Kratos Defense & Security Solutions, Inc. Q2 FY2021 Earnings Call

Good day and thank you for standing by. Welcome to the Kratos Defense & Security Solutions Second Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers presentation, there will be a question-and-answer session. I would now like to hand the conference over to your speaker today, Ms. Deanna Lund, Executive Vice President and CFO. Please go ahead.

Thank you. Good afternoon, everyone. Thank you for joining us for the Kratos Defense & Security Solutions second quarter 2021 conference call. With me today is Eric DeMarco, Kratos' President and Chief Executive 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.

Great. Thank you, Deanna, and good afternoon. Kratos has continued to execute on and achieve important milestones, further positioning us for the successful execution of our stated mission, our business plan, and our strategy. The organic growth we generated in Q2, including in our unmanned systems, space, satellite, and cyber businesses, we believe is representative of this execution. Additionally, Kratos' last 12-month, 1.2-to-1 book-to-bill ratio, which includes a 1.3-to-1 second quarter book-to-bill ratio in our space, satellite and cyber business—the company's largest and unexpected very strong second half of 2020 bookings—provides us the confidence in the forecast and the continued organic growth trajectory. Since our last report, we achieved a successful series of flight tests with the Skyborg autonomy core system or ACS. The flight test involved Kratos' UTAP-22 Mako tactical unmanned aerial drone system at Tyndall Air Force Base in Florida, which was an incredibly important program milestone for the company. As reported by the United States Air Force, the 96th Test Wing took part in a series of test flights of Kratos' Mako, and inside the Kratos Mako, the Skyborg autonomy core system—the brain of the autonomous aircraft—made its first three flights for the Autonomous Attritable Aircraft Experiment. The ACS is part of the AFRL Skyborg Vanguard program, with Skyborg's goal to develop low-cost unmanned aircraft to provide increased combat capability by integrating unmanned drones with traditional manned fighters. During this demonstration flight series, aircraft controllers on the ground provided commands to the ACS. In the future, the plan is for direct manned and unmanned teaming via commands sent from a manned F-16 Fighting Falcon to the ACS onboard the unmanned aircraft. Brigadier General Scott Kane, the 96th TW Commander reportedly said, 'The execution of this test flight is a great milestone for our closely integrated development and acquisition team, with the successful execution of this test providing the knowledge needed to advance the technology. We are highly motivated to bring war-winning technology to the next fight.' Major Nathan McCaskey said, 'This is a significant step toward teaming manned and unmanned aircraft in combat in the not too distant future.' The military envisions at least 15 different missions for these types of drones, representative of the extremely large opportunity we are pursuing. Kratos' Mako flying the Skyborg ACS core is also representative of the important first-to-market advantage we have with four classes of Kratos' attributable reusable or expendable drones flying today, and the integration of various sensors, systems, and payloads into our aircraft now for flight testing, operational concepts, and fielding. I cannot overemphasize the competitive importance of the various customer payloads being integrated into flown, tested, and demonstrated in Kratos' first-to-market high-performance jet drones today. The successful flight series with the Skyborg ACS and Kratos' Mako is, we believe, another important step in our strategic roadmap, including for ultimate volume production and fielding of Kratos' tactical jet drones as force-multiplying loyal wingmen to the warfighter. In addition to the successful flight from the Skyborg core, Skyborg Vanguard program-related systems and payloads are now being integrated into the first two Kratos Valkyries from the Oklahoma production line from the initial 12 lot, with the flight test for the Skyborg-equipped Valkyrie scheduled in the near future. Under the Skyborg Vanguard and other programs, we have multiple additional flights with Kratos' tactical drones planned for the second half of this year, as we move towards initial operating capability and fielding. These flights include the next Gremlins drone flight series with our DARPA customer and our prime partner Dianetics, with several tactical fighter jet and AirWolf program flights also scheduled for later this year. Related to Gremlins, it was recently reported that the Gremlins concept of operations continues to grow and evolve, including that the Gremlins are now expected to carry weapons, return to a mothership, refuel, rearm, and be sent back out on another mission. This again is representative of the increasing market opportunity we're pursuing. As I've mentioned, with Kratos having the only four high-performance affordable jet drones in this class flying today, with the Valkyrie, Mako, Gremlins, and AirWolf, we're highly confident that as we continue to execute, we will be the leading drone provider in this class. Kratos' Thanatos development is continuing, and we are hoping to successfully move from phase one to phase two of the program either later this year or early next year. Kratos' Ghost Works continues to work on certain programs and initiatives with certain initial system tests on track for next year. On new tactical opportunities that we are able to discuss, Kratos has partnered with North American Wave Engine Corporation to develop the Versatile Air-Launched Platform or VALP, which is an air-launched vehicle designed to leverage and demonstrate low-cost, high-impact technologies for future aerial systems. The VALP will use Wave Engine Corp's propulsion technology in an effort to bend the cost curve and reduce lead times for capabilities necessary to challenge near-peer adversaries, which is exactly consistent with Kratos' mission and our strategy. Kratos' partnership with American Wave and our responsibility for the air vehicle are representative of what we view as Kratos' industry-leading position for the development and production of affordable high-performance jet-powered drones and tactical systems. This new opportunity with American Wave is also representative of the increasing size of Kratos' tactical drone and powered weapon systems market opportunity. Another new attributable tactical drone program opportunity we are pursuing is OBSS, or Offboard Sensing Station, which if we are successful, we believe could ultimately be as significant and transformational to Kratos as we expect Valkyrie to be. Kratos' Ghost Works has been deeply involved in this system and vehicle approach for the last several months, and we expect to hear in the next several weeks if we have been successful in receiving a contract in this very competitive solicitation. We believe that the OBSS opportunity is also representative that the total addressable market opportunity for Kratos' class of tactical drones is rapidly expanding and clarifying as the Department of Defense strives for affordable force multiplier systems and technologies. This drone market is the same market that Kratos Turbine Technologies is pursuing, as drones need turbines and engines to power them, and analysis of the 2021 Pentagon budget revealed that approximately $7.5 billion of the budget was allocated to drones, robotics, and related technologies. Additionally, and very exciting, the just-released Senate Armed Services Committee, National Defense Authorization Act authorized $201.6 million for the Skyborg program, including an increase of $75 million specifically called out for the purchase of Valkyrie aircraft. It also authorized $125 million to accelerate the use of unmanned aircraft as augmented adversary support, which is a new market opportunity and one we believe Kratos is uniquely qualified for today with our Valkyrie and certain other aircraft. The recently released NDA also authorized an increase of $30 million for Air Force advanced aircraft propulsion development, another area we believe Kratos is uniquely positioned for, as I'll discuss in a moment. Additionally, and we believe related to the significant funding increases for drones, Skyborg, and drone technology, it was recently reported that the Air Force Chief of Staff said that the Air Force is considering building a fighter fleet with more drones than piloted aircraft and that the Air Force is currently performing the analysis and war games needed to assess the appropriate mixture of unmanned platforms and manned platforms. It was also reported that Air Force leaders providing updates on the next-generation air dominance program or NGAD stressed that NGAD and the force structure will include a variety of different platforms, as well as powered munitions and other systems, including manned aircraft networked together with loyal wingman drones, fully autonomous unmanned combat air vehicles or UCAVs, and swarms of low-cost unmanned aircraft. The U.S. military needs to immediately increase the size and technology of its unmanned aerial systems arsenal to be able to successfully fight two wars simultaneously with Russia and China, with Kratos' Valkyrie and Gremlins both being specifically mentioned. Also importantly, the Air Force has communicated that a key focus for the '23 and through 2027 budget will be the Agile Combat Employment or ACE initiative, which aims to operate away from established runways and be runway independent, operating in a manner that presents a very difficult distributed asset and lethality problem for our adversaries. ACE is an evolution of the United States Air Force agile basing concept that I have discussed with you previously and which has been identified as a top priority for the Air Force Chief of Staff. And related to the ACE initiative, the customers had reiterated directly to us just a few weeks ago that affordability, runway independence, and survivability are critical requirements for Kratos' class of drones, each of which Kratos is the clear industry leader. These are just some of the recent customer demand signals we have received, and we remain absolutely committed to supporting the customers' needs, requirements, and timetable. We are confident that it is not a question of if, but only of when Kratos' drones will be utilized in large quantities. The first flight of Kratos' drones at the Oklahoma range facility is now scheduled for the second half of this year, adding to Kratos' existing competitive advantage in speed of development, demonstration testing, fielding, and overall affordability. Kratos' target drone business also continued strong performance, led by our industry-leading position in high-performance affordable threat representative target drones. The global recapitalization of strategic weapon systems by the United States and its allies to address peer threats is providing a robust and growing target drone market opportunity both domestically and internationally, with the evolving threat environment contributing to extremely strong demand for Kratos' target drones. We are expecting several target drone program awards in the second half of the year, including from the U.S. Navy, the U.S. Air Force, and the Army, arguably the largest target drone utilizers in the world, as well as from international customers. The 2022 budget requests in the target drone areas came in as we expected, and we anticipate continued future year-over-year growth for this business. For Kratos' unmanned systems business, we are expecting significant bookings in the second half of this year in both the target and tactical drone areas, forecasting a second-half book-to-bill ratio substantially in excess of one-to-one if the current timing holds. In Kratos' space and satellite business, our software-based open space operating system and architecture, which we released first to market last year, is seeing incredible success and customer acceptance as we strive to disrupt and transform the space ground system market, similar to how Kratos' affordable jet drones are disrupting the UAV market. Since the beginning of this year, we have delivered products supporting the satellite industry's movement towards software-based virtualized ground systems to approximately 30 customers worldwide, including Kratos' Quantum and SpectralNet lines, both of which are part of our open space software-based family of dynamic virtual ground solutions. Kratos' open space Quantum products offer software versions of satellite ground system architecture, traditionally implemented with hardware, such as modems and front-end processors necessary to communicate with a satellite or its payload. Kratos' previous Quantum products have been used by hundreds of satellite operators globally, supporting tens of thousands of satellite passes per month, and Kratos' SpectralNet products provide the on-ramp to modern virtual ground operations by reliably digitizing the radio frequency signals from the satellite into an Internet Protocol format that can be processed by digital systems running in the cloud, on-prem, or in hybrid environments. We have transitioned both Kratos' Quantum and SpectralNet previously hardware-centric products and technology to software, exploiting our first-to-market position and clear technological advantage with our large existing global customer base. Kratos supports approximately 80% of the world's satellite providers, and we have the existing install base, the past performance qualifications, the credibility, and the market competence as we roll out our software-based open space systems. Our open space Quantum products, which we refer to as virtual network functions or VNFs, are less expensive than the hardware they replace. They operate at lower cost and with greater flexibility to adapt quickly to rapidly changing missions and conditions driven by accelerating technological advances in the satellite and space area. For example, previously, it could take weeks to deploy ground system hardware. Kratos' Quantum VNFs can be deployed and configured to support different missions in just hours. Kratos' Open Space Platform, currently the most advanced line in the open space family, is designed to enable satellite operators to deploy, configure, and adapt entire networks in just minutes using its orchestrated Software Defined Network or SDN architecture. Our plan is to lead the disruption and virtual transformation of the space and satellite industry with our first-to-market software-based and defined products. We are currently transitioning a number of additional previously hardware-based space and satellite ground infrastructure subsystems, systems, products, and solutions to virtual software products. Customers for Kratos' open space products include new space and satellite companies, satellite manufacturers, service providers, some of the world's largest operators, United States government agencies, and leading prime contractors. We see the open space Quantum and SpectralNet product lines as stepping stones for space and satellite companies seeking to take advantage of a digital transformation of their ground systems to support new space vehicles, customer requirements, goals, and opportunities, and Kratos is the clear first-to-market industry leader in the virtualization of space and satellite ground segments. Space domain awareness, including with Kratos' globally-owned and operated SDA network, is another area seeing significant growth, including advanced spectrum and signal monitoring. With the rapid growth of new satellite networks, satellites in space and VSATs, there is potential for significantly increased radio frequency interference in space. Interfering signals can be periodic or occur at different frequencies over time, making the discovery, identification, location, and removal or neutralization of the source of the interference a significant challenge for agencies, operators, and their customers. Additionally, as space becomes increasingly congested, it is also becoming more contested and competitive, and the ability to identify, locate, and track potential threats to on-orbit space systems through a more comprehensive view of the space environment is absolutely critical and increasing rapidly. Directly related to this issue, an example of the incredible value of Kratos' unique and one-of-kind globally-owned and operated space domain awareness network is a recent announcement that we have received awards totaling approximately $46 million to support space domain awareness efforts for certain customers. Kratos' SDA network consists of numerous RF monitoring sites, hosting fixed and steerable sensors and antennas, including L, F, CX, and KU bands in our 24/7 365 network operating center, which is the central hub for monitoring and integrating raw RF data from the global network. With the increasing volume and velocity of threats, Kratos is leveraging the technology behind our OpenSpace software platform to help satellite ground systems quickly adapt to changing conditions, including the OpenSpace software-centric architecture being used in our global monitoring network, enabling assets to be reconfigured and redeployed virtually, delivering the potential for much faster responses to potential threats in space. Kratos was elevated in our space and satellite business as we accelerated our investment to exploit our first-to-market mover position with our software-defined virtualized products and our SDA network and to protect our critical intellectual property position. In our view, Kratos' space and satellite business' backlog and opportunity pipeline has never been greater or of such high quality. The total addressable market opportunity for Kratos' technology and products is large and rapidly expanding. On the market opportunity side, one data point reported by Northern Sky Research or NSR indicates that over the next 10 years, satellite manufacturing and launch order volumes will reach nearly 24,700, with virtually all of these satellites meeting ground command and control, telemetry, tracking and control, and space domain awareness, areas in which Kratos is the industry leader. For our space business, we expect significant growth and margin expansion in the second half of the year, particularly in the fourth quarter, based on customer delivery and execution schedules and our transition to more software-based content, which I have been discussing with sustained year-over-year future growth and increasing margins expected. Our second half growth forecast for our space and satellite business is supported by recent and expected customer orders, including the 1.3-to-1 book-to-bill ratio I mentioned previously, and we are also forecasting a second-half book-to-bill ratio in excess of 1-to-1. Kratos' Microwave Electronics business based in Israel continued its outstanding performance, holding a record or near-record backlog and opportunity pipeline. Kratos' microwave products business is focused on space and satellite, missile radar communications, and other weapon systems, all of which continue to expand. We are forecasting a strong second half for this business based on the current backlog and production and execution schedules. Kratos' rocket system business performs ballistic missile target hypersonic and other rocket system work, reflective of the strategic asset to the United States' national security. Our rocket systems business recently announced that we supported the United States Navy's 6th Fleet, NATO's naval striking and support forces, and the Maritime Theater Missile Defense Forum during the successful execution of Formidable Shield 2021 at the U.K. Ministry of Defense's Hebrides Range in Scotland. The exercise included two Kratos medium-range ballistic missile targets, presented alongside Kratos MQM-178 fighter jet aerial target drones from our unmanned systems division. Our ballistic missile targets met all test objectives and were engaged by SM3 interceptors from the USS Paul Ignatius. The multinational exercise featured 16 ships, several aircraft, and approximately 3,300 personnel from 10 countries. Our rocket systems business also recently announced that we received a contract from the Navy Surface Warfare Center Port Hawaii Navy division, White Sands Detachment, to develop a hypersonic experimental test vehicle for the maturation of high-speed flight technology for missile defense and hypersonic systems. Hypersonics and missile defense are priority areas of the DoD budget, and we are forecasting future year-over-year growth for our rocket systems business with strong demand for targets, hypersonic systems, and other rocket and weapon system-related areas, with numerous future missions and launches currently planned. Kratos' turbine technologies also continue to make important strategic progress, including receipt of an $8.6 million task order under our Advanced Turbine Technologies for Affordable Mission or ATTAM IDIQ contract. The program will be managed by the turbine engine division of the Air Force Research Lab, and under the contract, Kratos will complete the design, build, assembly, and testing of an affordable turboshaft engine for Group 3 UAVs. This award follows the successful completion of multiple programs, where KTT completed concept and engine trade studies for Group 3 UAVs in conjunction with our partner, the AFL/RQT. The objective of this task order is to complete the engine development for flight testing and to demonstrate high power-to-weight, high efficiency, and increased durability of this engine design. This engine design is also convertible to produce the electrical power needed for advanced hybrid electric aircraft, which is also a key strategic growth focus area for the company. KTTS has now successfully completed a core engine test campaign under the ATTAM contract with the turbine engine division of the AFRL. Under this effort, testing of the engine core supports the development of small, affordable, high-performance jet engines for cruise missiles and unmanned aerial vehicles. During the test campaign, Kratos has successfully demonstrated key performance and operability targets of the core engine. These milestones and achievements by Kratos' next-generation turbojet and turbofan engine business on track to significantly disrupt the market with affordable, innovative, and transformational engine technology and products. The total addressable market opportunity for KTT and our engine businesses, including unmanned aerial vehicles, drones, cruise missiles, and powered munitions, is extremely large and rapidly growing, as the U.S. and our allies prepare for peer and near-peer adversaries. KTT is also heavily involved and under contract with multiple customers in the rapidly growing space launch and propulsion area where we are designing, developing, and manufacturing leading technology products in support of space companies and government customers. Our C5ISR business is head-down and focused on GBSD and several other major programs we are executing and pursuing. We expect very significant future year-over-year growth for Kratos' C5ISR business as we execute on several large new program wins and opportunities. On large new weapon system development programs, exact timing, execution, and delivery schedules early on are typically fluid, which we are experiencing with GBSD and others with our expected future strong growth trajectory and forecast intact and increasing. We believe that the Biden administration and Congress are absolutely committed to the nuclear modernization to address peer and near-peer threats. The Congressional Budget Office recently estimated costs at $634 billion to operate, sustain, and modernize the United States' nuclear forces, and certain of Kratos' largest programs are in this area, including C5ISR. The Biden administration's 2022 defense budget requested a $5.5 billion increase in research and development and an $8 billion cut to procurement. This is a clear signal emphasizing new technologies and future products and systems at the expense of older legacy programs, which is a beneficial signal for innovative and affordable technology companies like Kratos. Non-traditional defense contractors, like Kratos, have a real incentive to innovate, disrupt, and drive affordability. We are laser-focused on exploiting this opportunity with our government customers. As we enter the second half of the year, our backlog, expected strong second half bookings, and our record opportunity pipeline provide us excellent future visibility and confidence in our forecast. Accordingly, we're focused on execution with major items, including, since our last report, we have experienced a lower number of COVID cases among Kratos' employees, and we are watching this very closely, including in our Florida, Texas, and Oklahoma locations where we have recently seen an increasing number of cases. Additionally, certain DoD-related COVID restrictions have recently begun to tighten up again; this is also an important watch item for us. We continue to have some issues with the supply chain, including COVID-related issues with product lead times increasing on certain of our programs and systems, with increasing prices and costs from our vendors. We are also focused on hiring qualified people, primarily engineers and employees with technical and manufacturing experience, including the ability to obtain security clearances, primarily in our space, satellite, and unmanned system business. We are in the process of standing up several new facilities, including in our drones, space, and satellite areas, to accommodate certain large new programs we have received or that we expect to receive in the second half or in '22. We have taken all of these items into consideration in our execution planning for estimating the financial forecast and guidance range we are providing today. In closing, we're focused on disrupting and transforming the national security industry with rapidly developed, demonstrated, and fielded, affordable technology and systems. We believe no other company in the industry is as well positioned as Kratos, and as a result, we are internally focused on successfully executing our backlog and our $9 billion opportunity pipeline. We do not expect to pursue or make acquisitions of any size, only potential small or tuck-ins in the current areas of expertise. We believe that Kratos is at the beginning of a long upward growth trajectory, and we are focused on successfully executing for our customers, our country, our invaluable employees, and for our stakeholders.

Thank you, Eric. Good afternoon. Kratos' second quarter 2021 revenues of $205.1 million were at the upper end of our estimated range of $195 million to $205 million. Our Q2 21 consolidated operating income was $3.3 million, up from the second quarter of 2020 operating income of $2.9 million, which includes second quarter '21 increases in stock compensation expense of $1.8 million, increased R&D of $4.2 million, primarily in the space and satellite business, and increased depreciation expense of $1.6 million in the current period. As a reminder, over 80% of our total R&D is typically invested in our space and satellite business. Net income was $1.1 million for the quarter, which included a tax benefit of $3.6 million, primarily reflecting tax benefits related to stock compensation expense. GAAP EPS was $0.01 per share, compared to a loss of $0.01 in the second quarter of 2020. Adjusted EBITDA for the second quarter was $17.6 million in the range of our expectation of $14 million to $18 million reflecting increased investments in internally funded R&D, primarily of our software-defined open space and virtualized products, as well as revenue and product mix and more developmental projects as we begin to ramp a new developmental program. The second quarter operating results include over $400,000 of negative foreign exchange impact resulting from an increase in the Shekel against the U.S. dollar in our Israeli-based microwave business. Excluding this adverse foreign exchange, the second quarter adjusted EBITDA was $18 million. In the second quarter, the unmanned systems segment reported revenues of $60.3 million, up 43.6% from the second quarter of 2020, primarily due to the ramps in production in target programs, including the 177 and work performed on the Valkyrie program. Unmanned systems generated operating income of $4.1 million, up from $1 million in the second quarter of 2020, primarily reflecting the increased drone system-related revenues and leverage achieved on the fixed overhead manufacturing and G&A infrastructure. Unmanned systems generated adjusted EBITDA of $6.9 million, up from $3 million in the second quarter of 2020. KGS reported revenues of $144.8 million in the second quarter, up from $128.4 million in the second quarter of 2020, reflecting $11.8 million from the ASC acquisition and organic growth across our space, satellite, cyber defense, rocket, and microwave product businesses. This increase was offset partially by a net reduction of approximately $4.7 million in our Training Solutions business resulting from the previously disclosed reduction in scope of certain international contracts. KGS reported operating income of $5.9 million, down from $7.7 million in the second quarter of 2020. KGS second quarter 2021 adjusted EBITDA was $10.7 million, down from $12.3 million in the second quarter of 2020, reflecting a less favorable mix of revenues, including an increase in product and equipment revenues contributed from the recent ASC acquisition and negative impacts in our commercial Arrow business, coupled with increased R&D costs of approximately $4.3 million, primarily related to our spaces satellite business. Our adjusted EBITDA for the second quarter is consolidated continuing operations, including net income on loss attributable to noncontrolling interest, excludes non-cash stock-based compensation costs of $6.6 million, acquisition and restructuring-related costs of $100,000, and a foreign transaction loss of $100,000. Moving on to the balance sheet and liquidity, our cash balance was $369.3 million at June 27, with zero amounts outstanding on our bank line of credit and $5.9 million of letters of credit outstanding. Debt outstanding was $300.3 million at quarter-end, and net cash at quarter-end was $69 million. Cash flow used from operations for the quarter was $700,000 less CapEx of $10.9 million, resulting in a free cash flow from operations of $11.6 million. Our contract mix for the quarter was 70% generated from fixed-price contracts, 25% from cost-plus fixed-fee contracts, and 5% from time and material contracts. Revenues generated from contracts with the U.S. federal government during the quarter were approximately 72%, including revenues generated from contracts with the DoD, non-DoD federal government agencies, and FMS or foreign military sales contracts, which were approximately 4%. We generated 8% from commercial customers and 20% from foreign customers. Our backlog at quarter-end was $865.6 million, down sequentially from first quarter '21 backlog of $892.9 million, with bookings of $177.8 million and a book-to-bill ratio of 0.9-to-1 for the second quarter of '21. Funded backlog at quarter-end was $630.6 million, with $235 million funded for the last 12 months ended June 27. Our book-to-bill ratio was 1.2-to-1 with total bookings of $953.4 million. Our book-to-bill ratio for the last 12 months ended June 27 '21 was 1.0-to-1 for the unmanned systems segment and 1.2-to-1 for our KGS segment. Now for our financial guidance, we are providing our initial third quarter '21 guidance of revenues of $195 million to $205 million and adjusted EBITDA of $16 million to $20 million. Our guidance reflects the impact of the recent loss of an international training contract, which had contributed over $34.5 million in revenue in 2020 and generated approximately $13 million in 2021, a decrease of over $21 million year-over-year, and includes a full year of the recent ASC signal acquisition closed in mid-2020. Our forecasted revenue mix for '21 is expected to be increased developmental program-weighted based on the large number of new contract awards we have received and expect to receive and includes discretionary investment as compared to a more mature overall product lifecycle in 2020. For our third-quarter full year '21 guidance, with our backlog and recent and expected bookings, we are comfortable with our revenue and EBITDA forecasts, including the fourth-quarter increase with execution and delivery timing assumptions driving the range we provided. The expected ramp and margin profile in the second half of 2021 is similar to the trajectory in 2020, which is evident in our last 12 months adjusted EBITDA of nearly $83 million. Key assumptions included in our forecast include our supply chain's ability to deliver on-time and on-budget, and our ability to hire the resources that Eric discussed in line with our program and execution plans. Our space business is forecasting an extremely strong second half of '21, particularly in the fourth quarter, with successful execution on its backlog, including driving significantly increased margins from a favorable mix expected to include increased software and high-profit-based deliverables. In summary, we believe that the backlog, bookings today, and expected bookings and pipeline are in place for Kratos to deliver within our 2021 financial forecast.

Great, thank you, Deanna. We'll turn it over to the moderator for any questions.

Your first question will come from Mike Crawford with B. Riley Securities.

Thank you, Eric. You talked about the markup to the defense bill including first Skyborg; how would you characterize Kratos's position within Skyborg versus competitors like GA and Boeing?

I believe that our position is far ahead— the best. The press releases relative to the GA vehicle as it's a surrogate vehicle. So the vehicle they're using is by—I’m assuming by that word—not even the vehicle they're planning on finally utilizing, if it even exists. Boeing hasn't had a peep from them since their first flight of their vehicle, I think at the end of February or early March. So we're coming up on five, six months, not a peep from Boeing. I don't know what they're doing. We were first to fly the core. As I mentioned, we closest flown to a manned fighter in history, that we did, or integrating Skyborg payloads on the new Valkyries now, and we are extremely confident and comfortable with our position on this program.

Okay. And then related, you mentioned OBSS as potentially as transformational to Kratos as Valkyrie. Given that you're already a leader with these various other classes of drones, what separates OBSS from the rest?

Yes, there's very little publicly out there on this opportunity, very little. But it is an attributable low-cost system. If we—this is a very competitive—we are successful in receiving a contract on this, this has legs. This program has legs. I really can't say much more about it, Mike, other because there's only that one piece of paper out there on the program, but it's expected to be awarded very soon now.

Okay. So well, hopefully, you're one of the two winners of that down select. And then final question just goes back to OpenSpace. What is about Q4 milestones that you're expecting a bigger ramp in that quarter versus Q3?

Yes. It's the transition to the software deliverables. We've—and it has to do with the bookings, including the big ones we just had in Q2; we're going to be delivering product in Q4. It’s more software-intensive. And so the margins are higher on it. We’ve been talking about this probably for about a year now since we started releasing the product, I think in Q2 or Q3 last year and the uptake by the customer community has been incredible. This is brand new. What we're basically doing is we're taking the soft off the ground satellite infrastructure. Now my term from 2G cell phone network to 5G. We're going from legacy hardware-based systems to software virtual systems. And we're first to market; the customers are buying it, and we're going to be delivering it in Q4. That's why we see a significant margin uptick in that quarter.

Your next question will come from Peter Arment with Baird. Please proceed.

Hi, good afternoon. You actually have Eric Ruden on the line for Peter today. Eric, just in terms of framing up the second half bookings, obviously, you're expecting pretty significant pickup at unmanned specifically, could you just provide any color around some of the big moving pieces there? I know you mentioned book-to-bill well in excess of one. Do you think it's enough to make book-to-bill for the year over one, given the softer first half?

Yes. So on the first part of your question, the space and satellite business forecast is extremely strong in Q3 and extremely strong in Q4. As both Deanna and I said, it's coming off of the bookings we had recently, including, I think, 1.3 to 1 in Q2. We're off to an extremely strong start in Q3 for bookings in that space and satellite business. If we can get the people and we can deliver it, we're going to achieve it; we are going to do it. Now on your question on the second-half book-to-bill: across the company, we have some big programs we're expecting to book in the second half. Let me give you some examples. One of them is an Air Force target drone program; we're expecting to receive a multi-year award, which would be base years plus options. I believe this is a sole source that will carry us through. We're expecting a very large Navy target drone award in the second half of the year; that also we expect to be multiple years—base year plus options. There's a confidential program that I think is going to fall into Q3. There’s that large international one I've been talking about. I didn’t mention in the prepared remarks today where we've received the contract, but with the change in administration, it was going through some type of government review, and we expect that review to be successful and we'll receive that award in the second half of the year. In the engine area, we have a very large contract we are expecting to receive; I forget if it's Q3 or Q4, but that will put our engine business in a positive over 1.0-to-1. So we got a lot of big ones, most of which are sole source, which is why we're so confident that second half bookings are going to be so strong.

Okay, thanks. And then on just the comments about rising case counts with COVID and concerns about the Delta variant, what do you think the biggest risk is there in terms of both the order environment and the pace? Are you seeing any further delays on the testing ranges?

Okay, so last one first. Thus far, as of today, we have not seen or been informed of any test range delays. Now, as I mentioned, and you probably saw, the DoD is starting to tighten up certain restrictions at certain locations, including at the Pentagon; those are not problematic right now. We are seeing some issues on the commercial side regarding travel in the commercial SATCOM business; internationally, we have over 80%, 85% of global operators, so we’re seeing some delays there. We've factored that into our range; this is one of the reasons we have a range. We've put some dates all over the place. The primary issue I'm concerned about right now is that travel one—can we travel internationally to get the sign-off on certain things, and we’ve tried to incorporate that in. Like all other companies, we're seeing delays in the supply chain, and we're seeing price increases in the supply chain on new contracts. We can build those prices into our new contracts but on existing contracts, if they're firm fixed-price, we just have to figure out how to be more efficient so it doesn't impact our margin. These are all the moving pieces we've got going on.

Okay, appreciate it. I'll hop back in the queue.

Yes.

Your next question will come from Austin Moeller with Canaccord.

This is my first question here. So China is building 230 new ICBM silos out in the desert. How does this impact your Rocket Support contracts with Northrop for the GBSD for the missile transporters? Do you think it's unlikely that we're going to get to less than 400 ground-deployed GBSDs because of this?

Yes, sir. Hey, Austin. So you're exactly right; in the past three weeks, satellite shots have identified two new Chinese ICBM fields in two locations with over 100 each. I personally believe that the U.S. is in the very early innings of the next Cold War and the next arms race. I'm not going to get specific with certain programs or customers, but to answer your question, yes, I see what China is doing as being directly related positively to Kratos, our programs, specifically in the rocket area you talked about, which has to do with ballistic missile targets, hypersonic systems, potential hypersonic targets, launching payloads at affordable costs rapidly for our customers. All of this is a plus. I don't think I've said it, Austin, in the remarks, but our booked and anticipated launch schedule of missions for the rest of this year and through next year is very, very strong, and I believe it's directly related in part to what you're talking about.

Okay, great. And then you discussed that you have the two of the 12 Valkyries at the Oklahoma factory currently being outfitted with the Autonomy Core System. So is an Air Force contract to pay for those 12 aircraft contingent upon some forthcoming tests with the Valkyrie using the Autonomy Core System just like the Mako did, or how should we think about that?

Right. So we have a number of those—the number of the 12 that are coming off the line are already under contract. The two that I mentioned, those are under contract, right? So those are already spoken for. When the customers announce the quantities under—and we’re under two contracts now for Valkyries, for those 12 Valkyries, some of the 12, but we have two contracts. When the customers become public with the quantities and what they're doing, then obviously, we're going to talk about it. But those two I mentioned in the prepared remarks, those two are under contracts, and those are two of a number under contract for those coming off the line.

Okay. And just one last one, should we anticipate that there's going to be a Skyborg Valkyrie flight with the Autonomy Core System installed within the balance of the year here, or should we install longer than that?

Yes.

Yes.

Yes.

Okay, well, thank you for the color, Eric.

Yes, sir.

Your next question will come from Joe Gomes with Noble Capital.

Good afternoon.

Good afternoon, sir.

I just wanted to circle back here on the second half, and given the guidance that you provided, the fourth quarter is heavily weighted. Just trying to get your comfort zone; we oftentimes see a lot of political games around budgets and other things of that nature. How confident are you that and what’s your worry level that things of that nature could impact the fourth quarter?

Yes. The vast majority of our third and fourth quarter are in backlog. So the vast majority, this is not a book-and-burn situation. These are in backlog on funded contracts, it's execution; that's what this is. The key parts of the execution are, I think we have approximately 300 open wrecks right now or something like that, and we have some strategies, including taking advantage of other companies that are having some programmatic issues; we're hiring their people, and so far, so good on that hire side. The wild cards that I see are supply chains, okay. We have done the best we can to order in advance, the safety stock amounts, but the safety stock ordering now is pushing out; I think we're at like six to 12 weeks and now some things are like 24 to 30 weeks. Deanna is nodding, but that's correct.

Yes.

So we're seeing things slide to the right, and there are global supply chain issues, as we all know. So that's one. The second one is COVID; two prongs—do any of our major facilities get impacted where a number of people have to quarantine, etc.? I don't see that right now. The other one is what the other gentleman asked on the DoD side; if DoD restrictions tighten up, in particular, related to range access. But again, in our range, we’ve tried to take all of that from worst-case to normal case to good case; that’s why I’m very comfortable with how we’ve come at this, and we're going to be rock solid in that range.

Okay, thank you for that clarification. On the turbines, you were talking about the ATTAM programming contract, and one of the things I think in the press is talking about is affordability, and given the huge amount or the huge percentage that engines cost as part of a drone, I mean, can you kind of give us some examples or details? What kind of cost savings are you looking at here under your KTT versus the existing engines?

Yes. So we had our engine businesses; it’s a range. There are certain engines we're looking at orders of magnitude, three, four, and five times less costly. Other ones we're looking at 30%, 40% less costly. It just depends on the type of the engine. Most of these are turbojets and turbofans and the application. On the first part of your question, I do want to comment on the decline of the U.S. industrial base, especially for engine technology related to space systems—it’s really bad. The ability and there—in the past couple of weeks there have been a number of articles on the ability of U.S. companies to build very specialized machined or cast subsystems and components for rocket engines, it's that. We have that capability. You've heard me say in the prepared remarks, we're under a number of contracts, we're under NDA, but people who are going to space, people who are launching things; we’re probably under contract with them building engine components for them, and that business is ramping very rapidly right now, number one, because of the demand, but number two, the competition; there are not a lot of people out there that can do it anymore. We've lost that capability in the country, and so we're looking at it as a business opportunity and a national security opportunity.

Great. One last one for me, if I may. Perusing the queue before the call, I saw that you had a nice increase in the commercial revenue in the KGS segment. Is that related to OpenSpace or are there other things behind driving those commercial revenues higher for the quarter?

That's a big piece of it, on the commercial SATCOM piece.

Your next question will come from Pete Skibitski with Alembic Global.

Hey, guys, I want to follow up on the engine line of thoughts. Just Eric, you mentioned in the second half of the year a potential, you called it a large engine contract, and I just want to get my expectations in order because I think of what your KTT business in the past is getting a lot of task orders maybe $5 million to $10 million for development type; what are we talking about in the second half? Are we talking about a production contract or are we talking about maybe an advanced development contract that's larger?

It's multiple tens of millions.

Okay. Is just like an LRIP type contract?

I cannot get ahead of the customer, but it is several, several tens of millions is the size of the engine contract.

That's a nice breakthrough for the business, I would say?

The business is doing great, and the opportunity that the number of new missiles and powered munitions for the range that has to be achieved in the Pacific is incredible.

Will we see a press release when you get this, or is this too close to all kind of a thing?

I believe I'm hopeful the customer will announce it; I'm hopeful.

Okay, okay. Last one for me on KGS, I just want to, I feel like maybe I need to understand this business better. On the EBITDA margins at KGS, when we talk about, they're in kind of the upper single digits for the first half of the year, I guess, due to space R&D. What I'm wondering is, is every business within KGS in normal times can that be, or is it a mid-teens type of an EBITDA margin business that generates free cash? Is it just being suppressed right now because of space R&D, or is there a big range there, and some businesses are maybe more important than others?

So across the board, there are different margin rates within the businesses. So on the space and satellite side, those are on the higher end of the range. On some of our—we still have some legacy services business, and right now our engine businesses, most of that’s in development. Those are on the lower end of the margin rate range. So it’s a blend right now. What we're expecting for the second half is that space and satellite business is going to be more software-focused, which would lift those margins in the second half and more specifically in the fourth quarter. So that's what we see driving some of that margin uptick for the second half.

Okay, if we say more so on the mid-term, it is my last one, I apologize, but if we think more in the mid-term with engine getting a larger contract with space maybe moving more so into production type of stuff on the new space stuff, is your expectation that KGS in the mid-term can be kind of a mid-teens margin business or is that too large?

As you know, in our C5 business with GBSD, which I believe the announced contract is something like the developed—it's a development contract before production is $180 million. We’ve got a couple of other ones in there. Those development contracts margins are typically lower than production. I think in the second half we're going to win, we’re going to be awarded another large multiple tens of millions dollar weapon system contract for development that will then go into production. Those are going to offset a little bit some of the margin increases we’re seeing, like in the space and satellite area. To crisply answer your question, once everything gets into production like we predict and there were no more large development programs, it could be a low-teen business. But hopefully, we're going to continue to win development programs that put us in position for additional programs to drive organic growth. You know what I mean, it’s a cycle.

At this time, there are no further questions. I would now like to turn the call back over to Eric DeMarco for closing remarks.

Great. Thank you very much for joining us, and looking forward to our next report. Thank you, sir.

This concludes today's conference call. Thank you for participating. You may now disconnect.