Kratos Defense & Security Solutions, Inc.
Q4 2018 Earnings Call Transcript

Published: 1 Mar 2019

[Operator:]

Good day, ladies and gentlemen. And welcome to the Kratos Defense & Security Solutions Fourth Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. [Operator Instructions] As a reminder, today’s conference may be recorded. I would now like to turn the call over to Marie Mendoza, Senior VP and General Counsel. Ma'am, please begin.

[Marie Mendoza:]

Thank you. Good afternoon, everyone. And thank you for joining us for the Kratos Defense & Security Solutions fourth 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 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.

[Eric DeMarco:]

Great. Thank you, Marie. For Q4 in 2018 the organic growth trajectory of Kratos continued and we generated our company's best operating and financial performance in many years substantially exceeding EBITDA, gross margin, operating income and EPS objectives, including positive GAAP EPS in the fourth quarter. As we begin the new year, we are forecasting continued organic growth, including organic revenue growth of approximately 12.5% and adjusted EBITDA organic growth of approximately 15% for 2019 over 2018 and this excludes all of the following. It excludes the impact of the FTT acquisition we announced today. It excludes the impact of any potential tactical UAS production revenue we could generate. And it excludes the impact of the potential upside from certain very large hypersonic system and ballistic missile target opportunities we are pursuing, which are expected to be awarded this year. Supporting our future organic growth expectations, Kratos Q4 book-to-bill ratio came in at 1.3

[Deanna Lund:]

Thank you, Eric. Good afternoon. Kratos fourth quarter of 2018 revenues of $164.4 million, which were up sequentially from third quarter 2018 revenues of $159.4 million, came in below our expectations of $182 million to $192 million. Our revenue coming in below our expectations was primarily related to five programs four of which Kratos has now successfully received which were awarded either later in the fourth quarter that we forecast or which have not ramped as quickly as we forecast and our DIU program which Eric mentioned earlier with the new contract award now expected in Q2 of ‘19 to do the recent changes in DIU organizational leadership. The good news is that four of these are now under contract with Kratos we're working closely with our customers to ramp them up including the hiring of highly cleared personnel on two new UAS programs and we are forecasting that each of these contracts will be back on the planned run rate by the middle of 2019, which is reflected in our 2019 guidance. Compared to the fourth quarter of ‘17 revenues decreased slightly by $1.9 million or $166.3 million primarily due to the continued reduction in our legacy government services revenues as well as the timing of production and shipment ramps in the fourth quarter of ‘17 compared ‘18 primarily on our FSAT program in the Unmanned Systems division. Our debt to EBITDA came in at $18 million above our expectation of $13 million to $17 million primarily driven by a favorable mix of revenues and the positive benefit of cost reduction actions we have taken throughout 2018, as well as our initiative of enhancing operating margins by foregoing low margin opportunities or more aggressively negotiating more favorable margins with the potential results of reduced revenues. Additionally, Kratos’ adjusted EPS of $0.09 per share also exceeded our forecast of $0.03 per share to $0.07 per share for the quarter. In the fourth quarter, KGS generated revenues of $128.2 million, adjusted EBITDA of $15.1 million or 11.8% of revenue and operating income of $11.6 million, all which were up from the prior year comparable revenues of $124 million, adjusted EBITDA of $12 million and operating loss of $15.8 million or operating income of $8.4 million excluding the impairment of goodwill respectively, reflecting the growth primarily in the Satellite Communications and Training Systems business, a favorable mix of revenues, as well as margin improvement in our Modular Systems business. From an accounting standpoint, Kratos was required to adopt a new revenue recognition practice beginning January 1st of this year of 2018, which can affect the timing of revenue recognition for certain contracts. The impact of this new accounting standard was approximately $9.4 million and $29.9 million on Kratos’ fourth and full-year – fourth quarter and full year 2018 revenues respectively. Our Q4 operating income was $10.8 million or 6.6%, up from the fourth quarter of ’17, with an operating loss of $15 million, which included the impairment of goodwill and our DRSS or Legacy Government Services business of $24.2 million. Excluding the impairment of goodwill in 2017, operating income was $9.2 million or 5.5% of revenues. The increase was driven by a reduction of SG&A expenses reflecting the impact of the cost reduction actions we have take, as well as a reduction of discretionary R&D expenses. Our adjusted EBITDA for the fourth quarter from continuing operations and excludes non-cash stock compensation cost of $2.1 million and severance related cost of $400,000. On GAAP basis net income for the fourth quarter was $4.7, million which includes a loss from discontinued operations of $500,000 and include a tax provision of $200,000, primarily reflecting tax expense for foreign jurisdictions and for states for which we cannot utilize our NOLs. Moving on to the balance sheet and liquidity our cash balance was $182.7 million, plus $300,000 restricted cash at December 30th. At quarter end, we had zero amount outstanding on our bank line of credit and $9.7 million of letters of credit outstanding. Debt outstanding was $294.2 million at quarter end and net debt was $111.5 million. Our LTM adjusted EBITDA was $60.5 million with the net leverage ratio of 1.84

[Eric DeMarco:]

Thank you, Deanna. As Deanna mentioned, today we announced Kratos' acquisition of Florida Turbine Technologies are FTT. This is the first acquisition Kratos has made since 2012. FTT is a technology and products company, strategically positioned for the small to medium sized affordable turbofan and turbojet market, including for high performance unmanned aerial drones, missiles and weapons systems. The affordable leading edge in technology that FTT brings to Kratos and to our Unmanned Systems business is truly incredible. With recently developed FTT engine systems offering thrust and SFC performance improvements that have previously been unobtainable in the low cost jet engine area. As you know, the number one cost and most Kratos drone and weapon systems building materials is the engine and affordability is a key differentiator for Kratos' platforms and systems. Accordingly, we are looking for FTT to further Kratos' vertical integration of our drone and weapons systems, increase Kratos' technology and our performance lead in the systems and also reduce system costs. Additionally, the projected market for advanced turbojet and turbofan engines in this class alone is easily in the many thousands over the next five years, given the projected number of extended range and low cost cruise missile systems and next-generation unmanned weapons systems to be acquired. And Kratos and FTT, we intend to be the leader in this extremely large and growing market space. FTT today is currently under contract on or pursuing 12 specific programs at this time. Finally, beyond traditional turbo jet and turbo fan engines, FTT is also working to develop advanced affordable engines for hypersonic systems in their special programs area or Skunk Works that we believe will demonstrate a new class of affordable hypersonic propulsion system. Importantly, FTTs next-generation engine technology and programs were previously funded by FTT, meaning intellectual property ownership for Kratos. These FTT engine programs and initiatives are now substantially U.S. government agency and customer funded, meaning no significant internally funded Kratos investment should be required. Similar to CEi, which Kratos acquired in 2012 and which has been the core of Kratos' unmanned aerial drone system strategy and the UAS business we have today, we believe that FTT over the next few years will also be a disruptive and market transforming business with incredible growth and value generation expected to be realized for Kratos shareholders. FTT will now become Kratos Turbine Technologies or KTT, a new Kratos division with Stacey Rock, a senior Kratos executive and technologists for over 12 years, becoming the KTT President. It's important to note that the FTT founders and all of their employees will be staying with the company. KTT and Kratos' Unmanned Systems division will be organized so that they will work extremely closely together with Stacey and Steve Fendley, our Unmanned Systems Division President, both being honored engineer graduates. The acquisition of FTT furthers Kratos' position as a unique technology assets or company. We're disrupting the national security market with affordable leading technology systems and products, and we're in a growth trajectory that looks pretty substantial for the next several years. With that, we'll open the line up for questions.

[Operator:]

Thank you. [Operator Instructions] Our first question comes from the line of Peter Arment of Baird. Your line is now open.

[Peter Arment:]

Yeah. Thanks. Good afternoon, Eric, Deanna. P

[Peter Arment:]

Eric, just to I guess to focus on your initial comment about the, well, I guess the target business growing to $250 million in revenues. I guess is there a path you see -- how many years does that take and then you said over the next few years, but is it -- are we seeing this all by missile defense testing on existing programs or you see in new programs, maybe just some color there.

[Eric DeMarco:]

The vast majority is existing programs and we see ourselves getting there in three years or four years at the most.

[Peter Arment:]

Okay. And just as a follow-up, just -- if I could just on FTT, you mentioned the 12 programs are on, is there any programs or record that you can disclose or is there any more color on that? Thanks.

[Eric DeMarco:]

Let me say it this way and I'm going to say it this way for competitive reasons. If you take a look at weapons systems, a number of them are going to ER or extended range weapon systems. So if you look at existing weapon systems, these are air to surface weapon systems, ship borne to service weapon systems and you’ll see the name of the weapon system with the -ER for extended range that is a good representative example of the existing programs that are being modified for the threat.

[Peter Arment:]

Got it. I’ll jump back in the queue. Thanks Eric.

[Eric DeMarco:]

Thank you.

[Operator:]

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

[Ken Herbert:]

Hi. Eric and Deanna, good afternoon.

[Eric DeMarco:]

Good afternoon.

[Deanna Lund:]

Hi. Good afternoon.

[Ken Herbert:]

I just wanted to first start off just again on the FTT acquisition, it sounds like if they are successful on some of these you could potentially require fairly significant investments to support the production ramp. Can you would all talk about sort of how the CapEx associated with this business looks and NOI we see that's been a major issue for you over the last few years to capitalize to support the ramp. What's the outlook for this business assuming they are successful and what could the cash implications be around the investments?

[Eric DeMarco:]

The -- so the outlook for the business is extremely bright. There is a very large and strong demand from government agencies for alternatives and for next-generation turbojets and turbofans for their weapon systems. The initial investment that’s included in the business plan in our financial forecast is $3 million to $5 million per year, okay, that goes out for a number of years. If we are successful on some of these programs that we’re getting designed in on and they go into production, those numbers will increase, but so will the revenue of the business the profit of the business from a cash flow. I’m not going to get into details on what that looks like two or three years from, now if we get there – let’s take it like we did with our unmanned system division. Let’s get designed in, let’s win the programs then I'll walk you through the investment required for the growth.

[Ken Herbert:]

Okay. That’s great. But it sounds like on sort of a relative to your tactical business it's likely a much lower investment profile it sounds like?

[Eric DeMarco:]

Far lot – far -- it is nothing like we have done for the past several years on the Valkyrie and what we did previously on the Mako, no sir.

[Ken Herbert:]

Okay. Great. And if I could I just wanted to follow-up obviously on press this week on the Boeing announcement of their loyal wing manned market entrants into international markets. Can you comment Eric on I know obviously you would always expecting you had competition in the market but sort of how you view that relative to your portfolio and is it something you expect near or midterm to be a potential sort of threat to your United States business, and obviously, that particular aircraft seems to be targeted internationally. But how would you characterize a frame up of that?

[Eric DeMarco:]

Well, as you alluded to, Ken, we always new competition would come, because the market opportunity for jet drones that can perform in anti-access area denied airspace it’s in the billions, it’s coming we are following the unmanned systems strategic roadmap that was initially put out in 2010 and the last nine years have much pretty much tracked to that roadmap. Very candidly this competitor and it coming from Australia, with a significant Australian investment. We don’t think it could have worked out better for our company but let me tell you why. First of all our price point, as the price point on our Valkyrie depending on quantities is to $2 million to $3 million and we have basically proven that out as we built three aircraft, right? Our aircraft has least published 50% greater rate. Our aircraft has internal weapon space, right? We’re runway independent, which is critically important to the U.S. customers. We’re launched off a rail and recovered by a parachute including in water where we saw seal and turnaround time for our drones is incredible, right? Very importantly our drones exist today and they are flying today. The competitors they have a model today, they say they will be flying late next year. So, again, as you said, we knew the competition would come, but we are very comfortable with our position and the affordability for the performance we believe it’s unmatched and that’s from our customers.

[Ken Herbert:]

Great. Thank you very much. I'll pass it back there.

[Operator:]

And our next question comes from the line of Noah Popanaki of Goldman Sachs. Your line is now open.

[Noah Popanaki:]

Hello, Eric.

[Eric DeMarco:]

Hello.

[Noah Popanaki:]

Is FTT included or excluded from the 2019 guidance?

[Deanna Lund:]

It is included for the period, for the period of the -- of the period of acquisition through the end of the year and so roughly 10 months.

[Noah Popanaki:]

Can you quantify how much revenue is in the $720 million to $760 million from it?

[Deanna Lund:]

Yeah. So it’s approximately $45 million.

[Noah Popanaki:]

Okay. So – okay. So that number from got it. So then the – that implies I guess sort of 12% organic revenue growth in the business, Eric you made some comments here about changing the growth curve going forward. Are you saying you expect the growth rate in 2020/2021 to be higher than 12%?

[Eric DeMarco:]

Yes.

[Noah Popanaki:]

Okay. And then, on the margins, the EBITDA guidance implies a relatively flat adjusted EBITDA margin, but you have pretty good growth you should have some drop through your layering in a business with a higher margin than the legacy business and you’re vertically integrating what you just described is a pretty significant cost component. I would think that will all add up to a decent amount of margin left?

[Eric DeMarco:]

Yeah. So, as we’ve demonstrated over the last few years and including Q4, we've typically end up being conservative on our margin guidance. We have routinely achieved or exceeded it and we’re hopeful to do that again going forward.

[Noah Popanaki:]

Okay. Is it possible to quantify how much of your cost of goods sold is the engine. Just want to get a little bit any kind of way to frame a more precise degree of uplift from that vertical integration would be really helpful?

[Eric DeMarco:]

Yeah. It’s approximately 30% to 40% of the bill material cost depending on the drone.

[Noah Popanaki:]

Got it. That’s really helpful.

[Eric DeMarco:]

Yeah.

[Noah Popanaki:]

On cash flow at one point you were pointing to getting to 70% of adjusted EBITDA translated to cash from ops, for 2019 that would be over $50 million, the guidance is $40 million to $50 million and you've got what seems like a not insignificant amount of slippage out of 2018. When should we expect the cash flows to convert margin what we’re seeing on the P&L?

[Deanna Lund:]

As I had mentioned earlier on the call, Noah, there is a number of large training programs, which have milestones attached to final delivery, so we don't get to see those final milestones and the retention until the final delivery which is some of the slip into ‘19. However, as we have continued to grow that business at a faster pace than the rest of the business those milestones will continue to as old milestones are achieved there is new milestone that we need to achieve for final collection. So we won’t collect those amounts that we expected from ‘18 the new milestones will then be need to be achieved in ‘19 and ‘20 for the new training systems that we are building and then ultimately delivering in 2020 and 2021 as some of these programs are span a period of…

[Noah Popanaki:]

Okay.

[Deanna Lund:]

… over two years.

[Noah Popanaki:]

I see. I mean, I guess, I would thought you kind of knew that when you were targeting 70% of adjusted EBITDA is that fundamentally changed that target for the time being?

[Deanna Lund:]

Yes. Due to the mix of the business that we’re seeing and especially in on that training side and then also in our drone business as well because if milestones are similarly weighted in the drone business.

[Noah Popanaki:]

I see. Okay. Thanks so much.

[Eric DeMarco:]

Okay.

[Operator:]

And our next question comes from the line of Josh Sullivan of Seaport Global. Your line is now open.

[Josh Sullivan:]

Hi. Good evening.

[Eric DeMarco:]

Hi, Josh.

[Josh Sullivan:]

Just for FTT, looks like they won a $50 million what ATA on contract in December. Can you just expand on that? Is that something you're going to own the on the IP through or what's the vehicle there?

[Eric DeMarco:]

The primary IP related to that program, the company had already developed and they -- the company has several 100 patents or patents pending. These are developing -- these are next-generation engine programs with specific platforms in mind. So that is -- you found one, that is one of many that they have received in the past couple of years, which are pointing, Josh, to those 12 opportunities which are sitting right here in front of me as I'm talking to you, which we're getting designed into and which we expect to be the engine for going forward once again in the production.

[Josh Sullivan:]

Got it. And then just on the current drones using third-party jet engines for propulsion. Is there going to be an opportunity to use FTT engines at some point in the target drone business at some point?

[Eric DeMarco:]

Probably on the existing Target Drone, probably not, because once they're designed in, they're qualified and they're approved by the customer, you don't want to change it out in the middle of production run, a multi-year production run. However, on our Tactical Drones going forward, virtually all of them and on new target drones, the answer is yes, KTT, FTT, will be the vertically integrated engine. That's the objective.

[Josh Sullivan:]

And then is there any way to update the anticipated size of the orders that we should be looking for following the successful Valkyrie test?

[Eric DeMarco:]

I am not – I -- as I've said on my prepared remarks, Josh, we in the past month. We've recently met with a number of customers including at the Pentagon and which is why I said that this is going to happen. If this is happening, it's no longer a question of if it's when and the when is coming in. So I don't want to get ahead of the customer and I'm not going to do that. So, not yet, not yet. Josh, importantly on the question I think that, Ken asked; the fact that Boeing is making the investment that they're making and them coming after this, that validate this market that we've been going after and we've got the lead in. That's how we see it. It is about that -- that's probably the best validation external data point there is.

[Josh Sullivan:]

Got it. And then just one last one, on the new Oklahoma facility, I think, you made some comments there, but can you just provide any color how that's coming along, any progress there?

[Eric DeMarco:]

Yeah. On track. The first drone came off the line last month. We're going to have a significant function there with the Senator Inhofe and his staff and I think Senator Lankford is going to be there also. This is a big deal. These are -- we understand this facility, we are going to be the only provider of entire aircraft ready to fly in Oklahoma. So they are big supporters of ours. We're going to ramp-up throughout the year and the next year quantities are very, very significant once we're 100% set up there.

[Josh Sullivan:]

Okay. Thank you.

[Eric DeMarco:]

Sure.

[Operator:]

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

[Unidentified Analyst:]

Good afternoon. This is George Fica [ph] on the line for Mike.

[Eric DeMarco:]

Hi, George.

[Unidentified Analyst:]

First congratulations on the margin performance. Multi-year high. That's awesome.

[Eric DeMarco:]

Yeah. thanks. Thank you. As we've been talking, we've been receiving inbounds on that. Thank you and…

[Unidentified Analyst:]

Yeah.

[Eric DeMarco:]

… we're looking forward to continue to ramp going forward.

[Unidentified Analyst:]

Yeah. I come from industry. I know how hard it is to get it up. So great job.

[Eric DeMarco:]

Thank you, George.

[Unidentified Analyst:]

What changed that made you pull the trigger on the acquisition now? What was different now versus previous times?

[Eric DeMarco:]

So if you could see me I'm smiling and the reason I'm smiling is, we have been working with the owners, the founders surely enjoy for a year-and-half. So we have been tracking this, we have been working with them, understanding the technology, understanding what they want to do and their ambitions which are big, very large, understanding the programs they were going after and additionally over the past year and a half and most recently the past three months and six months, we know this next-generation of drones is about to happen. We know this next-generation of extended range weapon systems is happening. You can see that out there. Just take a look at JASSM-ER, Harpoon-ER, you can see the extended range weapons that are coming. And this market, the small engines, the technology is not current. And this company is disruptive, they are favored by the government customer, favored by them. And we've been working with the customer, we've been working with this company and this has all come together and so that's the picture of why we did it now.

[Unidentified Analyst:]

You mentioned something very interesting in your comment about 2019 about the drone mix. You mentioned that for 2019 most of it is going to be driven by Target Drones. When does mix shift and become more equal, where tactical is an equivalent portion of the revenue mix versus target? Is that something that you can expect in 2021?

[Eric DeMarco:]

That's a very fair question. So the mix in 2019 does not include any what I'll call production units for Tactical Drones, okay? The Valkyrie is going to fly very soon as the Air Force announced in December. We could get – if we were to receive an order for 25 or 30 Valkyries before the end of the year at $3 million each, 15 months – 15 months, 18 month production period, that mix could substantially change in 2020.

[Unidentified Analyst:]

And in terms of…

[Eric DeMarco:]

You know…

[Unidentified Analyst:]

Yeah. Go ahead. I am sorry.

[Eric DeMarco:]

Another one I want to mention is Program F, that system is flying today and it's being pulled to the left and we're going to be doing a number of demonstrations including some expected very interesting demonstrations in the middle of the year. If those are successful and that program goes end of this year, next year, we can get an order for a couple of 100 of those at $300,000, $400,000 each.

[Unidentified Analyst:]

Okay. And I mean that seems like those are your two top opportunities in the near-term, Valkyrie and Program F?

[Eric DeMarco:]

Gremlins with our partner Dynetics. The Gremlins are going to – the demonstration is scheduled in the second quarter. I am not going to get ahead of our partner Dynetics, but there is significant customer interest in this system. So, we've got a Fanatos [ph] is going to be significant next year.

[Unidentified Analyst:]

And I guess my last question; could you just familiarize us all again just once more on how many programs do you have in the hypersonic domain? And does FTT have any ongoing work in that domain and that's my last question? Thank you.

[Eric DeMarco:]

Yeah. So, FTT, I'm going to go in reverse order. FTT absolutely has work in the hypersonic domain, right? There are two programs that I can tell you about that we have been or are involved in on a hypersonic side; High Fire and High Cause. I cannot talk to you about any of the other ones and I'm just not going to do that.

[Unidentified Analyst:]

Thank you very much.

[Eric DeMarco:]

Sure.

[Operator:]

And our next question comes from the line of Mike Crawford of B. Riley FBR. Your line is now open.

[Mike Crawford:]

Thanks. Can you remind us the margin you're getting now on for SSAT production and the steps that might my take to increase margin on targets like SSAT towards those levels as you get more experienced in producing those drones?

[Eric DeMarco:]

Including the drone, ancillaries, payloads, et cetera, et cetera its mid-teens.

[Mike Crawford:]

On SSAT now, you say, SSAT, I would imagine be mid-single digits at best this year?

[Eric DeMarco:]

Yeah. Yeah. And we’re looking for that as we get the full rate production again assuming the aircraft payloads, spares, ancillaries, similar margin profile?

[Mike Crawford:]

And what about the Tactical Drones?

[Eric DeMarco:]

Similar margin profile.

[Mike Crawford:]

Okay. And then in your RSS business has been using these carrier, Malmous [ph], Oriole, sounding rockets, where -- what is the status of your, I guess, ability or exclusive ability to use these rockets for ballistic missile purposes?

[Eric DeMarco:]

The primary ballistic missile target system includes a rocket called Oriole. We have exclusive perpetual rights including a capped pricing grid for these for three purposes, ballistic missile targets, sounding rockets, and sub-orbital systems and if you look up sub-orbital systems, that’s a hypersonic system. So we have a very important and valuable asset here which is we believe one of the reasons why there are three large opportunities that are expected to be awarded this year. One of them imminently none of which we've included in our forecast and that I feel that system we think is a big differentiator for us.

[Mike Crawford:]

Okay. All right. Thank you.

[Eric DeMarco:]

Sure.

[Operator:]

And our next question comes from the line of Joe Gomes of NOBLE Capital. Your line is now open.

[Joe Gomes:]

Good afternoon.

[Eric DeMarco:]

Good afternoon.

[Joe Gomes:]

Just wanted to go back to FTT for a second here, you said you've been working with them for like 18 months, were you the only bidder year, why did the owners decide to sell, I mean, it’s great that they are staying, but just trying to understand why, what’s your thought process was as to why they decided to sell to you guys?

[Eric DeMarco:]

They see -- yeah. They see -- that one is easy. They see a very large production ramp coming and they are – they felt more comfortable doing it with a similar partner that focuses on affordability that is highly technical, we are a highly technical company as you know. They are very good at rapidly developing, demonstrating and fielding something so are we are, okay. Obviously, they see our drones. They know where are drones are going to be over the next several years. They can integrate their engines into our drones, this is why they agreed to structure it this way with the selling 80.1 and keeping 19.9, because they – where they can put that 19.9 to what so we call it in the future, because their business plan is phenomenal and they believe that they are going to hit a grand slam and they are going to participate in that grand slam with us with that 19.9.

[Joe Gomes:]

Okay. And you say they’re -- I think they are working on, bidding on 12 different type programs, is there any potential for conflict of interest so to speak once you start putting these engines in your drones or some of these programs. They are working on where some other outside customers would feel uncomfortable using their engines?

[Eric DeMarco:]

We see no risk of that at all, none.

[Joe Gomes:]

Okay. And then one last one, I think, you mentioned that, Valkyries expected to fly soon and happened to see an article today that said it's to take flight next week. Is that accurate?

[Eric DeMarco:]

We are coordinating closely with the United States Air Force on any official information related to this. That’s all I am going to say.

[Joe Gomes:]

Okay. Thank you very much.

[Eric DeMarco:]

Thank you.

[Operator:]

And our next question comes from the line of Sheila Kahyaoglu of Jefferies. Your line is now open.

[Sheila Kahyaoglu:]

Good evening, Eric, and thank you for the time. Can we talk about your $6.8 billion bid pipeline, kind of maybe can you talk about what’s in there, how it’s changed and how much of it is unmanned?

[Deanna Lund:]

So, Sheila, this is Deanna. So in total so we got about $1.8 billion that’s been submitted already, of that $6.8 billion and the unmanned piece is roughly $1.6 billion. So there are a number of opportunities that actually could be entered at weighted value of much less than what is expected. So for instances there are some large opportunities that for purposes of tracking are guys only put in as a dollar of value. So it actually it’s higher than the number that we actually report, but it is as I said about $1.6 billion of unmanned and $1.8 billion of the total has been submitted already.

[Sheila Kahyaoglu:]

Okay. Understood. And then in terms of unmanned revenue profile of $250 million potentially. How could we think about the contributors of that I am guessing SSAT obviously is good base and how do we think about the timeline of when contracts come in.

[Eric DeMarco:]

Yeah.

[Sheila Kahyaoglu:]

Eric you went through that on the call it seems like make us in Q2 now you’ll have Gremlins coming in, you mentioned Apollo with the new one, I was wondering if you could elaborate on that a bit?

[Eric DeMarco:]

Yeah. So the $250 million number you had mentioned that is substantially all Target Drone related, okay. Substantially all of that we have the programs. They are ramping. So we have the Air Force program which is our 167 Target Drone, that is in full rate production, but quantities are increasing as off tempo increase for peer, near peer threat or fight. The SSAT program I mentioned today with the U.S. Navy. We are in LRIP 2, LRIP 3 is coming full rate production is going to be next year. We’re going to that award and that’s why initial operating capability today was so important. So that U.S. Navy contract SSAT that is going to be one of the big drivers again the 250 of that goes from LRIP 2 this year, LRIP 3 next year at a full rate production. We have two programs with the U.S. Army they are both new, two different drones. They are both ramping. We have a program with the customer it is ramping to full rate production in two years from now. The international program we announced with Sweden well they are doing target drone threat representation for other militaries that is going to begin in the middle of this year and that one is going to ramp. That’s $100 million base. We have program with Kinetic, they are our teammate. They run the weapon ranges for the U.K. called the Tacts program [ph]. They have a 20 year contract. They’re 10 years into it. They signed a 10 year contract with us we’re providing them target drones. That is ramping. So those are all the Target Drone programs we have under contract sole sourced that are going to drive us toward that $250 million. And then in addition to that we provide drones to multiple international customers. International customers that buy U.S. weapon systems, they want to exercise them against the best and state-of-the-art drones in the world, those are ours. So we have programs with Taiwan, I can only mention some of these, South Korea, France. I'm not going to mention the other ones, because I'm not sure I can.

[Sheila Kahyaoglu:]

Okay. Okay. Appreciate the color. Thank you.

[Eric DeMarco:]

Yeah. Yes.

[Operator:]

Our next question comes from the line of Seth Seifman of JP Morgan. Your line is now open.

[Seth Seifman:]

Okay. Thanks very much and good afternoon.

[Deanna Lund:]

Hi.

[Seth Seifman:]

To start off, a quick question about the acquisition, what made you decide to structure it the way that you did in terms of the mix of cash and equity?

[Eric DeMarco:]

It was a sit down with the owners, and as I think, as I mentioned a minute ago, they are – they believe that they are going to hit a grand slam home run. They believe what does, they're going to hit a double grand slam home run and they wanted equity. They -- as part of this work since they took software, they did due diligence, they understand all of our drone programs, they want to get their engines in those drone programs, they see what that's going to do for the performance of the drones and the affordability. So they see a very significant upside in the Kratos stock. So, they took some cash now and they got big uppers with Kratos stock and with the 19.9.

[Seth Seifman:]

Okay. And then I apologize if you mentioned this earlier but in terms of the guidance for ‘19, can you break that down between the two segments on the sales and the adjusted EBITDA?

[Deanna Lund:]

Seth, are you talking about between KGS and unmanned?

[Seth Seifman:]

Exactly.

[Deanna Lund:]

Okay. We actually don't provide that guidance. We only provide it on a consolidated basis.

[Seth Seifman:]

Okay. Okay. Okay. I mean, any qualities color maybe?

[Eric DeMarco:]

Qualitative color? Okay. As I mentioned on the drone side LRIP2 is coming in a little bit – LRIP3 looks like it's going to come in a little lower than we initially -- and the Navy initially announced for SSAT. And the issue with the government shut down and we have a number of international drone customers that we pushed out as the backlog on the export licenses gets cleaned up. So our unmanned business, the trajectory, it's significant. But I don' want to get into the details here because I guess – I don't want to get into the details.

[Seth Seifman:]

Got it. Okay. And then maybe just as the last one, you talk about the opportunity on the tactical side being greater than on the target side, which I think makes sense. And you kind of talked about a timeframe when you'd ramp up to that $250 million on the target side being kind of over the next three years or four years. To see a ramp pass that level on a tactical side is something that would be -- the timeframe on that is that a few years beyond when you'd reach that point on the target side?

[Eric DeMarco:]

Well, obviously, it depends, I gave an example a few minutes ago if – I'll give a separate example. I mean Gremlins with our partner Dynetics successfully demonstrates at the -- in Q2 of this year. And by the end of this year or early next year an order was to come in for 200 Gremlins at $700,000 each. That would significantly change the mix, as I mentioned before, and if we get some Valkyries on top of that at $2 million or $3 million each, it could – couple of three years out, it could flip entirely, with the Tactical business revenue and profit is passing the Target business which is what we see.

[Seth Seifman:]

Okay.

[Eric DeMarco:]

As I mentioned, we've got six customer funded programs. Right now, Valkyrie, Mako, Program F, Fanatos, Eton [ph] and Gremlins, and we have three more that I think are going to be funded before this year is out. Spartan is going to be funded, Apollo is going to be funded and Fena [ph], they're all going to be funded. So, this is happening and as I said before, this is not if anymore. This is when and the when is coming.

[Seth Seifman:]

Great. Okay. Excellent. Thanks very much.

[Eric DeMarco:]

Yeah.

[Operator:]

And next we have a follow-up question from Noah Popanaki of Goldman Sachs. Your line is now open.

[Noah Popanaki:]

Eric. Do you have the revenue slippage out of the fourth quarter out of the end of 2018? Certainly, there are multiple large growth opportunities in the business. But I think in the industry in general not to specific deal when someone is growing quickly or ramping it's easy to have things slight to right, or easy to have slippage.

[Eric DeMarco:]

Yes.

[Noah Popanaki:]

And you've got a little bit of a backend loaded year. So, question is, what are the two or three pieces of your 2019 revenue guidance or specific programs where there's the most concern or the most risk of slippage from 2019 into 2020?

[Eric DeMarco:]

Our Unmanned Systems business is pretty substantially bolted in with the Navy and the Air Force and the Army program. So, Unmanned Systems is – I'm going through my head, pretty substantially bolted in. The one in the unmanned area that that moved on us, the DIU program as you know [inaudible] we knew very well, he left. Michael Brown took over, I know him, I met with him. We're tracking for Q2 award there, we're tracking. I think we're going to get it, that's the one maybe but I'm highly confident we're going to get it based on recent discussions. Our Modular Systems, our C5ISR business is bolted in with primes on weapon systems like the ones I went through. The one I see potentially, those two services contracts we won. We won the radar contract and we won the high powered laser contract. And we've won and they reach multi years but they're ramping slower than the customers bid plan. And so those two which are lower margin, so I think we're going to be fine on margin, those are the two that I think don't ramp up. If we're not ramped, headcount where we think we should be by the middle of the year that could be a flashing yellow light.

[Noah Popanaki:]

Okay.

[Eric DeMarco:]

Yeah.

[Noah Popanaki:]

Okay. Great. That’s helpful. Where to keep an eye.

[Eric DeMarco:]

Yeah.

[Noah Popanaki:]

Thank you.

[Eric DeMarco:]

Yes, sir.

[Operator:]

And next we have a follow-up question from the line of Michael Ciarmoli of SunTrust. Your line is now open.

[Michael Ciarmoli:]

Just one quick question, it seems going back to again what you previously mentioned, the larger players are really qualifying this opportunity, it's real, it's coming. You've got other multi-billion dollar competitors entering the market and you've kind of shown a little bit of your strategy. You're picking very critical technologies, bringing them in-house, giving yourself a long-term discriminator in terms of the product offering. It seems like this OK sea facility, is this going to be some type of center of excellence for all of the Target Drones and will it serve a dual use manufacturing capacity target and tactical? That's my question. Thank you.

[Eric DeMarco:]

It will ultimately be the tactical drone center of excellence, okay.

[Michael Ciarmoli:]

Thank you very much.

[Eric DeMarco:]

Yeah. You got it. Okey-dokey. There are no further questions. We look forward to speaking to you when we report Q1 in a couple of months. Thank you.

[Operator:]

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