Ladies and gentlemen, thank you for standing by, and welcome to the Kratos Defense and Security Solutions Third Quarter 2019 Earnings Conference Call. At this time, all participant lines are in a listen only mode. After the speakers' presentation, there will be a question and answer Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Marie Mendoza, Senior VP, General Counsel. Thank you.
Please go ahead, ma'am.
Thank you. Good afternoon, everyone. Thank you for joining us for the Kratos Defense and Security Solutions Q3 2019 conference call. With me today is Eric DeMarco, Kratos' President and Chief Executive Officer and Deanna Lund, Kratos' Executive Vice President and Chief Financial Officer. Before we begin the substance of today's call, I'd like everyone to please take note of the Safe Harbor paragraph that is included at the end of today's press release.
This paragraph emphasizes the major uncertainties and risks inherent in the forward looking statements we will make this afternoon. Please keep these uncertainties and risks in mind as we discuss future strategic initiatives, potential market opportunities, operational outlook and financial guidance during today's call. Today's call will also include a discussion of non GAAP financial measures as that term is defined in Regulation G. Non GAAP financial measures should not be considered in isolation from or as a substitute for financial information presented in compliance with GAAP. Accordingly, at the end of today's press release, we have provided a reconciliation of these non GAAP financial measures to the company's financial results prepared in accordance with GAAP.
With that, I will now turn the call over to Eric DeMarco.
Thank you, Maureen. As Kratos transitions from making significant investments and executing on development programs to executing on new or increased production programs. This transition is reflected in our financial performance, including organic growth and improved business mix, which is driving higher margins, profit and EBITDA rates. Representative third quarter financial highlights for Kratos include our revenues increased 15.5% over the prior year and importantly our unmanned systems revenues organically increased 37% over Q3 of 2018. Our operating income increased approximately 14% over the prior year and our adjusted EBITDA increased 22% over last year.
We generated $10,200,000 of third quarter operating cash flow, which brought our 9 month operating cash flow generation to $30,000,000 and our 9 month free cash flow generation of 12,000,000 dollars The free cash flow generation is even after the substantial investments we are making in our new Oklahoma drone facility and the build out of a separate new secured drone facility. And at the end of Q3, Kratos' LTM adjusted EBITDA was 75,000,000 dollars We believe that these financial results are representative of the long term growth platform we're building, including as reflected by the Q3's trailing 12 months book to bill ratio of our Unmanned Systems division of 1.3:one, where we are forecasting the strongest future growth for the company. Additionally, Kratos is on or positioned for a number of existing, new and planned for programs of record, which are expected to see significant future funding and growth as reflected in the pending 2020 DoD budget and in the 5 or fiscal year defense plan of the FITP. We also believe that affordability of Kratos' offerings, which have been a key element of our success, will be highly desired irrespective of which political party is in office or controls to Congress.
In Q3, our industry leading target drone business where we are sole or single source to the United States Army, Navy and Air Force generated particularly strong performance. And since our last report to you, we have received a number of contract awards, including international awards as global demand for threat representative target drones used to exercise radars and weapon systems continues to grow and Kratos' target drone opportunity pipeline contains several large new opportunities. When you see the large prime contractors receive a missile, a radar and a weapon systems program award, These systems, the related platforms and the operators need to be exercised and trained and Kratos' aerial seaborne and ground target drones are a key element in providing that operational readiness function. With the production programs we are currently executing on, the new contracts we expect to receive and the expected increased operating tempo as the U. S.
Military and our allies transition from fighting terrorists to addressing Russia and China. We expect our Target Drone business to continue its organic growth trajectory up to approximately $250,000,000 in annual revenue over the next few years. Since our last report to you, Kratos' Valkyrie successfully completed its 3rd test flight with all test points being achieved. As reported, the aircraft did suffer some very minor damage on recovery as the air cushion, which is provided to Kratos by a certain vendor, suffered an anomaly during parachute descent. The Valkyrie, like all of Kratos' high performance jet UAVs with our target drone heritage, is designed to be extremely rugged and quickly repaired and reused if damage is sustained in performing operational missions.
And as a result, the Valkyrie is easily repairable. The system robustness that we have is representative of the extremely high quality of Kratos' engineering, our execution teams and of the jet drones we produce. Very, very importantly, based on the flights performed to date and the resulting data generated, no changes are needed to any of the Valkyrie's airborne control systems, which is impressive for any newly developed system, but especially so for a high performance jet UAS. We believe that our customer set is extremely pleased with the XQ-58A system's performance to date, and we do not expect any delays in future orders from our customers as a result of this air cushion anomaly, as this cushion is only utilized for test events and is not contemplated to be used operationally. Since our last report to you, we have received additional contracts and increased Valkyrie funding.
We believe demonstrating increasing customer commitment and providing us confidence that we will receive future unit or production orders from multiple customers for the Valkyrie. The Air Force Association Conference was held during the Q3, at which we had numerous potential new customers come by the Kratos booth to discuss the Valkyrie, unmanned system concepts of operations, needs, requirements, timing of deployment and what the customer community envisions for the XQ-58A. An additional highlight at the Air Force was at the AFA conference at the Air Force Research Laboratory booth was a replica XQ-58A and an AFRL video showing the Valkyrie as the Skyboard program drone, with the AFRL also discussing the Valkyrie as a Vanguard program. As a result, the customer feedback we continue to receive and the contracts we have been and expect to receive, we are more confident than ever that if we continue to successfully execute, the Valkyrie will become a future program of record. We believe that there is currently an excess of $100,000,000 in the pending 2020 budget for the LCAC and Valkyrie related programs, and we expect this to be increased or plussed up by an additional $50,000,000 to 100,000,000 dollars once the 2020 DoD budget is approved.
Based on this expected funding and the recent discussions with our customers, we expect the 1st substantial Valkyrie related order within approximately 90 days after the 2020 budget takes effect. On the Gremlins program, we have now delivered the Gremlins' air vehicles to our prime partner Dynetics. And since our last report to you, the U. S. Air Force has designated the Gremlin as the X61A, which we believe is an important milestone for this current research agency program.
During the Q3, as a result of the Ridgecrest earthquake in California, which impacted the China Lake Range, the Gremlins' demonstration flights were announced to be delayed and Dynetics, our prime partner, is currently working to identify an alternative range site. As a result of this situation, at this time, we are currently planning for the Gremlins program to complete its demonstration series in the second half of next year. Based on recent discussions with Dynetics and directly with government representatives and the customer, we believe that customer interest in the Gremlins program similar to the Valkyrie has continued to increase due to the Gremlins systems capabilities, affordability and reusability. And we now have increased confidence that Gremlins will ultimately transfer to a service partner and also become a formal future program of record. We expect to receive initial orders for the Gremlin UAS once the demonstration flight schedule is successfully completed.
We have now received additional funding for Program F and we are working towards the next series of demonstration flights to begin early next year. We expect this phase of Program F demonstration flights to conclude around the middle of next year and based on most recent customer input, we are confident that once the demonstration series is successfully complete, we will receive initial program absystem orders. Kratos' Spartan drone program remains funded and on track. However, due to this program's nature, I am unable to comment further at this time. Program Apollo has recently received an excess of $10,000,000 in funding with a significant future funding increase now expected.
Program Thanatos has received an excess of $17,000,000 in funding, also now with a significant future funding increase also expected. As I have previously mentioned, we believe that Thanatos, if successful, has potential opportunity as large as we see for Kratos' Valkyrie. And since our last report to you, we have received approximately $9,000,000 in funding on 2 new tactical drone related program initiatives. On Kratos' Mako platform, I'm unable to discuss specifics at this time due to the restricted nature of the customer funded program Mako is associated with. I think that you can see from this report why we believe that customer acceptance and market demand for Kratos' affordable high performance drone systems and capabilities continues to increase and is gaining momentum.
Kratos' initiative with AeroVironment is tracking for an early 2020 flight and payload demonstration, and we are currently identifying an appropriate range location for the exercise. All other Kratos tactical drone programs and initiatives I have previously mentioned to you remain track. We believe that Kratos is the industry leader in our class of tactical drones and that Kratos has the only tactical drones in this class flying or in existence today, which include the Mako, the Valkyrie and Gremlin. We believe this is extremely differentiating to our customers and competitively important to our objective of ultimately building a very large tactical drone business. As we begin Q4, substantially all of Kratos' unmanned systems business forecasted revenue is currently in backlog and we are forecasting strong 2020 over 2019 organic growth and increased margins for this business.
In the Q3, Kratos' satellite business, the industry leader in ground command and control, continued to make progress on addressing its changing market and its related business transformation and positioning, which I discussed in detail on the last call. Our satellite business' new opportunity pipeline is robust. We are actively pursuing multiple large new program opportunities, both DoD and commercial, and we have high future expectations for this business. Missile and hypersonic vehicle tracking satellite programs are providing a particularly large opportunity for Kratos' satellite business and a Kratos team was recently successfully selected for the space sensor program, providing what we believe to be a large future growth opportunity for our company. We also believe that the new Space Development Agency, which was recently established and its vision for hundreds of small satellites, potentially hosting multiple payloads operating in a mesh network will also provide a new and very large opportunity for Kratos' Satellite C2 business.
Kratos' Satellite Business is where we routinely make the highest IR and D investments in the company and we are looking strong future performance and organic growth returns, including an expected business mix change, yielding somewhat lower revenues with higher margin rates, which I discussed on our last call with you. Growth drivers for Kratos' satellite ground equipment business include new LEO, MEO and GEO systems and constellations, including in the classified area and the continued growth in the high throughput and spot beam satellite systems. Representative programs of records we support include AEHF, Sivers, WGS and MUOS, and we are currently positioning for a very significant role on the next generation OPIR or overhead persistent infrared system, which if successful would be an additional significant future organic growth driver for Kratos. We currently expect year over year 2020 over 2019 organic growth for our satellite C2 business with increased margins. Kratos' Microwave Electronics business has been focused on achieving sole source designed in positions on a number of new platforms and systems and programs of record.
Since our last report to you, the initial order timing on certain of these large new opportunities has become much clearer as certain of our prime system customers have now received their initial orders and have indicated that the Kratos related orders are expected to be received soon. For example, Kratos is designed in on a certain airborne EW system and our prime partner just last week received its initial order for the first 350 systems. And we have been told that we will receive our 350 system order by Q1 of 2020. Kratos' content on this program is approximately $45,000 per system and both we and our prime partner expect the total number of systems to ultimately be far greater than this initial 350. We are expecting an exceptionally strong Q4 2019 from our microwave business with a substantial portion of our microwave business' expected Q4 revenue currently in backlog.
For our microwave business, we are forecasting year over year organic growth for 2020 over 2019 with increased margins, with representative programs or platforms we support, including Barak, Iron Dome, Aero, F-fifteen and F-sixteen. Kratos' turbine technologies finished the 3rd quarter performing on track and as we expected since our acquisition of Florida turbines earlier this year. KTT's next generation drone and tactical missile engine development programs, including in the hypersonic and classified areas also remain on track to our forecast. The tactical missile and drone market for the KTT class of engine is expected to expand and grow significantly over the next several years, with the expected demand for these engines to be in the 1,000. And we are positioning our company to participate in this very large market opportunity.
For customer and competitive reasons, we will no longer be providing any specific details on these next generation propulsion system programs or the platforms we are focused on and targeting. Kratos' C5ISR Modular Systems division performed as expected in Q3 and our Q4 outlook is solid with substantially all of Q4's expected revenue currently in backlog. Since our last report to you, our C5ISR business has been successfully designed in on or we are positioning for designed in on positions on a number of new for Kratos large system programs of record. As a result, our C5ISR business currently forecasting solid 2020 over 2019 organic revenue growth. Representative programs we support include Patriot, THAAD, SHORAD, SBIRS and CPP.
Kratos' Rocket Support business, where we are a prime contractor and a prime systems integrator for hypersonic, BMD target and other missions, was recently awarded a prime sole source contract for up to 33 Kratos proprietary rights for OREO Rocket Motors from a U. S. Government customer. We had not previously mentioned this opportunity, which has a total potential value to Kratos of up to approximately $150,000,000 and which is expected to be a significant financial contributor to Kratos beginning next year. In our Rocket Support business, we have recently been informed that our team was unsuccessful on one of the new Kratos large ballistic missile defense target opportunities we had previously mentioned, which we were tracking and expecting an award in the second half of twenty nineteen.
There is little impact to Kratos' 2019 from this opportunity loss as it was heavily factored in our forecast, though it could have been a significant financial contributor to Kratos beginning in 2020 had we been successful. We are currently in pursuit of a number of additional new hypersonic and BMD target opportunities in both the prime contractor and teaming role, certain of which may be awarded in the next few months. The U. S. National security focus and increased funding on hypersonic systems and capabilities are providing Kratos significant opportunities due to our proprietary proven and affordable hypersonic launch systems, and we expect Kratos opportunity set to continue to expand in this area.
We are currently forecasting year over year 2020 over 2019 organic revenue growth for our Rocket Support business. Kratos' Training Systems division is executing on a number of large programs and this business continues to have one of the strongest opportunity and business development pipelines in the company, driven by operational readiness requirements in new and upgraded weapon systems. Since our last report to you, we have received some very exciting news as Kratos was selected as the prime winner by the U. S. Army for a program to develop a virtual prototyping Holodeck to evaluate physical and psychological warfare under simulated real world scenarios.
This is a large prime contract win for Kratos' training business as this could be a very large future program and growth driver for our company. As we mentioned on last quarter's call, we were in a recompete on RS and FMS training services contract with Saudi Arabia, the company's largest at approximately $55,000,000 in annual revenue in 2019. With our existing contractual period of performance running through the end of this year. We were recently informed that we were not successful in the recompete. However, as a result of certain information we learned in the post award debrief, we protested the decision and we have just received potentially very favorable news on the protest.
As a result of the information we have received, the situation is now pending and though fluid, we currently expect to continue executing on this program into at least the beginning of Q2 of next year as the matter is resolved. For our Q4 and full year 2019 financial guidance, which we are reaffirming and that Deanna will cover, As I mentioned in my previous remarks, while we do need certain new bookings, we believe that we have our 'twenty nine forecast substantially in backlog at this time with final results depending on execution and business mix. Consistent with prior year's practice, we plan to provide our fiscal 2020 financial guidance with our full year fiscal 2019 financial report, which is currently planned for February of 2020. We believe this schedule will provide us with increased visibility into both the timing and funding content of the final DoD budget, which is particularly important this year with the current continuing resolution authorization underway, which typically prohibits new program starts and increased production on existing programs, both of which we believe are relevant to Kratos. However, irrespective of short term continuing resolutions and result in DoD budget delays, we believe that Kratos' future long term organic financial trajectory is up and to the right with increasing revenue, margins, profit and cash flow for the platform, programmatic and opportunity reasons I have discussed today.
Deanna?
Thank you, Eric. Good afternoon. Kratos' Q3 2019 revenues of $184,100,000 were at the high end of our estimates of $175,000,000 to $185,000,000 and our adjusted EBITDA of $20,400,000 exceeded our estimates of $16,000,000 to $18,000,000 due to a favorable mix of revenues and execution, primarily in our Space and Satellite Communications business. Excluding the impact of the recently acquired FTT entity, which contributed $16,300,000 in revenues, Kratos revenues grew organically 5.3% in the 3rd quarter compared to the prior year. Kratos adjusted EPS of $0.09 per share also exceeded our forecast of $0.05 to $0.07 per share for the quarter.
In the Q3, KGS generated revenues of 138,400,000 up 9.8 percent from $126,100,000 for Q3 2018, adjusted EBITDA of $15,500,000 or 11.2 percent of revenues, up from $14,100,000 in Q3 of 2018 and operating income of $11,100,000 up slightly from $11,000,000 in Q3 of 2018. Excluding the impact of the FTT acquisition, KGS revenues decreased 3.2% year over year or approximately $4,000,000 which resulted from the continued reduction in the company's legacy government services revenues, which declined $5,100,000 in the Q3 as compared to the prior year. Operating income and adjusted EBITDA were impacted by a favorable mix of revenue, including higher margin software revenues and leverage on fixed manufacturing overhead and administrative expenses. Revenues in our Unmanned Systems segment increased 37.2 percent from 33 point $3,000,000 in the Q3 of 2018 to $45,700,000 and adjusted EBITDA increased 88.5 percent from $2,600,000 to $4,900,000 in the Q3 of 2019. Our Q3 consolidated operating income was 11 $500,000 up from the Q3 of 2018 operating income of $10,100,000 Our adjusted EBITDA for the 3rd quarter is from consolidated continuing operations, including net income attributable to non controlling interest and excludes non cash stock based compensation costs of $2,800,000 and foreign transaction losses of $800,000 On a GAAP basis, net income for the 3rd quarter was 2 point $5,000,000 which includes $100,000 of income attributable to non controlling interest and a tax provision of $2,800,000 dollars Moving on to the balance sheet and liquidity.
Our cash balance was $181,000,000 at September 29. At quarter end, we had 0 amounts outstanding on our bank line of credit and $5,700,000 of letters of credit outstanding. Debt outstanding was $294,800,000 at quarter end and net debt was $113,800,000 Our LTM adjusted EBITDA was $75,100,000 with a net leverage ratio of 1.5:one. Cash flow generated from continuing operations for the 3rd quarter was $10,200,000 less capital expenditures of $8,100,000 or free cash flow from operations of $2,100,000 Our DSOs increased from 115 to 120 days due to the contractual milestone payments on long term delivery projects in our training solutions and unmanned systems businesses. Our contract mix for the quarter was 83% generated from fixed price contracts, 12% from cost plus contracts and 5% from time and material contracts.
Revenues generated from contracts with the U. S. Federal government during the quarter were approximately 69%, including revenues generated from contracts with the DoD, non DoD federal government agencies and FMS contracts, which were approximately 8%. We generated 10% from commercial customers and 21% from foreign customers. Our book to bill ratio for the quarter was 0.9:one, but the trailing 12 months was 1.0:1.
Our bookings were 172,500,000 dollars for the quarter with total backlog of $608,700,000 Just as a reminder, we typically do not include IDIQ contract values in our bookings or backlog. For instance, we recently received a $35,000,000 sole source IDIQ contract from the U. S. Air Force for subscale aerial target spares in September, under which we included $1,700,000 in our bookings and backlog as of September 29, representing the amounts that have been funded through that date. Today, we are reaffirming our full year revenue guidance of $720,000,000 to $740,000,000 adjusted EBITDA guidance of $71,000,000 to $77,000,000 and free cash flow guidance of $10,000,000 to $20,000,000 and the expected final cash receipt of the retained working capital at company's divested PSS business of approximately $4,000,000 to $6,000,000 We expect CapEx to be at elevated levels for full year 2019 with continued expected significant outlays in Q4 as we make the necessary company plans to manufacture in preparation of fulfilling expected customer requirements.
We expect our estimated cash taxes to be approximately $2,500,000 to $3,500,000 for FY 2019, reflecting the impact of the over $300,000,000 in net operating losses that we have. Eric?
Thank you, Deanna. We'll now turn it over to the moderator for any questions.
And our first question is from Josh Sullivan from Seaport Global. Your line is now open.
Good evening.
Just with regard to the Valkyrie program, outside of the continuing resolution timing, what are the remaining steps for the program before a larger order? How many more flight tests are required here?
And Josh, the first part I couldn't hear you talking on the Valkyrie?
Yes, on the Valkyrie program. How many more flight tests are required before an order?
So, well, I don't know how many flight tests are required before an order. I believe we could receive an order before any more flight tests occur, for example. So they're not I do not see them as directly linked together.
Okay, got it. And then just on the organic growth in the BMD segment in 2020 that you're referencing, does that assume any weighting on winning some of these hypersonic contracts you're going after? Or can you hit that independent of those wins?
We the vast majority of it, we believe we've got with that over 30 rocket motor order we just received. So the primary item that could impact it, Josh, would be timing on when we get a 2020 budget.
And then just the $6,000,000 to $8,000,000 related to the company owned aerial target drones you're building, was that increased? And then given you're investing in the drones or the product, will you own the IP for whatever programs those are going after?
Yes, Josh, that was increased by that $2,000,000 In total, CapEx has not increased, but the components within the CapEx for unmanned shifted a little bit. And those are targets that we own that we have the IP on.
And then just on the competitive environment, outside of the Valkyrie, Thanos, Spartan, Project F, are you seeing a competitive response? Are you still the only bidder in some of these programs?
Oh, no. There has definitely been a competitive response. Thanatos was competitive. Spartan was competitive. We're going after one right now that is competitive.
So there is definitely competition in this area. Got it. Thank you. Yes, sir.
Thank you. Our next question is from Noah Poponak from Goldman Sachs. Your line is now open.
Hello, everybody. Good morning.
Not sure where you are, Eric, but good evening to you.
Good evening.
Yes, maybe a long day. So I wanted to ask about the margins. There are better margins in the quarter and you kind of opened up your prepared remarks talking about the shift in mix that's and it didn't sound specific to the quarter. It sounded like you view it as an ongoing shift in mix improving the margins. And so on the one hand, early stages of new work can be lower margin.
On the other hand, you guys have had heavy investments that I think come out, faster volume growth can just have drop through. And it seems like you have a much more substantial degree of automation involved in future work. So should we be thinking about these 3Q margins as a new baseline that you work off of to go higher from here? Or is the Q3 really benefiting a lot from mix?
In our satellite and space business, which as you know is the biggest in the company, there is a transition moving more towards software defined elements than hardware, which is driving increased margins. We believe that is going to continue into next year and into the future until it stabilizes. So our satellite business, particularly in where we're doing the space situational awareness, where we own and operate the global network and in the products that we're delivering, which are moving more towards software. Margins are definitely increasing there. Revenue is coming down somewhat as it moves to software.
On the drone side, as we transition from these development programs to low rate initial production to full rate production. Right now that which is occurring in the target drone side as Deanna mentioned, we are getting increased margins there as quantities go up in the production facilities. We're getting leverage on the fixed manufacturing costs. We expect that to continue more going forward as more units go through the factories and we get the leverage on them. So those are the 2 primary areas where margins are going up and they're kind of sorted for different reasons.
Is there something offsetting those things?
Let me think. Probably depending on how the training business recompete turns out and the structure of that contract going forward, that very likely could have reduced margins to it. And I because of the situation we're in, which I said, we're in a good mood about how this appears to be trending right now. Because it's live, I don't want to get into it too much, but our training business margins, at least on that major program, if it's sustained, could start coming down somewhat. On our commercial satellite business, where we this is where we build earth stations, teleports, which do command and control and they do signal monitoring.
There is commercial pressure there. So those margins, we do not expect those to increase. And depending on the nature of the business, we could see some compression there.
So all in, Eric, do you what's your level of confidence that you expand the margins in 2020 versus 2019?
High.
Okay. If I take the guidance for 2019, and if I go to the midpoint of the revenue, in order to be at the midpoint of EBITDA, the margin in the Q4 would have to be down 200 basis points sequentially and it would have to be the lowest margin of the year, which is usually not the Is that conservatism or is there something specific in the
mix in the Q4? We are trying to be cautious because of the CRA that currently goes through the 3rd week of November and very possibly could go through the end of the year and what that potentially could do. For example, as you know, typically in Q3 and Q4 because it surrounds that federal fiscal year, we and particularly in the satellite business, we get dropship orders of equipment and software sales.
Yes.
And some of those can be very high margin.
So are those out of the guidance?
We have been we are looking at them on a case by case basis and factoring not knowing what's going to happen after November 22 or whatever that date is.
I understand.
Okay.
Related to the CR, I believe you said you could see a Valkyrie order within 90 days post a final 2020 budget. So is it looking increasingly likely you'll have not insignificant Valkyrie revenues in 2020?
Is it looking Noah, say that last part again. I want to make sure I answer the question.
Well, I guess prior to today, it felt like the timeline on Valkyrie, made 2021 and beyond revenues look very likely. And obviously, that's what matters most. But just in thinking of the pieces for next year, I thought Valkyrie revenue contribution was more of a coin toss. But it sounds like you're saying you would expect an order just a few months into next year, unless I heard that incorrectly.
No. I am expecting a material Valkyrie related order within 90 days after the 2020 budget becomes effective.
Okay. And then just last item, and I'll go back in the queue. Did you quantify the training, the annual revenue contribution from the training program that had the recompete?
Yes. And so, what we have said on the last quarter's call, when we talked about the recompete is that because of the restructuring that I mentioned a minute ago, it was looking to be something like $25,000,000 or $30,000,000 a year going forward, okay. However, for this year in 2019, because of the opt tempo that has been going on in the structure of the contract, it is about $50,000,000 And so we were planning on it coming down because of the structure. So this year was fifty-fifty 5, next year was 20five-thirty because of the structure change.
And then if I heard you correctly, because of the timeline of protest, it sounds like you will at least have that extended into mid-twenty 20 even if you ultimately don't keep it. And then obviously, if you keep it, you keep it. Is that correct?
Right. Yes. So what I said was that right now, based on and again, this is live, so I don't want to get ahead of anybody, but based on most recent communications, we're expecting to maintain it at least into the beginning of Q2.
Okay. Okay. Thanks so much.
Yes, sir.
Thank you. Our next question is from Seth Seifman from JPMorgan. Your line is now open.
Hey, good afternoon. This is actually Ben on for Seth.
Hi, Ben. Hi, Ben.
So I guess I wanted to hone in on the organic sales in KGS for a bit. I mean, you've given some encouraging commentary today about 2020. You've been talking about this business pretty positively the last few quarters. But if we kind of dig into Q3 and strip out KTT and even taking out the headwind from government services, the kind of the rest of this business was pretty flattish. So I guess how do we kind of square that up with kind of the go forward outlook for this business?
Right. So in our KGS business, let's take training, for example. We work on very large programs. Like for example, we are in production right now on KC-forty 6. We are in production on a number of Marine Corps common aircrew trainers.
These are tens of 1,000,000 of dollar programs. We are in a massive program with the Navy. So when we win these programs, when we're awarded them, our book to bill in that quarter can be 3 or 4 to 1. But then it runs out for 2 or 3 years, if you see what I mean. And so there are a number of things that we're pursuing right now that if we're successful on, there could be a significant blip upwards in our book to bill ratio that will carry that LTM forward at 1.2 or 1.3 to 1 for a while.
So that's one that's the dynamic of that business, which is also the same in our C5ISR business. Very, very large programs. And I believe it looks like you're going to see that in Q4 in our C5ISR business relative to a very large platform that we're sole source on. So we're going to get it. And if we do get it in Q4, you're going to see a significant upward tick because of the size of it and it's going to be all funded and how far it goes into the future.
And then on the satellite side, on the space side, that business, it's a mix of very large programs, like I mentioned, OPIR. As you know, we have an integral part on Sivers. OPIR is kind of sort of a follow on to Sivers. I believe we're going to get a significant sole source position on OPIR, which if that happens will be a significant uptick in bookings and backlog for that period. There's another part of this of satellite business that we were just answering with Noah about that is on the software side that is more of a book and burn where we get them quarter to quarter.
And so there's that mix going on. That's kind of how I reconcile what's going on in KGS.
Okay. That's pretty helpful. And I guess on the continuing resolution, the risk is increasing that we see this extended not only to the end of the year, but possibly, I mean, we're hearing what about what happens if it's a full year CR. I guess, which of your business units and the growth outlooks there are most at risk if we see some CR that extends into 2020?
So the good news is, is on the base business, we're in a coming in 2019 was a $720,000,000,000 defense budget. We're now in production on Navy SSAT. We're in production on AVSAT. We're in production on another one. So the good news is, is we've achieved production on a lot of these.
So the base business, if there were an extended continuing resolution, is very solid work in production. If the CRA is extended, for example, we cannot get to full rate production on SSA restricted program I can't say a lot about. We are in LRIP on it. It is a very good program, very profitable. We can't get to full rate production on that.
And that program happens to be in our unmanned systems business. On the tactical drone side, we have the development funding from the 2019 budget. Unless there is a reprogramming, which only occurs from time to time, we cannot move into significant production in
KGS, you think, is mostly unaffected by
a long term
Well, I want to be very clear here. It's unaffected. It cannot see significant growth increases in ramps in production without the budget. It can hold court, but as you know, there are no new production programs under CR and there are no increases to existing production programs under a CR unless there's a reprogramming.
Right. That makes sense. And just the last one, can you give us a percentage of the unmanned sales this year that comes from tactical drones?
I don't have that off the top of my head because we don't have production revenue in that area right now. It's substantially all target aerial drones, target ground drones and target seaborne drones and the related command and control and avionics and electronics. So I'm sorry, I don't have that right here with me.
That's okay. Thanks.
Okay.
Thank you. Our next question is from Ken Herbert from Canaccord. Your line is now open.
Hi, Eric, Indiana.
Hi, Ken.
Hi.
I wanted to first dig into Gremlins a little bit. I know we've been following and you've talked about the capacity issues around flight test ranges. Is it a similar dynamic with Gremlins that you could potentially get a follow on contract or incremental contracts without corresponding progress on the flight test side? Or is this program really dependent upon continued progress on the flight test and demonstration with the upcoming milestones, which means a contract, maybe the soonest is second half of twenty twenty depending upon schedule for the flight test program?
Right. Since obviously, since we're not the prime Dynetics, I don't ever want to get ahead of them. But from what we've seen with the Valkyrie and what we expect with the Valkyrie, I think it's absolutely possible that there could be drone orders before a phase or a series of demonstration programs is complete.
Okay. But it sounds like from your commentary that, I mean, CR issues aside, would you view that as a relatively low probability or something that maybe has a decent chance?
I think to be safe and to be conservative, I would go with the assumption that once the demonstrations are successfully completed, then you move to unit orders. I think that would be the safe way to go.
Okay. And if I could, Eric, just a bigger question. I mean, obviously, your customer on the Air Force side has talked a lot about the digital twin or digital thread or digital manufacturing as you think about how they are really trying to drive accelerated development processes and testing of weapons systems. I know you own the IP on the Valkyrie and it's obviously attributable. But to what extent did you sort of follow that design or incorporate that into design process?
And how much optionality or flexibility does that give you on that platform sort of moving forward with the risk of getting ahead of things, but it's pretty clear that programs like the Valkyrie will undergo fairly substantial refresh and upgrade cycles as the technology moves forward. And I'm just trying to get a sense as to your position on that considering the major focus of your customer.
That's a great question. Let me give you the analogy of this, Ken. The F-fifteen has been flying since the 70s and Boeing has now come out with an F-fifteen EX. And if you look at the airframe, the airframe of that 4 or 4.5 generation fighter is substantially or almost exactly the same as it was in the 70s. Hold that thought relative to the Valkyrie.
The Valkyrie is an incredible airframe. For security reasons, I can't say a lot about it. But if you look at it, you know what I mean. It has been specifically designed to be modular with open architecture for payloads. So the reason the F-fifteen is still flying today is because of new electronic warfare systems, new ISR systems, new Earth systems, okay, new weapon systems.
The Valkyrie has been designed the exact same way with open architecture plug and play modularity. So for that type of a system, it is extremely flexible. And we designed it specifically to address the thought you have right there.
Okay, excellent. Thank you very much, Eric and Deanna.
You got it. Thank you.
Thank you. Our next question is from Mike Crawford from B. Riley FBR. Your line is now open.
Thank you. Eric, why build company owned targets? I understand why you build company owned tactical drones like the Mako and the Valkyrie, but unless it was a hypersonic where you're trying to demonstrate something ahead of a known requirement, I understand why you would build a company owned target.
So we just completed in the last few weeks a very large target operation for an international customer at an international range, very large, multiple, multiple fire jet targets. The reason we got that job is because we had 10 or 15 fire jets company owned assets look at it as on the shelf, where that customer said, we want to do an op in 90 days. There's no way we could build them in 90 days with the production plans we have and everything else going on. We pulled the company owned assets off the shelf. We put together a contract that was a lease where they're leasing them.
So they're leasing the flight, they're leasing the representation. But in that agreement, when they shoot them down, they buy it and it's no longer company owned. So now the numbers I'm going to give you are an example because I can't get into the details. Let's say we brought 20 of them down there, we owned all 20 of them, they're ours. If they didn't shoot any of them down, we get all 20 back, they're customers, Kratos owned.
But if they shoot 10 of them down, they pay for the 10. We get the 10 that survived back. Those are still company owned and they go back into capital. It gives us the flexibility to react very quickly to customer demands, which gives us a competitive advantage.
Okay. Great. Thank you. And just maybe if I could dig in a bit further on the margin front. If you look at some unspecified future date where in unmanned systems you have target revenue approaching $250,000,000 a year and maybe tactical revenue nearly twice that much and running at a good full production rates at all your facilities.
Do you have a sense of what the EBITDA margins might be in unmanned systems at that point in time and more of a steady state like point in time?
Yes, 14% to 15%.
Okay, great. Thank you.
Thank you.
Thank you. Our next question is from Joe Gomes from Noble Capital. Your line is now open.
Thank you. Last quarter, you talked about you had placed the engine order, and you talked a little bit today about the 90 days of the budget being adopted of getting orders. Are you still very comfortable with where you are in the engine orders? You could give a little more color or detail there, I'd
appreciate it. Absolutely. We absolutely are. And Joe, very candidly, about 3 weeks ago, because of what's going on with the customer set, we had the discussions about actually ordering more engines because right now, it appears what the customer and it's plural, customers, what they envision is they want to start receiving the drones in 2021. And and with a 12 month lead time on the engine, the only way we could hit what they're communicating to us they would like is to order the ones we already ordered and potentially depending on how things are lining up, we may in fact order some more, which not only helps from a customer standpoint, but helps from a company standpoint because these engines are specific.
And we'll just talk about the Valkyrie because we're looking at this for different things. For the Valkyrie, let's say we get this order an order by the end of March, and that would assume end of the year through the end of the year continuing resolution. Well, we get that order and there's significant progress has been done building those engines. We believe these are going to qualify for a percent complete accounting instead of a unit delivery. We believe right now that's what it appears to be.
So that could be beneficial for us in my example that we could start generating revenue in Q2 on the effort incurred to date on the engines plus any other effort we've been doing on the program.
Okay. Thanks on that. And if you
could just provide a little more detail on the you talked about the legacy government services business that was down in the quarter. I mean, where do we stand on that business today? Is it just going to be bled off? Or what do we see for that business?
So that business right now is about $50,000,000 to $55,000,000 a year in revenue. And Joe, it's terrible business. Everything is LPTA, low price technically acceptable. It's all the cost shoot out. It's all commoditized.
It's very difficult. I thank God we're in a product and systems business. So we're still bidding. We're still trying to win, but we don't bid low. We're not going to bid gum, dumb low.
And so it's probably going to continue to trail off.
Okay, great. Thank you. Yes.
Thank you. Our next question is from Michael Ciarmoli from SunTrust. Your line is now open.
Hey, good evening, guys. Thanks for taking the questions. Hi, Michael. How are you? Eric, just on the continuing resolution, can you talk about how it's it is already or it may impact order flow?
Are you seeing anything on bookings? And then as it relates to you sort of gave us, I think, a pretty good timeline last quarter of Gremlins expecting a first half order, Thanatos, Spartan, Athena, some of the revenues they were supposed to get in 2020, I think Omega first half award. Does any of that change or slide to the right a little bit under a continuing resolution?
Yes. So we, as I went through, we've received some. We've been fortunate enough to receive some. But you heard me mention, Ike, we expect significant future funding on Thanatos. We expect significant future funding on Spartan.
Those are moving to the right. They're tied to the budget. That's what it looks like to us. They're directly tied to that 2020 budget. And so yes, we've been fortunate.
We've gotten some, but there's a handful or so that are just moving on us. They're sitting there. We've won them. They're ours, but it's just they're moving. So that tells me they're tied to a 2020 budget being approved.
Okay. And then just back to the margins, I think kind of what Noah was hitting on and Mike, you mentioned 14% to 15% EBITDA margins. It sounded like with volume, you can get better overhead absorption. But how should we think about, I guess, specifically maybe in Oklahoma, the production scheme there, you've been prototyping some Valkyries. You've got to step up.
You just talked about ordering the engines as you kind of transition from prototyping to even lower rate production? I mean, do we is there a little bit of a hiccup there with natural learning curves as you sort of begin to industrialize that process away from just prototyping?
Yes. So that's a good question. So in Oklahoma, right now, we are building production fire jets. And our plan over time is to transition a significant amount, if not all of the fire jet production, so the MQM-one hundred and seventy eight, out of Sacramento to Oklahoma. So the autoclave has arrived.
It's up and running. We're going to start building aerostructures there soon. And we need to do that because of our 177 production increases for the Navy in Sacramento. We cannot move that because of qualifications. And we are seeing also seeing increases with the Air Force and the 167.
And we have some other things going on in Sacramento that cannot be moved. So we're going to move the fire jets. We're building those in Sacramento right now. We're going to continue to move those. However, now to your point, there will definitely be a learning curve on the tactical drones, just like there is on a target drone, where and just like there is on F-thirty 5, where the first one costs X, the second one costs Y, which is less than X, the third one costs Z, which is less than Y, as you learn, as you build them and it comes down.
So, Mike, Mr. Crawford's question was when your steady state is normalized and that's how it's I took it. But when you are in initial production and LRIP, you do not have the efficiencies that you will have when you're in full rate production. So you will not have the margins.
Got it. Last one for me. Can we just get an update on the, I think, that last missile target contract, the Teeser contract, when you expect to hear something from that and maybe kind of order of magnitude, how that would impact revenues versus the current run rate of that program?
Right. So right now, that solicitation, it looks like it is due to come out either late this year, but I plan on Q1 because of what's going on in Washington. And as a result, the solicitation comes out in Q1 or so, I would look for a Q3 or Q4 award. I think this is one of those things that are being pushed to the right. Order of magnitude, what we are looking at right now, this can change because we have not seen the solicitation yet, is 25 to 50 a year.
Got it.
All right, perfect. Thanks guys.
Thank you.
Thank you. Our next question is from Pete Skibitski from Alembic Global. Your line is now open.
Hey, good afternoon, guys. Nice quarter. Hey, Eric, just can you side maybe this Ermi Holodeck program? It sounds like you're pretty high on that program.
I'm very I'm so proud of the team. Our training team knocked it out of the park on this one. Extremely competitive bid, but it was not low price technically acceptable, it was best value. And we won, in my opinion, because of our technology. And it's the initial award is a multi, multi $1,000,000 award that we're working on.
But the scope of this and what this touches, it's very, very significant. I can't say more than what we put out in our little brief press release to get ahead of the customer, But this is Kratos. This is leading edge technology integrated together to bring a solution to the customer that is very high-tech, but it's not bleeding edge. So there's not a ton of risk where it can be a win win, and we're looking for a multi year growing program here.
Okay. Appreciate it. Just one more question and I'm not even sure if you're tracking this, but this idea of having a system design agent for Skyborg seems to be kind of moving along. Do you think that impacts your role there on that program? It sounds like kind of an ecosystem approach that the Air Force is kind of thinking about this.
Could you are you tracking that and what's your thoughts on that?
Oh, yes, we're tracking it very closely. We responded to the RFI. I believe the RFP will probably come out in Q1. I do not believe that, that approach in any way adversely impacts Kratos. Skyborg is an AI program.
It's an artificial intelligence program. We are providing the platform or the platforms, and I want to say it that way because it could be platforms relative to the affordable tactical drone element of that AI program. So we're on it. We're tracking it. I am highly confident we will participate in this one way or another when it comes to fruition.
And this structure that they've been talking about for the past month, it's very interesting. I see what they're doing, but in no way is that adverse for our aspect of this.
Okay. But are you saying that you could potentially you look to prime on the SPA role as well? So it will be additive to the drone role?
Or not
necessarily? I don't want us to say that specifically to Skyborg because I don't know yet. However, remember Gremlins, we primed it and we partnered it. And in Phase 1, we won 1 of each.
Right. Okay.
Okay, fair enough.
Okay. Thank you.
Thanks for the color, guys.
Okay.
Thank you. Our next question is from Noah Poponak from Goldman Sachs. Your line is now open.
Eric, could you just circle back and just give us a fresh update on the total BMD hypersonic target opportunity topic because pretty recently it was the 3 programs you had won the first, Northrop won the second, the third was outstanding. But then a few weeks ago, you had the Oriole Rocket Motor Award that seemed to, at least to us came out of nowhere. And then in your prepared remarks today you said you're in pursuit of multiple BMD and hypersonic target ops, some of which could be awarded in the next few months. So that seems new. Is this just rapidly evolving?
Or what's the update?
So prime system integrators that are winning hypersonic weapon programs, they need to test aspects of it. They need to test the front end. They need to test what I'll call telemetry in the right place at the right time at the right speed of things. And as you know, we have a proven system that has been doing that for a long time on programs like High Cause and High Fire and Fast. And so we see that I have to be careful here.
We see the potential opportunity to support guys that have been winning system programs to help test for them to test their systems very rapidly and very affordably, so they can hit their deployment deadlines.
I'm assuming those are considerably smaller than something like the third one you talked about priming and it being a $1,000,000,000 program?
Correct. Absolutely. Yes, sir.
But they could come at you pretty quickly?
Yes, sir.
Okay. And then on Gremlins, what is the updated flight test timeline?
So I would, again, DynetX is the prime. However, Dynetics, their program manager did an interview in the past 3 weeks that is public, where they have indicated they have identified an additional range, a new one. They are working ISET plan on Q1. They are trying to get something done in Q4 this year. And so I encourage I don't want to speak for them.
I encourage you to take a look at that, their work on that.
So I think previously, you guys had estimated test flight before the end of 2019 and then the final test flight mid-twenty 20. Understand earthquakes are out of everyone's control, but sounds like the initial has slipped as a result, maybe tucks into the end of 2019, the final mid-twenty 20. Is that still a rough order of magnitude what we should be thinking?
In the prepared remarks, Noah, I had said that right now, I'm planning on the second half of 'twenty because of that anomaly and hopefully things will change and it will be sooner than that.
Okay. Thank you.
Thank you.
Thank you. At this time, I'm showing no further questions.
I would like to turn
the call back over to Eric DeMarco for closing remarks.
Thank you very much for joining us this afternoon, and we will be circling up with you when we report our Q4 in February. Thank you.
Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.