Ladies and gentlemen, thank you for standing by, and welcome to the Kratos Defense & Security Solutions First Quarter 2020 Earnings Call. [Operator Instructions]I would now like to hand the conference to over to your speaker today, Ms. Marie Mendoza, Senior VP and General Counsel. Thank you. Please go ahead, ma'am.

Thank you. Good afternoon everyone, and thank you for joining us for the Kratos Defense & Security Solutions first quarter 2020 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.

Thank you, Marie.Good afternoon everyone, and thank you for joining us today. I hope this call finds you and your family safe and healthy as we work to address the many issues brought on by the global COVID-19 crisis. As a corporation, I can assure you that Kratos is focused on taking the necessary steps to keep our employees safe, while remaining committed to delivering our systems, products and solutions to our customers to address their critical national security missions and requirements.Kratos has and will continue to implement protective measures consistent with CDC, state and local guidance including encouraging our employees where possible to work from home, distancing our office and manufacturing personnel, including with split shifts and modification for the workspace providing and supporting the use of protective equipment by our employees and enhanced cleaning of our facilities.We have also been reaching out communicating and working closely with our supply chain and vendor base including where possible procuring additional inventory for our key programs and other actions. I will comment more on COVID-19 later in my prepared remarks.As we begin the second quarter, we believe that Kratos is demonstrated ability to rapidly develop, demonstrate and field affordable systems is an increasing demand by our customers as reflected by our Q1 bookings, our increased backlog and the new large programs of record, which we are now involved with. All of which provides us increased visibility and confidence in our future forecast and expected future growth trajectory.We firmly believe that the demonstrated affordability of Kratos' systems and products will become even more of a competitive advantage going forward, based on input from customers, Congress and program offices.Kratos is continuing the successful execution of our plan of becoming an essential critical supplier and element of the United States Defense Industrial Base and…

Thank you, Eric. Good afternoon.Kratos' first quarter 2020 revenues of $168.9 million we're at the higher end of our estimate of $160 million to $170 million with particular strength in our Unmanned Systems segment, which reported revenues of $42 million, up 20% from first quarter 2019 revenues of $34.9 million.KGS reported revenues of $126.9 million, up from $125.5 million in the first quarter of 2020. Organic revenue growth in the first quarter of 2020 in our Microwave Products and Rocket and ballistic missile defense businesses and a full quarter's financial performance of KTT in 2020 were primarily offset by expected declines in our Training Solutions business, satellite communications and legacy government services business.Our adjusted EBITDA of $16.3 million exceeded our estimate of $12 million to $16 million due to a favorable mix of revenues and execution, primarily in our Space and Satellite Communications and Unmanned Systems businesses.Our adjusted EPS of $0.09, which also at the high end of our forecast of $0.05 to $0.09 per share for the quarter. In the first quarter our Unmanned Systems segment generated adjusted EBITDA of $2.3 million, up from $2 million in the First Quarter of 2019.The adjusted EBITDA margin rate remained fairly consistent year-over-year due to the mix of development programs, which are typically lower margin programs than production programs. This increased mix of development programs is expected to continue into 2020 until certain new production awards or increases in existing production programs are received.KGS generated adjusted EBITDA of $14 million or 11% of revenues down from $15.5 million in Q1 of '19 and operating income of $9.3 million, down from $11.4 million in Q1 of '19. A more favorable mix of operating margins and adjusted EBITDA margins in the Company's Space and Satellite, C5ISR and Microwave Products businesses in Q1 '20 were…

Thank you, Deanna.We will now turn it over to the moderator for any questions.

And your first question comes from the line of Pete Skibitski with Alembic Global.

On the sole source international training contract that fixed-price one that didn't get the contract renews. Could you just size that for us?

Yes. That's roughly about $8 million to $10 million per year.

Okay. And then on just the expectation I guess that 2Q will be kind of the low revenue quarter for the year. Is the underlying assumption essentially that COVID is impacting, and maybe once we are through the worst of this then things improve in the back half of the year. Is that kind of the driving assumption?

Yes. That's part of the impact. Yes.

Okay. Last question from me and I'll get to the back of the queue. On the Valkyrie, so let's, if we assume you get a contract later this year, do you start to book revenue on a percentage of completion basis? Or is it we wait till 2021 and you book the revenue on - deliveries?

So it depends, Pete, on the type of contract, if it's a production type contracts then yes it would be on a percent complete basis for the cost incurred. If it's a services contract then that would be based on what services are provided. So it really depends on the makeup of the contract.

Okay. And that's still uncertain right now is what's going on?

It could be both, yes.

Okay. So I guess the services contract, is that similar to what you do with targets. I know you sort of lend target services to some of the European countries. So you think it could be similar to that, maybe?

No, what we mean by that is, and I'm just giving examples here. We could get - we could receive a contract for units that we're selling. We could get a contract to continue to integrate weapon systems, command and control systems and other systems into the Valkyries. We could get a contract or contracts where Kratos owned Valkyries are involved in missions like the ABMS mission or some other missions or demonstrations. It could be in a very, in my opinion right now I think it's about a big sum of each.

And your next question comes from the line of a Sheila Kahyaoglu with Jefferies.

Eric, Deanna thank you for the time. Eric, you mentioned the repo replacement, in may be in the 2022 time frame. How do we think about that just because it's a group 5 much larger drone versus your offering. How could the Air Force receive that.

Right. So I think Sheila, some of them are actually Group 4 - Group 5 - Group 5 are things like Global Hawks and I will, I can only pass on in this forum, what has been publicly announced by the DoD. And as I said in my remarks what the DoD has said is that they're planning on ending production of them this year because they cannot perform and contested environment their missions.They've been phenomenal in the terrorist mission, and the asymmetric warfare mission. But they Air Forces come out and they said they want drones to replace them that can survive in an anti-access area denied environment, and we, as you can imagine, we believe we're very well positioned for this as we have a number of drones that are actually flying today, certain of which we believe could fill that mission admirably. So that's all I should say on this now.

Okay, no worries. And then I might have missed this in the prepared remarks, I know you said a few flight tests were pushed to the right. Can you just go over the latest on the Valkyrie. You I think you had your fourth by test in January that was successful. Kind of just a quick update there, because I don't know if you mentioned dates.

Absolutely. Just either yesterday or the day before yesterday, the Air Force announced that the next ABMS flight. Advanced Battle Management Systems flight which we are scheduled to on participating with the Valkyrie and several other of our jet drones. It has expanded now is currently planned for either August or September of this year. They announced that just this week.

Okay, got it. And then in terms of the additional funding on the Valkyrie potentially in 21, can you go over what you know - what we need to see what next steps are obviously the first round are funding first, but kind of the puts and takes there.

Sure. And so what is out there publicly is that the Chairman of the Senate Armed Services Committee, he made some remarks and those are publicly available and in those remarks, he said that because of the progress that we're making because of the Valkyrie flying today and its capabilities that he was supporting an additional $125 million in the 2021 NDAA to continue moving forward with attributable drone aircraft. So that's what the Chairman, said a few weeks ago.

And your next question comes from the line of Peter Arment with Baird.

Eric just following up on the Valkyrie. So if you have another test flight in August, September, maybe you could just shape how you're thinking about like the timing of above the potential contract. What's the roadmap look like there, once you have another flight, a flight test?

I believe that they are mutually exclusive. I believe and I'll go with what the Air Force announced a month ago. The Air Force announced a month ago, that they were going to move out post-haste on relative to Skyborg and that was the context that they were talking in relative to Skyborg on getting some information out relative to contracts for production this year.And as I said in my prepared remarks in our recent correspondence and communications, the Air Force and I'm not putting words in their mouth. In my opinion, they could be announcing something very soon.

So it's potentially before the flight. Okay. Just want to confirm that. And then could you give us your latest thoughts on I know Project F is Air Wolf. When those flights will also be around a similar timeline? Or is that are on a different schedule?

They are currently scheduled for Q3. So they're scheduled for Q3. I believe Gremlins scheduled for Q3. And Rattle Snake with their environment is now scheduled for Q3, along with ABMS and other Valkyrie flights that we have not talked about in detail. We can't. And this all has to do with the DoD travel restrictions, number one and social distancing relative to being in the command and control modules relative to the flights.

And your next question comes from the line of Ken Herbert with Canaccord.

Eric, I just wanted to ask you about TDI. Is it possible to maybe give us a little more detail on the revenue contribution from that acquisition this year? And then bigger picture, I mean, it clearly sounds like based on your prepared remarks, you were fairly optimistic about as you plan to TDI in with KTT, and you go after what you and, what looks like a pretty, pretty substantially expanding market in missiles, cruise missiles and things like that. Can you help maybe with sizing that market a little bit or just a little bit of the sort of the parameters that you're targeting now on the engine side?

Absolutely. So on for this year's contribution, it is - it's not material, because they do not have any production contracts right now, they are in development. They have a number of development programs, I mean the one that publicly out there of course is the one we talked about today with Gray Wolf. And so this year's contribution is not material.However, if things go according to plan and they are tracking right now with a number of engines running, we see our turbine technology business potentially next year with tied into two engines in particular. They could become begin to become material financial contributors next year.The market opportunity as you indicated is very, very large. As we've talked about before, the technologies that are out there right now are '70s or '80s technology that we're using the build-up of the missile systems in the '80s. And with what's going on in the self-try to see it in the Pacific extended range is significant. And that's why you see things like LRASM, ER, Extended Range or JASSM ER Extended Range or Harpoon ER Extended Range and there are several others and for competitive purposes, because this is competitive.I'm not going to get into many details, but I think I've said before relative to KTT, there is a handful or so of programs that we are looking at getting designed in that we're working on getting design bid on. And that a handful assuming we get a portion of that market, it's like $800 million over 5 years.

Okay, that's very helpful. And if I could just one other question for me on Valkyrie. As I listened to your prepared remarks, I mean, you're clearly outlining what sounds like and what was a very close collaborative effort with the Air Force as you developed the aircraft and the technology. There are certainly other companies that seem to be looking at this market with a lot of interest. Can you just talk - and remind us again about the competitive advantages of the Valkyrie? And why you're in the pole position? And how you think you can maintain that relative to what some other firms may be looking at doing as these move forward?

Absolutely. So we believe one of our strategies is first to market. It is critical and proven affordability, is equally critical. As I mentioned and as you know in 2015, we flew jet high performance drones with manned aircraft, manned unmanned teaming. So that was what 5 years ago or 4.5 years ago we did that.We have a number of drones flying today. They're all 100% substantially sourced in the United States made in the United States. We believe that's a competitive advantage. We are working with the United States Air Force as I said in my prepared remarks, the premier institution in the world globally for aircraft, remotely piloted aircraft, manned piloted aircraft et cetera.The number of drones we have that are flying today were integrating weapon systems and other systems into operationalizing them today. These aren't PowerPoint presentations or like little models. These are flying today.The market as I went through is accelerating now and is moving rapidly. And on affordability, as I mentioned, we are building well over 100 drones, a year right now demonstrated cost points $250,000 cost point for certain of them $500,000 for others, $1 million for others and on the Valkyrie obviously we know what we're targeting their $2 million bucks, $3 million bucks. So we've demonstrated it. We believe that those are all critically important competitive differentiators and we just need to continue to execute and move forward.

And your next question comes from the line of Michael Ciarmoli with Suntrust.

Glad to hear you guys are safe and healthy. Eric maybe going back, I think with Sheila's question on the repo replacement. Certainly, if we think about how the Air Force, how they develop their road map. I mean, are there other opportunities for you outside of a complete drone solutions, you were just referencing TDI and some of the development programs. I mean, could you potentially be a partner and provide turbine technology? Or is this you going after it with a complete platform solution? Maybe any color you could provide there.

Sure. So we are in competimate land, Mike, competimate. We are competing head on head with the competitors and we are teaming with many of them on programs. We are, we have incredible teaming relationships with Lockheed, incredible teaming relationships with Northrop, with Raytheon, they are just phenomenal partners. They are also ferocious competitors.

Okay. And then on the ABMS drones. You said you've got more in addition to Valkyrie, can you tell us which other of your drones are participating in that?

I cannot, because I do not believe that has been disclosed, yet other than what I said. I'm sorry.

Okay. On Valkyrie, are you still expecting orders in the range of 30 or so. Has anything changed? Certainly, it sounds like there is going to be more funding, but what sort of the general outlook in terms of number of units, you expect to secure?

I've - I don't want to comment on this, Mike because if things are going to happen, if you go with what the Air Force is publicly talked about in the last 3 or 4 weeks, and obviously we have some information as well. The next several weeks, couple of months let's just watch this play out. I'll though go with what I believe it was Dr. Roper said where I believe he in an interview, he said that we are looking to begin buying these in quantity this year. I believe he said that.

Got it. Last one for me. You obviously narrowed down or took down the revenue guidance you held the EBITDA. It sounds like you've got some higher margin business flowing through. Can you tell us what percent of revenues, you're deriving today from more of the higher-margin software type sales?

Deanna, what - how - the vast majority of that is in the space side?

It is. Yes, it's the space. And we don't know - software.

Yes, but it's the majority of it. Mike, it's in our space business. It's our space business, but it's also in the microwave business. The microwave business just weapon right now relative to electronic warfare systems.

And your next question comes from the line of Mike Crawford with B. Riley.

Eric, you mentioned the Black Dragon program was in your - is that with the smaller TDI engine or the bigger KTT engine?

It's a KTT program.

Okay. Thank you. And then you also you talked about Air Launch initiatives, didn't who we talked about railroads initiatives including your container deployment system that you've shown can help reach A2/AD environment. Is there any progress update there?

We are planning on completing and having ready for delivery. The first containerized rail launch systems middle of this year, next few months. We are working hand and hand with the Air Force.

And there's orders in place for those?

We can't talk about that right now.

Okay. And the last one. Do government announced and this follow the - it was targeting some - some opportunities. I think the way that electronic systems can you say whether you're working with to common maybe on engines or else otherwise?

Ducommun is an important partner of ours in our drone business.

And your next question comes from the line of Josh Sullivan with Benchmark & Company.

Just on GBSD. Are you able to provide some color on what you're going to be supplying on the program?

I'm other than the ground transport and missile transport system which is what Northrop has announced. We are unable to provide because obviously we're under an NDA with Northrop. They're great phenomenal partner. We cannot go beyond that. So pull up the minivan threes and take a look at the ground transport equipment of missile director systems and the missile transport systems and that will give you an idea of what's been disclosed, what we're doing.

Got it. And then just a question on TDI and the Golden Horde Program. The mass quantities, you've referenced on the low-cost engines. Will TDI, have the capacity to do that? Do you need a partner? Can you do that at your Oklahoma facility? Or one of the KTT facilities?

So the TDI acquisition, we with TDI acquisition we acquired a very small next leading technology additive manufacturing, engine production company. That's one piece. KTT has significant next-generation engine manufacturing techniques and technology. We believe with the hand we have now to hand the cards, we are in phenomenal shape for production runs, low cost, very quick, very simple next generation engines. We feel we're in good shape of what we've got.

And your next question comes from the line of Seth Seifman with JPMorgan.

Just kind of curious so with the revenue guide for the second quarter the implication I guess is that in the fourth quarter, the run rate for the second half we're going to get up to record level kind of 200 plus of sales. Talk about what kind of gives you the confidence in that level of step up?

The book to bill ratio, the bookings in the first quarter were phenomenal. As I said in the prepared remarks, our microwave business has a record backlog. Our unmanned business right now is backlog is just under a couple of hundred million.

Yes.

All right. We have very good visibility right now, then what's going on.

Excellent. And then just on the training business. Just to make sure I understand kind of the different pieces there. So we're talking about two separate international contracts. One in option was not exercised. That is a headwind in Q2 sequentially, and I would assume for the rest of the year as well along the lines of the size that you talked about with Pete's question. On the flip side, you did get an extension on the Saudi FMS contract through the U.S. Navy. And kind of how long does that extension last? And what is that due versus what you kind of had in the guidance previously?

Yes. So there is a couple of pieces, Seth. So there is the non-renewal of the international contract, but we did we were awarded the bridge contract on the previous contract that we have discussed in the prior quarters. There was also one contract that was a new bid that we lost-- that we, a new one that's under protest that was lost in March. So netting all those three items, it's about a net $3 million to $5 million shortfall from where we were the last time we provided the estimates.

Okay, got it. Okay, very good. And then is that Saudi on the U.S. Navy FMS is that now in extension, in that this is now are Kratos contract again or is this kind of a temporary extension while there is adjudication of protest?

It's a Kratos contract through the end of the year.

And your next question comes from the line of Noah Poponak with Goldman Sachs.

Eric, last quarter when you gave the initial outlook for 2020, initial 2020 guidance. You emphasized that you had excluded or significantly factored down multiple items that could come your way in a year. And Deanna just went through the moving pieces there in the guidance. And it's kind of a small number of contracts, and a small amount of revenue. And I understood --

Noah, that was just know that was just for the training piece. So that was a specific question that Seth had asked on because there is other pieces. So you if you - the prepared remarks that we talked about the commercial aero impact in our KTT business and in our Microwave Products business, that's about $10 million to 12 million.

No, I understood. There is, I was about to say that there is a global pandemic, right. So it's an unprecedented situation, but we're also watching other defense companies largely reiterate views or take guidance down very slightly. I guess, I'm just wondering where the things you excluded or things that were significantly factored our as offsets? And are those still available to you in the back half of the year? Or we now looking at sort of - I mean I think Seth makes a good point that it's a pretty back end loaded profile based on the second quarter guidance. Do you still have these things that are excluded and factor that could be added later in the year? Are we sort of clinging to the new range here?

The C5ISR contract $50 million that we won that was protested. If we're successful there, that could be added. If we receive contracts, contract or contracts related to Valkyrie or other tactical drone those could be, those would be added.

Okay.

There are, I'm going to say a handful of other brand new opportunities that are expected to be awarded in Q3, Q2 or Q3. If we're fortunate enough to win some of those - those could be additive. Because those are not in our forecast, either.

Okay. How many months of delay, do you have in the next upcoming test flights for Valkyrie and Gremlins from the disruption related to Coronavirus?

So the ones that are publicly out there, the ABMS flight with Valkyrie and some of our other drones was previously scheduled for May. As I mentioned this week either yesterday or the day before the Air Force announced that they are shooting for August, no later than September. Our Air Wolf flights which were scheduled for Q2, are now scheduled for Q3.

Okay. And then…

The one with - environment which was scheduled for Q2 is now scheduled for Q3..

Got it. And then, Eric, you had discussed previously how part and parcel to the $100 million plus up in funding that the Valkyrie saw that came with a requirement for AFRL to submit a plan for that to Congress by, I believe it was March 31. Can you speak to whether not that happened? And if everything related to that timeline is still in place?

Did absolutely happened, it was submitted. I don't know if that was submitted by March 31. I don't know the date to be very careful with you, but I know it has been submitted, because I have been told. It has been submitted, it has been, I have been told, it has been accepted. And I have been told that those are some of the reasons why I believe in the near future the Air Force may be putting some information out.

And this concludes our Q&A session. I would like to turn the call back over to Eric DeMarco for any closing remarks.

Great. Thank you all for joining us and we will chat with you when we report Q2 later on this year. Thank you.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.