Kratos Defense and Security Solutions Inc (KTOS) 2018 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Kratos Defense & Security Solutions First Quarter 2018 Earnings Conference Call. (Operator Instructions) As a reminder, this conference may be recorded.

I would now like to turn the conference over to your host, Ms. Marie Mendoza, Senior Vice President and General Counsel. Ma'am, you may begin.

Thank you. Good afternoon, everyone, and thank you for joining us for the Kratos Defense & Security Solutions first quarter 2018 conference call. With me today is Eric DeMarco, Kratos' President and Chief Executive Officer; and Deanna Lund, Kratos' Executive Vice President and Chief Financial Officer.

Before we begin the substance of today's call, I'd like everyone to please take note of the safe harbor paragraph that is included at the end of today's press release. This paragraph emphasizes the major uncertainties and risks inherent in the forward-looking statements we will make this afternoon. Please keep these uncertainties and risks in mind as we discuss future strategic initiatives, potential market opportunities, operational outlook and financial guidance during today's call.

Today's call will also include a discussion of non-GAAP financial measures as that term is defined in Regulation G. Non-GAAP financial measures should not be considered in isolation from or as substitute for financial information presented in compliance with GAAP. Accordingly, at the end of today's press release, we have provided a reconciliation of these non-GAAP financial measures to the company's financial results prepared in accordance with GAAP.

With that, I will now turn the call over to Eric DeMarco.

Thank you, Marie. Good afternoon, everyone. Revenues for Kratos' Unmanned Systems business grew organically 78% in Q1 '18 over Q1 2017, with virtually all of this revenue being generated by Kratos' high-performance target drone-related businesses. We are seeing significant demand for Kratos' target drones in the United States and also globally, as a recapitalization of strategic weapons systems to address nation-state adversaries is underway, with not only the United States DoD, but every NATO ally increasing its defense spending this year with 15 NATO countries increasing their defense budgets as a percent of their GDP.

These strategic systems being deployed need to be exercised against the highest performance and most realistic threat surrogates in the world, which are Kratos' targets and where Kratos is the undisputed industry leader. Directly related to the strong global demand that we are seeing, Kratos' Unmanned Systems division booked in excess of $200 million in sole-source or single award contracts in the first quarter of 2018, all of which we expect to convert to revenue over the respective contract's period of performance.

The book-to-bill ratio for our Unmanned Systems division was 2.6 to 1 for the first quarter. We are currently executing on low-rate initial production contract year 1, which we received in 2017 under the U.S. Navy SSAT program for Kratos' BQM-177 target drone. In Q1 2018, we received a sole-source contract award of approximately $24 million from the U.S. Navy for low-rate initial production year 2 and we expect to begin to see meaningful revenue, EBITDA and cash flow generation from this SSAT LRIP 2 in the third quarter of this year.

In addition to SSAT LRIP 2, we now expect to receive an SSAT LRIP 3 production quarter later this year at a significantly increased value. The combined value to Kratos of LRIP 2 and this new LRIP 3 arrangement is expected to be greater than what we had previously forecast to receive from just an LRIP 2 award. This will result in even higher 2019 revenue from the SSAT program than we had previously forecast.

We continue to expect to receive a sole-source multiyear full-rate production contract on the SSAT program in 2019 at the previously forecast full-rate production increased quantities and values. SSAT full-rate production is expected to drive significant additional growth for Kratos beginning in 2020 and beyond, with this program becoming one of the largest to our company.

In Q1 we received a $93 million sole-source contract from the United States Army for a modified Kratos 167 target drone, which is replacing the retiring MQM-107 target drone. This Army program, which is new for Kratos in 2018 and has now received initial funding, is expected to be an organic growth driver beginning in the third quarter of this year and continuing for many years into the future.

Kratos' Unmanned Systems division also received another new sole-source contract in Q1, though a little later than we had initially forecast with the delay directly related to the extended CRA. This CRA-related delay basically has shifted some work under this contract from Q2 to Q3 and we have adjusted our internal plan accordingly.

We also just received in the past several days an approximate $90 million 5-year IDIQ contract from a U.S. government agency for Kratos target drones and related systems and services. And we have just received the first funded task order under this new contract award. We hope to be able to formally announce this recent contract award in the near future. This contract is expected to become an important contributor to Kratos beginning in Q3 of this year.

Demand for Kratos' MQM-178 Firejet target drones also remains very strong and increasing, both domestically and internationally and we are currently building numerous 178s for deliveries beginning in the third quarter of this year and for expected new orders for this high-performance jet target drone. We are expecting a number of additional large sole-source target drone contract awards over the next several months, including with the United States Air Force for Kratos' BQM-167 drones for production years 14 through 16, which corresponds a 3-year production order covering 2019 through 2021 at substantially increased quantities and values over the last few years' annual production. We will begin to see meaningful revenue, EBITDA and cash flow growth from the expected increased AFSAT production quantities in the first half of next year.

Kratos' target drone business is rapidly ramping on a year-over-year basis with 2018 revenue expected to be significantly greater than 2017 and double that of 2016, as we had previously forecast. On a quarterly basis, we forecast our Unmanned Systems business Q2 to continue a growth trajectory above Q1 and then a large step function in growth for Q3 over Q2 with Q4 currently looking consistent with Q3, as execution increases on our under-contract programs in the second half of the year.

With the programs we have under contract, increasing production and multiple new opportunities we expect to win going forward, Kratos' unmanned target drone business is expected to be a strong year-over-year organic growth driver for our company for the foreseeable future with increasing profit margins and cash flow generation.

In the tactical UAS area, we are convinced that affordable high-performance tactical drone systems which can perform their mission in anti-access, area denied and contested environments, will be a significant part of the future force and Kratos is well-positioned under numerous contracts and has important intellectual property ownership in this high-priority national security market. With the Gremlins tactical UAS award with our partner Dynetics, Kratos has now won every high-performance tactical unmanned aerial drone system opportunity we have pursued, successfully competing against the largest aerospace and defense companies in the industry.

As just recently reported, a Gremlins program flight test at the Yuma proving grounds provided an opportunity to conduct safe separation and captive flight tests of the hard dock and recovery system. In addition to preliminary flight tests, the Gremlins team is focused on risk reduction via extensive modeling and simulation. The Gremlins team is now looking at how fifth-generation aircraft systems like the F-35 and the F-22 respond to threats and how they could incorporate Gremlins in higher-risk areas. The Gremlins' UAS expected lifetime of about 20 uses could provide significant cost advantages by reducing payload and airframe costs and by having lower mission and maintenance cost than conventional platforms which are all designed to operate for decades.

Demonstration of the Gremlins system is expected in 2019 and initial production buys could come shortly thereafter. As a reminder of the potential opportunity Kratos has with Gremlins, the detail information that came out with the program's RFP calls for requirements of a $700,000 price point UAV at order quantities of 1,000 at a time and Kratos is responsible for the UAV under this program. With recent information that we have, we are more confident than ever than once demonstrated, Gremlins will be a very significant program and future growth driver for Kratos.

Kratos' Valkyrie program remains on track, on budget and on schedule to demonstrate later this year at which time the investment Kratos has been making in this UAS for important intellectual property ownership and 2 Kratos-owned Valkyrie UASs will be complete, which is expected to immediately result in increased Kratos free cash flow. Similar to Gremlins, once we successfully demonstrate Valkyrie, we expect to receive initial orders for these UAS shortly thereafter, ramping over future years with the Valkyrie also being a significant future revenue profit and cash flow driver of the company.

A reminder on the Valkyrie or LCASD opportunity for Kratos, the program solicitation called for once in production a $3 million UAS at order quantities of less than 100 at a time and for a $2 million price point per UAS for order quantities greater than 100 at a time.

Kratos' Mako, which is the only high-performance jet powered tactical UAS in its flying class today and which has repeatedly demonstrated manned-unmanned teaming as well as other important capabilities, is expected to be under contract with multiple new customers by the end of this year now that we have a 2018 budget in place. Related to this we are currently in discussions with a certain entity as to Kratos receiving a Mako production contract by the end of this year or early in 2019.

Adding to the continued momentum we are seeing for Kratos' tactical high performance and affordable UASs, we have announced that Kratos' Mako is now approved by the United States State Department to be marketed internationally to a number of countries. We believe that this is an important positive development, as we see significant international opportunities for Kratos' Mako and all of our tactical UAVs due to our systems' high performance, runway independence, distributed lethality, forced multiplier attributes and ability to be recovered on both land and in the water.

Additionally, shortly after we announced the State Department's approval to market the Mako internationally, Kratos received State Department approval to market a second of Kratos' tactical UASs internationally. We believe that international sales of Kratos' tactical UAS are another opportunity area that is now gaining traction and will be another future growth revenue, profit and cash flow contributor for our company.

Also importantly, many of the countries and customers in which we have recently received approval to market Kratos' tactical UAS are already existing Kratos' target drone customers and the profit margins on international business are typically greater than domestic margins. There are also additional tactical UAS programs and opportunities that Kratos is involved with and we are pursuing which we are hopeful to be able to discuss with you later this year.

Kratos' new Oklahoma operation continues to expand and we are planning for the first fully integrated Kratos high performance unmanned aerial drone aircraft to come off the line in Oklahoma in the first half of 2019. Additionally, our discussions with another small, mid-sized defense company are continuing regarding a strategic production, integration and logistics relationship and I am hopeful to have this complete in the third quarter.

As I have communicated previously, the growth that Kratos' target drone business is experiencing and that we are forecasting for the next several years indicate that Kratos' current manufacturing facility will be at full capacity by the end of 2019. As a result, we are positioning now to accommodate this expected future target drone growth and also the expected significant growth from Kratos' tactical UAS business.

In summary, we are now more confident than ever that Kratos' high-performance tactical drone business will be a significant organic revenue, profit and cash flow driver for our company, which will be growth in addition to that which we are currently generating and forecasting just for our target drone business. And similar to Kratos' target drones, Kratos is the complete system provider for each of our tactical drones.

Excluding Kratos' approximate $60 million to $70 million annual revenue non-core Government Services business which we have deemphasized for some time now, KGS organically grew 7% over the first quarter of 2017. The largest first quarter 2018 growth in KGS was from Kratos' Training System business as a result of the multiple large long-term program Kratos has competitively bid on and won, including with the Royal Saudi, the Navy FMS, KC-46, MCAT and AVET/NATS.

Based on these under-contract long-term programs, a number of which Kratos is the system provider and our current bid pipeline, we expect Kratos' training business which we forecast to be approximately $80 million in annual revenue this year, to continue strong year-over-year revenue growth for the foreseeable future and we recently announced a significant expansion to Kratos' Orlando training facility to accommodate this expected growth.

Kratos Ballistic Missile Target business where Kratos is also the system provider began 2018 very strong with a number of successful missions and with a large order from a government agency related to Kratos' proprietary target system which is expected to drive growth beginning in the third quarter of this year. With the significant funding increases in the missile defense area which Kratos is directly seeing in large increases in opportunities, including in this hypersonics area and Kratos' intellectual property and proprietary rights ownership, Kratos' BMD target business is forecast to have a strong 2018 with an even stronger future beginning in 2019.

Our Microwave Electronics business had a particularly strong Q1, primarily related to the initial Gripen Electronic warfare contract award which we had previously anticipated. Based on the number of missile, radar, communications, EW and other programs our microwave business is designed in on sole-source or competing for, we expect our EW business to be a future organic growth driver for our company and a business with one of the highest profit margins and cash flow generation potential in our company.

Kratos' satellite communications, our space business, where Kratos' products and solutions support 85% of U.S. and 75% of global space missions, began 2018 stronger than we had originally forecast with a very favorable execution mix of revenues in Q1. We recently received a very large unexpected positive surprise for Kratos' space business, with 2 additional WGS satellites being added to the 2018 DoD budget just prior to its approval. WGS is one of our space business' largest and most important programs and these 2 additional WGS satellites increase our confidence for this business' growth prospects going forward.

Additionally and representative of Kratos' leadership position in the space communications market, it was just reported that Kratos and Hughes have been selected to prototype a joint military commercial satellite network. This network will be focused on the DoD bringing leading technology space communications to the military. Our space and satellite business is poised to have an outstanding 2018, including a strong Q3 and Q4 now that we have the 2018 DoD budget in place.

Over the long term, space and satellite communications is seeing some of the largest funding increases in the DoD budget, and we believe that this will be a direct extended growth catalyst for Kratos. Other notable areas, programs and systems where Kratos is either under contract or pursuing opportunities include Patriot, THAAD, F-15, F-16, F-35, hypersonics and high-power directed energy.

With the 2018 DoD budget now in place, a 2019 DoD funding level established with the bipartisan spending bill and the Trump Administration's national defense strategy published, we have high confidence in Kratos' 2018 financial forecast and in our future, as we believe that Kratos' systems, products and solutions are very closely aligned with U.S. DoD and global national security priorities.

Directly related to the extended continuing resolution, Kratos' second quarter forecast is similar to what we guided for Q1, with KGS being affected most by the CR due to the nature of its contracts. And we are currently forecasting a very strong third quarter and a similar to increased fourth quarter now that there is a DoD budget in place and as we execute on our under-contract programs, contracts and the expected awards.

With the pending divestiture of PSS, we have positioned Kratos as a high-growth technology and intellectual property based aerospace and defense company. We are laser focused on operational execution, increasing our profit margins and increasing our cash flow. Deanna?

Thank you, Eric. Good afternoon. Kratos' first quarter 2018 revenues of $143 million were in the range of our forecast of $140 million to $150 million for the quarter and our adjusted EBITDA of $13.7 million exceeded our forecast of $9 million to $11 million, primarily due to a favorable mix of revenues in our satellite communications, training systems and microwave products businesses. Kratos' adjusted EPS of $0.05 per share exceeded our forecast of breakeven to $0.01 per share for the quarter.

First quarter year-over-year consolidated organic revenue growth of 8.3% was driven by growth of 78.2% in our unmanned systems business, including low-rate initial production 1 of our 177 or SSAT aerial target. Revenues in our largest segment, KGS, increased approximately 7.3% year-over-year for the first quarter of 2018, excluding a reduction of $8.1 million in our legacy Government Services business that we have previously deemphasized. Including our legacy Government Services business, which annual revenues are now down to approximately $60 million to $70 million, KGS revenues declined slightly by 1%.

As mentioned earlier, we expect the PSS divestiture to close during the second quarter and accordingly have recast all current-year and prior-year financial data to reflect the PSS business as a discontinued operation. As also previously mentioned, Kratos' corporate overhead and public company costs of approximately $2.5 million which was historically allocated to the PSS business, has now been allocated to our remaining business segment to KGS and unmanned systems and we have laid out a detailed plan to reduce these costs by as much as possible by the end of this year in order to increase our margins and cash flow.

From an accounting standpoint, Kratos was required to adopt a new revenue recognition practice beginning January 1 of this year, which can affect the timing of revenue recognition for certain contracts. As a result of this adoption, Kratos realized approximately $7.7 million of increased revenues in the first quarter, approximately $3.2 million and $4.5 million of the increases were related to the KGS and KUSD divisions, respectively.

On a year-over-year basis, our Q1 '18 adjusted EBITDA increased 34.3% or $3.5 million from $10.2 million in the first quarter of '17 to $13.7 million in the first quarter of '18. Our adjusted EBITDA for the first quarter is from continuing operations and excludes non-cash stock compensation costs of $1.7 million and severance-related restructuring costs of $400,000.

Our operating income increased 400% from $1.4 million in the first quarter of '17 to $7 million in the first quarter of '18. This improvement was primarily due to the improvement in gross margin from 27.3% to 28.5% and overall gross profit from $36.1 million in the first quarter of '17 to $40.8 million in the first quarter of '18, resulting primarily from the favorable mix of revenues during the first quarter of '18.

On a GAAP basis, net loss for the first quarter was $2.2 million, which includes a loss from discontinued operations of $3.5 million which reflects approximately $2 million of increased costs on security deployment projects with a metropolitan transit authority and approximately $800,000 of transaction expenses related to the pending divestiture of PSS.

Moving on to the balance sheet and liquidity, our cash balance is $128.2 million on April 1, including $400,000 of restricted cash. At quarter end, we had zero amounts outstanding on our bank line of credit and $9.6 million of letters of credit outstanding. We generated cash flow from continuing operations for the first quarter of $6.5 million, which includes approximately $1.1 million of internal non-capital expense related development costs related to the LCASD program. Capital expenditures of $6.7 million were primarily related to investments we are making in our satellite communications and Unmanned Systems businesses.

Approximately $4.5 million of the CapEx was related to the Unmanned Systems business, which is primarily related to the 2 LCASD aircraft and related equipment we are building for our own use. We expect this capital effort to be complete by the third quarter, with CapEx at elevated levels for the second and third quarters similar to the first quarter, as we complete this program.

DSOs increased from 121 days at the end of the year to 133 days at the end of the first quarter. Our DSOs include the impact of milestone payments 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 in our Unmanned Systems segment. In addition, we have a number of billing milestone payments that are expected to be paid upon completion of contractual milestones in certain of our training solutions projects that are expected to be achieved in the second half of the year.

As we are the prime contractor on sizeable projects in our Unmanned Systems, training systems, and rocket support services businesses, our DSOs will continue to be lumpy as the payment terms will be based upon achievement of milestones rather than progress billings. Our contract mix for the quarter was 86% of revenues generated from fixed price contracts, 9% from cost plus fixed fee contracts, and 5% from T&M contracts.

Revenues generated from contracts with the U.S. federal government during the quarter were approximately 71%, which includes revenues generated with the DoD and with non-DoD federal government agencies. We also generated 12% from commercial customers and 17% from foreign customers, with our aggregate non-DoD revenues comprising 29% of our total revenue.

Backlog at first quarter end was $551.8 million with $495.4 million funded and $56.4 million unfunded. As we had discussed on our fourth quarter conference call, the adoption of the new accounting standard on January 1 has resulted in our backlog being calculated as a dollar value of the remaining performance obligations on executed contracts, as defined under the new accounting standard.

Backlog will not include orders for which neither party has performed and which grant each party the unilateral right to terminate a wholly unperformed contract without compensating the other party. As such, backlog generally does not include options for additional performance obligations which have not been executed unless they are considered a material right of the base agreement or contract.

For IDIQ contracts, only tasks that have been approved are included for backlog purposes. As we had expected, our backlog was negatively impacted by the adoption of the new accounting standard and has resulted in the reduction of approximately $138.6 million of our backlog. On an apples-to-apples comparable basis, our backlog at yearend was $518.1 million with $455.5 million funded and $62.6 million unfunded. The backlog related to the PSS business has also been removed from both periods. Accordingly, our book-to-bill ratio was 1.2 to 1 for the first quarter of '18.

As we mentioned on our last quarterly call, we do not include the full value of contract awards in our bookings or backlog until tasking or funding is received. Also, importantly a number of our systems and products are designed in, on and support long-term multiyear, multi-decade programs. Although these expected Kratos deliveries are not reflected in our backlog, they do provide significant operational and financial visibility to our company.

For instance, we may not necessarily include in our backlog or bookings certain contract awards, depending on current government funding on the award. As an example, we only included $7 million in our bookings for the recent contract award for aerial targets from the U.S. Army of $93 million, which represents the executed delivery orders received to date, although we expect to ultimately receive executed delivery orders for the $93 million.

Moving on to guidance, today we are providing second quarter revenue guidance of $140 million to $150 million and adjusted EBITDA guidance of $9 million to $11 million, which is slightly lower than what we had originally planned, primarily due to a certain under-contract UAS program that Eric mentioned being impacted by the CRA with the effect of approximately 4 to 5 drones moving into Q3 from Q2. We have now received this funded contract. We are affirming Kratos' full year 2018 revenue guidance of $640 million to $650 million and adjusted EBITDA of $55 million to $59 million with average organic growth increases from 2017 of approximately 7% and 20%, respectively.

We are also affirming Kratos' full year cash flow from operations guidance including the expected collection of net working capital proceeds of the PSS business retained by Kratos of $35 million to $45 million. Kratos' full year 2018 financial guidance for revenues is $640 million to $650 million as compared to $603.3 million for the full year of 2017 and full year adjusted EBITDA of $55 million to $59 million as compared to $47.6 million for the full year of '17. Kratos is forecasting full year 2018 adjusted EPS of $0.16 to $0.18.

We expect our total capital expenditures to be in the range of $23 million to $26 million for 2018, with approximately $14 million to $17 million related to our unmanned aerial systems business. The balance of the capital expenditures is 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 the remaining estimated investments of $7 million to $10 million we plan to make to develop the LCASD platform to maintain the intellectual property that is 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. Cumulative to date through Q1 end we have funded over $12 million of non-capital LCASD investments.

In summary, our estimated cash investment for the Unmanned Systems businesses for 2018, including the LCASD capital and other development costs, is $21 million to $27 million. We expect that these cash investments for our unmanned tactical initiative will be substantially complete by the third quarter of '18. We expect our estimated cash taxes to be approximately $3 million to $4 million for '18. We expect the impact of tax reform to be fairly insignificant to our estimated cash taxes due to our net operating loss position. Our NOLs are approximately $380 million.

Despite the heightened level of continued investments in '18 of approximately $30 million to $35 million between CapEx and the remaining non-capital investments for LCASD, we expect to generate cash flow from operations of $35 million to $45 million and free cash flow of $12 million to $19 million for '18, as we expect a number of the billing milestones which have impacted DSOs to be collected during the year.

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

(Operator Instructions) Our first question comes from Ken Herbert of Canaccord.

Yes, I just wanted to first ask, on the target drone business it clearly looks like you're seeing a nice inflection in the third quarter now that we have the budget and you've got visibility there. What does the guidance imply for margins for that business in the second half of this year and into 2019 on sort of that 100-150-ish business we should see this year?

For the second half of the year compared to the first half, we're expecting margins to increase as we ramp, definitely. We're expecting them to increase. Right now for 2019, we're expecting them to continue to increase and expand as we continue to ramp and we get leverage off of our fixed overhead and our fixed manufacturing costs.

And in addition to that, we're working on a number of international opportunities. We're hoping to have some of those booked in the second half of this year and those international opportunities, they typically bring significantly higher profit margins to the company, because we're not dealing with the TINA issues because we own the data packages on the drones.

So just to clarify, the target drone business this year, the mix is largely for the United States, correct? There's very little international in there?

There is some in there, but it is the majority, the vast majority is the United States. But there is -- we have a number of international customers. But the largest drone, target drone users in the world are the United States Navy, the United States Air Force -- when I say world, the free world -- United States Navy, the United States Air Force, the United States Army. We're a sole source with each of them.

Then the UK Ministry of Defense, we're with them. And then there's the fifth one is coming and we're in solicitation on that one right now. And then it drops off precipitously from a funding standpoint.

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

My expectation is before the end of the year on the tactical side, we're going to book some Mako sales. I have the full expectation of that. And I'd rather not get into sizes right now. But they'll be meaningful -- they're be additive to '19 if we're successful in getting them booked by the end of this year.

And I definitely expect orders internationally to increase in '19, because obviously internationally it takes time. It's a process. It's not an event. But we do have an advantage that a number of these customers that the State Department approved for us specifically related to the Mako, they're already our target drone customers, so we know them. We have access and we know how to work it.

Okay, great, thank you. And if I could just finally, Deanna, with the second quarter guidance you provided, do we see sort of a similar profile for free cash flow in the second quarter as we've seen in the first quarter or is there anything you'd highlight specifically we should keep in mind about the second quarter?

Sure. What I'd highlight specifically about the second quarter is our interest payment is due at the end of May and that's roughly about $9.5 million, $10 million. So that will be an additional cash outlay in the second quarter that we did not see in the first quarter.

Our next question comes from Mike Crawford of B. Riley FBR.

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

Well, I'm glad you asked the question, Mike, so I can clarify. No, that did not include the Oklahoma facility. To be clearer, our Sacramento facility, we expect it to be at full capacity by the end of 2019 and that full capacity is going to be primarily dedicated to the U.S. Air Force 167, the U.S. Army derivative 167, the United States Navy 177, and some other things.

We are looking right now -- right now we're building Firejets there. It is highly likely that we're going to be transitioning Firejets by the end of this year and then all tactical planes right now are contemplated to be manufactured in Oklahoma. And the capacity that we're looking for in Oklahoma, we want to be able to have a capacity to build at least a few hundred drones a year there.

Okay, thank you. There was an article that quoted, I think, you or Steve Fendley mentioning that the Gremlins was kind of a hybrid between Firejet and AFSAT. Is that true? And then also are you still continuing development of the Gremlins concept, the separate concept that you had developed as a prime in phase 1 of that competition?

On the first question, Mike, I would say that there are definitely similarities from a design and integration standpoint between the 167 and the 178, absolutely. And related to our Gremlin, we absolutely took our Gremlin UAS. We took our techniques, our production methodology, our autoclave methodology in how we came up with our Gremlin; and also very candidly with the Valkyrie.

And we believe that's a winning combination for us in all areas because it's a low-cost high-performance methodology that we have perfected. On your second Mike, relative to Kratos' Gremlin, I really -- and I apologize. I cannot talk about that right now at this time.

Okay, thank you, and then final question is, with all these good things going on and countered with the fact that you have just maintained guidance, what were the puts we've seen that would counterbalance all these good things?

The primary put that we have right now is when we gave our guidance we gave ranges and we had an extended continuing resolution that went all the way -- it literally went 6 months. So the primary put is us being able to execute on all the programs that we have. And we want to be conservative in what we're saying to make sure that we can meet what we're saying from a financial standpoint.

This is not a question on the guidance of we need to go book stuff. It's not. It's we need to execute and we need to do a good job. We have a great reputation with our customers right now that we do what we say. We do it on time, on schedule, on budget affordably and we cannot mess that up. So those were the primary thinking in us maintaining our guidance at this time. We have a lot of wood to chop that we've booked.

Our next question comes from Michael Ciarmoli of SunTrust.

Maybe Eric, just to stay right on that line of questioning on the guidance, can you give us a sense of how much of the '18 revenue plan is already in backlog or booked or that you have clean line of sight to versus what you might need to go out there and get some book ship business, if you would?

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

Got it, and then just back to the margins. You mentioned opportunities to cut some of that corporate overhead I guess. Could you maybe elaborate there?

And similarly I guess if your current capacity in Sacramento gets up to -- if you get to full capacity, what sort of leverage should we expect you guys to -- whether it's incremental margins or can you give us a sense of maybe what that business could look like at sort of a run rate when you're operating at full capacity?

Michael, this is Deanna. On the first part of your question as far as what type of steps are we taking to reduce the overall infrastructure costs, we are negotiating reduced terms with certain of our large service providers, such as our external auditors, IT service providers.

And we're looking at other internal costs as well to reduce those costs. We will be moving our facility later this year, the corporate facility, which should maintain some of those costs as well. So we're looking at all aspects from a corporate overhead infrastructure perspective.

And Mike, let me add one more to that. When we identified on the public safety business that's non-core, about a year ago -- or more than a year ago, we made the conscious decision at the corporate cost level that if people retired or they went to other companies, that we would not replace them. And we have continued that aggressively. And that can be significant at this level as well. And so that's another one.

On the first part of your question, Oklahoma, one of the primary reasons we elected Oklahoma is because of the cost structure. And the cost structure of manufacturing drones in Oklahoma is significantly less than in California for all the reasons you can think of.

So we have a two-for and then a three-for coming that we see over the next couple 3 years in our margins. The most immediate one is as our business continues to ramp in Sacramento on the target drones, we're going to be levering off of that fixed manufacturing cost and margins are going to increase. I'll give you some estimated rates in a minute. Then as we start selling more drones internationally, those margins are inherently higher for the reasons I stated.

But as I went through before, the predominant of our business will always be, I believe, the United States government. And then thirdly when we start manufacturing drones in Oklahoma, which as I indicated is going to be in the first half of 2019, that cost structure is going to be less. The margins there going to be higher.

We're looking at this business. We're going to get to 10% and then we're going to go into the low teens and ultimately at high rate we'd like to get to the mid-teens.

Okay, yes, and I was going say, I mean you've got probably a disproportionally higher amount of your revenues at fixed price contracts versus some of your peers. So that should enable you to get up to that teen rate. So it sounds like that's definitely in the plan.

Yes, so the vast majority of our contracts in Unmanned are fixed price. There's only one that comes to mind as we're chatting that's of any significance that's cost-plus.

Okay, just the last one from me, how should we think about any CapEx going forward as you sort of build out Oklahoma?

Right, so we are in the literally finalizing the negotiations on that plan right now. But rest assured, because of the commitments that we are making as to the number of jobs we're going to place there and the pay structure of the number of jobs that we're going to place there, Oklahoma is being -- the state, the city and the county is being very generous with us right now relative to, say, leases and credits that they've committed to give us, et cetera.

All that means we are looking at a very low or limited capital outlay related to that, very low or limited, not material.

Our next question comes from Brian Ruttenbur of Drexel Hamilton.

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

Absolutely. So as you're alluding to, our net debt position pro forma post the PSS sale is going to be approximately 2 to 1. So we have significantly de-levered. And we have no intention, no intention at all of re-levering up for any reason.

We are, as we talked in our prepared remarks, we've got a number of programs that we spoke about on the drone side that are beginning to ramp. We've got some opportunities that are very real that we have not gotten into detail with here that we could hit by the end of the year that would be very significant and could change the paradigm for us.

It's important to us for a number of reasons until we see how this works out that we maintain a significant liquidity position on our balance sheet. So A, there is no question in these customers' minds based on the size of the potential programs they're thinking about giving us that we can execute the production on them and we want to be able to easily handle any working capital requirements related to those without significantly impacting our net leverage position.

So that's a long way of saying for right now, we're going to sit tight as we continue to pursue these new very large potential opportunities. We'll see where we come out on that and if they don't come to where I think they're going to come out at the beginning of next year, then we'll make some decisions.

As you probably know, relative to our bonds, if we do not deploy that cash in 12 months, depending on some characteristics in the indenture, we can call the bonds at par.

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

Sure, so Brian, it should be about consistent, the SG&A from Q1 to Q2 sequentially. And there really shouldn't be a lot of movement throughout the year, except for probably in the fourth quarter. Typically that's when we have more of the accruals on some of our audit fees, et cetera. But otherwise, it should be about at the same rate it's been at in the current quarter.

Our next question comes from Ben Klieve of NOBLE Capital Markets.

Just one kind of bigger picture question from me today. I'm curious about the impact of a 1-year versus a 2-year budget as it pertains to the various UAS programs that you've discussed that are kind of in the early stages of capture and negotiation.

I'm curious to what extent do you think the timeline from negotiation to development of these programs could be accelerated given the 2 years of visibility we have as compared to the programs that we all know about that came into development amid just constant budget pressure.

Absolutely, yes. Absolutely correct. And the Secretary of Defense has actually alluded to that relative to the rapid innovation offices and the science and technology agencies, most of these as you know that we're working directly with on a number of these programs.

The Secretary of Defense either this morning or just yesterday, he addressed the [ask]. And he specifically talked about that over the next 2 or 3 years they are focused on the rapid identification, development, demonstration and fielding of high-performance systems that have got to be at an affordable cost. And that is exactly how we position the company.

Because we position ourselves for what you're alluding to that irrespective that we have a $700 billion defense budget this year and with the bipartisan spending bill we're going to have another $700 billion defense budget next year, affordability is still going to be tantamount and deploying quantities is going to be equally important as quality.

And we believe because of our size, small, and the nature of the programs we're going after, that is a very important competitive differentiator for us to our customers.

(Operator Instructions) Our next question comes from Seth Seifman at JP Morgan.

It's actually Ben Arnstein on for Seth. I wanted to ask about cash from ops kind of thinking beyond 2018. The guidance this year right at the midpoint with $40 million, I mean that as a percentage of EBITDA that's about 70%.

And there are obviously some investments going on this year in Unmanned that are going to kind of fall off. Is that a good starting point for thinking about your cash generation as we go in the year ahead? I mean is there any reason why it's going to be worse than like 70% of adjusted EBITDA?

Year to year, that is an absolute good starting point and there is nothing that comes to mind right now that would indicate that it would be any worse. The only practical thing I could see that could impact that and it would not be significantly or for a very long period of time, is if in the next 6 or 9 months we received an order for 300 drones, and we had to deliver them in 24 months.

And just depending on the milestone structure and the payments, it might split a 12-month to a 15-month. But that's the only thing I could see.

Now that would not be a bad problem to have, I guess.

No. But that ties directly into the question on and the answer on --

And the working capital requirement.

And maintaining cash on the balance sheet, because we're working on some stuff.

Right, right. And then maybe just kind of on space, I mean there's a lot going on right now in the space market. And you're kind of well-positioned in the sat-com world.

Can you talk a little bit about some of the trends that you're seeing and how you feel about your opportunity to grow and whether or not you think that your sat-com business can maybe be the fastest growing part of KGS once we get out beyond the training awards?

Yes. The high-level line item right now is the amount of restricted or classified work is increasing rapidly. That's number one. Number two, I mentioned WGS, the 2 additional WGS satellites. You may have seen, it just came out this morning on the next-generation's space-based infrared surveillance. We're involved in all of these.

So new satellites that go up, we are involved in the ground segment on these. As I said, we're involved with 85% of U.S. space missions. We are in. What is happening right now is distributed communications. So instead of having exquisite $1 billion, $2 billion, $3 billion GEO-station orbit satellites that make potentially nice juicy targets for an adversary, it's being distributed to hundreds, if not thousands, of LEOs.

So these cap satellites are much less capable, but there's a lot more of them. That means that they require an entire new generation of ground equipment and we are directly involved in that as we speak.

In addition, as you know, we own and operate the only commercial global network, our spectrum services business, where we are routinely monitoring hundreds of beams for our customers. This is expanding rapidly right now because of -- I'll use words like interference or interception that is happening with beams.

And people, our customers, want to know what's getting interfered with, how's it being done, and then we geo-locate specifically where it's coming from so it can be mapped and neutralized. Those are the threats we're seeing. Those are the drivers we're seeing.

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

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

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