Good day, ladies and gentlemen. And welcome to the Kratos Defense and Security Solutions first quarter 2016 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will host a question-and-answer session and instructions will follow at that time. [Operator Instructions]. As a reminder, this conference if being recorded over the webcast. Now, I would like to hand this over to Ms. Marie Mendoza, Vice President and General Counsel. Ma'am, please proceed.

Thank you. Good afternoon, everyone. And thank you for joining us for the Kratos Defense and Security Solutions first quarter 2016 conference call. With me today is Eric DeMarco, Kratos' President and Chief Executive Officer and Deanna Lund, Kratos' Executive Vice President and Chief Financial Officer. Before we begin the substance of today's call, I would like everyone to please take note of the Safe Harbor paragraph that is included at the end of today's press release. This paragraph 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. Today we announce that Kratos has successfully received a Phase 1 contract on DARPA's Gremlins program, a very important strategic win for our company furthering Kratos' entry into the tactical unmanned combat aerial market. Gremlins Phase 1 is to explore different systems approach as to launch and recover in-flight multiple low cost high performance unmanned tactical aerial systems that will be networked and cooperating for electronic attack and reconnaissance missions from stand-off ranges. This exploration phase is designed to pave the way for a proof of concept flight demonstration. An important objective of the Gremlins program is for relatively inexpensive unmanned aerial vehicles that are reusable to be used in mass quantities to saturate enemy air defenses. There were four announced winners to Gremlins Phase 1, including Kratos and the others being Lockheed Martin, General Atomics and Dynetics. Phase 1 is currently scheduled to lead to a systems requirements review at the end of the first quarter of 2017 at which time DARPA plans to down-select two teams issuing contracts of approximately $20 million each for a Phase 2 preliminary system design. In the second quarter 2018, DARPA will hold a preliminary design review and one team will be selected for Phase 3 and an estimated $35 million contract, concluding with a flight test in 2020. The estimated price target for the Gremlin UAF is approximately $700,000 per aircraft, excluding payloads for 1,000 unit order quantities, once in production. Additionally, we have also just recently received and are now under contract for a second high performance tactical UAS opportunity. We are unable to provide additional information as to this new UAS contract award at this time due to specific customer confidentiality obligations, though we anticipate being able to do so in the future. We believe…

Good afternoon. Thank you, Eric. Our first quarter 2016 revenues were as expected at $153 million with year-over-year organic revenue growth of 23.4% in our microwave products business, 14.5% in our unmanned systems business and 11.3% in our satellite communications business, offset by a year-over-year reduction in revenues generated by our modular systems and public safety businesses of 30% and 19.5%, respectively. Modular systems and public safety declines were primarily the result of reduced shipments of hardened mobile tactical facilities and our change in strategic focus in our PSS business to pursuit primarily smaller size, higher margin security system deployment projects rather than larger size projects, which typically have lower margin projects. Our Q1 adjusted EBITDA of $4.6 million was positively impacted by stronger than expected performance in our core satellite communications, microwave products and defense and rocket support businesses, offset partially by a weaker than expected performance in our modular systems, public safety and unmanned systems businesses. Additionally, as Eric briefly mentioned and as we communicated with the company's fiscal 2015 year-end financial report in March 16, during the first quarter of 2016, Kratos continued to maintain significant engineering, technical, management and other unmanned aerial system related resources in anticipation of successfully being awarded three new high performance tactical UAS program opportunities which the company was competitively pursuing. The maintenance of these resources and the associated costs related to the pursuit of these new UAS opportunities significantly adversely impacted Kratos' first quarter 2016 adjusted EBITDA. As Eric mentioned, Kratos was recently successfully awarded and is now under contract for two of the three new opportunities with the third UAS opportunity not yet being formally awarded. We will continue to maintain the resources related to the third new UAS opportunity in anticipation of successfully receiving a contract award in the…

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

[Operator Instructions]. Our first question comes from the line of Mike Crawford with B. Riley & Co. Your line is now open. Please go ahead.

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

Yes. Mike, repeat that please, buddy.

That your Gremlins concepts would include a vehicle based on your Firejet?

I am not going to comment on that here, Mike.

Okay. There was that InsideDefense article. And then Eric, on the targets business, for Gremlins you talked about excluding payloads $700,000. I am sorry, a certain price.

For Gremlins, Mike, what's publicly out there is approximately $700,000 per aircraft for order quantities of 1,000 at a time.

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

So for Firejet depending on configuration and depending on payloads, $250,000 to $350,000 and for AFSAT depending on configuration and payloads, $600,000 to $1.4 million.

In AFSAT, you said around $1 million.

In the ballpark. Yes, sir.

Okay. And then, in the past there has been comments about the Navy running out of old targets. But is there no way to start delivering AFSATs before? What does it take to enter the LRIP on the AFSAT?

So we have a base contract and then we have two production options under the base contract. The option one right now is currently anticipated to be exercised before the end of this fiscal year. As I said in my comments, I don't know if or how s potential CRA, a Continuing Resolution Authorization, would impact that. There is a time fuse in the contract of when that option has to be exercised by and that is coming up in after year-end, but shortly after year-end. And then there is a second production option a year later underneath that contract. And so the customer is going to be performing some flights over the next few months. We are done with our flights. The customer is going to be performing some flights, training out their teams and then the execution of the contract is option once, as expected.

Okay. Thanks. And then on the second unmanned tactical platform won, is that something that you have been pursuing for a long time? Or is that something that came up through an unusual channel?

We have been pursuing a for approximately one year.

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

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

Okay. Thanks. And I will just ask one last question. Can you just describe what it is that Kratos brings to the table in terms of this other capability you have of controlling swarms and also including what you are currently doing?

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

Okay. Thank you.

Yes, sir.

Thank you. Our next question comes from the line of Mark Jordan with Noble Financial. Your line is now open. Please go ahead.

Thank you and good afternoon. Eric, you mentioned in the first release a bid pipeline of $7.1 billion. Could you detail what amount of that has been submitted? What will be submitted between now and the end of this calendar year? And finally, what amount of that total do you expect to be adjudicated in the current year?

I cannot, but Deanna can.

So the pursuit review which is submitted is $1.3 billion that's been submitted to-date.

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

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

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

Totally separate. Absolutely, totally separate.

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

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

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

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

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

What I will do is, stick to the comments that we made last quarter, we say the guidance that we gave was that our free cash flow or cash flow generation would be improved in 2015's performance, specifically pointing to the interest carry is about $11 million of a reduction as a result of the redemption of the senior notes and paying down the revolver. Obviously that remark that if we aren't expecting an improvement from when we were in 2015.

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

Yes.

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

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

All right. Thank you very much.

Thank you.

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

Hi. Good afternoon guys. Thanks for taking my questions. Eric, maybe just on the outlook for the year. EBITDA generation, are we still thinking, given the weak first quarter here that we are going to be comparable to the 2015 level?

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

Okay. So that was like, I am just looking at your base case was flat EBITDA but it presumably really depends on this contract here.

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

Okay. Did you know what the specific hold-up is?

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

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

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

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

So I will give you the pluses and then the minuses. So the plus is, our satellite communications business is extremely strong right now, both in unclassified and classified area. We are seeing particular strength in this area related to the perceived Chinese and Russian threat to the space assets and the infrastructure and that business is looking very, very good. I expect that business to knock it out of the park this year and next year. Our microwave electronics business is looking very, very solid. For the same reason, we are designed in a number of missile and radar systems and communication systems. And I mentioned, the plus-up with the half I mentioned what's going on with Eurofighter Typhoon. That business is going to do very, very well. Our unmanned systems business is going to do very, very well both on the target side and I believe on the tactical side because of the contracts we won. The one I am hoping we win and if some things work out for us with our UTAP-22. And the last good one is our ballistic missile target business because of the perceived North Korean and Iranian and other threats. That business looks real good when you look at the schedule. As I mentioned in the remarks, right now we are in a nine or 10 unit production run for launches. The government services business is stable right now because we are fairly well bolted in but that business remain very, very tough unless you are focused in that area and have the critical mass, which we don't because we went the products way. With bid protests still prevalent, low-priced technically acceptable still prevalent that businesses is stable but it's a challenging business. In the modular systems business, we are truly transforming…

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

It's about 45%, Mike.

45%.

Yes.

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

Thank you.

Thank you. Our next question comes from the line of Eric Selle with SunTrust. Your line is now open. Please go ahead.

Hi. Good afternoon. A lot of the question-and-answer are good. It looks like you are going to get or you are expecting and obviously, depending on this third contract and we all understand that the timing of that is obviously not now, but it looks like you are going to get about $10 million EBITDA lift in the second half? And as in the world you see today, what are the major building blocks for that second half lift?

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

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

Right. Because that's 120 heads and a figure, I am just doing rough math at $50,000 a head, that's $6 million annualized savings, you should be at least $3 million out of that.

Yes. So the impact that we adjusted for in the pro forma adjusted EBITDA is roughly $1 million in each of those businesses. So $1 million for PSS for Q1 and $1 million for modular systems for Q1.

Okay. Great.

So an annual --

I am sorry.

Go ahead.

I interrupted. So these rates, if we summarize, you guys have a lot of high margin sales growth that's coming through and then through some labor cost savings. Is there any risk to the growth in those three components, the satellite, electronic warfare? Obviously the unmanned is undetermined for the first two. Is there any risk to that ramp in revenue?

I don't mean to be flippant at all in this, Eric, but I have learned, anything that's not under funded backlog with the shipping schedule that we are about we ship has risk. I feel very confident in those three businesses that we are going to achieve our objectives. I feel very confident because of what we have got. As I mentioned, our microwave electronics business just came off a 1.2 book-to-bill with backlog remains at near record. I think I have said that in the three or four quarters. Our unmanned systems business just had 2.5 book-to-bill and I ripped off a couple of big target programs we have won. Those are going to be delivered. Our satellite communications business, we don't talk about a lot of the work they do for obvious reasons. We don't disclose it. We don't talk about it. But that business looks really, really good. Our training business, I mentioned the combat helicopter training systems that we are designed in on, that's now going into production. That looks very, very good. Our training business will definitely grow this year in backlog. I feel good about it, but I have learned some things can bite you in the ass.

If it ain't in the bank, you can't count it.

That's it. So I ain't counting the chickens.

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

Hard to call, sir.

Well, as always, I appreciate your time and look forward to hearing from you in the near future.

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

Thank you. [Operator Instructions]. Our next question comes from the line of Sheila Kahyaoglu with Jefferies. Your line is now open. Please go ahead.

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

So on the three, as we put out in the release, the Gremlins Phase 1 is just under $4 million and the time burn on that is relatively quick. It's just under 12 months. On the second one, I really can't say. I really can't say. And on LCAS, I don't want to say anything other than what's publicly out there, which I know you are familiar with. It's very sensitive. I don't want to talk about that. And so that's where we sit. As I said when we did our last call, I said I felt confident that by June, it would be clear and I remain pretty confident that by June the path will be clear one way or the other for us.

And just on the outlook in PSS?

So as I said on the other question, my outlook on PSS, I think they are going to do $1.20 to $1.30.

Okay.

And one I think the margins are going to pop because of the significant cost reductions we made in Q1 that were very difficult. We had to do it. I think EBITDA is going to start coming up in Q2, but it will go a little better in Q3 and it will go better in Q4 as the impacts of those is affected across the business unit.

Okay. Thank you.

Yes, ma'am.

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

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

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