Marie Mendoza - Senior Corporate Attorney and Acting General Counsel Eric DeMarco - President and CEO Deanna Lund - Executive Vice President and CFO.

Mike Crawford - B. Riley and Company Mark Jordan - Noble Financial John Nelson - The State of Wisconsin Investment Board Kevin Ciabattoni - KeyBanc Capital Markets Sheila Kahyaoglu - Jefferies Eric Selle - SunTrust.

Good day, ladies and gentlemen. And welcome to the Kratos Defense and Security Solutions Third Quarter 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will host a question-and-answer session, and instructions will follow at that time.

[Operator Instructions] I would now like to turn the call over to Marie Mendoza, Senior Corporate Attorney, Acting General Counsel. Ma’am, you may begin..

Thank you. Good afternoon, everyone. And thank you for joining us for the Kratos Defense and Security Solutions third quarter 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 emphasis the major uncertainties and risks inherent in the forward-looking statements we will make this afternoon.

Please keep these uncertainties and risks in mind as we discuss future strategic initiatives, operational outlook, and financial guidance during today’s call. Today’s call will also include a discussion of non-GAAP financial measures, as that term is defined in Regulation G.

Non-GAAP financial measures should not be considered in isolation from or as a substitute for financial information presented in compliance with GAAP. Accordingly, at the end of today’s press release we have provided a reconciliation of these of these non-GAAP financial measures to the company’s financial results prepared in accordance with GAAP.

With that, I will now turn the call over to Eric DeMarco..

Thank you, Marie. Good afternoon. As we've previously mentioned to you, the fourth quarter would be an important period related to the progress of certain of our unmanned aerial vehicle products, platforms and our initiatives.

We are pleased to report that we have successfully completed the initial flight of Kratos’ UTAP-22 high performance unmanned tactical aerial platform, with additional future flights scheduled in the near future to further demonstrate this aircraft’s capabilities and evaluate potential requirements.

The successful flight of Kratos’ UTAP-22 is the most important milestone that our company has achieved to-date in our tactical aerial system strategic initiative.

For competitive, confidentiality and other considerations, at this time, we will not communicate more than what was included in today's earnings release related to this successful initial flight. Though we have received preliminary positive feedback from certain potential customers we have been meeting with.

We are all very excited about the future prospects for Kratos’ UTAP-22 and we hope to communicate additional positive developments with you over the next few months.

A key element related to Kratos’ returning to sustained organic growth is the Subsonic Aerial Target or SSAT program, which remains on track to begin low rate initial production in late 2016, with Kratos executing another recent successful flight during which we achieve all of our flight objectives.

The SSAT 177 is Kratos’ unmanned aerial target platform that we are under contract to develop and produce for the U.S. Navy, which replaces the legacy BQM-34 and BQM-74 target systems, which are no longer production.

The most recent SSAT flight demonstrated certain advanced flight performance characteristics that we have been working on over the past several years and where we are making a considerable investment.

Kratos’ SSAT contract vehicle includes price options, which are expected to be exercise in late 2016 for LRIP or Low Rate Initial Production, initially of approximately 30 to 35 units to be delivered in fiscal 2017 at approximately a 1 million per vehicle and are currently estimated additional 40 to 50 LRIP units to be delivered in 2018 under LRIP II.

Following these deliveries, we expect to move to full rate production, which we anticipate will reach approximately 100 units annually.

Due to increase in anticipated SSAT deliveries over the next few years, this program is expected to ultimately be Kratos' largest before consideration of other new platforms or programs that we are currently developing or responding to via RFPs.

Additionally, a separate large confidential program we are working on also remains on track to begin LRIP in late 2016, with this program also expected to become one of Kratos’ largest over the next few years once it achieves full rate production.

We are also in pursuit of a number of new unmanned opportunities in the tactical target drone and ground system areas, certain of which solicitations have come out since we reported Q2, and which we are currently expected to be awarded in the next few months.

Certain of these opportunities if Kratos is successful could also become some of our company’s most portal programs. With the third quarter closing of the sale of Kratos’ U.S. and U.K. electronic products businesses, and our recent success for UTAP-22 flight, it's important to clearly reiterate Kratos' strategy and our go-forward plan.

For the past two years, we have been making significant discretionary internal investments in certain potential high-growth areas, including most importantly, the tactical unmanned aerial system area.

These discretionary investments have increased as certain new solicitations for potentially high, large, high-performance value unmanned aerial system program opportunities have recently come out, which we see as validation of our tactical unmanned aerial system strategy, which commenced in earnest last year and as the genesis of Kratos’ UTAP-22.

We have been executing our unmanned systems strategic plan, knowing that we have core businesses, including Satellite Communications, Microwave Electronics, Defense and Rocket Support Solutions, Training Systems, Cybersecurity and Aerial Target and Drone Systems that generates significant profitability and cash flow.

We also believe that these businesses and our company are highly valuable as indicated by our recently completed strategic review process. The internally funded discretionary investments that we've been making in the unmanned aerial system area have significantly reduced the recent profitability and cash flow of our company.

However, we have been consciously executing this strategic plan in the pursuit of sustained long-term and potential transformational growth. The culmination of Kratos’ unmanned initiative and the investments will be playing out over the next several quarters.

With our UTAP-22 progress and the award of certain of these new high quality unmanned tactical aircraft solicitations, which we are -- if we are successful will position our company as the leader in the new and expected to be high-growth future market area.

Obviously, we understand that in the tactical UAS area we are competing against some of the most experienced, technological and well-funded enterprises in the industry.

Though we expect success in the tactical UAS area, especially with our recent successful flight, if we do not obtain our planned goals we will dramatically reduce the discretionary investments we have been making, which would immediately and significantly improve Kratos’ profitability, free cash flow and our leverage position.

We would then focus on being the world's leading provider of high performance unmanned aerial target drone systems, where we are currently under contract on two programs, which as I mentioned before, are expected to go into LRIP in the second half of next year and once in full rate production are expected to generate in excess of $100 million a year a new high margin incremental annual revenue for Kratos.

At that time, we anticipate that Kratos will be the primary high performance unmanned aerial target drone system provider to the United States Air Force, Navy, Army and multiple international customers, with numerous new and updated weapon and other systems being fielded requiring operational testing driving demand.

Additionally, Kratos’ Microwave Electronics business, where we currently have a near record high backlog and are positioned on a number of new programs is also extremely well-positioned for future growth with recent global military emphasis on electronic warfare, missile and radar systems.

And related to Kratos’ Microwave Electronic Products business we just recently learned that Kratos is expect to begin product deliveries next year for an upgraded to a certain airborne electronic warfare platform system, which is estimated to be 500 chipset at approximately 30,000 to 35,000 per chipset to Kratos over the next few years.

And in Kratos’ Satellite Communications business area, this is where we are the leading provider of ground, aerial and seaborne communications, signal monitoring and intelligence infrastructure and equipment. As we are seeing increased growth prospects as a result of the Chinese and Russian threat to U.S.

space assets and opportunities driven by nano and small satellites.

These three core Kratos’ business areas, Unmanned Systems, Satellite Communications and Microwave Electronics, which make up over 50% of our company, are all leaders in technology, intellectual property and differentiated products, and are expected to be priority and well-funded areas of national security as noted in recently executed budget agreement.

Accordingly, we have a very clear plan, where we have thought through the potential future alternatives and we believe that we have positioned the company for significant revenue, profit and cash flow growth, with our existing core business, with success in the tactical unmanned aerial system area, potentially resulting in even greater and possibly transformational future growth for our company, if we are successful.

Operationally, in the third quarter, Kratos’ Unmanned Systems, Modular Systems and Microwave Electronics businesses generated sequential growth of approximately 11%, 10% and 6% over the second quarter of ’15, respectively, with sequential growth in our Unmanned and Modular Systems businesses being driven by initial deliveries under the AFSAT and Patriot Programs, which are expected to continue into and throughout 2016.

In Q3, the mix of Kratos’ business remained favorable, including in the Satellite Communications, Cybersecurity, Microwave Electronics and Training Solutions areas, and Kratos booked a significant number of new and large contract awards generating a 1.2 to 1 book-to-bill ratio in Kratos’ Government Solutions business, which is our company’s largest segment and a 1.7 to 1 book-to-bill ratio in our Satellite Communications, Cybersecurity and Training areas.

Additionally, over the past few quarters, major areas of our business have begun to firm up, representative of the sequential growth and new contract awards we are seeing, and with a two-year U.S. Federal and DoD budget agreement now in place, we are hopeful that there will be greater predictability in our industry and for our business.

Since we last reported to you, we have had two disappointing areas within our Modular Systems and PSS businesses. In our Modular Systems business, we have a large program where Kratos has been under contract with the government agency where we have been delivering product.

This government agency had previously communicated to us that additional significant orders under this program would be made to Kratos in 2015. These follow-on orders under this existing Kratos program have not been made to date.

Additionally, in Modular Systems we had an existing contract we have been working on canceled for convenience by a separate customer which we understand was due to funding issues.

In our Public Safety business, we have made excellent operational progress across the division with the average gross margin rate for the majority of all new projects booked since beginning of 2015 being approximately 30% and with certain PSS regions generating direct EBITDA rates, up to 18%.

However, certain other PSS geographic regions have not performed to our expectations. And accordingly, we are taking appropriate actions to get these areas on track including restructuring and consolidation of the organization and management and personnel changes.

We will get this fixed as we have demonstrated with other PSS regional performance with meaningful impact as a result of these actions targeted to the first quarter or half of 2016. These Modular Systems and PSS issues have caused us to adjust our ‘15 forecast to $640 million to $660 million in revenue and adjusted EBITDA $40 million to $45 million.

In summary, as we head into the end of the year, we have achieved two of the most important 2015 objectives for our company, a successful initial UTAP-22 flight with all objectives being achieved and with positive customer feedback and a successful SSAT flight positioning Kratos for LRIP in 2016.

As we’ve discussed today, the vast majority of Kratos’ business is performing well and trending positively including Kratos’ government business firming up as demonstrated by our sequential growth backlog, book-to-bill ratio and our bid pipeline.

There is now a two-year Federal and DoD budget employees providing the best industry clarity we have had in several years.

And we are pursuing a number of large opportunities, certain of which are currently expected to be awarded over the next few months and some potentially by the end of this calendar year, where if we are successful, these opportunities could significantly enhance the future prospects of Kratos.

I will now turn it over to Deanna to discuss our financial results for the quarter in detail..

Thank you, Eric. Good afternoon. As a reminder, our financial data has been recast to reflect the U.S. and U.K. electronic products businesses as discontinued operations for all periods presented.

The third quarter results reflect the sale of the divested businesses as well as the repurchase of the $175 million senior notes, both of which were completed during the quarter. Our third quarter revenues from continuing operations were $161.7 million with sequential growth from our second quarter revenues of $160.7 million.

Although we did not provide quarterly financial guidance for Q3, our financial performance came in less than we expected primarily due to the items Eric discussed related to our Modular Systems and PSS businesses.

On a year-over-year basis, revenues decreased from $190.8 million in the third quarter ‘14 to $161.7 million in 2015 due to reduced revenues of $16.4 million in our KGS segment, which were result of reduced shipment of hardened mobile tactical facilities with certain U.S.

government agency customer in our Modular Systems business of $11.3 million combined with the continued contraction in aggregate government services revenues of approximately $3.5 million.

In addition, reduced revenues of $9.7 million in our PSS segment resulting from the change in strategic focus in PSS to emphasize higher margin smaller projects impacting overall sales volume and a reduction in our Unmanned Systems division of $3 million as a result of the timing of work and shipments in 2015 impacted our Q3 revenues.

Our adjusted EBITDA of $11.5 million for the third quarter is from continuing operations and excludes the following charges which have been reflected as adjustments, consistent with our prior presentations since we either believe the items are non-operational or non-recurring in nature.

Restructuring related items of $1.5 million which includes the following, excess capacity cost of $700,000 in our Modular Systems and Unmanned Systems businesses which reflects the unabsorbed manufacturing overhead cost due to reduced sales volumes, volumes resulting from the delays in anticipated contract awards, $400,000 of restructuring related costs and $400,000 of investments we are making in conjunction with the government agency to develop a non-recurring IP investment we discussed a few quarters ago that we are making for our unmanned combat aerial system platform, and also included in our reconciliation to compute adjusted EBITDA, our $600,000 of unanticipated contract adjustments related to certain projects in our PSS business.

On a GAAP basis, net income for the third quarter was $55.1 million which included a net gain from discontinued operations of $50.8 million, reflecting the gain on sale of the U.S. and U.K.

electric -- electronic products business, $2.8 million of expense related to amortization of intangible assets, non-cash stock compensation of $1.6 million, a $15.3 million tax benefit and a $3.4 million loss on extinguishment of debt reflecting the write-off of unamortized deferred financing cost of the recently completed repurchase of $175 million of our senior notes.

Moving to the balance sheet and liquidity, our cash balance was $35.8 million at September 27th plus $700,000 in restricted cash. We utilized the net sale proceeds from the sale of the U.S. and U.K.

electronic products business of approximately $232 million by paying down the $41 million outstanding on our revolver and repurchasing $175 million of our senior notes, reducing our debt to approximately $450 million with zero amount outstanding on our $110 million line of credit and approximately $36 million of cash on our balance sheet.

Cash flow from continuing operations for the third quarter was a use of $8.2 million reflecting working capital requirements primarily in our Unmanned Systems business. Capital expenditures for the quarter was $2.9 million. DSOs decreased six days from the 116 days at the end of the second quarter to 110 days.

DSOs continue to be impacted by milestone payment on long-term delivery projects where we are unable to contractually invoice for amount until the completion of certain milestones and/or final delivery of products with a demonstration of certain wide parameters, specifically in our Unmanned Systems segment.

Our contract mix for the quarter was 80% firm fixed price, 14% cost plus fixed fee and 6% time and materials. Revenues generated from contracts with the federal government were approximately 60% which included revenues with DoD and non-DoD government agencies.

We also generated 7% of our revenues from same local governments, 20% from commercial customers and 13% from foreign customers with our aggregate non- DoD revenues comprising 40% of our total revenues. Backlog at quarter end was $961 million with $552 million funded and $409 million unfunded.

Book to bill was one-to-one for the third quarter and for the last 12 month was 1.1 to 1.

The guidance Eric provided earlier reflects increased investments related to IR&D, bid and proposal, NRE and CapEx in certain of our microwave products, satellite communications and Unmanned Systems businesses, specifically also related to the Unmanned Systems demonstration flights during the fourth quarter and the bid and proposal activities related to new opportunities we are actively pursuing in that business.

We remain focused on cost reduction opportunities. For instance, we recently executed a sublease expansion agreement for one of the largest lease commitments that we assumed in 2011 in conjunction with the Integral Systems acquisition.

The expansion now extends through the entire term of the lease commitment of March 2020 and encompasses the entire facility.

Over the expanded period and space of the sublease expansion, our net cash flows will improve approximately $2 million to $2.5 million per year or for an aggregate improvement of over $11 million for the remaining term of the lease commitment through 2020. We continue to pursue opportunities to reduce cost and enhance cash flows.

In closing, post electronic product asset sale and the bond repurchase, we believe that we are well-positioned to continue to execute our strategy of building a differentiated product and technology business with major future growth opportunities in the Unmanned Systems, satellite communications and related cyber security businesses..

Thank you, Deanna. We’ll turn it over to the moderator now for questions..

[Operator Instructions] Our first question comes from the line of Mike Crawford with B. Riley and Company. Your line is now open..

Thank you.

With the UTAP-22 flight test, did any one try to shoot it down?.

No, not in this flight..

But is that something anticipated in the future flights?.

As I said Mike, for competitive and other reasons, I’m not going to get into the details of what we’re going to be doing in the future flights for next few weeks..

Okay. Great. And then, regarding the SSAT, I noticed in the joint Aegis ballistic missile test earlier this week that there was Northrop target use with Chukar if no longer in production.

Do you know how many more of those that navy has less than inventory?.

Yes, I do. Though I’m not sure Mike, I’m allowed to say the number but yes I do..

Okay.

Without saying a number, is it a lot or is there more of a pressing need for inventory?.

Right. Without saying the number, based on the op-tempo that the customer, the navy, has had and as they are projected to have, it gives us high confidence in the LRIP in the full rate production schedules that are coming that their inventories will be depleted and that they will need new targets to replace those that are depleted..

Okay. Thank you. And then, regarding other combat and electronic warfare opportunities you are pursuing, one, I presume is DARPA’s Grumman’s program which has received a lot of press really and there is proposal -- technical proposals look like they are due in two weeks time.

Can you discuss whether you are involved with that or what you think of that program?.

We think that that is an excellent opportunity for what we have to offer, Mike..

Okay.

And there has to be four phase 1 winners, are you getting as a prime or any other teams or can you say?.

I should not say specifically for competitive reasons, how we’re going to combat at..

Okay. Then, I guess, final question then is let’s say whatever unexpected reason that all of your efforts to build combat systems are unsuccessful and so you have to just go back to be a supplier of targets where you have this $150 million a year type of revenue increase coming down a pike in a few years.

So how much -- what is the magnitude of the investment reduction you might be able to see in your operating expense and cost of revenue levels in such a scenario?.

Right. I think somewhere around approximately $5 million in expenses, maybe a little less, maybe a little more, $6 million to $7 million in CapEx right off the top and those are the low-hanging fruit, Mike. And there will be significant leverage on the overheads and the rates once those go under production, which will further increase profitability.

So this is several and several million of dollars if we are unsuccessful both on the P&L side, the cash flow side and the CapEx side..

Okay. Great. Thank you..

Yes, sir..

Thank you. And our next question comes from the line of Mark Jordan with Noble Financial. Your line is now open..

Thank you. Good afternoon, Eric and Deanna.

Eric, you talked a little bit about obviously a very robust pipeline of $7.3 billion, could you talk about what of that pipeline, what has been submitted and what do you expect would be solicitations would be going in say the next 6 to 12 months?.

Right. So submit -- Mark, submitted -- right now approximately $1.5 billion of that has been submitted, the vast majority of the rest of it is being tracked to be submitted within the next 18 to 24 months.

And Mark, what was the other part of your question please?.

Just it was again what win would you expect those to go in? In your experience, have you seen any change regards to your customers willingness to plan and start to commit funding schedules? Again, it offers soon, so we’ve got sort of a break in the financing end of things, but have you detected here in the last three months any change in customer behavior and any feeling as to the response to the budget once it’s merged?.

Right.

So Mark, in certain areas, yes, absolutely, so, specifically, in the satellite communications area where in the past three months for example 60 minutes ran show talking about the space threat and an incremental $5 billion that was being earmarked immediately to safeguard the space assets and that relates directly to us and we are absolutely seeing an uptick in that area and that ties into the 1.7 to 1 book-to-bill ratio we just experienced.

That’s area number one. Area number two in our Microwave Electronics business, on surface-to-air missile platforms, air defense, both low, mid and high, we are designed in a number of platforms.

There is a test coming up in November this month that if it is successful, we will begin production with the Prime to start delivering and it’s thousands of missiles beginning next year. And this is an area that we've seen significant strength.

And the third area that we've seen this year is in our Cybersecurity business, particularly on the government side. And what we’re doing in that area, a lot of which I can’t get into here, we’re seeing particular strength there. So in those three areas, we're seeing a lot of strength.

And as Mike alluded to in the past couple few months just as we talked about on the last call, there have been a number of solicitations released in the tactical and manned aerial system area. We are pursuing several in the tactical ground unmanned system area, several of which are very large, that is picking up as well..

When you are talking about the microwave surface-to-air missiles, we've got your Israelis subsidiary that was retained that was early?.

Yes, sir. And the subsystems we’re providing are both on the ground radar and on the missiles themselves..

Okay.

The 1.7 multiple of the satellite, that’s a lot more impressive number if it was relatively short duration contracts versus say a five year -- couple of five year contracts, could you give a little bit of fuel for, are these just a plethora of shorter-term task or [indiscernible] nature?.

So we’ve got a mixed bag in there. So in the quarter we received a contract, a $50 million contract. We’re funded $20 million upfront. We’ve already received the funding and the payment on it. That is a five-year one, that will be burned fairly ratably over five years. However, there was another $40 million or $50 million one, we received.

The way that one is burning, I would not be surprised Mark if the majority of that is shipped next year and that is specifically in the satellite communication area..

Okay.

And a question for me, for Deanna, in your accounts receivable it’s been a pretty high number for quite a while, what is in there that in essence unbilled waiting for specific milestone to occur to be billed?.

Yeah, so this is fairly sizeable amount of milestone driven collections in our Unmanned Systems area where until we hit final delivery and/or flight demonstrations upon final delivery, we are not able to bill until that time. So, that is impacting our DSOs.

We have some similar type of milestones in some of our other Modular Systems business area as well..

Mark, in that unmanned area, there is one international customer in particular, it is between 10 and 20 aircraft and the aircraft are now complete, virtually substantially complete, there are some modifications left and the flight schedules are not for a while.

And once those flight schedules are successful as Deanna mentioned, then we can bill it out..

Anyway to just say that put in absolute dollar figure on that on bill portion of the 195?.

Judge for that business, it is probably about $20 million related to the plate parameters that need to be hit..

Okay. Thank you..

Yes, sir..

Thank you. And our next question comes from the line of John Nelson with The State of Wisconsin Investment Board. Your line is now open..

Thank you. Hi, Eric and Deanna.

My question is related to what’s going on in the PSS, public, safety and security markets and are the revenues from that division coming in, in line with your expectations and your profitability targets?.

Right. So John, the answer, the first answer to your question on what’s going on in that area, there are numerous opportunities, there is a robust opportunity set in that area. No doubt about it. As you know we've been focused on going after higher margin stuff, some of the highest margin stuff.

As I mentioned in my remarks, we year-to-date on the majority of the opportunities that we go after in the book and burn area it’s over 30% gross margin. So that has impacted the revenue and it’s impacted it more than I had anticipated. So we are enhancing part of the plan we are doing as we are enhancing the sales force to expand it.

So we can go after even more of these because we are passing on the low margin ones. We still have a pretty big, not I think, John, it’s $20 million or $30 million a year of very large deployment project, security system deployment projects we're working on.

Two big ones drop off in '16, another few drop off in '17 and then we’re basically done except for one big one, okay. As I said in my remarks in several of our regions and I talk by region because that’s how we’re organized. We are knocking the cover off the ball.

In one region, John, we’re generating direct EBITDA for that region approximately 18% and another one we’re generating like 11% or 12% where we're doing great.

There were two reasons very candidly that during the quarter was -- there were some jobs that were terrible and they impacted the entire division and that is where we have, we have made personnel changes, we have made management changes, we are doing some reorganization because if you look at the other regions, we can execute this which means it’s people, and so we’re fixing it.

And as I said, our plan is to get this fixed Q1, Q2 of next year..

Okay.

Let’s see, are the sales force expansion going to be would you say large, small?.

20%..

Okay..

Up 20%..

Okay..

Absolutely. And we’re probably 5% into that 20% increase, okay. So we've increased it 5%, we’ve got another 15% to go to hit the target that we have set by the end of the year, January. We want to make sure we get the right people, just don’t bring in people and they turn out to be a wrong people..

Okay.

And as the pipeline for the projects that meet your kind of margin targets, would you say it’s growing slowly, leveling up, or I mean I know you're increasing your sales force, but is it -- I guess is it broadening out to a lot of different businesses that you had not expected before, or is there any significant change in the customer profile?.

Right. Let met bifurcate it into opportunities and the pipeline. The number of opportunities drawn are significant.

Security system deployment, whether it’d be access control, basic video cameras, infrared cameras, CBRNE, facial recognition, it is in demand business in this country and it has to do with any type of new construction, office building, mass transportation, energy, energy transport across the board, it’s growing. So the opportunity set is there.

Our pipeline has not been growing as fast as I would like for two reasons. Number one, we have set some very high parameters balanced on the profitability we’re willing to accept because the business has got to make an acceptable margin for us.

Number two, with the sales force size, I believe that I mentioned to you where we believe that if we can expand this sales force along the lines that we discussed, that we can capture more of these higher margin opportunities which will drive the business forward..

Okay. Terrific. Thanks very much..

Yes, sir..

Thank you. And our next question comes from the line of Kevin Ciabattoni with KeyBanc Capital Markets. Your line is now open..

Hi. Eric and Deanna, thanks for taking the questions here.

Just starting big picture, Eric, you know does the two-year budget deal signed help you get more comfortable with your expectations around 2016? And if there’s any kind of particular areas within your business that might see the biggest benefit of this in the near-term, any color you can give there?.

Right. I think the areas that we’re going to see benefit in the near-term is in the satellite communications area.

The Training Systems area, we are seeing significant strength there and the budgets, if you dig into them, if it turns out the way that it’s expected is going to be significant for us in the Training area, especially in the aerial vehicles, manned aerial vehicles Training Systems area.

The target drone area, I think the target drone area is going to be very strong and very predictable for us, starting now for the foreseeable future, not just because of the contract that we have because of what’s going on with opt tempo out there relative to certain platforms that’s looking pretty strong.

Based on the most recent ballistic missile test schedule, I think our ballistic missile target area will be very predictable. We have booked a significant number of work there recently and we’re expecting some more in the near future that will play out, that will be able to build, ship and launch over the next couple years.

That looks pretty strong right now. Services area looks weak. Modular Systems area in missiles and radars is very strong.

In some of these other specialty areas where these high profile national security systems like this contract that we have and we’ve been delivering on and the customers has told us you’re going to deliver 20 million or 30 million more this year and the next that now we’re delaying with no definitive schedule, that’s lumpy because it’s politically driven.

So the majority of it’s good, services soft, certain specialty areas, choppy..

So just looking at that modular piece, the 20 million to 30 million I know that obviously hit the full year guidance.

Just the budget deal help kind of move that along or is it outside of?.

I have to be very careful on how I say this because we are the prawn and this is a very high profile program. The money is in the budget for you, it is there. That money can be taken and used for other things, which has impacted my confidence because you can have a program and you can have a contract and then for reasons money can be redirected..

Okay. And then, I know you mentioned the Grumman’s program a little bit earlier in the call.

I think your original expectation on timing for that was an award in 1Q '16, is that still kind of what you're thinking?.

Nothing has changed in my thinking on any of those that have come out, that’s different than what has come out of the solicitations..

Okay. And then last one for me.

I guess, the PSS shortfall in the quarter, you mentioned a couple of specific region, was it that revenue came in light and impacted -- lighter than you saw and impacted the margins there? Or was it -- you got the revenue drop, but it was lower margin business that you’ve kind of been trying to avoid the combination of I guess?.

Right. So let me frame that up for you. On the modular system program, I think $20 million of revenue at 30% gross margin. The other piece was revenue light and in certain regions the execution was not acceptable..

And that compounded with the revenue light and the infrastructure that had a double impact on the EBITDA margin..

Right. I got it. Okay.

On the modular piece the $20 million, was that for the quarter or for the remainder of the year?.

Six months..

Six months, okay.

Is the restructuring impact from PSS going to be meaningful from a dollar standpoint?.

I don't think it will be meaning material, it depends on ones, it’s not going to be tens of millions, a few, it’s not going to be significant..

Okay. Perfect. That’s all I had. Thanks..

Okay..

Thank you. And our next question comes from the line of Sheila Kahyaoglu with Jefferies. Your line is now open..

Hi. Good afternoon. Eric and Deanna, thank you for taking my question. I guess, can you reconcile put together the pieces that when we think about the revenue outlook with your bid pipeline, the two large contracts rolling off in PSS. The Modular Systems just seems to -- those two contracts seems to impact ‘15 only.

So can you let us know how we should start thinking about 2016?.

Right. Hi, Sheila. We -- because of the number of things that are going on right now with us is the number of opportunities that we are pursuing. Some of which that as I mentioned in my prepared remarks, possibly could be awarded by the end of the year and some of these are very, very large and could be very important.

We’re not going to get into ‘16 right now. We just -- we don't want to do that until we have more information..

Sure.

I guess can you let us know the size of the PSS contract?.

The two that are going to be rolling off the …..

That will be completed I guess in 2017?.

Well, there are two that are going to be completed in 2016. And I think Sheila, they are like -- its like combined, its $5 million to $10 million of revenue..

Okay. Okay.

So smaller than I thought?.

Yeah..

And then I guess on Government Solutions, within that business, is it just all the impact from Modular Systems where the margins are impacted?.

Sheila, yes..

So is there, I guess, how should we think about the moving pieces there because the profitability does swing around a bit?.

Typically, our satellite communication and training and cyber area is one of the highest margin areas, that strong arm. Microwave Electronics business is extremely strong. We’re sole source on virtually everything that we do. Our services business area is weak as you would expect the services business area would be, it's weaken there.

Modular Systems when the volume are right as average, an average type of the business 8% to 10%, when the volumes are there to leverage off the fixed overheads. The Unmanned Systems area right now is hard to gauge because what the massive investments that we’re making.

Historically, though if you look back a couple of three years, it made 15% to 20% EBITDA margins, just as on the target business. So that’s kind of how you should think about that.

If I believe we’re going to be successful in the tactical area, I believe that, especially now with the success of our aircraft and the customer feedback that we’ve gotten, which has been much stronger than I thought in such a short period of time.

But heaven forbid if we’re not successful and we have to make some changes there, head targets business in the past has made 15% to 20% EBITDA margins..

Got it. Thank you. That’s helpful color. I think that’s all I have for now..

Yes, Ma’am..

Thank you. And our next question comes from the line of Eric Selle with SunTrust. Your line is now open..

Hey, good afternoon.

Eric and Deanna, how are you doing?.

Pretty good..

You’ve gone through some of it but basically the EBITDA guidance is down $10 million versus the last guidance. And the disclosure you gave on the modular business, I think it compromises about 60% of that mix. And so basically, second, third and fourth quarter EBITDA going to be pretty flat sequentially.

Despite the headcount cuts, despite the better bidding if we assess and despite delivering contracts that we’re paying upon delivery that you incur cost in the first half. I mean, is that how we have to look at it? We didn’t get the ramp in the back half and just a one lumpy modular loss that comprising 60% of the loss in masking all those savings.

It just hard for me to look at this and you’ll explain this?.

Right. I want to be clear and reiterate. The modular area, we didn't lose anything. We have a program. We have a contract we have been delivering on. We have been delivering tens of millions of dollars worth of product over the past few years on this. We had a delivery schedule from the customer where we have this program for 2015.

The customer came to us and said no more deliveries this year. We do not have a delivery schedule for ‘16. So we didn’t lose anything. We have a program on a contract with the customer where we’re the prime. That’s on that one. As I said that -- as you said that’s about 60%.

In the PSS area, the two areas that Deanna mentioned, number one, we came in light on revenue for two reasons that I talk to John about. Number one, I think it's because we're being very aggressive in what we’re going after that, 30% mark gross margin is the target, okay.

That really has limited the opportunities because of that we are going to be expanding the sales force to make sure that we're seeing every opportunity out there so that we don't miss any. So we were revenue light because of that, that’s my opinion.

And number two, in two geographic regions in particular and on just a few projects programs, the performance was terrible and it impacted the margin significantly. So we loss the leverage on the revenue and we have the impact on the execution and that was the shortfall. You add those together that that’s the guidance..

Okay. So just 50% to 60% of it was [HA] [ph] versus the guidance really a sudden change in a long-term customer.

The other was at PSS and I guess, there is my question with PSS, I mean, the PSS had a rough ‘14, it’s not been -- despite the margin change, it sounds like you guys are increasing price to make some contracts? My question is why invest in sales? I mean, why put more money in PSS in the sense a disappointing last 18 months. I understand it’s growing.

I understand the industrial demand, but can you possibly compete against the [CISCO] [ph] I mean or is it something that how it belongs and no tone over there?.

Right. The -- so on your question why invest in the sales, because the sales people should pay for themselves. And as I mentioned to John, the target set, we believe the targets environment is rich, okay.

We've demonstrated we can generate as I indicated in my prepared remarks up to 18% gross margins in recent region, I mentioned, one there was 11% or 12%, so it can be done.

So we believe that it’s a low investment on the sale side to bring in the people, to try to capture more of that high margin revenue, get leverage on the G&A and then hit our 8% to 10% overall EBITDA target rate, that’s our plan..

Okay. And then, on the unmanned drone, you said you’re testing in the next couple weeks.

Do you guys expect to make an announcement on winning or losing that by year end?.

It depends. I don’t know right now. And the reason I’m saying that is, I’m not sure exactly what we will be able to disclose, when we will be able to disclose it or if we will be able to disclose it..

Okay..

I just don’t want to say because I don’t know..

Now the customer always dictates that and I definitely understand that. And I guess my final question is, if you look at your -- how much capacity in willing if you guys have to buyback bonds in open market? I know you have some in excess closer to [indiscernible] talking bankers, looked at covenants and all that.

How much expense could that be if you choose to go after more bonds in those markets?.

That’s something we would obviously need to study from our working capital perspective, Eric, so not really prepared to respond to that at this point..

Okay. Thank you..

Okay..

Sure..

Thank you and our next question comes from the line of Kevin Ciabattoni with Keybanc Capital Markets. Your line is now open..

Hi. Thanks. Real quick follow-up.

So just -- I just want to make clear that the lower EBITDA guidance doesn’t reflect any changes in expectations around R&D for the year?.

As Deanna mentioned, in Q4 in the R&D area and the BMP area, and in certain NRE areas, primarily all related to the unmanned area, those are up..

Versus prior expectation..

Correct..

Okay. Thanks..

Thanks..

Okay. Thanks..

Thank you. I’m showing no further questions at this time. I would now like to turn the call back to Eric DeMarco for any closing remarks..

Excellent. Thank you for joining us this afternoon. And we will keep you updated as we can as we continue to move forward with some of these initiatives. Thank you..

Ladies and gentlemen, thank you for participating in today's conference. That does conclude the call. You may all disconnect. Everyone have a great day..