Good day, ladies and gentlemen. And welcome to the Kratos Defense and Security Solutions Fourth Quarter 2015 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] I would now like to introduce you host for today's conference Ms. Marie Mendoza, Vice President and General Counsel. Ma’am, you may begin.

Good afternoon, everyone. And thank you for joining us for the Kratos Defense and Security Solutions fourth quarter 2015 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 emphasis the major uncertainties and risks inherent in the forward-looking statements we will make this afternoon. Please keep these uncertainties and risks in mind as we discuss future strategic initiatives, operational outlook, and financial guidance during today's call. Today's call will also include a discussion of non-GAAP financial measures, as that term is defined in Regulation G. Non-GAAP financial measures should not be considered in isolation from or as a substitute for financial information presented in compliance with GAAP. Accordingly, at the end of today’s press release we have provided a reconciliation of these non-GAAP financial measures to the company's financial results prepared in accordance with GAAP. With that, I will now turn the call over to Eric DeMarco.

Thank you, Marie. Good afternoon. Based on recent industry related and Kratos specific events, we believe that the defense industry budget bottomed in 2014, 2015. The framework has now been set with the recent Federal fiscal 2016, 2017 by a part of some spending agreement, the 2016 budget agreements, and the President's 2017 DOD budget submission for growth to begin in 2016. In the fourth quarter Kratos saw sequential growth across virtually all of our businesses which Deanna will discuss in her remarks. In Q4 we successful completed another flight of Kratos AFSAT on unmanned aerial target drone system on our navy program and we remain on track to commence LRIP later on in 2016. In Q4 we also remained on track in our unmanned business to begin LRIP on a separate confidential program later on in '16 or early ’17, which is also expected to ramp up to full rate production over the next couple of years. These two programs combined once in full rate production, are expected to contribute in excess of 100 million in incremental annual revenue to our company and this does not include potential additional international asset sales opportunities we believe will materialize once we successfully achieve U.S. Navy 177 operating capability. In Q4 we successfully completed our planned series of demonstration flights at China Lake with Kratos unmanned combat aerial system or UTAP-22 achieving 100% of our objectives. Kratos UTAP-22 was a low cost unmanned combat aerial system capable of mark 0.96 with manned fighter light performance which can perform its mission in an A2AD environment. The Kratos has internally developed and funded over the past few years and which is at the forefront of the DOD's third offset strategy and Defense Innovation initiative. Since the successful completion of the UTAP-22 demonstration flights, we…

Thank you, Eric. Good afternoon. Our fourth quarter 2015 revenues were $177.5 million with sequential growth of 9.8% from our third quarter revenues of $161.7 million. The strong bookings in the third and previous quarters of 2015 resulted in sequential, organic growth of 41.8% in our microwave product business, 16% in our Modular Systems business, 9.6% in our satellite communications business, 4% in our defense and Rocket Support business, and 16.6% in our public safety business, offset partially by reduced shipments in our unmanned systems business of 20%. On a year-over-year basis, revenues decreased from $192.1 million in the fourth quarter of 2014 to $177.5 million in the fourth quarter of 2015, due to reduced revenues of $7 million in our KGS segment, which were result of reduced shipments of hardened mobile tactical facilities for a certain U.S. Government agency customer in our modular systems business of $11.4 million, offset partially by aggregate increased revenues primarily in our microwave products and satellite communications business of approximately $4.4 million. In addition, reduced revenues of $2.5 million in our PSS segment resulting from the change in strategic focus in PSS, to emphasize higher margin, smaller size projects, impacting overall sales volume, and a reduction in our unmanned systems division revenues of $5.1 million as a result of the timing of awards and shipments in 2015 which impacted our Q4 revenues. Our adjusted EBITDA of $13.4 million which was impacted by a favorable mix of products with 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 believed the items are non-operational, or non-recurring in nature. Restructuring related items and other of $3.6 million which includes the following, $2.2 million of cost and expenses related to investments…

Thank you Deanna. Budget Control Act of 2011. The last several years have been extremely difficult for many small and mid-cap defense companies including Kratos. Specifically, over the past several years we have seen our government services business contract from approximately $300 million in revenue at its peak to less than $100 million today with the services business decreased being by far the primary cause for Kratos' declining revenues over the past several years. We believe that our government services business has now stabilize at its current revenue level. With the 2011 BCA, we assess the company's options and made the decision to stay independent and execute a longer term plan where we would focus on certain areas of the DOD market which we believe would provide the best opportunity for long-term future growth based on the quadrennial defense review and once DOD spending began to increase. Our focus areas included unmanned systems, satellite communications and the microwave electronics area. Areas where Kratos owns significant intellectual property and proprietary products. As mentioned previously, each of these businesses generated solid sequential growth in the fourth quarter and we expect each of these businesses to generate year-over-year organic revenue growth for '16 over '15 and to continue that growth into the future. In the unmanned systems area, we have made very significant discretionary internally funded investments over the past few years and hope the penetrating the tactical unmanned aerial systems market. These discretionary investments have included approximately 5 million to 8 million annually in IR&D, NRE and other business capital related costs and an additional 4 million to 8 million in capital expenditures all of which have reduced our recent EBITDA and cash flow. I believe that over the next few months these discretionary investments are going to prove out to have…

[Operator Instructions] And our first question comes from the line of Mike Crawford with B. Riley and Company. Your line is now open.

Thank you. Regarding the UTAP-22, when would you need to receive an order if you were to deliver some units to be used in the large by annual fleet exercise?

And with the fleet exercise Mike or a different branch exercise be a '16 exercise or be first half '17 exercise.

I believe there is a large rim pack '16 exercise scheduled for the June time frame this year.

Yes, so. If we were to participate in that, we would have to receive the order imminently or immediately. For potential other exercises in the second half of '16 or in '17 over the next few months.

And Eric, when you were talking about talking to potential customers and related entities regarding features of that system. I think were you referring primarily to be slowed you did those demonstrations or after both?

Both, for the last two, two and half years we have been interacting with the user community, regarding what their gaps are, their needs are and I'll use the word requirements. So that has a special word terminology in the industry as you know. And we designed the airplane and the demonstration flights around the inputs we've received over the last two, two and half years from those users. Then we have the successful flights in Q4. In the last two months, since those successful flights, we have reengaged - they have reengaged with us or we have reengaged with them regarding the next step for the aircraft in this trajectory. So it's both and it's been very heavy in the last 60 days.

And just more broadly ahead of the administration's budget request release there was a lot of talk from Secretary Carter and others regarding things like swarm - unmanned swarms and then things that they have really highlighting that we're coming inspite of this third offset yet then when you actually see the budget request itself. Those you can't find the word swarm anywhere in there, what do you make of that?

There are some new offices that have been stood up. In '99 for all naval unmanned aerial systems DUIX out of Silicon Valley which is trying to be an interface between the DOD and the Silicon Valley venture capital which as you know we have on our Board of Directors. There is another one that the Secretary of Defense just recently talked about which is the - which previously was classified office the SCO the Strategic Capabilities Office. Those are just some areas where there is money for the swarming capabilities and technologies that you've talked about. In addition to that, there are two others that I'm just not sure if I should be talking about them, where they have flexibility in some of their PE their Program Element lines to address swarming capabilities.

Okay, thank you. And then maybe I'll just end with one other question. You talked about asset deliveries exceeding 2015. What were they in 2015 and also can maybe just more broadly can you talk about what you have enhanced asset versus there is a lots of celebrity 13 production.

Right, okay. So on the first part of your question Mike, at the end of '14 we had a continuing resolution which significantly delayed the execution of our production years '11, '12 and '13 on AFSAT. So we didn't start delivering targets in '15 until approximately midyear. And so '15 was a down year because of that. And so we're delivering a lot of 11 now and we're going to begin delivering lot 12 this year. And so fiscal '16 will have a full year's delivery as compared to '15 which only had a partial years delivery because of the budgetary environment at that time. It's going to be up approximately $10 million 8 to 10 aircraft in '16 over '15. Okay, now to the second part of your question what we have in hand. We have a base contract and right now we are under contract for lots 11, lots 12 and lots 13. We believe that we are going to be entering negotiations in the next several months on lots 14, 15 and 16 the next three production years. And it is possible that that could be a five year lot which we had previously. So it could be '14 through '18 or '19.

Okay, thank you.

Thank you. And our next question comes from the line of Mark Jordan with Nobel Financials. Your line is now open.

Good afternoon. Question on accounting. As you startup the production of SSAT 3, also the one classified program. From an accounting standpoint, are you accounting through those new platforms on percent completion basis or on a shipment basis because the shipments in '17 and in your estimates for the year what are - what have you assumed for the accounting of those two programs?

Mark, this is Deanna. So on the accounting we still need to discuss with our external auditors on the proper accounting. It could either be the units of delivery, rise of shift or cost over cost percentage of completion. We believe it's probably going to be percentage of solutions cost over cost but we still need to have those discussions with our accountings. As far as the classified, it's confidential program that is expected to be on a cost plus fixed fee.

Okay. The AFSAT articles where they are talking that the Navy is running short on targets to practice with, is there a possibility for acceleration from LRIP into full volume production there and then secondly what is the benefits derived from sort of light fire training versus stimulation.

Very interesting Mark you bring that up. We won't specifically allowed to talk about that publically until recently because popular mechanics in the last month or so ran an article on the Navy target program where R177 which is going into production is replacing the legacy 34s, and legacy 74s. And the article talks about the quantities are diminishing quickly and the Navy has having to do some very interesting things to certain of the remaining aircraft to keep them flying. I believe it is very possible, very possible that LRIP quantities could be increased above what were currently expecting that’s based on communications with the customer and that will be determined over the next few months because as you indicated the Navy's opt tempo needs to be maintained and the number of aircrafts they have and inventory on the 34s and 74s is coming down.

Second part of that question was stimulation versus light fire training is - how does the Navy view this - necessity of the light fire versus stimulation?

I can only tell you on the programs that we're on and the programs that we’re on there is no substitute for light fire versus stimulation. And that was proven out historically tragically in the Vietnam War prior to that where a significant amount of the training prior to that was done in stimulation and then when the real thing happened it became apparent that there was - that stimulation was not a substitute for the real thing. And so I don’t see any adverse potential impact at all relative to 177 program, our 167 program with the Air Force, our 178 program with the certain government customer which is expanding very quickly now, I don’t see any threat at all from stimulation.

Okay. U-class program which was a carrier based UAB, I have seen talk about that shifting to a concept of using that platform as a tanker. If the Navy gives up on that high cost attack project is there anything out there now that is flying, that has performance envelope similar UTAP-22 now that the U-class seems to be shifting in focus.

We are aware of nothing out there that is anywhere close to the aircraft we have for the ones that are coming.

Okay. Final question for me, the public RFPs out the widely advertised the Air Force research lab and all those initiative on Glam 1, specifically do you think what might be the timing where you believe that those two organizations might make public what their intentions are?

I really shouldn’t say anything at this time Mark.

Okay, thank you.

Thank you. And our next question comes from the line of Michael Ciarmoli with KeyBanc Capital Markets. Your line is now open.

Good evening guys. Thanks for taking my questions. So Eric just on the '16 guidance, you kind of gave us a view almost like your different end markets and everything grown organically, I guess the one headwind appears to be on the modular side, is that the only product line that's creating the headwind to drive the flat revenue growth next year?

Yes it is.

Can you size that for us? And maybe the amount of the headwind?

So Michael as you pointed out as I went through, I went through each area and I indicated growth, I also said I believe that the business is going to grow but I said that our base case guidance was something less than that. So let’s say that we’re trying to be – we’re trying to be on the cautious side here with the guidance that we’re giving. That is what we are trying to do.

Okay.

As a size on that Michael, I would say it could be 15 to 30.

Okay. The headwind?

Revenue headwind 15, 16.

Got it, that's helpful.

It could be. We have basically included little to nothing up for new bookings.

Okay. And then what about even - in this market I think EBITDA generation cash flow, it sounds like you’re going to get anywhere from $10 million to $16 million of pickup just on the ending of the R&D for unmanned and the associated CapEx, can you give us a little more color I mean should we expect to see some meaningful EBITDA growth year-over-year. I mean I know you said cash flow would improve, are we expecting a reasonably positive number on cash flow and anything also you can provide there or elaborate on?

Yes, so Michael the reason we’re not being more specific right now is because there is a lot that is going to happen in the next few months. So for example. Let’s say that we are unsuccessful across the board in our tactical stuff and let’s see that we’re unsuccessful and we make that decision by June 30 unsuccessful. You know the numbers that we’ve been investing and as I indicated in my prepared remarks, we’ve been maintaining the development team. If we’re unsuccessful, let’s say we’re unsuccessful make that decision by June 30, we make a significant cost cut and we make infrastructure cuts and we make infrastructure consolidations and over the balance of the year that could be $10 million.

Okay.

And it could be into 17 even more.

Okay.

Just straight to the bottom line if we are unsuccessful. If we are successful and God willing we are going to be, let’s say UTAP-22 the substantial development that we internally funded is complete. If we are successful there, that should be revenue and EBITDA generating because it’s under contract or it funds that could be a positive, we have included - we have not included any of that in our forecast. On one of the opportunities that we’re chasing, the way that it is structured, it could be revenue and it could be EBITDA generating. On another opportunity that we’re chasing it could have a different answer relative to intellectual property which is you know is very important to us and so we got a lot of things going on here. I’m very confident, we will know before June 30 and we will be able to sort this through.

Got it. And then just last from me, what percent of your backlog is shippable in 2016, thanks.

It’s roughly about 40% to 45%.

Thanks guys.

[Operator Instructions] And our next question comes from the line of Eric Selle with SunTrust. Your line is now open.

Hi, good afternoon. You guys changed your guidance last year around this time I believe it was and you guys stripped out a potential and protested activity and you introduced summary you guys gotten more conservative on guidance. And as I look at this year with modular being $15 to $20 million revenue topline, I got to imagine that's high decremental margins, the impact in the back half of last year was $10 million on EBITDA. So it’s sounds like - I mean it’s sounds like your guidance is somewhat conservative is that a true characterization?

That's correct Eric.

Okay, good. I like that. And then Deanna I got you, you said zero outstanding under the revolver, was there any LCs – what was the availability at the end of the year do you have that?

Yes, so the LCs were roughly $10 million to $11 million dollars and the availability was subject to the borrowing base and we had the reserve related to the least divestiture, it was roughly about $48 or $50 million.

Right. And you guys haven’t – obviously need that over the last couple of years?

No

So as I look out what are the risks to the guidance, I mean is there - I guess you stripped out protest contracts, the positive and negatives or may be winning those back, but what are the major risks to this? I mean it looks like, like we said its conservative, but what are you guys worried about this year?

In the public safety business orders don’t come through at the margins that we expect, as I mentioned in my prepared remarks, thus far this year with the bookings today have better than average growth margin of 29%. And I think we been reporting gross margin at 25% to 26% or something like that until those margins if can keep gone planned or executing, smaller jobs high margins that EBITDA should start lifting especially after the first quarter when we complete the reorganization and the cost cuts that we’re doing. So that's a risk. We don’t generate the volume in PSS at the margins that we hope to. In our unmanned systems division, I’m going to say 85% or 90% of that I feel real, real good about. We have one may be two international opportunities out there. We believe we won, it's been down selected, we believe we’re going to get but in today’s world things can get delay, they can get pushed so there is a probably a little bit there in the unmanned systems area that’s primarily international related that could impact us. On the cyber site, I’m not aware of any issues right now but we delivered cyber – some of our cyber businesses cyber products it’s cyber software and it is higher margin and if we're unfortunate we don’t book there, we don’t ship it there or get’s delayed there that could impact us but we need to put some cyber work as we do every year over the course of '16. So that’s a risk that we can't control. We can do the best we can, we can't control the ordering cycle. Those are the major ones that come to mind. I believe in modular systems we have haircut that significantly.

You have been conservative again in those risk or somewhat offset by the wining the unmanned UTAP potentially the verification projects – ends - there is a equal balance in the upside as well so I appreciate that and definitely good quarter year. What is – just real quick getting into the details. What is the cause of the sequential drop in backlog, was that seasonal or is there anything to worry about there?

No, we shift - obviously we had a big revenue for us, big sequential revenue in Q4. So we shipped a lot in Q4 that took them backlog as I went through and you can see our releases. We had some big bookings in Q1 and right now in the satellite communications area, they are looking very, very strong for Q2. So I don’t believe there is anything at all to worry about. The book of business looks stronger than it has in last several years.

That's great news. And then finically you guys I think have about $25 million remaining under the asset sale proceeds. Do you guys expect to come after bond or have you guys decided what you can do - I guess you had about six months decide, but if you guys come into a conclusion on that?

Actually it was roughly about $15 million Eric and is disclosed in our K that - I don’t know we filed already, I think it probably did cross the wire, but there is net proceeds that have not been reinvested yet $4 to $6 million, but we expect that those will be reinvested before the 365 days is up.

So you're doing that in the CapEx.

Correct.

Cool, solid quarter. Appreciate it. And I'll see you at the call.

Thank you. This concludes today's question-and-answer session. I would now like to turn the call back to Mr. Eric DeMarco for closing remarks.

Thank you very much. We look forward to speaking with you at the end of the first quarter unless events prior to then initiate us to have a separate phone call. Thank you.

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.