U.S. Markets closed

Edited Transcript of KTOS earnings conference call or presentation 2-Nov-17 9:00pm GMT

Thomson Reuters StreetEvents

Q3 2017 Kratos Defense and Security Solutions Inc Earnings Call

SAN DIEGO Nov 12, 2017 (Thomson StreetEvents) -- Edited Transcript of Kratos Defense and Security Solutions Inc earnings conference call or presentation Thursday, November 2, 2017 at 9:00:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Deanna Hom Lund

Kratos Defense & Security Solutions, Inc. - CFO and EVP

* Eric M. DeMarco

Kratos Defense & Security Solutions, Inc. - CEO, President & Director

* Marie Mendoza

Kratos Defense & Security Solutions, Inc. - VP, General Counsel & Secretary

================================================================================

Conference Call Participants

================================================================================

* Brian William Ruttenbur

Drexel Hamilton, LLC, Research Division - Senior Equity Research Analyst

* Joshua Ward Sullivan

Seaport Global Securities LLC, Research Division - Director & Senior Industrials Analyst

* Kenneth George Herbert

Canaccord Genuity Limited, Research Division - MD and Senior Aerospace and Defense Analyst

* Mark Conrad Jordan

NOBLE Capital Markets, Inc., Research Division - Senior Research Analyst of Government Services and Defense Technology

* Michael Frank Ciarmoli

SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst

* Michael Roy Crawford

B. Riley & Co., LLC, Research Division - Senior MD, Co-Head of The Discovery Group & Senior Analyst

* Sheila Karin Kahyaoglu

Jefferies LLC, Research Division - Equity Analyst

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Good day, ladies and gentlemen, and welcome to the Kratos Defense & Security Solutions Third Quarter 2017 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. I would like to introduce your host for today's conference, Ms. Marie Mendoza, Vice President and General Counsel. Ma'am, you may begin.

--------------------------------------------------------------------------------

Marie Mendoza, Kratos Defense & Security Solutions, Inc. - VP, General Counsel & Secretary [2]

--------------------------------------------------------------------------------

Thank you. Good afternoon everyone, and thank you for joining us for the Kratos Defense & Security Solutions Third Quarter 2017 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 M. DeMarco, Kratos Defense & Security Solutions, Inc. - CEO, President & Director [3]

--------------------------------------------------------------------------------

Great. Thank you, and good afternoon. Over the past 20 plus years, the U.S. Military has focused on winning the fight at hand, the war on terrorism in Afghanistan, Iraq and elsewhere.

During that time, our nation's adversaries have been investing heavily in new technologies and systems to catch up with and potentially surpass the United States and its allies' national security capabilities.

In response, innovation, technology infusion and a recapitalization of systems to address peer and near-peer adversarial capabilities and U.S. operational readiness has begun. And Kratos is well positioned for this recapitalization with our proven ability to rapidly innovate, develop and field leading-technology systems at an affordable cost.

As a result of these perceived threats, national security and defense-related budgets are anticipated to increase globally, including for the U.S. and its allies.

Kratos's core business areas, which we believe are closely aligned with today's national security priorities, include our satellite communications business, where we are an industry leader in providing signal monitoring, intelligence and command-and-control equipment, which supports approximately 85% of all U.S.-based missions.

We also own and operate a global terrestrial network, which monitors satellite signals and beams for our customers, whereby we can identify interference, jamming and other anomalies, and we geo-locate where the source of these issues originate, so that our customers can take action and neutralize them.

Unmanned systems. We are the industry leader in high-performance jet powered unmanned aerial drone systems, which are utilized for tactical missions and adversary threat representation for operational readiness.

Microwave electronics, where we provide subsystems and components in support of electronic warfare, missile, radar, missile defense, ISR and communication systems, and ballistic missile defense, where we provide targets, which represent ballistic missile threats of potential adversaries of the United States, like North Korea, and where we provide specialized hardware in support of BMD systems, including Patriot, THAAD, Aero, Barak, Iron Dome and Sling of David.

Kratos is an innovator. And we believe that we have the right products at an affordable cost to address today's global national security requirements. A recent example of Kratos having the right products to address today's national security requirements was displayed just a few weeks ago at the multinational and NATO-led exercise Formidable Shield '17, over an approximately 3-week period off the coast of Scotland. Formidable Shield 2017 was an integrated air and missile defense exercise, simulating real-life threat situations, where U.S. and NATO radar, ballistic missile defense, integrated C5, ISR and other systems were tested.

This exercise was supported by the United States Navy and Missile Defense Agency, and multiple Kratos ballistic missile targets, high-performance jet powered unmanned aerial drone systems and other assets were utilized.

With our success at Formidable Shield, our third quarter financial performance and an increasing number of new opportunities that we are pursuing, we believe that Kratos' position as a leader in technology innovation at an affordable cost, is a clear differentiator of our company in today's environment.

For Q3, Kratos exceeded its revenue and EBITDA guidance. Kratos' third quarter bookings as we expected were very strong, coming in at a book-to-bill ratio of 1.2:1 across the company. Our Q3 revenue and EBITDA trajectory and bookings indicate that we are on track to achieve both our Q4 and full year 2017 financial targets. And for 2018, revenue, EBITDA and positive free cash flow, all to be substantially greater than 2017.

Additionally, as our business and revenue grows, generating leverage on our company's fixed cost infrastructure and with certain of our investments in the unmanned area winding down, we expect our profit margin rates to continue to improve in Q4 and into next year, when all significant unfunded investments are expected to be complete.

We also remain on track for Kratos' Unmanned Systems business's revenue to double from 2016 to 2018, excluding any potential upside from our tactical unmanned aerial drone business, of which, we have multiple development programs either under contract or in contract discussions, and opportunities that we are pursuing, including several new opportunities since our second quarter report.

Specifically stated, any production contributions from Kratos' tactical drone business would be additive to the expected 2018 doubling of revenue generated from our UAS business from 2016 to 2018. As I discussed last quarter, in the unmanned area, as a result of competitive, national security-related and other factors, we are unable to discuss specifics on certain programs that we're involved in, and that while we will be letting the financial performance of our Unmanned business reflect the progress that we're making.

Kratos' Unmanned business Q3 2017 revenues grew organically 127% over Q3 last year and they grew 87% sequentially over Q2 of this year, with our Unmanned Systems business generating a Q3 2017 book-to-bill ratio of 1.4:1.

In the third quarter, we received the first year's production contract on the SSAT program for Kratos' BQM-177 target drone, arguably the highest-performance unmanned aerial drone system flying today. The SSAT program is expected to significantly ramp in production over the next 3 years, at which time it will be one of the largest production programs in our company.

We recently met with our customer on the AFSAT program and Kratos' BQM-167 unmanned target drone system, on which we are currently in year 13 of production. Based on a recent customer meeting, we expect to receive the AFSAT award for production years '14, '15 and '16 on a sole-source basis in the second quarter of 2018.

Based upon indications from our customer, we expect that the annual production quantities for production years '14, '15 and '16, which are expected to be delivered over the next 3 years or so, will significantly exceed the prior production 3 year's annual deliverable quantities.

We continue to deliver Kratos' MQM-178 high-performance unmanned aerial drone system to a U.S. government customer and multiple international customers.

This aircraft achieved outstanding performance at the Formidable Shield 2017 military exercise that I mentioned previously.

In Q3, Kratos' UTAP-22, our Mako UCAS, successfully performed at a certain military exercise, which we were able to formally announce earlier this week and we expect a significant increase in funding for this program in 2018. Kratos' LCASD program remains on budget and on schedule for completion of development and initial flights in the middle of 2018. And to date, we have now received several spirals for scope and funding increases to address customer-required enhancements. Kratos' Gremlins program, on which we are teamed with Dynetics and where Kratos is responsible for design and production of the UAS, remains on schedule and on budget with the down select of the final Phase III winner expected in Q1 of 2018.

We are also working on several other programs in our Unmanned business, including a very recent opportunity with a new customer, which has the potential to be very significant for our company. We are also hopeful of receiving a contract by the end of this year, or early next year for up to approximately 100 unmanned aerial drone systems from a certain customer. And we are actively in pursuit of several international opportunities for Kratos' high-performance jet powered unmanned aerial systems.

In our Unmanned Systems business, a number of the programs we are under contract on are funded from the science and technology line items of the DoD budget, which have a significant funding increase in the 2018 budget request. The DoD Science and Technology accounts are where some of our country's leading innovation and rapid capability initiatives are located.

Before the end of this year, we expect to formally announce the new engineering and production location for Kratos' Unmanned Systems, where we have already made several key hires and a Senior Kratos manager will be relocating.

In summary, Kratos' Unmanned Systems business returned to profitability in Q3 after a period of focused investment. And we expect this profitability to continue going forward with the expectation that 2018 unmanned revenue and EBITDA will substantially exceed 2017's.

Kratos' largest business unit, Satellite Communication, Cybersecurity, Technology and Training, our company's greatest generator of revenue, EBITDA and cash flow had another very solid quarter in Q3, including a book-to-bill ratio of 1.3:1. Our current forecast indicates that this business, which grew over 10% organically last year will have a particularly strong Q4, including EBITDA generation, based on our recent bookings, backlog and forecasted execution and delivery mix.

In the 2018 DoD budget request, the space and satellite-related funding lines received one of the largest increased requests over the prior year, which is directly related to the perceived threats to U.S.-based capabilities.

Major satellite programs Kratos support, include WGS, AEHF, SBIRS, MOUS and numerous small cube nano and other satcom programs and initiatives.

Kratos' Microwave Electronics business also had a solid Q3. And based on a current record backlog and expected delivery schedule, Q4 is expected to be by far this business' strongest quarter of the year from both a revenue and EBITDA standpoint, with the profitability mix for Kratos' Microwave business looking particularly strong for Q4.

As you know, and as I mentioned previously, a significant amount of the work that we do across our company supports ballistic missile defense programs, including Patriot, THAAD, Aegis, AMDR, SBIRS, high-powered directed energy lasers, Railgun, Iron Dome, Aero, Barak and many others.

In the 2018 U.S. DoD budget request, missile defense is another area where the expected 2018 funding is significantly greater than 2017. And Kratos' Missile Defense related business is expected to have a strong Q4 and be a growth driver for our company going forward.

Kratos' Public Safety & Security System Integration business generated a profitable Q3 with an adjusted EBITDA margin of just under 7%, reflecting improved overall performance, with our change in focus towards higher-margin programs yielding a gross margin in year-to-date new bookings of greater than 30%.

Additionally, certain lower-margin legacy programs that are wrapping up and nearing completion, which also is aiding profitability as is the impact of cost-reduction actions that we made in the first half of 2017.

Based on current backlog, recent bookings, a strong Bid and Proposal pipeline and the expected completion by the end of this year of substantially all legacy lower-margin programs, 2018 profitability is expected to significantly exceed 2017's profitability for this business.

As you saw from today's financial report, Kratos had a strong Q3. And based on third quarter bookings and our current backlog, we're expecting an even stronger Q4.

Kratos is a unique technology-based growth company that has invested in innovation over the past several years, with these investments now generating significant returns.

As a result of these investments, Kratos is a leader in rapidly developing and delivering affordable products, which address global national security priority areas. We believe the strength of Kratos' model continued to be demonstrated with our third quarter results.

As you know, the federal fiscal 2018 began in October 1 of 2017 about a month ago, without a federal or DoD budget being executed. We have been operating under a continuing resolution authorization, or CRA, since that time, which currently runs through December 8 of this year. In our effort to provide what we believe is conservative fourth quarter 2017 forecasting, which was in our Q3 release today and which Deanna will provide in detail, we have incorporated into our fourth quarter outlook, planning for a range that considers the potential outcomes of the budget process in Washington. The potential outcomes being the 2018 budget is resolved by December 8; another CRA is put in place on December 8; or that the government has a shutdown in December.

At the high end of our range, we are forecasting an additional CRA at December 8 through at least the end of 2018.

At the low end, we anticipate some effect from the inability of government employees to visit our facilities to release product for delivery in event of a shutdown.

The upcoming December date is much talked about and we have 2 thoughts on this.

First, the U.S. government is -- currently has a number of service men and women in harm's way in Asia-Pacific, the Middle East and elsewhere, globally, and adversely impacting these people, this country's top 1% in my opinion would be extraordinary, even with the current state of affairs in Washington.

Second, Kratos' trajectory has been established by the investments we have made in leading-edge technologies and new market segments, our leadership and innovation and the resulting contracts and programs we have received. All of which ensure that this company has an attractive future growth path, which we believe will not be affected by short-term noise in Washington, D.C.

In summary, we're extremely optimistic for our company's future, revenue, profit, cash flow and overall growth prospects and we're focused on executing our business plan.

We currently plan on providing 2018 financial guidance with our fourth quarter earnings call, which is consistent with prior years and when hopefully, there will be better clarity from Washington. Deanna?

--------------------------------------------------------------------------------

Deanna Hom Lund, Kratos Defense & Security Solutions, Inc. - CFO and EVP [4]

--------------------------------------------------------------------------------

Thank you, Eric. Good afternoon.

Kratos' third quarter '17 revenues of $196.2 million exceeded our expectations of $180 million to $190 million for the quarter, due primarily to strong execution and deliveries in our Satellite Communications and Training Systems businesses and our Unmanned Systems business, with certain deliveries previously expected for the fourth quarter coming in the third quarter.

Year-over-year consolidated organic revenue growth of 18.6% was driven by growth across all of our reportable business segments, with 10.9% in our Satellite Communications, Technology and Training businesses as a result of recent contract awards in these areas, growth of 127.3% in our Unmanned Systems business, which was also driven by recent contract awards and 14.3% in our Public Safety and Security business, driven primarily by a security system deployment for a mass transportation authority.

Our Q3 adjusted EBITDA of $14.5 million exceeded the high end of our expectation of $10 million to $14 million, due primarily to a favorable mix of higher-margin work in shipments in our Unmanned Systems and Microwave Products businesses and improved performance in our Public Safety business. On a year-over-year basis, our Q3 '17 adjusted EBITDA increased 7.4% or $1 million from $13.5 million in the third quarter of '16 to $14.5 million in '17.

Our adjusted EBITDA for the third quarter is from continuing operations and excludes the following charges, which have been reflected as adjustments consistent with our prior presentations, since we either believe the items are nonoperational, nonrecurring in nature or meaningful for investors to understand our financial performance. Restructuring-related items and other of $2.1 million, which includes $2 million representing access overhead capacity, consisting of $1.4 million in our Modular Systems and $600,000 in our Unmanned Systems divisions. As production efforts are expected to ramp in our Modular Systems business based upon new contract awards and production schedules primarily for radar programs and as we continue to ramp up for Low Rate Initial Production on AFSAT and the additional confidential program later this year, we expect the excess overhead capacity to decrease.

As expected, the operating profit and adjusted EBITDA for Kratos Government Solutions segment had a less favorable mix of products sold during the third quarter. The company expects a more favorable mix of revenues in the fourth quarter, based upon production and execution schedules, which is expected to result in higher operating and adjusted EBITDA margins for the Government Solutions segment.

On a GAAP basis, net loss for the third quarter was $4.3 million, which included the restructuring-related items and other, $2.8 million of expense related to amortization of intangible assets and capitalized contract and development costs, noncash stock compensation expense of $2.8 million and a $200,000 tax provision.

On a last 12 months, or LTM, basis for the period ended October 1, 2017, revenues were approximately $732 million with LTM adjusted EBITDA for the same period of approximately $50 million.

We believe this is a good indicator that we are on path for our updated 2017 annual guidance of revenues of $735 million to $745 million and adjusted EBITDA of $52 million to $54 million, especially with the expected deliveries and production schedules for the fourth quarter.

Moving to the balance sheet and liquidity. Our cash balance was $239.2 million at October 1, plus $200,000 in restricted cash.

Kratos also had 0 amounts outstanding on our bank line of credit and $9.2 million of letters of credit outstanding.

Cash flow from continuing ops for the third quarter was a use of $5.4 million which includes approximately $1.1 million of internal noncapital expense-related development cost related to the LCASD program.

Capital expenditures of $6.3 million were primarily related to investments we are making in our Satellite Communications and Unmanned Systems businesses. Approximately $3.2 million of the CapEx was related to the Unmanned Systems business, which is primarily related to the 2 LCASD aircraft and related equipment we are building for our own use. We expect this capital effort to be substantially complete in the first half of '18.

DSOs increased from 111 days at the end of the second quarter to 113 days at the end of the third quarter. Our DSOs continued to be impacted by milestone payments on long-term delivery projects, where we are unable to contractually invoice for amounts until the completion of certain milestones and/or the final delivery of products or the demonstration of certain flight parameters, specifically in our Unmanned Systems segment.

We currently expect certain of these milestones that we have been closely tracking to now be achieved late in the fourth quarter of '17 or the first quarter of '18, with collection expected in the first and second quarters of '18. We have previously expected these milestones to be achieved in the third quarter, with collection in the fourth quarter of this year.

In addition, we have a number of billing milestone payments that are expected to be paid upon completion of the large critical infrastructure projects that are expected to be completed in the fourth quarter of '17 and first quarter of '18.

In aggregate, this handful of milestones in our Unmanned Systems business and Public Safety business is approximately $26 million to $28 million, which is now expected to be collected in the first half of '18. As we are now the prime contractor on sizable projects in our Unmanned Systems, Public Safety & Training Systems businesses, our DSOs will continue to be lumpy as the payment terms will be based upon achievement of milestones rather than progress billings.

Our contract mix for the quarter was 88% of revenues generated from fixed price, 6% on cost plus and 6% on time and materials.

Revenues generated from contracts with the U.S. government for the third quarter were approximately 60%, including revenues generated from contracts with the DoD and non-DoD federal government agencies.

We also generated 7% from state and local governments, 21% from commercial customers and 12% from foreign customers, with our aggregate non-DoD revenues comprising 40% of our total revenues.

Backlog at third quarter end was $798.9 million, with $586.2 million funded and $212.7 million unfunded. This compares to backlog at second quarter-end of $766 million, with $544 million funded and $222 million unfunded.

Our book-to-bill ratio was 1.2:1 for the third quarter and 0.9:1 for the 12 months ended October 1. Today, we are updating the range of our full year '17 guidance from $720 million to $740 million in revenues to $735 million to $745 million, and maintaining our annual adjusted EBITDA guidance of $52 million to $54 million, with estimated fourth quarter revenues of $185 million to $195 million and adjusted EBITDA of $15.4 million to $17.4 million.

Based on our production and delivery schedules, the fourth quarter is expected to be particularly strong. We are updating our free cash flow guidance for '17 to a use of $51 million to $58 million, which reflects our current expectation of the completion and collection of certain milestones in our Unmanned Systems and Public Safety businesses of approximately $26 million to $28 million, which are to occur in the first and second quarters of '18.

We expect our total CapEx to be in the range of $26 million to $30 million for FY '17 with approximately $17 million to $22 million related to our Unmanned Aerial Systems business.

The balance of the capital expenditures is expected to be in our Satellite Communications and Training and Electronic Products businesses to fund growth initiatives in both of these businesses.

We expect our operating cash flows will be impacted by estimated investments of $7 million to $10 million we plan to make to develop the LCASD platform to maintain the intellectual properties that are not included in capital expenditures.

As a reminder, the total estimated investment that is not related to capital was accrued as a forward loss accrual in the third quarter of 2016, when we were awarded the contract. Year-to-date through Q3 end, we funded approximately $6 million of noncapital LCASD investments.

In summary, our estimated cash investment for the Unmanned Systems business for 2017, including the LCASD capital and other development costs is $24 million to $32 million, plus approximately $18 million to $22 million in other working capital requirements for our Unmanned Systems business to fund production ramps, prior to milestone achievements for an aggregate cash outlay of $42 million to $54 million for our Unmanned Systems business for substantially all the free cash flow use we are estimated for the corporation for the year.

We expect that these cash investments for our unmanned tactical initiatives will be substantially complete in the first half of '18 and that we will return to free cash flow generation in fiscal 2018. Today, we also reported in our 10-Q that we have completed our initial assessment of the impact of adopting the new revenue recognition standard, which is effective January 1, 2018. We expect that the cumulative effect of adopting this new standard will not be material with an estimated increase of revenues of less than $3 million and an increase in operating income of less than $2 million. Eric?

--------------------------------------------------------------------------------

Eric M. DeMarco, Kratos Defense & Security Solutions, Inc. - CEO, President & Director [5]

--------------------------------------------------------------------------------

Great, thank you very much, Deanna. We will turn it now over to the moderator for questions.

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) And our first question comes from the line of Ken Herbert from Canaccord.

--------------------------------------------------------------------------------

Kenneth George Herbert, Canaccord Genuity Limited, Research Division - MD and Senior Aerospace and Defense Analyst [2]

--------------------------------------------------------------------------------

Just wanted to first ask, in the Government Solutions operating segment, the step down in operating profit, I think you attributed that to mix. Can you provide any more detail specifically on what that mix impact was and maybe the -- some of the products that were -- and shipments in terms of maybe a little softer than expected in the quarter?

--------------------------------------------------------------------------------

Deanna Hom Lund, Kratos Defense & Security Solutions, Inc. - CFO and EVP [3]

--------------------------------------------------------------------------------

Sure. There's both in our Modular Systems business. So that was impacted from an operating income perspective due to the excess overhead capacity issues, and that was about $1.6 million -- $1.4 million, excuse me. In our Satellite and Communications business, that was primarily a heavier mix of hardware versus software licensing, which typically would be higher-margin. We do expect those shipments, of the higher-margin product mix to occur in Q4. So there was a fairly sizable impact during the quarter on that business unit. Those were the 2 primary drivers.

--------------------------------------------------------------------------------

Kenneth George Herbert, Canaccord Genuity Limited, Research Division - MD and Senior Aerospace and Defense Analyst [4]

--------------------------------------------------------------------------------

Okay. And I think, just so I understand correctly, you do sequentially and year-over-year expect to see a growth in operating income in this particular segment, correct?

--------------------------------------------------------------------------------

Deanna Hom Lund, Kratos Defense & Security Solutions, Inc. - CFO and EVP [5]

--------------------------------------------------------------------------------

We -- Ken, we don't provide guidance on a segment-by-segment basis. Just on a full year -- on a full consolidated basis.

--------------------------------------------------------------------------------

Eric M. DeMarco, Kratos Defense & Security Solutions, Inc. - CEO, President & Director [6]

--------------------------------------------------------------------------------

But Ken, I want to reiterate what Deanna and I said in our prepared remarks. The mix in Satellite in Q2 was very strong. The mix in Q4 looks -- right now it's shaping up will be the strongest quarter of the year. Being product and delivery-based on small production lots that include software and firmware, it can just be lumpy. So that's -- it's just a timing matter.

--------------------------------------------------------------------------------

Kenneth George Herbert, Canaccord Genuity Limited, Research Division - MD and Senior Aerospace and Defense Analyst [7]

--------------------------------------------------------------------------------

Okay, perfect. That's helpful. And if I could just finally on the Unmanned segment. I appreciate the doubling of the business [without] any of the sort of tactical opportunities. You did however mention Eric, you do expect some uptick in funding associated with UTAP-22. And I know you recently had some successful demonstrations there. Can you just provide an update on that particular programming, maybe some of the technology you've recently sort of validated? And what you view is the potential sort of magnitude of what could be the upside there heading into 2018?

--------------------------------------------------------------------------------

Eric M. DeMarco, Kratos Defense & Security Solutions, Inc. - CEO, President & Director [8]

--------------------------------------------------------------------------------

Yes. Ken, this is one of the programs that as I mentioned last quarter, I -- going forward, we have to be very, very careful on what we talk about. So I apologize, I cannot talk about what we validated. And I'm not -- I can't talk about what's going on here. I apologize.

--------------------------------------------------------------------------------

Kenneth George Herbert, Canaccord Genuity Limited, Research Division - MD and Senior Aerospace and Defense Analyst [9]

--------------------------------------------------------------------------------

Okay, that's fine. Maybe then if I could ask finally on the legacy business. You've highlighted a number of opportunities around Missile Defense and the target side of that business. And I know there seems to have been a step up in contract activity. Therefore, maybe you can just talk into '18 around Missile Defense opportunities and the upside you potentially see there as part of that step up in unmanned.

--------------------------------------------------------------------------------

Eric M. DeMarco, Kratos Defense & Security Solutions, Inc. - CEO, President & Director [10]

--------------------------------------------------------------------------------

Absolutely. So relative to the -- relative to Missile Defense on unmanneds, Ken, is that where you're going, is that it?

--------------------------------------------------------------------------------

Kenneth George Herbert, Canaccord Genuity Limited, Research Division - MD and Senior Aerospace and Defense Analyst [11]

--------------------------------------------------------------------------------

Exactly. Missile defense in general.

--------------------------------------------------------------------------------

Eric M. DeMarco, Kratos Defense & Security Solutions, Inc. - CEO, President & Director [12]

--------------------------------------------------------------------------------

In general, got it. So missile defense in general, we are one of 2 primary providers of ballistic missile target systems that are used to exercise radar systems like AMDR, which we've had several successful tests recently. Weapon systems, surface-base, surface-to-air missile system, which -- one of which was validated at Formidable Shield. The op tempo here is increasing significantly. It is expected to increase significantly for us going forward because of world events. We are a key provider on specific hardware on the Patriot missile-defense battery. We are right now in a very large production run on Patriot batteries for our prime customer. There have been some large recent awards for THAAD. We have historically been one of the key providers for THAAD-related ground equipment. A very big one, fingers crossed, that we're going to get very soon has to do with the Barak-8 missile, where our content is around $40,000 per missile and in order to begin a production run of several hundreds of these in the next couple of quarters. So that missile defense system is a key system for us. That's just a handful of the ones we're involved in, Ken, that come to mind.

--------------------------------------------------------------------------------

Operator [13]

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Michael Roy Crawford, B. Riley & Co., LLC, Research Division - Senior MD, Co-Head of The Discovery Group & Senior Analyst [14]

--------------------------------------------------------------------------------

Can you provide some color on how you're progressing with SSAT production, as you kind of move up the learning curve on LRIP 1 production, and what that could mean for margins in LRIP 2 in [full ramp] Production?

--------------------------------------------------------------------------------

Eric M. DeMarco, Kratos Defense & Security Solutions, Inc. - CEO, President & Director [15]

--------------------------------------------------------------------------------

Absolutely. So we received LRIP 1 at the end of Q2. We had expected to receive it much earlier in the year, possibly even at the beginning of the year. But because the 2017 continuing resolution went almost 6 months and it was a new production start, we got it later than expected, we got in...

--------------------------------------------------------------------------------

Deanna Hom Lund, Kratos Defense & Security Solutions, Inc. - CFO and EVP [16]

--------------------------------------------------------------------------------

End of June.

--------------------------------------------------------------------------------

Eric M. DeMarco, Kratos Defense & Security Solutions, Inc. - CEO, President & Director [17]

--------------------------------------------------------------------------------

End of June, June 30. And so we -- as I believe I indicated on our Q2 call, we worked very closely with our customer and we leaned forward and we have placed orders on most of the long lead items on the bill of material, including number one, the turbo fan engines. So we are ramping up very quickly now on these first number of drones. Deliveries are going to begin next year. And we expect sometime in the middle of next year, depending nothing crazy happens with the 2018 budget, to get LRIP 2, which has an opportunity for significantly increased quantities, those would overlap on top of LRIP 1. So 2 things would happen, we'll be coming down the learning curve and we will be able to spread the fixed overhead manufacturing costs across a greater number of units, which hopefully will just increase overall profitability for the entire -- those entire runs. And then, currently, full rate production, which is expected to be even a greater number of units, is expected to begin in 2019 at which time greater quantities, greater learning, margins would hope to increase further. And Mike, I don't want to give any rates on that right now, because we are still working some of these things with our customer.

--------------------------------------------------------------------------------

Michael Roy Crawford, B. Riley & Co., LLC, Research Division - Senior MD, Co-Head of The Discovery Group & Senior Analyst [18]

--------------------------------------------------------------------------------

Okay. Related, when you started progressing down the path of all this internal R&D in your Unmanned Systems business, you took down what had been a third production line at CEI, and have been running just 2, I believe, for AFSAT and Firejet, et cetera. And are you now back up to running 3 production lines in Sacramento, or still 2 on the R&D line?

--------------------------------------------------------------------------------

Eric M. DeMarco, Kratos Defense & Security Solutions, Inc. - CEO, President & Director [19]

--------------------------------------------------------------------------------

We are back at 3, and we're going to be full blown at 3 next year in 2018. We are also doing the development programs there as well. So this...

--------------------------------------------------------------------------------

Michael Roy Crawford, B. Riley & Co., LLC, Research Division - Senior MD, Co-Head of The Discovery Group & Senior Analyst [20]

--------------------------------------------------------------------------------

Okay. And then, in the past week, I think we saw the first production, other transaction agreement from the DIUx to take one of these incubated technologies out for -- to the broader market for this company, a world-wide technology for a cybersecurity product, import management product. Is that something that you're looking for on the Mako as well?

--------------------------------------------------------------------------------

Eric M. DeMarco, Kratos Defense & Security Solutions, Inc. - CEO, President & Director [21]

--------------------------------------------------------------------------------

We are working on a number, Mike, of OTAs across the company, with differentiated offices. It's part of our strategy. And we are working on that type of vehicle with the customer that you mentioned. I don't want to get ahead of any customers or anything here. But that is the model we are pursuing, not just there but elsewhere across the company.

--------------------------------------------------------------------------------

Michael Roy Crawford, B. Riley & Co., LLC, Research Division - Senior MD, Co-Head of The Discovery Group & Senior Analyst [22]

--------------------------------------------------------------------------------

Okay. And one final question. In September, your RT Logic business was named with a number of other companies as part of a near billion dollar IDIQ for a weapon systems research testing evaluation. Is that -- can you talk about what's going on there at all?

--------------------------------------------------------------------------------

Eric M. DeMarco, Kratos Defense & Security Solutions, Inc. - CEO, President & Director [23]

--------------------------------------------------------------------------------

Absolutely. Mike, that is a -- we're looking at that as a fantastic vehicle, not just for RT Logic but across our company, based on the statement of work and the applications that are appropriate underneath that vehicle. This is -- this was a key win. Our RT Logic guys, they are some of the best in the absolute company and they drilled it with this one for the entire business. This is one -- I'm glad you're asking, and let's both you and I both stay on top of this one going into '18 and '19, this could be another growth driver for us across many disciplines that are noted in that statement of work. So that was a good one that you picked up.

--------------------------------------------------------------------------------

Operator [24]

--------------------------------------------------------------------------------

Our next question comes from the line of Mark Jordan from NOBLE Capital.

--------------------------------------------------------------------------------

Mark Conrad Jordan, NOBLE Capital Markets, Inc., Research Division - Senior Research Analyst of Government Services and Defense Technology [25]

--------------------------------------------------------------------------------

Eric, you mentioned the Formidable Shield fleet trials were out in the North Atlantic in September and October. I know that you -- there were multiple Firejets used in that exercise. Was Firejets used in that application because of your [SS] 18 was not available? Or is Firejet a very viable alternative in the foreign military sales area for that type of training exercise?

--------------------------------------------------------------------------------

Eric M. DeMarco, Kratos Defense & Security Solutions, Inc. - CEO, President & Director [26]

--------------------------------------------------------------------------------

Good question, Mark. It is absolutely spot on for foreign applications, as in Formidable Shield. QinetiQ put out a press release. They're a strong strategic partner of Kratos'. QinetiQ has the 20-year CAPS contract with the U.K. Ministry of Defence for their weapons ranges and providing them threat representative targets. QinetiQ's press release talked about this was the first time that they are now providing those targets to the U.K. Ministry of Defence. This is -- I think they actually said in their press release that this is the most sophisticated target, which it is, in their inventory, that they're providing, the MoD, the U.K. MoD. This is just one example where we see significant growth opportunities going forward. I was forwarded a briefing over the weekend on the high-performance target market internationally and globally. And Mark, very simply said, when you see friendly allied countries to the U.S., buying U.S. weapon systems, they want to exercise those weapons against the best targets, which are U.S. targets, which are Kratos targets, because you know we deliver to the U.S. Navy, Air Force and Army. And the -- right now, the Firejet is the tip of the spear for us and it is -- we are selling it to a number of international customers. We just signed a contract, I can't disclose who, for a number of them with an additional international party. So it's -- your spot on, on this relative to FMS and direct commercial sales internationally.

--------------------------------------------------------------------------------

Mark Conrad Jordan, NOBLE Capital Markets, Inc., Research Division - Senior Research Analyst of Government Services and Defense Technology [27]

--------------------------------------------------------------------------------

Okay. Could you comment on what your debt refinancing strategy and/or plans will be?

--------------------------------------------------------------------------------

Eric M. DeMarco, Kratos Defense & Security Solutions, Inc. - CEO, President & Director [28]

--------------------------------------------------------------------------------

We -- as you can imagine, with our bonds now approximately 18, 19 months out in the middle of the 2019, we are very closely studying alternatives for the company, right now. The markets, the debt markets -- and our current contemplation would be a straight debt refinancing, debt for debt. The markets are very, very strong right now, and they're very strong for Kratos. You may have seen, and Deanna will help with me here, recently the rating agencies, did they upgrade us?

--------------------------------------------------------------------------------

Deanna Hom Lund, Kratos Defense & Security Solutions, Inc. - CFO and EVP [29]

--------------------------------------------------------------------------------

Yes, shortly after the equity, the last equity raise, they did, both rating agencies upgraded us.

--------------------------------------------------------------------------------

Eric M. DeMarco, Kratos Defense & Security Solutions, Inc. - CEO, President & Director [30]

--------------------------------------------------------------------------------

So we are -- Mark, we're closely looking at this right now. Our net leverage right now is under 3:1. We have completely restructured and repositioned the balance sheet and we're looking to take advantage of that as soon as practical.

--------------------------------------------------------------------------------

Mark Conrad Jordan, NOBLE Capital Markets, Inc., Research Division - Senior Research Analyst of Government Services and Defense Technology [31]

--------------------------------------------------------------------------------

Okay. Do you -- could you -- do you have a sense of, with the current debt load you have, how much you would reduce that $369 million of debt to in this next round? And any sense of, would you pay down $100 million of that? And if so, what kind of drop in rate would you assume?

--------------------------------------------------------------------------------

Deanna Hom Lund, Kratos Defense & Security Solutions, Inc. - CFO and EVP [32]

--------------------------------------------------------------------------------

So Mark, when we did the equity raise, our intention -- stated intention was to use approximately $100 million of those proceeds to redeem or retire debt. So that's still within the range of what our expectation is. As far as rate, it's a little premature to discuss what -- where we think it could end up at.

--------------------------------------------------------------------------------

Eric M. DeMarco, Kratos Defense & Security Solutions, Inc. - CEO, President & Director [33]

--------------------------------------------------------------------------------

Depending on which path we chose. If we [whip] bonds or we [went term] debt or, we want a bank -- they, again all have their pluses and minuses, of course. So we're looking at all that and obviously, we're in close communication with the rating agencies relative to that as well.

--------------------------------------------------------------------------------

Mark Conrad Jordan, NOBLE Capital Markets, Inc., Research Division - Senior Research Analyst of Government Services and Defense Technology [34]

--------------------------------------------------------------------------------

Just a final question, relative to the debt issue. Which would it be safe to assume that you would like to implement some restructuring by the end of the first quarter of 2018?

--------------------------------------------------------------------------------

Eric M. DeMarco, Kratos Defense & Security Solutions, Inc. - CEO, President & Director [35]

--------------------------------------------------------------------------------

Mark, all things being equal, it would be great if we could have this all wrapped up by Q1. Absolutely, yes, sir.

--------------------------------------------------------------------------------

Mark Conrad Jordan, NOBLE Capital Markets, Inc., Research Division - Senior Research Analyst of Government Services and Defense Technology [36]

--------------------------------------------------------------------------------

Okay. Final question for me. It's relative to DSOs and milestones. Obviously, when you've had UAV customers signing contracts with you a year or so ago, your capabilities were not as demonstrated in the marketplace as they are today. Moving forward, as you sign contracts with customers, can you -- will you be seeing improved cash terms because your capabilities are demonstrated now, and therefore, being able to get cash earlier, because there's less technology risk for the customer?

--------------------------------------------------------------------------------

Deanna Hom Lund, Kratos Defense & Security Solutions, Inc. - CFO and EVP [37]

--------------------------------------------------------------------------------

You're exactly correct.

--------------------------------------------------------------------------------

Eric M. DeMarco, Kratos Defense & Security Solutions, Inc. - CEO, President & Director [38]

--------------------------------------------------------------------------------

Yes, sir.

--------------------------------------------------------------------------------

Deanna Hom Lund, Kratos Defense & Security Solutions, Inc. - CFO and EVP [39]

--------------------------------------------------------------------------------

Especially with the most recent awards that we've been awarded, they are more progress billing-focused rather than milestone-focused. So yes.

--------------------------------------------------------------------------------

Eric M. DeMarco, Kratos Defense & Security Solutions, Inc. - CEO, President & Director [40]

--------------------------------------------------------------------------------

Yes, we're moving -- we're strategically moving more towards progress billing, Mark.

--------------------------------------------------------------------------------

Operator [41]

--------------------------------------------------------------------------------

And our next question comes from the line of Michael Ciarmoli from SunTrust.

--------------------------------------------------------------------------------

Michael Frank Ciarmoli, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [42]

--------------------------------------------------------------------------------

Maybe just first on the -- just for clarity, the bookings front. That was -- the strong bookings in the quarter, you had the $65 million that slipped out of the last quarter. So I was just trying to get a sense, I guess the year-to-date is about 0.8x or so. What areas of the business are you seeing weakness in the bookings? I mean...

--------------------------------------------------------------------------------

Eric M. DeMarco, Kratos Defense & Security Solutions, Inc. - CEO, President & Director [43]

--------------------------------------------------------------------------------

Our Government Services business -- yes, our Government Service business, Mike, is about $70 million or $80 million, something like that. And those contract vehicles are typically 3 to 5 years. And so, when you win a contract, let's say it's a $30 million contract, you book $10 million of it in funded and $20 million of it non-funded, and that's the booking. And so that cycles and we have had very low bookings thus far this year in our Government Services business, directly related to that. That booking cycle starts coming back next year, okay? But that's where the number one downer has been, the legacy Government Services or SETA contracting.

--------------------------------------------------------------------------------

Deanna Hom Lund, Kratos Defense & Security Solutions, Inc. - CFO and EVP [44]

--------------------------------------------------------------------------------

And I guess just to put it in a more clear focus is every business with the exception of that legacy Government Services business, have had a book-to-bill over 1:1. 1:1 or over for the quarter. Yes, so it's -- that clearly was dragging it, yes.

--------------------------------------------------------------------------------

Michael Frank Ciarmoli, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [45]

--------------------------------------------------------------------------------

Got it. And then just again I want to make sure that I heard you correctly, that the free cash flow this year, given the collections. So it's going to be negative $55 million this year?

--------------------------------------------------------------------------------

Deanna Hom Lund, Kratos Defense & Security Solutions, Inc. - CFO and EVP [46]

--------------------------------------------------------------------------------

That's correct.

--------------------------------------------------------------------------------

Michael Frank Ciarmoli, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [47]

--------------------------------------------------------------------------------

And then so as we look into next year, I mean the expectation is positive free cash flow. So you'll get the pickup in the collection presumably. I think Eric, last quarter, I believe you did a walk for us in terms of what some of the investment things that roll off. But I mean are we thinking an improvement over the $55 million? Can we get to -- is it just above breakeven? Or can you maybe quantify the level of cash flow to some extent for next year?

--------------------------------------------------------------------------------

Deanna Hom Lund, Kratos Defense & Security Solutions, Inc. - CFO and EVP [48]

--------------------------------------------------------------------------------

So Mike, if -- let me walk back through what the investments have been this year. So of that $51 million to $58 million of use this year, $42 million to $54 million of that is unmanned systems. So about half of that is CapEx, some of it is the LCASD investment that is noncapital related, and then there is about $18 million to $22 million related to milestones that will be collected next year. So as Eric and I both mentioned, the investments in LCASD are winding down. To date, we've invested about $6 million on the LCASD noncapital investment where the total we expected over time is $13 million to $14 million. So there's a little bit left for Q4 and as well some into '18. The CapEx we expected on LCASD was about $15 million to $17 million. To date, we've incurred about $10 million to $11 million, so there is still some to be completed in the fourth quarter and in '18. But clearly, the lion's share of that investment was completed -- will be completed in '17. So in addition, with those investments winding down and those milestones being collected, we've also entered into production on LRIP, which is progress billing focused and that's about -- that was the $37 million award that we announced at the end of June, and that will be on a progress billing perspective. So there's a lot -- and as you can imagine on a number of the programs in unmanned systems, in 2017, they were in development. So they were either at low margin, no margin or negative margin. And those have been a flip into profit in '18. So you've got both those waves, if you will, impacting total consolidated cash flow.

--------------------------------------------------------------------------------

Michael Frank Ciarmoli, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [49]

--------------------------------------------------------------------------------

Got it, got it, that's helpful. Appreciate that. And then just the last one for me. Eric, on the doubling of unmanned, what is, sort of -- when we look out to '18, what would be the mix versus the target drones, the legacy CEI, versus revenues from some of the newer programs, call them the intelligent tactical drones if you would?

--------------------------------------------------------------------------------

Eric M. DeMarco, Kratos Defense & Security Solutions, Inc. - CEO, President & Director [50]

--------------------------------------------------------------------------------

It's going be 90-10, 80-20, something like that. 90-10, 80-20 in that ballpark. And Mike, one thing I want to add on to what Deanna said, very importantly, our plan to make those investments is to own the intellectual property in all the planes, which we do, so no one else can build them. That was just our -- that was more of a commercial model.

--------------------------------------------------------------------------------

Michael Frank Ciarmoli, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [51]

--------------------------------------------------------------------------------

Yes. Since you brought it up, with that commercial model, any idea what the margins might be?

--------------------------------------------------------------------------------

Eric M. DeMarco, Kratos Defense & Security Solutions, Inc. - CEO, President & Director [52]

--------------------------------------------------------------------------------

Yes. So let me -- you can see this on our previous SEC filings. Before we started investing in tactical, our unmanned business was low to mid-teens. Then we started investing in the tactical. And in a couple of next generation target drones. As we saw in Q3 and as Deanna just explained, the investments have started coming off. We make $5 million of profit in Q3 on unmanned and they're going to continue to come down, production is increasing in a number of areas now. So we're now heading into the up step.

--------------------------------------------------------------------------------

Operator [53]

--------------------------------------------------------------------------------

And our next question comes from the line of Sheila Kahyaoglu from Jefferies.

--------------------------------------------------------------------------------

Sheila Karin Kahyaoglu, Jefferies LLC, Research Division - Equity Analyst [54]

--------------------------------------------------------------------------------

Actually, I did have a very similar question on unmanned and the impact of mix. And maybe could you parse that out a little bit further, Eric, on the moving pieces of unmanned and the significant improvement in earnings there?

--------------------------------------------------------------------------------

Eric M. DeMarco, Kratos Defense & Security Solutions, Inc. - CEO, President & Director [55]

--------------------------------------------------------------------------------

Yes. The 2 big pieces are investments we've been making in a number of drones are winding down. The only significant one we have going right now that's left is LCASD. We've completed the investments in all the other ones, and they're flying or they're about ready to fly. And LCASD is going to be substantially done by the end of this year, completely done first half of next year. So those investments are coming down. And those investments were in drones that are now going into production. And so, we've got a twofer going here, the investments or those expenses are coming down and production and revenue is driving up. And that is what is driving the profit, which I think last year, our Unmanned business in Q3 did $1 million in profit and this year it did $5 million directly related to less investment and the investment in the drones that we're making to go into production are now going into production.

--------------------------------------------------------------------------------

Sheila Karin Kahyaoglu, Jefferies LLC, Research Division - Equity Analyst [56]

--------------------------------------------------------------------------------

So if we think about the production aircraft for next year, is it FSAT and the SSAT in terms of ...

--------------------------------------------------------------------------------

Eric M. DeMarco, Kratos Defense & Security Solutions, Inc. - CEO, President & Director [57]

--------------------------------------------------------------------------------

So let's talk about the 3 primary target platforms. There's the 167. The primary customer for the 167 is the U.S. Air Force. However, we are selling it to multiple international customers, multiple. The primary customer for the 177 drone is the U.S. Navy. We have sold that to multiple international customers, and we expect that to start ramping up significantly internationally, now that the U.S. Navy is going into production. We have been selling the 178, the Firejet, to the U.S. Army. But as I was -- as related to Mr. Jordan's question, that is probably the drone that we are selling the most internationally. And so, all of those to the 3 U.S. customers and the multiple international customers that are ramping is what is driving it across those, and those are just target drones.

--------------------------------------------------------------------------------

Sheila Karin Kahyaoglu, Jefferies LLC, Research Division - Equity Analyst [58]

--------------------------------------------------------------------------------

And then on Public Safety, what is -- is it a one-time contract and should we assume more of a normalized run rate for the business?

--------------------------------------------------------------------------------

Eric M. DeMarco, Kratos Defense & Security Solutions, Inc. - CEO, President & Director [59]

--------------------------------------------------------------------------------

So on -- in the Public Safety business, we've had 4 or 5 very large security deployments that we were awarded years ago. And so, Sheila, our strategy was when the Budget Control Act came in 2011, and budget -- the defense -- the base defense budget was going down from 550, 560 to 480, we made a decision that we were going to start bidding on very large security deployments to offset that DoD revenue drop. And we won a number of them. In our Public Safety business, revenues were from something like 130 to 210. When the bipartisan spending agreement was signed at the end of '16 -- at the end of '15, excuse me, with the President and Congress, which basically shut off sequestration for '16 and '17, defense budgets were stabilizing at 530, 535 base, we made the decision not to bid on any more of those large deployments. And we actually announced that in Q3 of '15 on the call. So these 4 or 5 very large programs that are very, very low-margin, they're winding down. And they're going to be almost all 100% complete by the end of this year, 1 or 2 might go into Q1 of next year, but they'll all be done. And with those coming down and we switched our strategy to bid on higher-margin pure system integration jobs, that's why I mentioned our bookings, thus far, this year -- our gross margin in bookings have been 30%. This is why our Public Safety business, its profitability is now ramping. The big old legacy low-profit ones are coming off and the new higher-margin pure security system integration ones are coming in. And that's why the profitability is ramping.

--------------------------------------------------------------------------------

Sheila Karin Kahyaoglu, Jefferies LLC, Research Division - Equity Analyst [60]

--------------------------------------------------------------------------------

Okay, so this is a normalized run rate for profitability going forward?

--------------------------------------------------------------------------------

Eric M. DeMarco, Kratos Defense & Security Solutions, Inc. - CEO, President & Director [61]

--------------------------------------------------------------------------------

It's -- I'm going to say it's normalizing, it's normalizing. We're going to head into Q4. But as I did say next year, next year, we expect next year to be far more profitable than 2017, because of what I said.

--------------------------------------------------------------------------------

Sheila Karin Kahyaoglu, Jefferies LLC, Research Division - Equity Analyst [62]

--------------------------------------------------------------------------------

Sure. And just last a clarification for Deanna. On Mike's question with free cash flow, do we think about free cash flow going like swinging from negative $55 million to around -- it could be quite a significant fling to positive $20 million to $40 million next year?

--------------------------------------------------------------------------------

Deanna Hom Lund, Kratos Defense & Security Solutions, Inc. - CFO and EVP [63]

--------------------------------------------------------------------------------

Sheila, I not -- I can't give you a number, Sheila, since we are not giving guidance yet for '18 but we do expect it to be positive, especially in the second half of '18. Clearly in the first half of '18 we still have some of these investments that we'll be completing. But we should also -- that should be offset by some of these milestone collections that have been pushed up from Q4.

--------------------------------------------------------------------------------

Operator [64]

--------------------------------------------------------------------------------

And our next question comes from the line of Josh Sullivan from Seaport Global.

--------------------------------------------------------------------------------

Joshua Ward Sullivan, Seaport Global Securities LLC, Research Division - Director & Senior Industrials Analyst [65]

--------------------------------------------------------------------------------

Just a clarification question on the manufacturing footprint. If you do get that, that 100-unit order you mentioned in the prepared remarks, or the other recent significant order, do you have the capacity in the current footprint to meet those orders?

--------------------------------------------------------------------------------

Eric M. DeMarco, Kratos Defense & Security Solutions, Inc. - CEO, President & Director [66]

--------------------------------------------------------------------------------

We are comfortable that we're good through '19. However, as I believe I said on the last call, we pulled in the new facility. We're going to be signing the leases by the end of this year. We've already started hiring people. We have a key executive who's agreed to relocate there and we'll have the ribbon cutting by the end of this year. We'll be up and running next year. So we will have the flexibility if some of these other bluebirds occur, that we can handle it. So we are tracking this very closely as you're very attuned to, Josh.

--------------------------------------------------------------------------------

Joshua Ward Sullivan, Seaport Global Securities LLC, Research Division - Director & Senior Industrials Analyst [67]

--------------------------------------------------------------------------------

Okay. And then, I know you don't want to talk about specific programs. But maybe on a learning curve basis, for the upcoming flight test on the LCASD. Can you talk about any commonality with the test you've had on, maybe on the UTAP-22 or other platforms? Flying these drones in swarms or other missions, is the learning curve maybe lower for LCASD, just given that commonality?

--------------------------------------------------------------------------------

Eric M. DeMarco, Kratos Defense & Security Solutions, Inc. - CEO, President & Director [68]

--------------------------------------------------------------------------------

Yes. Yes, sir.

--------------------------------------------------------------------------------

Joshua Ward Sullivan, Seaport Global Securities LLC, Research Division - Director & Senior Industrials Analyst [69]

--------------------------------------------------------------------------------

Okay, fair enough. And then, I think you mentioned some investments on the training capabilities. Can you dig into that, where those investments are being made?

--------------------------------------------------------------------------------

Deanna Hom Lund, Kratos Defense & Security Solutions, Inc. - CFO and EVP [70]

--------------------------------------------------------------------------------

Those are more CapEx related.

--------------------------------------------------------------------------------

Joshua Ward Sullivan, Seaport Global Securities LLC, Research Division - Director & Senior Industrials Analyst [71]

--------------------------------------------------------------------------------

Any specific capabilities?

--------------------------------------------------------------------------------

Deanna Hom Lund, Kratos Defense & Security Solutions, Inc. - CFO and EVP [72]

--------------------------------------------------------------------------------

Nothing specific to talk.

--------------------------------------------------------------------------------

Eric M. DeMarco, Kratos Defense & Security Solutions, Inc. - CEO, President & Director [73]

--------------------------------------------------------------------------------

Yes, the big programs that they're related to are the KC-46, the aerial refueler that we won last year. The Marine Corps common aircrew trainer for multiple Marine Corps helicopters we won last year. Those are the 2 primary ones and the -- those are the 2 big ones that come to mind.

--------------------------------------------------------------------------------

Deanna Hom Lund, Kratos Defense & Security Solutions, Inc. - CFO and EVP [74]

--------------------------------------------------------------------------------

Yes. Most of the investments for that segment are primarily related to the Satellite Communications business, Josh. Not as much so on the training side. They just happen to be all in the same operating division, but most of it's on the satellite side.

--------------------------------------------------------------------------------

Operator [75]

--------------------------------------------------------------------------------

And our next question comes from the line of Brian Ruttenbur from Drexel Hamilton.

--------------------------------------------------------------------------------

Brian William Ruttenbur, Drexel Hamilton, LLC, Research Division - Senior Equity Research Analyst [76]

--------------------------------------------------------------------------------

Just one final question on timeline of events to watch for catalyst. It looks like the biggest one on the UAS division is the Gremlins in the first quarter of '18. What other ones should we be watching for along the magnitude of the Gremlin?

--------------------------------------------------------------------------------

Eric M. DeMarco, Kratos Defense & Security Solutions, Inc. - CEO, President & Director [77]

--------------------------------------------------------------------------------

If we're fortunate enough to be successful on this approximate 100 unit, drone award, that could happen by the end of the year of Q1. And if that's announceable, that would be a biggie. We are designed in on a fighter aircraft on the electronic warfare system. And our content is $200,000 to $250,000 per plane. We are keeping our fingers crossed. We're expecting our order for the first 100 aircraft in Q4, Q1. There's a missile system we're designed in, it's $35,000 to $40,000 -- approximately $40,000 per missile. We are expecting our order for the first several hundreds of these Q1, Q2. So those are some of the biggies that come to mind.

--------------------------------------------------------------------------------

Brian William Ruttenbur, Drexel Hamilton, LLC, Research Division - Senior Equity Research Analyst [78]

--------------------------------------------------------------------------------

Okay, so those are top 4 or 5, perfect. And then the last question, plans to maybe streamline operations, focusing only on UAS. Is there any thought about doing that? And where you're going to be kind of a pure player versus these other divisions?

--------------------------------------------------------------------------------

Eric M. DeMarco, Kratos Defense & Security Solutions, Inc. - CEO, President & Director [79]

--------------------------------------------------------------------------------

We are very focused and we're going to be more focused than ever on Satellite Communications, Microwave Electronics, Unmanned Systems and our Training business, which is just ripping. I mean that $100 million contract we just won was fantastic. So those are the 4 that have done great and they're really well positioned.

--------------------------------------------------------------------------------

Operator [80]

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Eric M. DeMarco, Kratos Defense & Security Solutions, Inc. - CEO, President & Director [81]

--------------------------------------------------------------------------------

Great. Thank you all for joining us this afternoon. And our next scheduled chat will be when we report Q4, I think at the end of February or so. Thank you very much.

--------------------------------------------------------------------------------

Operator [82]

--------------------------------------------------------------------------------

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