 million of litigation-related items related to a litigation settlement of a contract dispute in our PSS business related to a project that was performed in 2014, which matter is now resolved, and $400,000 related to initial investments we began to make for certain unmanned aerial systems in anticipation of a related contract award.

We have also presented pro forma adjusted EBITDA to reflect the impact of the significant restructuring actions that we took during the quarter of -- first quarter of 2016 to eliminate personnel costs in our PSS and modular systems businesses as if these actions had occurred at the beginning of the quarter to present a full quarter's impact of the action.

As I mentioned, the restructuring actions, which were substantially completed by the end of the first quarter, resulted in a reduction of over 120 personnel in these two businesses. The full quarter's impact of these actions was estimated to be $2 million, with approximately $1 million attributable to PSS and $1 million attributable to our modular systems business.

We expect to record an additional non-cash impairment charge related to the PP&E assets contained in the modular systems facility, as well as an accrual related to the underlying lease when we vacate that facility during the second quarter of 2016.

On a GAAP basis, net loss for the first quarter was $22.2 million, which included $2.7 million of expense related to the amortization of intangible assets, non-cash stock compensation of $1.5 million, and a $3.6 million tax provision.

Moving to the balance sheet and liquidity, our cash balance was $20.1 million at March 27, plus $700,000 in restricted cash. Kratos also had zero amounts outstanding on its bank line of credit at March 27. Our availability in our line of credit at quarter end, net of our $10.1 million of letters of credit outstanding, was $52.8 million.

Cash flow from continuing operations for the first quarter was a use of $11.5 million. Capital expenditures for the quarter were $2.1 million, and the total net decrease in cash was $8.4 million at quarter end.

DSOs increased from 106 days at the end of the fourth quarter to 124 days primarily as a result of two sizable advanced billings, which were made during the first quarter, for which revenues have not yet been recorded, as the word has not yet been performed, which have negatively impacted our DSOs. Since quarter end, we have collected these advanced billing amounts. As we perform work on these projects and revenue is recorded, our DSOs are expected to reduce accordingly.

Excluding these two sizable advanced billings, DSOs were approximately 113 days at the end of the first quarter of 2016. In addition, DSOs continue to be impacted by milestone payments on long-term delivery projects, which we are unable to contractually invoice for amounts until the completion of certain milestones and-or final delivery of products, or the demonstration of certain flight parameters specifically in our unmanned systems segment.

Our contract mix for the year was 83% of revenues generated from fixed price contracts, 12% from cost plus contracts, and 5% from time and material contracts. Revenues generated from contracts with the federal government were approximately 62%, including revenues generated from contracts with the DoD and with non-DoD federal government agencies.

We also generated 7% of our revenues from state and local governments, 20% from commercial customers, and 11% from foreign customers, with our aggregate non-DoD revenues comprising 38% of our total revenues.

Backlog at quarter end was $909 million, with $554 million funded and $355 million unfunded. Kratos's book-to-bill ratio was 1 to 1 for the first quarter, and for the last 12 months was 0.9 to 1.

Eric?

Thank you, Deanna. With the Gremlins and the second tactical UAS award we recently received, in addition to being a leader in high-performance target drones used for training pilots and testing weapons systems, Kratos is a new entrant in the tactical combat drone for force multiplication market area. As we move forward, we will be executing a plan focusing on our core, technology rich and high growth unmanned systems, satellite communications and microwave electronics business areas while also improving the Company's capital structure.

With that, we'll turn it over to the moderator for questions.

Thank you. (Operator Instructions) Mike Crawford, B. Riley & Company.

Eric, in the media, you were reported as saying that the Gremlins was based on your Firejet platform. Is that accurate?

Yes, Mike, repeat that, please, buddy?

That your Gremlins concept would include a vehicle based on your Firejet.

I'm not going to comment on that here, Mike.

Okay. Okay. There was that Inside Defense article. And then, Eric, on the target's business -- well, for Gremlins, you talked about excluding payload of 700 -- I'm sorry, a certain price with the --

Yes, for Gremlins, Mike, what's publicly out there is approximately $700,000 per aircraft for order quantities of 1000 at a time.

And could you go through what your -- kind of your ASPs are for like the SSAT, AFSAT and the Firejet?

So for Firejet, depending on configuration and depending on payloads, 250 to 350, and for AFSAT, depending on configuration and payloads, 600 to 1.4.

And the SSAT you said around $1 million?

In the ballpark, yes, sir.

Okay. And then it's -- in the past, there have been comments about the Navy running out of old targets, but is there no way to start delivering SSATs before -- what does it take to enter that LRIP on the SSAT?

So we have a base contract, and then we have two production options under the base contract. The option one right now is currently anticipated to be exercised before the end of this fiscal year, as I said in my comments. I don't know if or how a potential CRA, a continuing resolution authorization, would impact that. There is a time fuse in the contract of when that option has to be exercised by, and that is coming up in the near -- after year-end, but shortly after year-end.

And then there is a second production option a year later underneath that contract, and so the customer is going to be performing some flights over the next few months. We are done with our flights. The customer is going to be performing some flights, training out their teams, and then the execution of the contract is -- of Option 1 is expected.

Okay, thanks. And then on the second unmanned tactical platform, one, is that something that you've been pursuing for a long time, or is that something that came up through an unusual channel?

We've been pursuing it for approximately one year.

Okay. But it just hasn't been officially announced?

We are -- as I said, Mike, we have been given strict -- we are unable to talk about this at this time. I'm hopeful in the very near future that either the customer will announce it or we'll be able to announce it.

Okay, thanks. And I'll just ask one last question. Can you just describe what it is that Kratos brings to the table in terms of this other capability you have of controlling swarms, including what work you're currently doing?

Yes, we have a collaborative communication technology that's ours. We call it Wolf Pack. We haven't talked about that much, and it has to do with the command and control of up to approximately a dozen drones at a time and how it's secure, how they can be truly autonomous, how if some of them go down, others can replace them and replace their mission, and we are under contract and we're demonstrating this right now. So it's our technological capability on the command and control of unmanned aerial vehicles in swarms.

Okay. Thank you.

Yes, sir.

Mark Jordan, Noble Financial.

Eric, you mentioned in the press release a big pipeline of $7.1 billion. Could you detail what amount of that has been submitted, what will be submitted between now and the end of the calendar year, and, finally, what amount of that total do you expect to be adjudicated in the current year?

I cannot, but Deanna can.

Yes, I said that the pursuit review, which I said the submitted is $1.3 billion, that's been submitted to date.

And expectation of what you might do incrementally through the year, and, finally, what do you expect to be adjudicated this year?

I would -- the majority of those, Mark, would be expected to be awarded by the end of the year. The vast majority that we've submitted would be expected to be awarded, barring unforeseen circumstances, by the end of 2016.

All right. You noted in your press release the second bullet point, which was for a high-performance UAV that you couldn't give any details on. I'd just like to confirm that this is a separate program than the, quote, unquote, classified program you referred to earlier that was similar to the SSAT program, roughly half the size, on the same ramp. I'm just confirming that those are two different programs.

Totally separate. Absolutely, totally separate.

Okay. Also, in your release you noted that the BMD targets and defense services operations had, quote, unquote, a solid performance, and you mentioned that you looked at them to be stable through the balance of the year. As you quantify the relative size, at least current run rates, for the SATCOM business, the Israeli microwave, could you size that package of businesses?

So on our ballistic missile target business, think 15 to 20. On the services business, 80 to 90.

Okay. You mentioned or talked about the SSAT hitting LRIP along with that other classified program probably this fall, assuming the contracts can be awarded and other things. Do you know how you're going to account for those yet in terms of either as a percent completion or upon shipment?

Mark, we're not sure yet. I believe it will most likely be on a percent complete cost over cost, but we still have to resolve that matter with our external accountants.

Okay. And a final question for me, please. Obviously, you consumed cash here in the current quarter. As you assume improved revenues and fundamentals through the balance of the year, could you see what you expect in terms of cash flow and cash consumption between now and the balance of the year?

What I'll do is stick to the comments that we made last quarter. The guidance that we gave was that our free cash flow or cash flow generation would be improved from 2015's performance, specifically pointing to the interest areas, about $11 million of a reduction as a result of the redemption of the senior notes and paying down the revolver, and I'll just leave it at that remark that it's -- we are expecting an improvement from where we were in 2015.

All right. In the satellite tech and training, you mentioned there was a $59 million first quarter, good growth year over year. Do you expect that business sequentially to show growth from that first quarter base?

Yes.

Okay. And then I guess a final question for me -- the microwave business. With what is out there, that has the potential, it seems, to have potential for step function growth later in the year if certain things hit from that sort of 12.5 million base. Is that correct also?

Yes, and as I mentioned in the remarks, we're designed in on certain -- less than a handful, but more than two or three new missile and radar system opportunities with a prime, and the prime has a customer, and if the customer makes the decision to go into production, our content per ship set on the missiles could be a step function for us once it gets the full rate, yes, sir.

All right. Thank you very much.

Thank you.

Michael Ciarmoli, KeyBanc Capital Markets.

Eric, maybe just on the outlook for the year, EBITDA generation -- are we still thinking, given the weak first quarter here, that we're going to be comparable to the 2015 level?

So a big -- as I sit here today, I'll say, yes, I believe we're going to be in the ballpark of that. A big swinger, Mike, is this third contract we're waiting for. If, God willing, it's awarded sooner rather than later and we win, that's going to give us one answer. If we're unfortunate and we lose and we have to make significant cuts and we don't have that contract, that's going to give us another answer. And the timing of when that happens, if it's extended before that decision is made, we have to continue to carry these resources, because I believe we're going to win.

Okay. So that was -- I mean, I'm just looking at it. Your base case was sort of flat EBITDA, but it presumably really depends on this contract here.

I had -- Mike, I had fully expected this contract to be awarded by now.

Okay.

Fully.

Do you know what the specific hold up is?

I really shouldn't say anything other than what I just said.

Okay. In terms of -- I think you mentioned sort of plans to improve the capital structure. Can you guys elaborate a little bit on that?

I do not want to elaborate at this time. However, I believe that we will be elaborating as this year progresses.

All right. Fair enough. What are your bigger-picture defense -- I mean, I heard you reference continuing resolution. Are you seeing anything, any changes to the plus or minus side in the overall defense budget environment?

So let me give you -- I'll give you the pluses and then the minuses. So the pluses -- our satellite communications is extremely strong right now, both in the unclassified and the classified area. We are seeing particular strength in this area related to the perceived Chinese and Russian threat to the space assets and the infrastructure, and that business is looking very, very good. I expect that business to knock it out of the park this year and next year.

Our microwave electronics business is looking very, very solid, for the same reason -- we're designed in a number of missile and radar systems and communications systems, and I mentioned the plus-up with the (inaudible). I mentioned what's going on with the Eurofighter Typhoon. That business is going to do very, very well.

Our unmanned systems business is going to do very, very well both on the target side and I believe on the tactical side because of our -- the contracts we've won, the one I'm hoping we win, and with -- if some things work out for us with our UTAP-22.

And the last good one is our ballistic missile target business, because of the perceived North Korean and Iranian and other threats. That business looks real good when you look at the schedule. As I mentioned in the remarks, right now we're in a nine- or ten-unit production run for launches.

Okay.

The government services business is stable, but that -- right now, because we're fairly well bolted in, but that business remains very, very tough, unless you're focused in that area and have the critical mass, which we don't because we went the products way. With bid protests still prevalent, a low price technically acceptable still prevalent, that business is stable, but it's a challenging business.

In the modular systems business, we are truly transforming this business right now. It's like that book, Someone Moved My Cheese [sic], where a couple -- two or three years ago, we were heavily involved with tactical systems. These are products for tactical communications systems, tactical radar systems, special operations types of communication equipment, things of that nature. That has significantly, if not virtually, gone away, and now it's shifting to missile systems, like Patriot and EEU and THAAD and other ones. And so there are a lot less units, but a lot bigger ones at a higher value, and we're right in the middle of that transition, so that business has been very, very challenging as we're trying to pivot with the market.

In our public safety business, it -- as Deanna mentioned, we just made a significant headcount cut. We did a significant restructuring. We've reramped -- we have revamped the salesforce to focus on smaller but higher margin jobs, and we've taken all those actions, but that process is going to take some time, and so that business will probably remain challenging.

I think it's going to improve, but it's still remaining challenging for the rest of the year, because a couple years ago, it was a couple hundred million dollar business, when we were doing very large massive security system deployments at very low margins. This year, it might do a buck twenty, a buck thirty, but the margin rate will be higher and the liquidity will be better.

Got it. That is helpful. The last one I had -- how much of the backlog is shippable in the next 12 months?

It's about 45%, Mike.

Forty-five percent?

Yes.

All right. Thanks, guys. That's all I had.

Thank you.

Eric Selle, Suntrust.

A lot of questions have been answered, but it looks like you're going to get, you're expecting -- and obviously, depending on this third contract, and we all understand that the timing of that is obviously not known now, but it looks like you're going to get about a $10-million EBITDA lift in the second half, and as the world you see today, what are the major building blocks of that second half lift?

The major building blocks, quarter to quarter -- quarter-over-quarter growth in our microwave business, significant quarter-over-quarter growth in our satellite technology and our training business, significant quarter-over-quarter growth in our unmanned business. However, the timing of that award and the resources we maintain the length of that time impacts the EBITDA, depending if we're under contract or not or how we're going to account for that or not. Those are the big building blocks.

And just to add to that, Eric, the expected benefit from the restructuring actions that we've taken in public safety as well as in modular systems.

Right. That's 120 heads, and you figure -- I mean, I'm just doing rough math. At $50,000 a head, that's $6 million annualized savings. You should get at least three out of that.

Yes, the impact that we adjusted for in the pro forma adjusted EBITDA is roughly $1 million each in those businesses, so $1 million for PSS for Q1 and $1 million for modular systems for Q1, so an annualized --

Okay, great. So to summarize it -- I'm sorry, I interrupted you. I apologize.

No, go ahead. Go ahead.

Well, so basically to summarize, you guys have a lot of high-margin sales growth that's coming through and then some labor cost savings. Is there any risk to those -- the growth in those three components, the satellite, electronic warfare -- I mean, obviously the unmanned is undetermined, but the first two, is there any risk to that ramp in revenue?

I don't mean to be flippant at all on this, Eric, but I've learned anything that's not under funded backlog with the shipping schedule that we're about to ship has risk. I feel very confident in those three businesses that we're going to achieve our objectives. I feel very confident because of what we've got -- as I mentioned, our microwave electronics business I think just came off of 1.2 book to bill. Its backlog remains at near record. I think I've said that the last three or four quarters.

Our unmanned systems business I think just had a 2.5 book to bill, and I think ripped off a couple of big target programs we've won. Those are going to be delivered. Our satellite communications business -- we don't talk about a lot of the work they do, for obvious reasons. We don't disclose it, we don't talk about it, but that business looks really, really good. Our training business -- I mentioned the combat helicopter training systems that we're designed in that's now going into production. That looks very, very good. Our training business will definitely grow this year in backlog. I feel good about it, but I've learned something can bite you in the ass.

If it ain't in the bank, you can't count it. We've all learned that.

That's it, so I ain't counting the chickens.

And then on the third UAS contract, I mean, any sense on timing? I know it's hard to call, but, I mean, are we thinking about June, or it's just hard to call?

Hard to call, sir.

Okay. Well, as always, I think (inaudible), and I look forward to hearing from you all in the near future.

I look at the good news that we're two for two with one more to go.

Thank you. (Operator Instructions) Sheila Kahyaoglu, Jefferies.

To follow up on Michael's question a bit in terms of the moving pieces a little bit on the guidance, I guess for unmanned, is there any way you could quantify the three contract opportunities one more time? I may have missed it, Eric. And then in terms of PSS, it seems like although revenue guidance is unchanged, maybe that's the one that poses the most risk for the full year.

So on the three, the -- as we put out in the release, the Gremlins Phase 1 is just under $4 million, and the time burn on that is relatively quick. It's just under 12 months. On the second one, I really can't say. I really can't say. And on LCAS, I don't want to say anything other than what's publicly out there, which I know you're familiar with. It's very sensitive. I don't want to talk about that.

And so that's where we sit. As I said at the -- when we did our last call, I said I felt confident that by June it would be clear, and I remain pretty confident that by June, the path will be clear one way or the other for us.

And just on the outlook in PSS?

So as I mentioned, as I said in my -- as I said, I think, on the other question, my outlook on PSS, I think they're going to do 120 to 130, and I think the margins are going to -- because of the significant cost reductions we made in Q1 that were very difficult but we had to do it, I think the EBITDA is going to start coming up in Q2. It'll go a little better in Q3, and it'll go better in Q4 as the impacts of those is affected across the business unit.

Okay. Thank you.

Yes, ma'am.

Thank you. Ladies and gentlemen, this concludes our question-and-answer session for today. I would now like to hand the call back over to Mr. Eric DeMarco for closing comments.

Thank you very much for joining us. We will look forward to speaking with you when we report our next quarter in a few months. Thank you.

Ladies and gentlemen, this does conclude today's program, and you may all disconnect. Everybody have a wonderful day.