Kratos Defense and Security Solutions Inc

NASDAQ:KTOS

Earnings Call Transcript 2018-Q1

[Operator]

Good day, ladies and gentlemen, and welcome to the Kratos Defense & Security Solutions First Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be provided at that time. [Operator Instructions]. As a reminder, this conference maybe recorded. I would now like to turn the conference for your host Mr. Marie Mendoza, Senior Vice President and General Council. Ma’am, you may begin.

[Marie Mendoza, VP and General Counsel]

Thank you. Good afternoon, everyone and thank you for joining us for the Kratos Defense & Security Solutions first quarter 2018 conference call. With me today is Eric DeMarco, Kratos’ President and Chief Executive Officer; and Deanna Lund, Kratos’ Executive Vice President and Chief Financial Officer. Before we begin the substance of today’s call, I’d like everyone to please take note of the Safe Harbor paragraph that is included at the end of today’s press release. This paragraph emphasizes the major uncertainties and risks inherent in the forward-looking statements we will make this afternoon. Please keep these uncertainties and risks in mind as we discuss future strategic initiatives, potential market opportunities, operational outlook and financial guidance during today’s call. Today’s call will also include a discussion of non-GAAP financial measures, as that term is defined in Regulation G. Non-GAAP financial measures should not be considered in isolation from or the substitute for financial information presented in compliance with GAAP. Accordingly, at the end of today’s press release, we have provided a reconciliation of these non-GAAP financial measures to the company’s financial results prepared in accordance with GAAP. With that, I will now turn the call over to Eric DeMarco.

[Eric DeMarco, President and CEO]

Thank you, Marie. Good afternoon, everyone. Revenues for Kratos’ Unmanned Systems business grow organically 78% from Q1 ’18 over Q1 2017. Virtually all of these revenues being generated by Kratos’ higher performance target drone related business. We are seeing significant demand for Kratos’ target drones in the United States and also globally. As a recapitalization of strategic weapon systems to address nation state adverse areas is underway. With not only United States DoD, but every NATO ally increasing its defense spending this year with 15 NATO countries increasing their defense budgets as a percent of their GDP. These strategic systems being deployed need to be exercise against the highest performance and most realistic [targets] to the world, which are Kratos’ targets and where Kratos’ is the undisputed industry leader. Directly related to the strong global demand that we are seeing. Kratos’ Unmanned Systems division booked in excess of 200 million in sole source or single award contracts in the first quarter of ’18, all of which we expect to convert to revenue over the respective contracts period of performance. The book-to-bill ratio for Unmanned Systems division was 2.6 to 1 for the first quarter. We are currently executing on low rate initial production contract year one, which we received in 2017 under the U.S. Navy SSAT program for Kratos’ BQM-177 target drone. In Q1 2018, we received a sole source contract award of approximately 24 million from the U.S. Navy for low rate initial production year two and we expect to begin to see meaningful revenue, EBITDA and cash flow generation from this SSAT LRIP2 in the third quarter of this year. In addition to SSAT LRIP2 we now expect to receive an SSAT LRIP3 production quarter later this year at a significantly increased value. The combined value to Kratos’ of LRIP2 and this new LRIP3 arrangement is expected to be greater than what we had previously forecast to receive from just an LRIP2 award. This will result an even higher 2019 revenue from the SSAT program and we are previously forecast. We continue to expect to receive a sole source multi-year full rate production contract on the SSAT program in 2019. At the previously forecast full rate production increased quantities and values. SSAT full rate production is expected to drive significant additional growth for Kratos’ beginning in 2020 and beyond. With this program becoming one of the largest to our company. In Q1, we received a $93 million sole source contract from the United States Army for a modified Kratos’ 167 target drone, which is replacing the retiring MQM-107 target drone. This army program, which is new for Kratos’ in 2018 and has now received initial funding is expected to be inorganic growth driver beginning in the third quarter of this year and continuing for many years into the future. Kratos’ Unmanned Systems division also received another new sole source contract in Q1, so a little later than we had initially forecast with the delay directly related for the extended CRA. This CRA related delay basically has shifted somewhat under this contract from Q2 to Q3 and we have adjusted our internal plan accordingly. We also just received in the past several days an approximate $90 million, 5-year IDIQ contract from the U.S. government agency for Kratos target drones and related systems and services and we have just received the first funded task order under this new contract award. We hope to be able to formally announce this recent contract award in the near future. This contract is expected to come and important contributor to Kratos beginning in Q3 of this year. Demand for Kratos is MQM-178 Firejet target drones also remains very strong and increasing both domestically and internationally and we are currently building numerous 178s for deliveries beginning in the third quarter of this year and for expected new orders for this high-performance jet target drone. We are expecting a number of additional large sole source target drone contract awards over the next several months including with United States Airforce for Kratos’ BQM-167 drones for production years ‘14 through ’16, which corresponds a 3-year production order covering 2019 through 2021 as substantially increased quantities and values over the last few years annual production. We will begin to see meaningful revenue EBITDA and cash flow growth from the expected increased asset production quantities in the first half of next year. Kratos’ target drone business is rapidly ramping on a year-over-year basis with 2018 revenue expected to be significantly greater than 2017 and double that of 2016 as we have previously forecast. On a quarterly basis, we forecast our Unmanned Systems business Q2 to continue with growth trajectory above Q1 and then a large step function in growth for Q3 over Q2 with Q4 currently looking consistent with Q3 as execution increases on our under-contract programs in the second half of the year. With the programs we have under contract increasing production and multiple new opportunities we expect to win going forward, Kratos’ Unmanned target drone business is expected to be a strong year-over-year organic growth driver for our company for the foreseeable future with increasing profit margins and cash flow generation. In the tactical UAS area, we are convinced that affordable high performance tactical drone systems, which can perform their mission and anti-access area denied and contested environments will be a significant part of the future force and Kratos is well positioned under numerous contracts and has important and intellectual property ownership in this high priority national security market. With the Gremlins tactical UAS award with our partner Dynetics, Kratos is now one every high performance tactical unmanned aerial drone system opportunity we have pursued successfully competing against the largest aerospace and defense company in the industry. As just recently reported, Gremlins program flight test at the [indiscernible] provided an opportunity to conduct safe separation and captive flight test of the hard dock and recovery system. In addition to preliminary flight test, the Gremlins team is focused on risk reduction the extensive modeling and simulation. The Gremlins team is now looking at how 5th Generation Aircraft Systems like the F-35 and the F-22 respond to threats and how they could incorporate Gremlins in high risk areas. The Gremlins UAS expected lifetime of about 20 uses, it could provide significant cost advantageous by reducing pay load and air freight cost and by having lower emission and maintenance cost than conventional platforms for all designs to operate for decade. Demonstration of the Gremlins systems is expected in 2019 and initial production buys could come shortly thereafter. As a reminder of the potential opportunity Kratos' have with Gremlins the detailed information that came out with the programs to RFP calls for requirements of $700,000 price point UAV at order quantities of 1,000 at a time, and Kratos' is responsible for the UAV under this program. With recent information that we have, we are more confident than ever that once demonstrated Gremlins will be a very significant program and future growth driver for Kratos. Kratos' Valkyrie program remains on track, on budget and on schedule to demonstrate later this year, at which time the investment Kratos' has been making in this UAS for important intellectual property ownership and to Kratos' owned Valkyrie UAS will be complete, which is expected to immediately result in increased Kratos' free cash flow. Similar to Gremlins, once we've successfully demonstrate Valkyrie, we expect to receive initial orders for these UAS shortly thereafter, ramping over future years with the Valkyrie also being a significant future revenue, profit and cash flow driver of the company. A reminder on the Valkyrie or LCASD opportunity for Kratos' the programs solicitation called for once in production a $3 million UAS that order quantities of less than 100 at a time and for $2 million price point per UAS order quantities greater than 100 at a time. Kratos' Mako, which is the only high-performance jet powered tactical UAS and as flying class today, and which has repeatedly demonstrated manned unmanned teaming as well as other important capabilities it is expected to be under contract with multiple new customers by the end of this year. Now that we have in 2018 budget in place. Related to this, we are currently in discussions with the certain entity as to Kratos' receiving a Mako production contract by the end of this year or early in 2019. Adding to the continued momentum we are seeing for Kratos' tactical high-performance and affordable UAS, we have announced the Kratos' Mako is now approved by the United States state department to be marketed internationally to a number of countries. We believe that this is an important positive development, as we see significant international opportunities for Kratos' Mako in all of our tactical UAVs and due to our systems high-performance, runway independent, distributed lethality, force multiplier attribute and ability to be recovered on both land and in the water. Additionally, shortly after we announce the State Departments approval to market the Mako internationally Kratos' receives State Department approval to market of second of Kratos' tactical UAS internationally. We believe that international sales of Kratos' attack UAS or another opportunity area that is now gaining attraction and will be another future growth, revenue, profit and cash flow contributed for our company. Also, importantly, many of the countries in customers in which we have recently received approval to market Kratos' tactical UAS are already existing Kratos' target drone customers and the profit margins on international business are typically greater than domestic margins. There are also additional tactical UAS programs and opportunities that Kratos’ is involved with and we are pursuing which we are hopeful to be able to discuss with you later this year. Kratos’ new Oklahoma operation continues to expand and we are planning for the first fully integrated Kratos’ high performance unmanned aerial drone aircraft to come off the line in Oklahoma in the first half of 2019. Additionally, our discussions with another small midsized defense company are continuing regarding a strategic production, integration and logistics relationship. And I’m hopeful to have this complete in the third quarter. As I’ve communicated previously, the growth that Kratos’ target drone business is experiencing and that we are forecasting for the next several years indicate that Kratos’ current manufacturing facility will be on full capacity by the end of 2019. As a result, we are positioning now to accommodate the susceptive future of target drone growth and also the expected significant growth in Kratos’ tactical UAS business. In summary, we are now more confident than ever that Kratos’ high performance tactical drone business will be a significant organic growth, profit and cash flow driver for our company, which will be growth in addition to that, which we are currently generating and forecasting just for our target drone business. And similar to Kratos’ target drones, Kratos is the complete system provider for each of our tactical drones. Excluding Kratos’ approximate $60 million to $70 million annual revenue non-core government services business, which we have deemphasized for some time now, KGS organically grew 7% over the first quarter of 2017. The larges first quarter of 2018 growth and KGS where from Kratos’ training system business. As a result of the multiple large long-term program Kratos’ system competitively bid on and won, including with [indiscernible] the Navy FMS, KC-46 MCAT [indiscernible]. Based on these under contract long-term programs, a number of which Kratos is the system provider and our current bid pipeline, we expect Kratos’ training business, which we forecast to be approximately 80 million in annual revenue of this year to continue strong year-over-year revenue growth for the foreseeable future and we recently announced the significant expansion for Kratos’ Orlando training facility to accommodate this expected growth. Kratos’ ballistic missile target business, where Kratos is also the system provider began 2018 very strong with a number of successful missions and with a lager order from a government agency related to Kratos’ proprietary target systems, which is expected to drive growth beginning in the third quarter of this year. With a significant funding increases in the missile defense area, which Kratos is directly seen in large increases and opportunities included in the hypersonic area and Kratos’ intellectual property and proprietary rights ownership. Kratos’ BMD target business area is forecast have the strong 2018 with an even stronger future beginning in 2019. Our Microwave Electronics business had particularly strong in Q1 primarily related to the initial Griffin electronic warfare contract award which we have previously anticipated. Based on the number of missile, radar, communications EW and other programs, our microwave businesses design and sole source or competing for. We expect our EW business to be up future organic growth driver for our company and the business with one of the highest profit margins in cash flow generation potential in our company. Kratos' satellite communications or space business where Kratos products and solutions support 85% of US and 75% of global space missions began 2018 stronger than we had originally forecast with a very favorable execution mix of revenues in Q1, we recently received a very large unexpected positive surprise for Kratos' space business with two additional WGS satellites being added to the 2018 DoD budget just prior to its approval. WGS is one of our space business is largest and most important programs and these two additional WGS satellites to increase our confidence for these businesses gross prospects going forward. Additionally, and representative of Kratos is leadership position in the space communications market was just reported that Kratos in use have been selected to prototype joint military commercial satellite network. This network will be focused on the DoD bringing leading technologies, space communications for the military. Our space and satellite business points to have an outstanding 2018, including a strong Q3 and Q4. Now we have the 2018 DoD budget in place. Over the long-term space and satellite communications are seeing some of the largest funding increases in the DoD budget and we believe that this will be a direct extended growth catalyst for Kratos. Other notable areas, programs and system for credit Kratos is either under contract or pursuing opportunities include patriot, fab F-15 and F-16 F-35, hypersonics high-power directed energy. With a 2018 DoD budget now in place the 2019 DoD funding level established with the bipartisan spending bill and the Trump Administration national central defense strategy published, we have high confidence in Kratos' 2018 financial forecasts and in our future as we believe that Kratos' systems, products and solutions are very closely aligned with US DoD and global national security priorities. Directly related to the extended continuing resolution Kratos' second quarter forecast similar to what we guided for Q1 with KGS being affected most by the CR due to the nature of its contracts and we are currently forecasting a very strong third quarter and a similar to increase fourth quarter. Now that there is a deal DoD budget in place and as we execute on our under-contract programs contracts and the expected awards. With the pending divestiture of PSS, we have positioned Kratos as a high growth, technology and intellectual property-based aerospace and defense company. We are laser focus on operational execution, increasing our profit margins and increasing our cash flow. Deanna.

[Deanna Lund, EVP and CFO]

Thank you, Eric, good afternoon. Kratos first quarter 2018 revenue is 143 million were in the range of our forecasting 140 to 150 million for the quarter and our adjusted EBITDA have 13.7 million exceeded our forecasted 9 million to 11 million, primarily due to a favorable mix of revenues in our satellite communications, training systems and microwave products businesses. Kratos adjusted EPS of $0.05 exceeded our forecast of breakeven to $0.01 for the quarter. First quarter year-over-year consolidated organic revenue growth of 8.3% which driven by growth of 78.2% in our unmanned systems business including low rated initial production one of our 177 or SSAT aerial target. Revenues in our largest segment KGS increased approximately 7.3% year-over-year for the first quarter of 2018 excluding a reduction of 8.1 million in our legacy government services business that we have previously deemphasized. Including our legacy government services business which annual revenues are now down to approximately 60 to 70 million, KGS revenues declined slightly by 1%. As mentioned earlier, we expect the PSS divestiture to close during the second quarter, and accordingly have recast all current year and prior year financial data to reflect the PSS business as a discontinued operation. As also previously mentioned Kratos' corporate overhead and public company cost of approximately 2.5 million, which was historically allocated to the PSS business has now been allocated to our remaining business segment for KGS and unmanned systems, and we have laid out a detailed plan to reduce these costs by as much as possible by the end of this year in order to increase our margins and cash flow. From an accounting standpoint Kratos' was required to adopt a new revenue recognition practice beginning January 1 of this year, which can affect the timing of the revenue recognition for certain contracts. As a result of this adoption, Kratos realized approximately 7.7 million of increased revenues in the first quarter, approximately 3.2 million and 4.5 million of the increases were related to the KGS and KUSD divisions, respectively. On a year-over-year basis, our Q1 18 adjusted EBITDA increased 34.3% or 3.5 million from 10.2 million in the first quarter of 17 to 13.7 million in the first quarter of '18. Our adjusted EBITDA for the first quarter is from continuing operations and excludes non-cash stock compensation cost of 1.7 million and severance-related restructuring costs 400,000. Our operating income increased 400% from 1.4 million in the first quarter of '17 to 7 million in the first quarter of '18. This improvement was primarily due to the improvement in gross margin from 27.3% to 28.5% and overall gross profit from 36.1 million in the first quarter of '17 to 40.8 million in the first quarter of '18 resulted primarily from the favorable mix of revenues during the first quarter of '18. On a GAAP basis net loss for the first quarter was 2.2 million, which includes a loss from discontinued operations of 3.5 million, which reflects approximately 2 million of increased costs on security deployment projects within Metropolitan transit authority, and approximately 800,000 of transaction expenses related to the pending divestiture of PSS. Moving on to the balance sheet and liquidity. Our cash balance is 128.2 million on April 1, including 400,000 of restricted cash. At quarter end, we had zero amounts for outstanding on our bank line of credit and 9.6 million of letters of credit outstanding. We generated cash flow from continuing operations for the first quarter of 6.5 million which includes approximately 1.1 million of internal non-capital expense related development costs related to the LCASD program. Capital expenditures of 6.7 million were primarily related to investments we are making in our satellite communications and unmanned systems businesses. Approximately 4.5 million of the CapEx was related to the unmanned systems business, which is primarily related to the two LCASD aircraft and related equipment we are building for our own use. We expect this capital effort to be complete by the third quarter with CapEx at elevated levels for the second and third quarter similar to the first quarter as we complete this program. DSOs increased from 121 days at the end of the year to 133 days at the end of the first quarter. Our DSOs include the impact of 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 where the demonstration of certain flight parameters, specifically in our Unmanned Systems segment. In addition, we have a number of billing milestone payments that are expected to be paid upon completion of contractual milestones is to written of our training solutions projects that are expected to be achieved in the second half of the year. As we are the prime contractor on sizable projects in our Unmanned Systems, training systems and rocket support services 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 86% of revenues generated from firm fixed price contract, 9% from cost plus, fixed fee contracts and 3% from T&M contracts. Revenues generated from contracts with the U.S. federal government during the quarter were approximately 71% which includes revenues generated with the DoD and with non-DoD federal government agencies. We also generated 12% from commercial customers and 17% from foreign customers with our aggregate non-DoD revenues comprising 29% of our total revenue. Backlog at first quarter end was $551.8 million with $495.4 million funded and $56.4 million unfunded. As we have discussed on our fourth quarter conference call the adoption of the new accounting standard on January 1st has resulted in our backlog being calculated as a dollar value of the remaining performance obligations on executed contracts as defined under the new accounting standard. Backlog will not include orders for which neither party has performed and which grant each party the unilateral right to terminated wholly unperformed contract without compensating the other party. As such backlog generally does not include options for additional performance obligations which have not been executed unless they are considered a material right of the base agreement when contract. For IDI2 contracts only tasks have been approved are included for backlog purposes. As we had expected our backlog was negatively impacted by the adoption of the new accounting standard and has resulted in the reduction of approximately 138.6 million of our backlog. On an apples-to-apples comparable basis, our backlog at year-end, which 518.1 million with 55.5 million funded and 62.6 million unfunded. The backlog related to the PSS business has also been removed from both periods. Accordingly, our book-to-bill ratio was 1.2 to 1 for the first quarter of ’18. As we mentioned on our last quarterly call, we do not include the full value of contract awards in our bookings or backlog until testing or funding is received. Also, importantly a number of our systems and products are designed in on and support long-time multi-year multi-decade programs. Although these expected Kratos deliveries are not reflected in our backlog, they do provide significant operational and financial visibility to our company. For instance, we may not necessarily include in our backlog or booking certain contract awards depending on current government funding on the award. As an example, we only included 7 million in our bookings for the recent contract award for aerial targets from the U.S. Army of 93 million which represents the executed delivery orders received to date although we expect to ultimately receive executed delivery orders for the 93 million. Moving on to guidance. today we are providing second quarter revenue guidance for the 140 to 150 million and adjusted EBITDA guidance 9 million to 11 million which is slightly lower than we had originally planned primarily due to a certain under contract UAS program that Eric mentioned being impacted by the CRA with the effect of approximately 4 to 5 drones in to Q3 from Q2. We have now received this funded contract. We are affirming Kratos' full year 2018 revenue guidance of 640 million to 650 million and adjusted EBITDA of 55 million to 59 million with average organic growth increases from 2017 of approximately 7% and 20%, respectively. We are also affirming Kratos full year cash flow from operations guidance, including the expected collection of net working capital proceeds of the PSS business retained by Kratos up 35 million to 45 million. Kratos full year 2018 financial guidance for revenues is 640 million to 650 million as compared to 603.3 million for the full year of 2017 and full-year adjusted EBITDA of 55 million to 59 million as compared to 47.6 million for the full-year of 17. Kratos is forecasting full year 2018 adjusted EPS of $0.16 to $0.18. We expect their total capital expenditures to be in the range of 23 million to 26 million for 2018, with approximately 14 million to 17 million related to our unmanned aerial systems business. The balance of the capital expenditures is expected 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 the remaining estimated investment of 7 to 10 million we plan to make to develop the C PLATFORM to maintain the intellectual property that is 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. Cumulative to date to Q1 and we’ve funded over 12 million of noncapital investment. In summary our estimated cash investment for the unmanned systems business is for 2018, including capital and other development costs is 21 million to 27 million. We expect that these cash investments for our unmanned tactical initiative will be substantially complete by the third quarter of 18, we expect our estimated cash taxes to be approximately 3 million to 4 million for ’18. We expect the impact of tax reform to be fairly and significant to our estimated cash taxes due to net operating loss position. Our NOLs are approximately 380 million. Despite the heightened level of continued investment in '18 of approximately 30 million to 35 million between CapEx and the remaining noncapital investment for LCASD we expect to generate cash flow from operations of 35 million to 45 million and free cash flow of 12 million to 19 million for ‘18 as we expect a number of the billing milestones which have impacted DSOs to be collected during the year.

[Eric DeMarco, President and CEO]

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

[Operator]

[Operator Instructions] Our first question comes from Ken Herbert of Canaccord. Your line is open.

[Ken Herbert, Canaccord]

Yes, I just wanted to first ask on the target drone business it currently looks you are seeing a nice inflection in the third quarter not only you have the budget and you've got visibility there. What is the guidance implies for margins for that business in the second half of this year and into 2019 on sort of that 150ish business which we see this year?

[Eric DeMarco, President and CEO]

For the second quarter half of the year compared to the first half we are expecting margins to increase as we ramp. definitely we are expecting them to increase. Right now, for 2019 we're expecting them to continue to increase and expand as we continue to ramp, and we get leverage off of our fixed overhead, our fixed manufacturing cost. And in addition to that we're working on a number of international opportunities, we're hoping to pass some of those to book in the second half of this year and those international opportunities they typically bring significantly higher profit margins to the company because we're not dealing with that [teenier] issues because we own the data packages on the drones.

[Ken Herbert, Canaccord]

So just to clarify the target drone business this year the mix is largely for the United States correct there is way for little international in there?

[Eric DeMarco, President and CEO]

There is some and there but it is the majority the vast maximum majority of the United States but there is we have a number of international customers. But the largest target drone users in the world are the United States Navy, United States Air Force, United States Army, we are sole source with each of them, then the UK Ministry of Defense we are with them and then there is the fifth one is coming and we're in solicitation on that one right now. And that drops off precipitously from a funding standpoint.

[Ken Herbert, Canaccord]

And if I could just one final question on the international opportunity, you've talked about obviously couple of your tactical vehicles getting approval from the Department of State, can you provide any more detail on timing around when these international opportunities could start to hit and any insight on relative size or quantifying the opportunities there?

[Eric DeMarco, President and CEO]

My expectation is before the end of the year on the tactical side we are going to book some Mako sales. I have the full expectation of that and I rather not get into slices right now but there will be meaningful -- they will additive to '19 and for successful in getting them book by the end of this year. I definitely expect quarters internationally to increase in '19 because obviously internationally it takes time, it's a process it's not an event, but we do have an advantage that a number of these customers to the state department approve for a specifically related to the Mako they are already our target drone customers so we know them, we have access and we know how to work it.

[Ken Herbert, Canaccord]

With the second quarter guidance you provided do we see sort of a similar profile for free cash flow in the second quarter as we've seen in the first quarter or is there anything you would highlight specifically we should keep in mind about the second quarter?

[Deanna Lund, EVP and CFO]

Sure, what I would highlight specifically about the second quarter is our interest payment is due at the end of the May and that’s roughly 9.5 to 10 million so that will be something an additional cash outlay in the second quarter that we did not see in the first quarter.

[Operator]

Our next question comes from Mike Crawford at B. Riley FBR. Your line is open.

[Mike Crawford, B. Riley FBR]

When you said that you expect to be, so with your current capacity by the end of ’19 is that including the Oklahoma facility? And what is the expected capacity of that Oklahoma facility versus what you have now in California?

[Eric DeMarco, President and CEO]

I’m glad you ask the question, Mike so I can clarify. No, that did not include the Oklahoma facility to be clear. our sacramental facility we expect to be at full capacity by the end of 2019. And that full capacity is going to be primarily dedicated to the U.S. Air force 167, the U.S. Army derivative 167, the United States Navy 177 and some other things. We are looking right now -- right now we’re building Firejets there. It is highly likely that we’re going to be transitioning Firejets by the end of this year. And then all tactical planes right now are contemplated to be manufactured in Oklahoma. And the capacity that we’re looking for in Oklahoma, we want to be able to have a capacity to build at least a few hundred drones a year there.

[Mike Crawford, B. Riley FBR]

There was an article that quoted. I think you or Stephen mentioning that the Gremlins was kind of the hybrid between Firejet and asset, is that true? And then also you still continuing development of the Gremlins concept, a separate concept that you had developed as a prime and Phase 1 in that competition?

[Eric DeMarco, President and CEO]

On the first question. Mike, I would say that, there are definitely similarities from a design and integration standpoint between the 167 and the 178 absolutely. And related to our Gremlin we absolutely took our Gremlin UAS. We absolute took our techniques, our production methodology, our auto play methodology and how we came up with our Gremlin and also very candidly with the [indiscernible]. And we believe that’s a winning combination for us in all areas because it’s a low cost high performance methodology that we have perfected. On your second question Mike, relative to Kratos’ Gremlin, I really -- I apologize, I cannot talk about that right now at this time.

[Mike Crawford, B. Riley FBR]

And then final question is with all these good things going on and [countering] with the fact that we just maintained guidance. What were the puts we’ve seen that would counter balance obviously get things?

[Eric DeMarco, President and CEO]

The primary put, that we have right now is when we gave our guidance, we gave ranges and we have an extended continue resolution that one all the way, it literally went six months. So, the primary put is us being able to execute on all the programs that we have. And we want to be conservative in what we are saying to make sure that we can meet what we are saying from a financial standpoint. This is not a question on the guidance of a book stuff, we need to execute and we need to do a good job. We have a great reputation with our customers right now that we do what we say, we do it on time on schedule on budget affordably and we cannot mess that up. So those were the primary thinking in estimating and maintaining our guidance at this time, we have a lot of wood to chop that we booked.

[Operator]

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

[Michael Ciarmoli, SunTrust]

Maybe just to say questioning on the guidance, can you give us a sense of how much of the ’18 revenue plan is already in backlog or booked for the clean line of sight to versus what we might need to go out there and get some book ship business if you would.

[Eric DeMarco, President and CEO]

The vast majority of our guidance in ‘18 is in backlog, the vast majority. And now with the '18 budget its getting funded as we speak.

[Michael Ciarmoli, SunTrust]

Got it and then just back to the margins, you mentioned opportunities to cut some of that that corporate overhead. I guess could you maybe elaborate there and you know, similarly I guess if your current capacity in Sacramento gets up to -- if you get to full capacity what sort of leverage should we expect you guys to whether its incremental margins or can you give us a sense of what that business could look like that sort of a run rate when you are operating at full capacity?

[Deanna Lund, EVP and CFO]

Michael this is Deanna, on the first part of your question far as what type of steps we are taking to reduce overall infrastructure cost, we’re negotiating reduced terms with certain of our large service providers such as our external auditors, IT service providers, and we’re looking at other internal costs as well to reduce those costs. We will be moving our facility later this year, the corporate facility which should maintains some of those costs as well. So, we’re looking at all aspects of corporate overhead infrastructure perspective.

[Eric DeMarco, President and CEO]

And Mike let me add one more to that, when we identified from the public safety businesses non-core about a year ago a little a more than a year ago, we made the conscious decision at the corporate cost level that if people retired or they went to other companies that we would not replace them. And we have continued that aggressively and that can be significant at this level as well. And so that's another one. on the first part of your question, Oklahoma, one of the primary reasons we elected Oklahoma is because of the cost structure and the cost structure of manufacturing drones in Oklahoma is significantly less than in California for all the reasons you can think of. So, we have a [two for and a three for] coming that we see over the next couple of years in our margins. The most immediate one as our business continues to ramp in Sacramento on the target drones we are going to be levering off that fixed manufacturing costs and margins are going to increase. I'll give you some estimated rates in a minute. Then as we start selling more drones internationally, those margins are inherently higher for the reasons I stated, but as I went through before the predominant of our business will always be, I believe the United States government. And then thirdly we start manufacturing drones in Oklahoma which as I indicated it's going to be in the first half of 2019 that cost structure is going to be less the margins they are going to be are going to be higher. We're looking at this business, we're going to get the 10% and then we're going to go into the low teens and ultimately at high rate we would like to get to the mid-teens.

[Michael Ciarmoli, SunTrust]

And I was going to say I mean you've got probably disproportionately higher amount of your revenues at fixed-price contracts versus some of your peers so that should enable you to get up to that teen rate so it sounds like that's in plan?

[Eric DeMarco, President and CEO]

So, this vast majority of our contracts in unmanned is our fixed price, there is only one that comes to mind is [Indiscernible] that's of any significance that's cost plus.

[Michael Ciarmoli, SunTrust]

How should we think about any CapEx going forward as you sort of build out Oklahoma?

[Eric DeMarco, President and CEO]

Right. So, we are literally finalizing the negotiations on that plan right now. But rest assured, because of the commitments that we are making as to the number of jobs we are going to place there and the pay structure of the number of jobs that we are going to place there. Oklahoma is being the state, the city and the county is being very generous with us right now relative to say leases and credits that they've committed to give us etcetera. All that means we are looking at a very low or limited capital out related to that very low or limited not material.

[Operator]

Our next question comes from Brian Ruttenbur of Drexel Hamilton. Your line is open.

[Brian Ruttenbur, Drexel Hamilton]

Couple of housekeeping questions, maybe less housekeeping but in terms of cash, your plans so you have 128 million right now, you are going to be getting the inflow of cash from PSS. Could you give us any light on what your plans are with that cash?

[Eric DeMarco, President and CEO]

So, as you're alluding to our net debt position pro forma post the PSS sale is going to be approximately 2:1. So we have significantly delevered and we have no intention at all of relevering up for any reason. As we talked in our prepared remarks, we've got a number of programs that we spoke about on the drone side that are beginning to ramp, we've got some opportunities that are very real, that we have not got into detail with you, that we could hit by the end of year, that would be very significant and could change the paradigm for us. It's important to us for a number of reasons until we see how this works up and we maintain a significant liquidity position on our balance sheet. So, A, there is no question in these customers minds based on the size, the potential programs they are thinking about giving us that we can execute the production on them. And we want to be able to easily handle any working capital requirements related to those without significantly impacting our net leverage position. So that’s a long way of saying for right now, we’re going to sit tight as we continue to pursue these new very large potential opportunities. We’ll see what we come out on that and if they don’t come to where I think they’re going to come out at the beginning of next year then we’ll make some decisions. As you probably know relative to our bonds, if we do not deploy that cash in 12 months depending on some characteristics in venture. We can call the bonds at par.

[Brian Ruttenbur, Drexel Hamilton]

And then my second question was SG&A. Can you talk about it from first quarter or second quarter kind of on a sequential move expecting to be flat and maybe talk about it as a total dollar amount on the year?

[Deanna Lund, EVP and CFO]

Sure. So, Brian, it should be about consistent that SG&A from Q1 to Q2 sequentially. And they really should be a lot of movement throughout the year except for probably in the fourth quarter typically that’s when we have more accrual, audit fees et cetera. But otherwise it should be about the same rate, it’s been at in the current quarter.

[Operator]

Our next question comes from [indiscernible] with Noble Capital Markets. Your line is open.

[Unidentified Analyst]

Just one kind of bigger picture question for me today. I’m curious about the impact of the one year versus the two-year budget as it pertains to the various UAS programs that you discussed that are comes in early stages of capture negotiation. I’m curious, what do you think the timeline from negotiation to development of these programs could be accelerated given the two years of visibility we have as compared to the programs that we all know about, that came into development amidst constant budget pressure?

[Eric DeMarco, President and CEO]

Absolutely, yes. Absolutely, correct. And the Secretary of Defense is actually alluded to that relative to the rapid innovation offices and the science and technology agencies most of these as you know that we’re working directly with on a number of these programs. The Secretary of Defense either this morning or just yesterday, he addressed the [indiscernible] and he is specially talked about that over the next two or three years, they are focused on the rapid identification, development, demonstration and fielding of high performance systems that have got to be in affordable costs and that is exactly how we position the company. Because we positioned ourselves for what you’re alluding to, that irrespective that we have $700 billion defense budget this year and with the bipartisan spending bill we’re going to have another $700 billion defense budget next year. Affordability is still going to be paramount, and deploying quantities is going to be equally is important the quality. And we believe because of our size small and the nature of the program we’re going after that is a very important competitive differentiator for us to our customers.

[Operator]

[Operator Instructions]. Our next question comes from Seth Seifman of JPMorgan. Your line is now open.

[Unidentified Analyst]

It’s actually Ben on for Seth. I wanted to ask about cash from ops kind of thinking beyond 2018. The guidance this year right at the midpoint, 40 million I mean that as a percentage of EBITDA that's about 70% and there are obviously some investments going on this year on unmanned, the falloff is that a good starting point for thinking about your cash generation as we go in the year ahead. is there any reason why couldn't be worse than like 70% of adjusted EBITDA?

[Eric DeMarco, President and CEO]

Year to year that is an absolute good starting point. And there is nothing that comes to mind right now that would indicate that it would be any worse. The only practical thing I could see that could impact that and it would not be significantly for a very long period of time is if in the next six or nine months we received an order for 300 drones. We have to deliver them in 24 months. And just depending on the milestones structure and the payments it might split 12 months to a 15 month but that’s the only thing I could see.

[Unidentified Analyst]

That, a bad problem to have I guess.

[Eric DeMarco, President and CEO]

No, but that ties directly into the question on maintaining cash on the balance sheet as we’re working on some stuff.

[Unidentified Analyst]

And then maybe just kind of on space. I mean there is lot going on right now in the space market, you are kind of well positioned in satcom world. Can you talk a little bit about some of the trends that you’re seeing and how you feel about your opportunity to grow and whether or not you think your satcom business can be the fastest-growing part of KGS once we get out beyond the training awards?

[Eric DeMarco, President and CEO]

The high-level line item right now is the amount of restricted or classified works is increasing rapidly, that's number one. Number two, I mentioned WGS, the two additional WGS satellites. You may have seen it just came out this morning on the next-generation's space-based infrared surveillance. We're involved in all of these. So new satellites that go up, we are involved in the ground segment on these. as I said we involved 85% US space missions we're in. what is happening right now is distributed communications. So instead of having exquisite $1 billion, $2 billion, $3 billion geostationary orbit satellites that make potentially nice UC targets for advisory is being distributed to hundreds if not thousands of Leos. So, these satellites are much less capable, but there's a lot more of them that means that they require an entire new generation of ground equipment and we’re directly involved in that as we speak. In addition, as you know we own and operate the only commercial and global network, our spectrum services business where we’re routinely monitoring hundreds of beams for our customers. This is expanding rapidly right now because of I'll use words like interference or interception that is happening with beans and people our customers want to know what's getting interfered with how it is being done and then we geo locate specifically where it's coming from so we can be mapped and neutralized those are the direct sourcing that those would be the drivers for same.

[Operator]

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

[Eric DeMarco, President and CEO]

Outstanding. Thank you very much for joining us. The next news that you'll probably see from us hopefully is the close of the PSS sales in the very near future and then will be chatting with you again at the end of Q2. Thank you.

[Operator]

Thank you, ladies and gentlemen, this does conclude today's conference. Thank you for your participation. Have a wonderful day. You may all disconnect.