Kratos Defense and Security Solutions Inc (KTOS) 2016 Q4 法說會逐字稿

Good day, ladies and gentlemen, welcome to the Kratos Defense & Security Solutions fourth-quarter 2016 earnings conference call.

(Operator Instructions)

I would now like to turn the call over to Marie Mendoza, Vice President and General Counsel. Ma'am, the floor is yours.

Thank you. Good afternoon, everyone, and thank you for joining us for the Kratos Defense & Security Solutions fourth-quarter 2016's 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 would 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 in mind 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 turn the call over to Eric DeMarco.

Great. Thank you, Marie. Kratos' fourth quarter and full-year 2016 came in stronger than expected with the company significantly exceeding both our revenue and our EBITDA estimates. Deanna will be providing all of the details regarding our fourth-quarter and full-year 2016 financial results in her prepared remarks.

The macro US defense and national security environment continues to improve, and in particular as related to Kratos and the satellite communications, cyber security, and unmanned systems areas which was a key factor for Kratos' return to growth in 2016, and for our expected continued growth trajectory in 2017. Kratos' largest business unit, satellite communications cyber technology and training, which generated $257 million in revenue in 2016, had a particularly strong year with year-over-year growth of over 10% significantly beating virtually all of our forecasted financial targets, including having full year and fourth-quarter 2016 book-to-bill ratio of 1.2 and 1.2 respectively, positioning this business for an even better 2017.

Thus far in 2017, Kratos' satellite communications business has received a number of new contract awards totaling in the tens of millions of dollars, including in the classified arena and awards we have not formally reported, which is providing us additional confidence that 2017 will be very strong for this business. Also very importantly, Kratos' owned and operated satellite signal monitoring and interference and location business generated important traction in 2016 with new customer contract awards, and we are currently forecasting in excess of 30% growth in 2017 over 2016 revenues for this high-margin specialize business.

Our signal monitoring and interference detection and location business, which we believe we are the only company that has this capability where we have significant Kratos owned assets and infrastructure sites across the globe and where we are monitoring literally dozens of satellite beams for our customers, is a very valuable asset of our Company. Major programs that Kratos supports in our satellite communication business include WGS, AEHF, Sivers, and MO US.

With the well-publicized potential threats from the US space-based assets from potential peer and near-peer adversaries and the ever-increasing demand for space-based communications, intelligence surveillance and reconnaissance and data links, including for unmanned systems, we believe that we are at the beginning of a significant long-term funding trend increase in the MILSATCOM area. Kratos is the industry leader in satellite communications, ground equipment and infrastructure, or command and control, radio frequency interference identification, geolocation, and related cyber security.

Kratos' training systems business, which generated approximately $50 million in 2016 revenue, is currently projecting approximate 20% growth in 2017 revenues over 2016, with the majority of 2017's forecasted revenue currently in backlog, primarily as a result of certain large multi-year program awards we received in 2016 including the KC 46 aerial tanker, and the Marine Corps' MCAT helicopter award. In our training systems business, we are currently in pursuit of certain very large opportunities, including a single $75 million opportunity with contract award currently expected by September 30, which if we are successful, will further accelerate the forecasted growth for this business.

Kratos' cyber security business is also positioned for significant 2017 growth, as we are one of the leaders in the country addressing the Fed ramp compliance requirements for enterprises doing business with government agencies in the cloud. Kratos' unmanned systems business had a very strong fourth quarter, generating significant sequential quarterly and year-over-year revenue growth.

In the fourth quarter of 2016, Kratos was awarded a large target drone program with a new international customer that we are currently ramping up on and which we believe will be an important revenue and EBITDA generator in the second half of 2017. We are also now in final contract negotiations with an additional new international target drone customer where we hope to receive the contract award in the next few months. This new international customer contract award is also expected to be an important contributor to our unmanned systems business in the second half of 17.

As you know, Kratos' high-performance target drone systems require a significant amount of related ground, range, command and control, and other infrastructure and investment by new customers. And once a customer has made this investment, we believe that we will be supporting the customer with our target drones indefinitely. And as Kratos target drones or shot at with weapons by our customers and ultimately destroyed, this business is recurring in nature.

In 2017, once the 2017 federal DOD budget is a place, Kratos expects to begin production on two new unmanned aerial drone target system programs we have under contract, one with the US Navy and one with a confidential customer. Together, we expect these two programs will drive at least a doubling in size of Kratos' unmanned systems business over the following 24 months. We expect this growth trajectory to continue into 2018 and 2019 as production ramps up on these under contract programs.

We are also in discussions with a US government customer for a multi-million dollar order for a modified existing Kratos unmanned target drone system, which we are hopefully expecting to receive in the next few months. And very importantly, we were just informed by our AB Sat customer that they will be requesting an increase in the number of unmanned drone aircraft for 2017 with expected quantities above each of the prior year's orders and what we had previously forecast for 2017. Additionally, we also currently anticipate that in 2017 we will begin negotiations with the US Air Force for production years 14, 15 and 16 for Kratos' 167 unmanned aircraft under our AB Sat program which would cover FY18 to FY20 for our Company.

Kratos' target drone businesses clearly beginning to ramp up both domestically and internationally with the recapitalization of strategic weapon systems underway, and Kratos is the clear industry leader in the high-performance, unmanned aerial target drone market space. On the tactical or unmanned combat aerial system side, in 2016, Kratos' unmanned systems business one each of the high-performance jet powered UCAS opportunities that we bid on, and we are currently executing on each of these programs.

On the LCASD program with the Air Force research lab, we are currently on budget and on schedule to demonstrate Kratos' LCASD aircraft in the second quarter of 2018, and over the past several months, potential user and customer government agency interest in the LCASD aircraft has been significantly increasing. For competitive reasons, I cannot get into details at this time regarding specific opportunities we are in discussions on or aware of related to the LCASD, but we fully expect that once successfully demonstrated, there will be significant demand for this UAV.

Kratos' UTAP-22 program, with the defense innovation unit experimental, is also on budget and on schedule for multiple Kratos owned UTAP-22 unmanned combat aircraft to participate in a major exercise in the second half of 2017. Due to the nature of the exercise and what we will be doing, I will not get into details in this forum.

However, similar to the LCASD program, we have been in discussions and working with the DIUx so that once we successfully execute in this exercise, we will be in a position to begin delivering UTAP-22 systems to the war fighter. Importantly, the DIUx mission is to identify disruptive, leading technology or systems with venture capital backed Silicon Valley pedigree, nontraditional companies and within 24 months get the identified company under contract, demonstrate the system, and deliver the system to the user community or the war fighter.

As you know, a number of the members of Kratos' Board of Directors are venture capitalists and entrepreneurs. Kratos has been executing on a nontraditional government contract and strategy in the unmanned aerial system space for a number of years, and we have true nontraditional DOD players on our DIUx program team. The DIUx executed its contract with Kratos in September 2016, and we are on track and supporting the stated DIUx 24-month mission.

On the Defense Advanced Research Project Agency Gremlins program, we understand that DARPA may be announcing which companies will be moving on to phase 2 in the very, very near future. And accordingly, I cannot say too much publicly at this time. However, as you know, we believe that a key reason Kratos was selected as one of the four Gremlin prime phase 1 contract awardees was due to Kratos' industry-leading position in designing, demonstrating, producing, and fielding low-cost high-performance jet UAVs in a short timeframe.

And today, I am truly more confident than ever that Kratos will be producing a UAV for the Gremlins program. On the confidential tactical UAV program we were awarded last year, I believe that we will be able to discuss in greater detail this program and the Kratos aircraft sometime before the end of Q2 of this year.

In our microwave electronics business, since our last report, both the arrow three missile system and the Barack eight missile system had successful test flights, and both of these cradle supported systems were Kratos has tens of thousands of dollars of content per system are expected to begin production late in 2017. Additionally, Kratos' designed end for the electronic warfare system on the Griffin fighter with Kratos content up to approximately $250,000 per aircraft.

The Griffin E aircraft is a 4.5 generation fighter whose initial delivery is scheduled for 2018 and is expected to replace the Swiss Air Force's fleet of F5 EF Tigers. We understand that an order for 100 Griffins has already been placed and that the Griffin has also been down selected in India for two final competitors for several hundred aircraft. We're keeping our fingers crossed on this one, as it appears that in late 2017 or 2018 we could have a growth step function in our microwave electronics business when this program is reached -- achieves production.

In summary, in 2016, Kratos' satellite communication, cyber security, unmanned target systems, and training businesses won a number of new contract awards and are positioned for sustained increased growth and profitability and our microwave electronics business is designed in on a number of new programs that are expected to achieve production status. In the new tactical unmanned aerial system area, Kratos won each of the tactical program opportunities we pursued in 2016, and if we ultimately achieve production status on any of these programs, this could be significantly additive to Kratos' target business model of $800 million in annual revenue and $80 million in annual adjusted EBITDA.

As we begin 2017, we believe that Kratos' prospects are extremely bright, and that 2016 was the beginning of a long-term revenue cash flow and EBITDA growth trajectory for our company. We believe that we have the right business, the right cost products at the right time, and we are focused on execution of our core businesses. Importantly, we are also currently considering certain steps that would refine our focus even more during 2017 as we generate long-term value for Kratos' stakeholders.

Now for our 2017 financial guidance summary, over the past several years the US Defense budget has been reduced by hundreds of billions of dollars. As I mentioned earlier, with the 2015 bipartisan spending bill, the perceived peer or near peer threats to the US, and a call for increased defense spending by the new presidential administration including today, defense budgets are increasing including in Kratos' core business areas.

Additionally, we have also been seen increased international demand for our products and solutions by foreign allies to the United States, and we expect international demand to increase further going forward with the Trump administration's call for all NATO countries to increase their annual defense spending to the stipulated 2% of their respective country's GDP. As a result of the improved and expected to continue to improve environment, our visibility and our confidence in the business is increasing, and accordingly, beginning with the first quarter of 2017 in addition with full year annual financial guidance, we will now also be providing quarterly guidance for Kratos.

As you know from our third quarter 2016 report, and the conferences that Deanna and I have recently attended, we have provided full-year 2017 financial guidance for revenues of $700 million to $720 million and adjusted EBITDA of $52 million to $54 million, which we believe is conservative in which we are afforming today. We are currently confident in this forecast based on our funded backlog, our pipeline, and that we have two sizable new programs expected to begin production in 2017 once there is a defense budget in place, which is currently expected to begin at the end of April, early May.

Though we cannot predict when there will be a 2017 defense budget, when it does happen, it would be a significant positive event for Kratos, and we expect to revisit our financial guidance at that time. Additionally, with the company returning to growth in 2016 and with that growth expected to continue going forward, we expect to begin to realize earnings and cash flow leverage from the business as we move ahead, and we expect our income statement to become cleaner for the investor.

Deanna will provide the details on Kratos' 2017 full year and first-quarter financial guidance in her prepared remarks. Deanna?

Thank you, Eric. Good afternoon.

Kratos' fourth-quarter 2016 revenues of $182.1 million exceeded our expectations of $178.4 million with year-over-year consolidated organic revenue growth of 2.6%, driven primarily in our unmanned systems business, which was up 59.6%, satellite communications technology and training businesses which was up 5.9%, and in our defense and rocket support services businesses, which was up 26.3%. Our Q4 adjusted EBITDA of $13.4 million also exceeded our expectations of $11.4 million due a favorable mix of higher-margin work in our satellite communications, technology, training and cyber- related businesses offset partially by unexpected increased cost, contract cost growth of approximately $3.4 million on certain of our large, legacy critical infrastructure projects in our public safety business, which are nearing completion in the first half of 2017.

Once these projects are complete, which is expected to occur in 2017, we will only have one remaining large critical infrastructure project which is expected to be in the build-out phase for another five or so years out. If we would not have incurred the increase cost on the soon to be completed projects in our PSS business, our fourth quarter 2016 adjusted EBITDA would've been $16.8 million.

Accordingly, we believe that we are making excellent progress towards our stated target business case for annual revenues of $800 million and annual adjusted EBITDA of $80 million. Our adjusted EBITDA for the fourth 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, nonrecurring in nature, or meaningful for investors to understand our financial performance.

Restructuring related items and other of $1.5 million, which reflects a $1.4 million non-cash write down impairment charge of one of the facilities we shut down in our modular systems business earlier in 2016, and $100,000 of related severance cost. Also excluded from our adjusted EBITDA is $500,000 representing excess overhead capacity in our unmanned systems division. On a GAAP basis, net loss for the fourth quarter was $4.3 million, which included the restructuring of $2.6 million of expense related to amortization of intangible assets, non-cash stock compensation expense of $900,000, and an $800,000 tax provision.

For FY16 results, revenue with $668.7 million compared to 2015 revenues of $657.1 million, or a 1.8% increase. This compares to our FY16 expectations of $665 million in revenues, adjusted EBITDA for 16 was $45 million compared to $44.6 million for 2015. This compares to our FY16 expectations of $43 million of adjusted EBITDA.

Year-over-year growth was driven primarily by increased shipments and work performed in our satellite communications business of approximately $21.1 million, simulation and training business of approximately $6.7 million, and in our ballistic missile targets business of approximately $8.6 million, offset by a reduction in shipments of our specialized ground equipment products resulting primarily from delays in contract awards of $11.8 million and other reductions primarily in our government services business, which includes our weapons reset business of approximately $4.9 million.

Increased revenues of $9.5 million in our unmanned systems segment resulted from recent contract awards in unmanned combat aerial systems and unmanned aerial target systems as well as due to an increase in shipment of unmanned aerial target systems. Organic full year-over-year growth in our satellite technology training and cyber business of 10.4%, 14.2% in our unmanned systems business, and 7.9% in our defense and rocket support business, were the drivers that brought the revenues back to organic year-over-year growth of 1.8% in 2016, the first time that has occurred since 2012.

Declines in our public safety business of $17.6 million were primarily the result of our change of strategic direction in the fourth quarter of 2014 to capture higher-margin work and only selectively bid on larger security integration projects that traditionally generate lower margins, coupled with the impact of over $4 million in unexpected cost growth primarily recorded during the fourth quarter of 16 on several large long-term security integration projects, which are nearing completion, which impacted our revenues in this business.

Moving to the balance sheet and liquidity, our cash balance was $69.1 million at December 25, plus $500,000 in restricted cash. Kratos also had zero amounts outstanding on our bank line of credit at December 25. Availability on our line of credit at quarter end net of our $11.1 million of letters of credit outstanding, was $56 million based upon our borrowing base. Cash flow from continuing operations for the fourth quarter was a use of $3.7 million, reflecting the working capital impact at the 10.1% fourth-quarter 2016 over third quarter 16 sequential revenue growth the company generated offset by the semi annual interest payment of $15.8 million in November.

Capital expenditures for the quarter were $4.1 million with the majority of expenditures related to our unmanned systems business and satellite communications technology and training business. DSOs remain flat at the end of the fourth quarter compared to the end of the third quarter at 114 days. Our DSOs continue to be impacted by milestones on long-term delivery projects where we are unable to contractually invoice for amounts until the completion of certain milestones and/or the final delivery of products or the demonstration of certain flight parameters, specifically our unmanned systems segment. We expect certain of these milestones to be achieved in the second and third quarters of 2017.

During the fourth quarter of 2016, we completed an equity offering, generating net proceeds of $76.2 million after underwriting expenses. Consistent with the company stated use of proceeds, raise in equity offering, cash of over $14 million was utilized during the fourth quarter to retire approximately $15 million of the company's senior notes bringing the total amount outstanding of senior notes at December 25 to approximately $435.5 million.

During the fourth quarter, as mentioned earlier, the company made investments in its LCASD and UTAP-22 combat aircraft of approximately $1.9 million, primarily for capital expenditures related to two programs that Kratos is working under contract on. In the fourth quarter, the company also made an initial $5.1 million strategic investment in a satellite communication signal monitoring, signal intelligence, and location identification technology and product line, which we believe significantly enhances Kratos' existing satellite medications business offering, which is our largest and most profitable business in the company.

Our contract mix for the year was 84% of revenues from fixed-price contracts, 11% from cost-plus contracts, and 5% from time and materials contracts. Revenues generated from contracts with the federal government were approximately 57%, including revenues generated from contracts with the DOD and non-DOD federal government agencies. We also generated 4% of our revenues from state and local governments, 25% for commercial customers, and 14% from foreign customers with our aggregate non-DOD revenues comprising 43% of our total revenues.

Backlog at fourth-quarter end was $900 million, with $626 million funded and $274 million unfunded. This compares to backlog at third quarter end of $901 million with $582 million funded and $318 million unfunded for an increase of $44 million in funded backlog. Kratos' book-to-bill ratio was one to one for both the fourth quarter of 2016 and for the year ended December 25, 2016.

As Eric mentioned and as we announced in our fourth quarter earnings release earlier today, we are reaffirming our full-year 2017 guidance for revenues of $700 million to $720 million and adjusted EBITDA of $52 million to $54 million with a 2017 sequential quarterly trajectory similar to 2016. We're also providing first-quarter 2017 guidance for revenues of $158 million to $168 million and adjusted EBITDA of $6 million to $8 million.

As I mentioned, we expect the quarter-to-quarter trajectory during 2017 to be similar to 2016, which was also similar to FY14 and FY15. Specifically, we expect the first quarter of 2017 to be our lowest from a volume and margin perspective with sequential quarterly growth in the second, third, and fourth quarters.

Typically our third and fourth quarters have been our strongest from a top line and margin perspective since the third quarter is the end of the government fiscal year and many customers are prone to expend the funds they have before they expire with shipments and orders occurring in the third and fourth quarters. The trajectory also reflects the estimated shipments according to customer deliverable requirements.

Specifically in our unmanned systems business, we expect the second half of 17 revenue and EBITDA to be significantly higher than the first-half of the unmanned systems business primarily due to execution on certain new target drone programs we were awarded in 2016 and which we expect to be awarded in the next few months, as Eric previously mentioned. Also driving expected growth in the second half of 2017 is the beginning of low rate initial production on the large Navy and confidential programs once the DOD 2017 budget is in place, which we currently anticipate will not occur until late in the second quarter. We also expect that in the first half of 2017 revenue and EBITDA in our unmanned systems business will be down from second half of 2016, due to the level of shipments in production that was completed on certain of our target programs in 2016 as compared to that expected in the first half of 2017.

From a cash flow perspective, we expect a significant amount of investment to occur as we fund our expected near-term growth of $31 million to $51 million in top line revenue increase for 2017, as well as our longer-term growth as we build our company owned LCASD aircraft, as well as the UTAP-22 aircraft that we will fly in the exercise sponsored in the DIUx contract. We expect our total capital expenditures to be in the range of $28 million for $33 million for 17 with approximately $18 million to $23 million related to our unmanned ariel systems business, which we believe will provide a foundation for the 2X growth we are anticipating for this business over the next two years.

The balance of the capital expenditures are expected in our satellite communications and training and electronic products businesses to fund growth initiatives in both of these businesses. We expect our operating cash flows will be impacted by estimated investments of $7 million to $10 million we plan to make to develop the LCASD platform to maintain the intellectual property that are not included in capital expenditures.

As a reminder, the total estimated investment that is not related to capital was accrued as a forward loss accrual in the third quarter of 2016, when we were awarded the contract. Accordingly, our free cash flow estimate for 2017 is a use of $26 million to $31 million reflecting estimated cash interest of $30.5 million and cash taxes of $3 million to $4 million and an increase of working capital uses to fund the near-term expected top line growth, including the estimated cash spend on the internal LCASD investment that is not capital expenditure-related less the total estimated capital expenditures of $28 million to $33 million.

In summary, our estimated cash investment for the unmanned systems business in 2017 including the LCASD capital and other development costs is $25 million to $33 million, or substantially all of the free cash flow use we're estimating for the corporation for the year.

Thank you, Deanna. Focus has been the mantra inside Kratos for a while now. So in closing, I want to give you an idea of how our focus has evolved, it's increasing, and what it means for our assets, employees, and our shareholders. For those of you that have a long history with our Company, you will know that through the middle of 2012 we acquired a number of companies. This strategy held until the 2011 Budget Control Act and Sequestration, impacting the 2012 defense budget which marked the beginning of billions of dollars taken out of defense spending between 2011 in 2016.

As the old saying goes, pressure makes diamonds, and this very difficult period caused us to take a heavy look at our overall Business and required us to define a company that could survive and thrive in such an environment. With our resulting new strategy, we wanted to create a business that makes employees happy, provides them opportunity, and gives them a will to win, as well as create a growth profile that has financial matrix that make our shareholders happy. The strategy change led us to the high-performance unmanned drone market for contested environments, where we saw an open market opportunity and where our natural strength and target drones, satellite communications, and electronics could truly differentiate Kratos and provide a significant competitive advantage.

Viewing the company through this lens, we began the process of identifying assets that did not match this focus for deemphasis, as we wanted to ensure that we had a laser focus on those areas we believe we can win at and that we could have the most meaningful impact to our Company. Our program wins last year in the high-performance unmanned aerial drone space and our book-to-bill ratio of 1.2 to 1 in our satellite communications area are evidence of wins.

The corporate assessment process continues, and we are reviewing ways to increase focus even more and win. Luck or not, the headwind that was defense spending has now become a tailwind, and we believe that we have a product set that matches where NexGen defense spending is going. This turnaround of our Company is a result of the dedicated effort of our employees, and I want to personally thank them for that.

We will now turn it over to the moderator for questions.

(Operator Instructions)

First question, Mike Crawford, B. Riley & Company.

Thanks, Eric. Relative to your UTAP-22 opportunity, can you talk about first the status of the DIUx and the SCO under the new administration, and then separately, maybe frame how Kratos can handle increasing production volumes in its unmanned systems business, given the $150 million or so of revenues over the next few years that layers in from the FSAT and the new weighted confidential program given that you might have UTEP, LCSD, and Gremlins vehicles being built, as well. Thank you.

Absolutely. Michael, the DIUx in Secretary of Defense Mattis's confirmation hearings, he was specifically asked if he supported the DIUx, and he crisply stated that he absolutely did. And he has made additional comments since then. I personally speak routinely with the head of the DIUx and the SCO, and they are both fully supportive of innovation and in particular with what we're doing with the UTAP-22.

On your comment on growth, right now we believe that our current facilities in Sacramento can handle the volumes we foresee through 2018, 2019. That is what we currently see. We have already moved out, and this will most likely be in states other than California to identify new state of the art production facilities that are going to be heavy in robotics and additive manufacturing techniques for the manufacture of all of our tactical aircraft. So that process has already begun, and I believe we are narrowed it down to two potential sites already. And over the course of this year, we're going to be making the final decision on those.

Okay, thank you. Then a follow-up question. Relative to your satellite command and control business, you have this recurring revenue business that is growing in Colorado. But you mentioned MO US, WGS, AEHF constellations, but are you also monitoring military traffic over commercial networks, as well with that unit?

Absolutely. Absolutely.

And that -- you said it's growing 30%, but from what base?

I'm not going to get into the details on that, Mike, but it's not insignificant.

Okay, thank you. And just a final question is you kind of said it two ways during your prepared remarks. Once you said you are considering other certain steps to extract value, and then you also said your corporate assessment process continues. So I take that to be referring to non-core business and possible divestiture thereof. Is there any unit that you might look to divest first, or can you comment any further in that regard? Thanks.

In 2017, we are going to very specifically take steps -- or attempt to take steps to refine and increase our focus in our core business areas for this Company.

Okay, thank you.

Next, Ken Herbert, Canaccord.

Hi, good afternoon, Eric and Deanna.

Good afternoon, Ken.

I just wanted to first ask, the incremental investment you said you made in the SATCOM product offering, could you provide any more -- I know you went through this in some detail, but any more detail maybe the specific opportunity that that addresses and maybe what you view as perhaps some of the revenue opportunity from this -- from the new investment or the new product or service push there?

This company and this technology and its products are focused on defense and the tens of thousands of VSATs that are deployed and that are continuing to be deployed. And they have technology and capability that we believe no other commercial company has, to be able to very quickly and precisely identify issues with traffic and for VSAT networks and on specific VSATS themselves.

So this is a very sophisticated signal monitoring type of technology. It is on the border of signal intelligence technology, and we haven't announced it formally yet, but with them in the past couple of months, we have one a multi-million dollar opportunity already. Over $10 million. And we are pursuing several other ones. So this little tuck-in technology acquisition we did, this is going to be a grand slam for this Company in 2017 and beyond.

Okay, that's helpful. It sounds like it really helps round out the portfolio to an extent with -- and very complementary to the existing businesses.

It is absolutely complementary. It is a tuck in of a technology that fits hand in glove with what we have, and our guys are very, very excited about it. I believe if you go to our website, you can -- there is some additional information on the Company, the name of the Company, et cetera, as of right now.

Okay. Okay, great. Thank you very much. And then if I could, it sounds like obviously we're waiting for the 2017 budget, clearly seems to be some incremental upside relative to expectations for what the president announced today in his attentions. Can you just, Eric, walk through, assuming we get these kinds of numbers, the $54 billion they talked about -- and obviously Congress will have to work on that, but where, aside from Avstat and maybe some of the obvious ones, where else could we expect to see maybe some of the most near-term impact, assuming we get a much more significant step up in FY17 than I think a lot of us have been expecting?

Right. So let me answer your question this way. First of all, I believe that even if there is not, though I do believe there will be. Even if there's not a significant increase in the defense budget, there is a significant shift going on within the defense budget to strategic systems. Our Company basically has been at war fighting terrorists since the first Gulf War of 1991, and there has not been a capitalization or recapitalization of strategic systems for the last 25 years.

In fact, I believe the F 35 contract was awarded on October 26, 1991. And certain peer and near-peer adversaries have caught up, particularly in the space area, the electro-magnetic spectrum, and some areas in the unmanned systems area. So I believe there is a significant shift going on. We're seeing that now. We saw it in 2016. We're seeing it at 2017, particularly in our satellite communication area and in our unmanned area where funding is increasing.

Now on top of that, as you just pointed out, the president came out today, and he says he is looking to significantly increase the defense budget. I don't know how much it will go up, but my tummy tells me defense budgets are going to rise. And in my opinion, they are going to rise in some of the areas we are in, satellite communications, unmanned systems, and on microwave electronics.

And relative to our targets business, you hear about readiness and improving readiness. I mentioned in my prepared remarks that our largest drone customer just in the past week came to us, and they said that 2017 buy, We're going to significantly increase it. And they're looking to increase the quantities for the 2018, 2019, 2020 buys. That's our understanding. I personally believe that ties right into increased readiness, operational tempo, and that is a sweet spot of our business where it's one of the larger parts of our Company. So we're feeling really good about it right now.

Okay, that's very helpful. And then just finally, when I look at the free cash flow guidance for this year and the investments you're making, I know obviously it depends on the pipeline and your success rate, but is it fair to think right now with the visibility you have that this is probably the peak year -- or FY17 is the peak year in terms of cash -- free cash flow usage, and we should see an improvement into 2018 and beyond, or how do we think about moving out of 2017 in the free cash flow?

Yes, absolutely. So, Ken, as I said in my prepared remarks, the forecasted use of cash flow is both to fund the near-term growth, top line growth of $31 million to $51 million to the range of our guidance of $700 million to $720 million. But more importantly, it is to fund LCASD investment and other initiatives within the unmanned systems area, which is comprising about $28 million to $33 million of that cash flow usage.

So we do expect that to decrease significantly going into 2018 as the first flight is scheduled for LCASD in the beginning of 2018 in the May timeframe. We would expect a significant amount of that investment to be behind us by the time we move into 2018.

Okay, thank you very much. I'll pass it back to Eric. Thank you.

Thank you, Ken.

Mark Jordan, Noble Financial.

Good afternoon, everyone. Eric, I would like to talk a little bit how funds might flow on the SSAP Program. As you stated I think in multiple conferences over the last couple of months, that you saw first-year funding on that program of $40 million to $45 million and second-year funding in the $55 million range. If we were to get a budget here in the end of April, early May and you received your first-year funding by midyear, how much would you be able to realize of revenue of that first-year $45 million of funding -- $40 million to $45 million of funding? And if you said only could realize a portion of that, would that carry over into 2018 and be added to the year 2 funding? So 2018 would be a major step up because of that part of 2017's funding and then the full-year funding for 2018?

Yes, sir. So, Mark, I met with our customer last week, and so I have first-hand real-time information on this. The customer is ready to go and is ready to initiate at low rate initial production one. If, let's say, by April 28, the end of the continual resolution, we have a budget or we have of funding vehicle that allows new contract, starts, which we are hearing that that's what's going to happen, we envision within 30 to 45 days, we will be under contract to begin production. We have already placed orders for the most material long lead items, those marked primarily are the engines and the electronics and the avionics, and then thirdly is the composite material. So we're getting all that locked and loaded.

So if we are under contract by the end of June, we're looking at somewhere between $17 million to $20 million in revenue incremental in the second half of the year. And then exactly as you indicated, the remaining piece, let's say it's $20 million to make the math easy for me.

The remaining piece of $20 million or $25 million would then go into calendar 2018, but then in calendar 2018, we expect are to be under LRIP 2, which right now they are talking about 45 aircraft or so. And so LRIP 2 would be overlaid on top of half of LRIP 1. So the beginning of 2018 and then into the second half of 2018 would be another significant step function of growth on that. So that is how that is laying out right now.

Thank you. That is clear. And could one assume that the one classified program that is running in parallel to the SSAP would have a similar topography?

Yes. Envision maybe -- on that confidential program, maybe it starts 60 days later for certain reasons. But the similar topography.

Okay. You mentioned there was a pipeline of $5.7 billion. Two questions related to that. When do you expect those bids to be out on the street? And then the second question, I think more importantly for me is, of that by $5.7 billion, what percentage is for programs where you currently are -- you know, you're active in, that you are, for example, it would be -- follow the arms of programs that you currently control?

Okay. So for example, and -- for the last second part of your question. In that pipeline, would be ABSAT, years -- production years 2014, 2015, and 2016 with the US Air Force. That is where we are sole-source because we own the design package on the airplane. As I indicated in my prepared remarks, we're going to be beginning negotiations with the Air Force this year, and we expect by the end of this year, we will be awarded those three production years. So there's very, very good clarity there.

Similarly, in that pipeline is what we are pursuing for SSAT with the Navy, so there would be two years of somewhere up near $100 million of revenue that we have very good clarity on. This is very similar in our satellite communication area. In our satellite communication area, this is the crown jewel of our company, and these of the best guys in the company right now, they are executing incredibly.

They have this all mapped out by program, by customer set. Most of these were designed in -- we have relationships with the customers, and as I indicated, their book-to-bill was $1.2 [billion] for the year end in Q4. So they are pretty much bolted in as well.

And then in our microwave electronics business, literally, Mark, they are $50 million to $60 million of revenue for 2017 is in backlog. 100% is in backlog. We win additional programs, or they go in to production, we're going to get an upside. On your proposal submitted, $1.3 billion of that pipeline has been submitted. Okay?

And I want to mention one other thing relative to your question. We are assessing, pursuing a new tactical opportunity in our unmanned systems division, which is right in our sweet spot. It is not in our pipeline. It's a multi-several hundred million dollar opportunity, it is $1 billion plus opportunity. RFPs are expected out later this year and contract award is expected later this year, and I think we're going to go for it. And that is not in our pipeline.

Okay. Question, there is an RFP up from the Army for replacement for the Streaker. Is there any update to that, and could that be potential 2017 incremental revenue that is not in your model?

We are absolutely looking at that. And depending on how the cards fall and timing, it absolutely could be a significant upper.

Okay. A final question for me, now that you are into the LCASD program a little bit, do you have any clarity with regards to any potential spirals that might be realized in 2017?

Yes, yes. Yes, sir. We have very, very good clarity on the spirals. Our customers is very sensitive on these, so I'm just not going to get into it here. But crisply said, yes, we do.

Okay. And is that in your current budget?

No, Sir.

Thank you very much.

Next, Michael Ciarmoli, SunTrust.

Good afternoon guys. Thanks for taking my questions. Eric, just looking at the budget environment, obviously there's a laundry list of positives out there. I think even what Ken was alluding to, but what are the potential obstacles or roadblocks in the near-term? Sounds like we could get a CR that might be for the full-year but would allow a new star to make some growth. That's some upside. But we potentially move into maybe a government shutdown discussion, I'm sure there's going to be bickering back and forth in DC. I'm just trying to get a sense of any sort of risk to your guidance.

Certainly, it sounds like there's much more upside but is there a downside scenario you see for this year? You are guiding to 6% top line growth, and I think you said depending on the timing of the deal, there could be upside. But what's sort of the other side of that coin that you could see as an obstacle?

We tried to be very, very conservative when we put out our guidance. And very candidly, the reason we did not take our guidance up today is because of not knowing precisely when the 2017 funding will be taken care of. And, Michael, exactly as you have said, we're hearing that 2017 may be a full-year continuing resolution. It may be a full-year continuing resolution up 5%, so up $30 billion or $40 billion. That will allow new starts.

Okay. Everything we're hearing is that new starts are going to be allowed because it will be so negatively impactful to national security. However, to your question, the downside to the model would be as if there is a full-year continuing resolution in 2017, and there are no new starts awarded.

And so those two programs don't get going forward. I believe based on the way we have modeled this, we still hit our target. We still hit the range. That's how confident we are in the business plan right now. We will still hit the annual guidance we've got out there even if those don't happen.

Got it, okay. That's helpful. And then you talked about that target model again, $800 million of revenue, $80 million of EBITDA, but can you elaborate -- I think you mentioned, I may have missed it, what would be additive to that model and would you specify sort of the potential upside to the longer-term model?

Absolutely. So the biggest one that we see right now is LCASD. That is a single award contract. Publicly, Michael, there have been two high-performance jet unmanned combat aircraft procurements in the normal solicitation way, LCASD and Gremlins. Kratos is on both of them.

There's nothing else out there, there's nothing else in sight. So if you take a look at who you believe is going to be the loyal wingman aircraft that's going to accompany our fourth and fifth-generation manned fighters, it is LCASD. And that plane, as Deanna said, is going to fly in Q2 of 2018. As I said in my remarks, the potential customers and users are lining up already, and we're having discussions with them, which ties into the spiral question Mr. Crawford asked. And I have continued to see the DOD establishment put out -- make public statements reiterating the quantities, hundreds, several hundreds, thousands of these planes at $2 million to $3 million a plane.

Got it, okay. Okay, that's helpful. Last one for me, obviously there is a lot of opportunities, you guys are spending a lot of money. You mentioned kind of looking at the strategy, obviously potential divestitures. How are you thinking about your overall cap structure? You've got a significant amount of investment, thinking about leveraging, do you have a target average model with -- or a target leverage ratio with that long-term model?

You know, Deanna's and my -- until we went into this investment mode in the unmanned area, and very candidly also in the satellite communication area where we have significantly ramped up our IRND, which is paying off in spades. Look at the growth rate that team is generating. We believe that the growth projections, we have and what we see, it might be off some months here or there, but 2017, 2018, 2019, this business is going to grow significantly.

No question about it. It's going to grow significantly. Deanna's and my historical targets have always been in the 3 to 4 times lever area. For a defense company, you know, big backlogs, big pipeline. That is our target, no pun intended.

Got it, okay. Very good, thanks a lot, guys.

Next question, Sheila Kahyaoglu, Jefferies.

Good evening, guys -- or Deanna. Eric, I don't know if you could give us any detail for 2016 in terms of the government solutions business and what each of the pieces contributed, whether it's microwave electronics, modular systems, or just the full-year growth rate, if you could.

Absolutely. So in my prepared remarks for the government solutions, I talked about our satellite, cyber and training business was approximately $255 million, $265 million in revenue. Our microwave electronics business is $50 million to $55 million in revenue. And our government services business and our ballistic missile targets business -- and you may have seen, we had a very successful ballistic missile target launch in intercept a couple of weeks ago, is right around $95 million to $100 million. Those are the pieces.

Understood, thank you. And in terms of the acquisition you did, could you disclose what the potential revenue contributions would be in 2017?

We are not, we are not disclosing that quite yet. We very well may going forward because some of the bids that we are going after are very, very large, and they would demand that. But right now, since it was just a small technology buy, we are not. We just folded it in.

Okay, understood. And just so I'm clear on this, Deanna, would it be possible for you to repeat the free cash flow guidance for the year in terms of thinking about it for 2018? Would we sort of assume the CapEx tabs and the ([LCASD] investment goes away, if you could just maybe go over that little bit more?

Sure, Sheila. So the estimated CapEx is $28 million to $33 million, of which $18 million to $23 million is related to unmanned systems. Then there is also -- included in operating cash flows, there is an estimated investment of $7 million to $10 million for the LCASD platform, so that is the non-capital investment related to LCASD. If you recall, we took a loss accrual of about $18.6 million, $18.8 million in Q3, so that is the cash spend of that for 2017. So the total free cash flow estimate for 2017 is a use of $26 million to $31 million, which includes the estimated cash interest of $30.5 million, cash taxes of $3 million to $4 million, and then the CapEx up $28 million to $33 million.

And, Sheila, we are building a number of aircraft, UTAP-22s, right now for the big exercise in the second half of this year. That will drop off in Q3, assuming that flight schedule holds. So that part of the CapEx will drop off because it is not expected to be repeated. And as Deanna said, the LCASD, we will be flying that in May. That CapEx is not expected to be repeated, and so there will be a significant reduction in CapEx and a significant increase in cash flow as those investments drop off. And obviously, we're making those investments because we're going after some big opportunity.

Sure. And then in terms of the second half ramp in unmanned systems, is that roughly SSAT or are there other revenue contributors in that?

So the big E is SSAT. That's number one. Number two, we were awarded that large, foreign international contract in Q4. That one is ramping. As I mentioned, I think in the next 60, 90 days, we're going to be awarded another multi-million, tens of millions of dollars of contract -- new customer, new international one. That is going to ramp in the second half. I mentioned an existing customer we have that is flying one of our airplanes. They are very interested in a separate one of our airplanes. I think we're going to get that order in the next 60 to 90 days. That is going to significantly ramp.

And then very importantly, Deanna talked about our unmanned systems division in the second half of 2016 and in Q4 was very, very strong because we delivered a number of Air Force aircraft. Okay? I just mentioned we're getting going on production lot 13 now, which has increased quantities. We will start delivering those and building those out in the second half of the year. So we are going to have a dip in the first half, but then the second half is going to ramp significantly for ABSAT and the 167, including the additional target drones the customer has indicated they want.

Perfect. That makes sense. Thank you very much.

Ladies and gentlemen, this is all the time we have for questions today. So now, at this time, I would like to hand the call back over to Mr. Eric DeMarco, President and Chief Executive Officer, for closing remarks.

Excellent. Thank you for joining us, and we truly look forward to speaking to you again in a couple of months when we report the first quarter. Thank you.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program, and you may all disconnect. Everybody have a wonderful day.