Kratos Defense & Security Solutions, Inc. Q4 FY2021 Earnings Call

Good afternoon. Thank you for joining us for the Kratos Defense & Security Solutions fourth quarter and fiscal 2021 conference call. With me today is Eric DeMarco, Kratos' President and Chief Executive Officer; and Deanna Lund, Kratos' Executive Vice President and Chief Financial Officer. Before we begin the substance of today's call, I'd like everyone to please take note of the safe harbor paragraph that is included at the end of today's press release. This paragraph emphasizes the major uncertainties and risks inherent in the forward-looking statements we will make this afternoon. Please keep these uncertainties and risks in mind as we discuss future strategic initiatives, potential market opportunities, operational outlook and financial guidance during today's call. Today's call will also include a discussion of non-GAAP financial measures as that term is defined in Regulation G. Non-GAAP financial measures should not be considered in isolation from or as a substitute for financial information presented in compliance with GAAP. Accordingly, at the end of today's press release, we have provided a reconciliation of these non-GAAP financial measures to the company's financial results prepared in accordance with GAAP. With that, I will now turn the call over to Eric DeMarco.

Thank you, Marie. Good afternoon. As we reported today, Kratos finished fiscal ‘21 with approximately 10.7% organic growth, excluding our training business which legacy LPTA contracts will be completely out of our financials after Q2 of this year. Our 2021 revenue growth included growth of approximately 24% and 19% respectively, in our largest businesses, unmanned systems, and space satellite communications and cyber. We reported a fourth quarter book-to-bill ratio of 1.5 to 1 that includes 2.4 to 1 in our unmanned systems business and 1.2 to 1 in our KGS segment, positioning the company for continued future organic growth and providing us with confidence in our 2022 forecast that we're providing today. Kratos’ Q4 and fiscal ‘21 financial performance and our 2022 forecast of organic growth are representative of the strength of Kratos’ business model and our team considering the continuing global COVID pandemic and recent Omicron variant impacts which have spiked for Kratos in Q4 and thus far in Q1 ’22. The continued and increasing disruptions in the supply chain and the federal government and our industry also operating without a federal budget and under a CRA since October 1, 2021. All of which Deanna is going to discuss in detail. As we begin 2022, we believe Kratos continues to be uniquely positioned and aligned with the United States and its allies’ national security priorities, including affordability and rapid development, testing and fielding of hardware products and systems. In the tactical drone area, the customer recently communicated its commitment to and continued prioritization of affordable, loyal wingman force multiplying tactical drones and autonomous systems for the future force structure. These comments include additional new planned drone program opportunities for the 2023 budget request, and potential envisioned concepts of operations, including drones teaming with multiple manned platforms. For example, the customer noted that loyal wingman drones in the manned unmanned teaming may include the F-22, the F-35, the B-21 and the Next Generation Air Dominance or NGAT system as system of system quarterbacks to the drones. These applications are in addition to previously discussed drone loyal wingmen or force multiplier applications, including with the F-15 aerial tankers and other manned aircraft. The customer also stated that they envision up to five loyal wingman jet drones per manned fighter aircraft, which would represent a very large market opportunity. Based on what has recently been communicated, it's possible that in the future, certain Kratos tactical drone initiatives, programs or platforms that you are familiar with may be combined into new programs or prioritized or deprioritized. And you may also become aware of certain additional Kratos drone programs or platforms or systems, including from Kratos as Ghost Works. This may occur as the customer prioritizes certain technologies capabilities, drone systems initiatives, mission requirements, etc., as they move toward initial operating capability or IOC and fielding. With the numerous tactical drone programs Kratos has successfully competed for and received, the family of affordable jet drone aircraft we have flying today and additional systems we have in development, including with the customer, we believe that Kratos is uniquely positioned to address this increasing and accelerating market opportunity, including when the customer is ready for scale production and fielding. Also, with Kratos operating active tactical and target jet drone production lines at multiple facilities today, where we are producing hundreds of high performance jet drone aircraft, we also believe that Kratos is further uniquely positioned to support customer requirements if certain geopolitical or other events were to occur, and affordable rapid platform acceleration were necessary. The customer also recently emphasized that national security is of increasing importance, including that certain loyal wingman and other drone programs will be classified at high security levels and no longer routinely discussed publicly. Accordingly, we will be very limited in what we can disclose and discuss publicly going forward from a tactical drone customer programmatic and platform perspective. Since the last report to you, Kratos’ drone initiatives have continued to make progress, including as represented by our financial results, including our unmanned systems business’s Q4 24% year-over-year growth rate, and a book-to-bill ratio of 2.4 to 1. Our 2022 tactical drone revenue forecast is expected to be greater than 2021, and the year-over-year future revenue growth trajectory is expected to continue in the future. The manufacturer of our first Valkyries of the 12 serial production lot continues, several of which are currently under customer funded contract or commitment, and certain of which now have customer flights scheduled. As I have mentioned previously, once we have an approved 2022 budget, and the 2023 budget request and future year's defense program or fight up, we should have the information necessary regarding possibly moving ahead with a second Valkyrie serial production lot, adjusting our current internally funded investment profile for the Valkyrie or for derivatives, or for potential other new platforms, including potentially certain Kratos Ghost Works initiatives. In the fourth quarter, it was reported that Kratos’ X-61A Gremlins drone was successfully recovered in flight by a C-138A aircraft. As Dianetics is the primer on the Gremlins program, we are unable to comment further on Gremlins at this time. Though I will mention that Dianetics is an incredibly important and valuable strategic partner of Kratos’ and we are working together on a number of additional exciting initiatives and opportunities. It was recently reported that a Kratos AirWolf drone launched an AeroVironment tactical drone in a demonstration, including for drone swarming range and mission extension capabilities and enhancements including for AVAV’s industry-leading systems. AeroVironment tactical drone systems are an incredible asset and AVAV is a valuable partner to Kratos in certain scenarios we are working. Kratos’ Ghost Works and our industry-leading digital engineering group have been very busy as you can imagine with everything that is going on in the tactical drone area, including as related to Kratos’ new Demogorgon system which was recently unveiled and several others. We are currently under contract and bidding on multiple additional tactical drone opportunities, which are a key element of Kratos’ ‘22 and future forecast growth trajectory. Since our last report to you, we have received a $51 million sole source production contract from the United States Navy for BQM-177 target drone systems, including 50 drones for the Navy, seven drones for Japan, and eight drones for Saudi Arabia. The international customers are of particular importance, representing additional new growth opportunities for Kratos’ 177 target drone system. The BQM-177 platform and related Navy program is an important element of Kratos’ future growth trajectory, including domestic and international opportunities where the infrastructure to launch, operate and recover Kratos’ drones are analogous to the razor and the drones are analogous to the razor blades in a recurring revenue model. The BQM-177 is one of the highest performing unmanned aerial drone systems in the world. And it has just recently entered full rate production, which is expected to continue sole source to Kratos for many years into the future. As a data point to date, we have produced over 170 BQM-177 jet drone aircraft. This $51 million sole source U.S. Navy contract award and program along with the $370 million U.S. Air Force sole source target drone award Kratos received late last year provide us confidence in our 2022 financial forecast and expected future growth trajectory. As an additional data point on the abSat program, we are currently in production year 17 with the BQM-167 for the Air Force, once again sole source. And to date we have produced over 500 of the 167 jet drone aircraft. We have a confidential program that also continues to progress is currently in low rate initial production and is expected to achieve full rate production in the future sole source to Kratos which also provides us confidence in our forecast and future growth trajectory. We are a teammate on another large unmanned aerial drone system program, where it was recently announced that the most recent full rate production award has now been made by the customer. With this program representing an additional key component of our 2022 financial forecast and future growth trajectory. As Kratos is not the prime on this program, we are unable to provide further information at this time. We also just received a contract from a new international customer for Kratos target drones, infrastructure, and support equipment for multiple tens of millions of dollars, with this new customer award, also providing us confidence in our future financial forecast. Kratos’ space satellite and cyber business with Kratos being the first to market industry leader in software-based defined ground command control and telemetry tracking and control systems is also positioned for future year-over-year growth, which we are forecasting for 2022 over 2021 and continuing thereafter. There are currently approximately 4,500 satellites in orbit today, a number which is expected to grow by some estimates up to 100,000 by 2030. This expected satellite growth is being driven in part by the rapidly dropping cost of launch systems to put satellites into orbit and technological advancements related to the satellites themselves, including smaller, faster, more powerful and capable satellite systems. Satellite operations are also growing in complexity, including proliferated constellations, spectrum management challenges, interference avoidance across LEO, MEO and GEO high rates of satellite handover as 5G advances and more. Kratos’ future forecast growth trajectory is tied directly to this large expanding market opportunity, the successful launch and operation of the planned for satellites and the anticipated market penetration and success of our first to market products and systems. Our plan continues to be to make internally funded high R&D investments to achieve designed in positions on new satellite constellations and with the operators. And then once the satellites are launched in orbit and operating for Kratos to see revenue growth and margin expansion as we transition from development and testing to operational services. Several of the satellite opportunities we are pursuing and or teamed on as strategic partners are classified in nature. And therefore we may be limited in what we can discuss publicly. However, our recent financial performance, including approximately 19% Q4 growth and a rapidly expanding opportunity pipeline provides us confidence in our 2022 and future financial forecast. Since our last report to you, Kratos has made a small tuck-in acquisition Cosmic AES, which is just an incredible technology-based product and solution provider in the space signals and cyber domains, with Caroline Zan’s culture and commitment to the mission exactly consistent with Kratos’. For example, Cosmic believes that actual security needs arise faster than requirements and Cosmic builds adaptable mission-driven solutions that empower the warfighter to confront urgent and changing threats in the space and cyber domain, threats that emerge too quickly for the traditional acquisition cycle to address. Cosmic also brings several new customer sets to Kratos with the majority of Cosmic’s work being classified. Cosmic’s margins are currently lower than Kratos’ space satellite and cyber business, including due to the existing nature and maturity of certain work they perform in their contractual arrangements. However, the margins are expected to increase as we move forward as certain Cosmic work matures or transitions to higher-end products and execution delivery. Kratos’ turbine technologies and engine businesses for drones, missiles, powered munitions, space, hypersonic and other systems continue to make progress including the receipt of our first small serial production contract for Kratos jet engines. We expect our engine and turbine businesses to generate 2022 over 2021 year-over-year organic revenue growth, including growth in KTT’s space rocket, hypersonic MRO and specialty engine areas as multiple established and new rocket system and launch entities engage Kratos for complex technology and hardware for their propulsion systems. Kratos’ rocket systems business which includes and supports target ballistic missile and hypersonic systems, our microwave products business, which supports missile, radar, space, satellite and communication systems, and our C5ISR which supports drone, hypersonic, space satellite, missile, radar and strategic deterrence systems are each expected to generate year-over-year 2022 over 2021 organic growth based on current backlog and the opportunity pipeline. We recently announced that Kratos’ rocket systems business is teamed with Hypersonix to develop and fly the DART hypersonic drone, which will be powered by the fifth generation Spartan zero emission clean hydrogen scramjet engine. The Hypersonix’s scramjet powered DART drone will be multi-mission capable and 3D printed out of exquisite materials. Additionally, Kratos’ rocket systems business is also investing in coordination with the government customer set in the design and development of an additional new affordable hypersonic vehicle named Aeronish and a complementary affordable boost system. The affordable Kratos designed boost system will accelerate the Kratos developed and manufactured Aeronish hypersonic vehicle to speed greater than Mach 5 before release, at which point Aeronish will perform predetermined mission sets. The Kratos Boost system, and Kratos Aeronish hypersonic vehicle, which we believe are exactly consistent with recent SecDef priorities including low cost and moving fast, which we have been working on for some time now, continue to make progress as we move towards initial flight. Aerojet Rocketdyne is a key partner to Kratos on certain of our hypersonic rocket, system missile defense and other national security programs. Since our last report to you, Kratos has successfully closed on an additional very small tuck-in acquisition in the microwave electronics area, CTT. Similar to Cosmic, CTT was a negotiated transaction with the Principal, David Tye with CTT’s business being consistent with Kratos’ existing microwave products business, including with CTT having a focus on space and satellite systems, which I am very interested in. Also similar to Cosmic, CTT will provide a channel to additional new customer opportunity sets for Kratos with David having built a solid rapidly growing first-class business and a top-notch team of professionals and employees. In summary, Kratos had a solid 2021 despite the global COVID pandemic, continued and increasing supply chain disruptions and a federal government continuing resolution for our entire fourth quarter. Even with these continuing issues and challenges, we are forecasting year-over-year organic growth for 2022 over 2021 of approximately 5% to 10% or 7% at the midpoint excluding the training business. Additionally, we have the opportunity for increased future growth in the tactical drone area. Once the government moves forward and procures affordable high performance jet drones, which the customer has publicly stated they are planning to do. When the customer makes this decision, Kratos will be ready. For our initial ‘22 financial guidance, of which Deanna will be providing the details, I want to emphasize a few points. The current CRA has obviously been going on for the past five months since October 1, 2021 and is currently expected to continue at least through March 11, 2022. The CRA is directly adversely impacting our industry and Kratos, including as related to our 2022 financial forecast, particularly our 2022 first quarter, the entirety of which has been covered by continuing resolutions to date. Based on our current backlog forecast execution and delivery pipeline, and with an expected March 22 DoD budget approval, we expect Kratos’ second half of ‘22 to be substantially greater than the first half. Simply stated, we have the programs, the contractual backlog and the visibility for ‘22. We need the budget and then we will have a lot of executing to do over the last nine months of Kratos’ fiscal year assuming we get this budget in March. From an operational standpoint, Kratos’ space satellite and cyber business, our company's largest and very rapidly growing is transitioning from long cycle dedicated, hardware centric ground infrastructure products and programs to quicker turn software-based and defined virtualized solutions. As we saw most recently in 2021, this new and increasing software element of our satellite business and the related quick customer order development and delivery aspect results in cyclicality, cyclicality of customer orders, revenue generation and profit rates, including around the September 30 federal government fiscal year-end, when the government customer typically obligates substantial funds and make significant procurement decisions to ensure 100% budgeted funding utilization. Also contributing to our space satellite and cyber businesses cyclicality and expected increased revenue and profit around Kratos’ Q3 and Q4 of ‘22 is a calendar year and is also when non-DoD customers typically procure products and solutions, including for similar budgetary spend reasons. Accordingly for ‘22 and going forward, for Kratos’ space and satellite and cyber business, we expect to forecast increased revenues and margins in our fiscal Q3 and Q4, with substantially lower expected revenue and margins in Q1 and Q2 to reflect this business locality we have experienced, including just finished 2021. This business cyclicality also impacts the leverage Kratos receives on our fixed overhead G&A research and development and other expenditures. As obviously when we have higher revenues, we generate higher profit margins, as we just saw in Q4. We have reflected this expected cyclicality and second half increased operating leverage and anticipated revenue mix for our space satellite and cyber business in the ‘22 financial guidance we provided today, which we believe may be even more pronounced this year, as a result of the ongoing extended continuing resolution. With that, I'll turn it over to Deanna.

Thank you, Eric. Good afternoon. As we have included a detailed summary of the fourth quarter and fiscal year financial performance and financial guidance in the press release we published earlier today, I will limit my comments to the highlight in my remarks today. Kratos’ fourth quarter 2021 revenues of $211.6 million was at the midpoint of our estimated range of $205 million to $215 million. We achieved the midpoint in spite of continued COVID related supply chain and other delays, which impacted revenues by $11.2 million during the quarter with the most significant impacts in our C5ISR and our international commercial SATCOM businesses. Our Q4 2021 consolidated operating income was $9.2 million, up from the fourth quarter of 2020 operating income of $9 million, which includes fourth quarter 2021 increases in R&D of $1.4 million, primarily in our space in satellite and unmanned systems businesses, and increased SG&A costs of $4.8 million, primarily resulting from our increase in revenues as well as due to increased headcount in our unmanned systems business, resulting from the growth in this business. In particular, total headcount in our unmanned systems business has increased by 90 heads from 812 in Q4 of ‘20, to 902 in Q4 of ‘21, as this business experienced a 24% increase in revenues from 2020 to 2021 with additional future growth expected. Net loss was $2.6 million for the fourth quarter of ’21 and a GAAP loss of $0.02 per share, compared to net income of $78.1 million in the fourth quarter of 2020 and GAAP EPS of $0.62, which included a non-recurring tax credit of $75.3 million. Included in the net income for the fourth quarter was a tax provision of $4.5 million on income before taxes of $3 million or an approximate 150% tax provision rate. As a reminder, we have approximately $235 million of U.S. Federal net operating losses, which we expect to continue to substantially shield us from domestic base Federal Income Cash tax payments. We generated adjusted EBITDA of $23.4 million for the quarter at the higher end of our expected range of $20 million to $24 million, which included a more favorable mix of revenues in Kratos’ space satellite and cyber business resulted primarily from higher margin software sales and work performed on certain confidential programs, as well as a more favorable mix in our microwave products business. In the fourth quarter, our unmanned systems segment reported revenues of $54.4 million up 9.9% from the fourth quarter of 2020, including ramps in production in certain drone programs, including the BQM-177, and Valkyrie related work. KGS reported revenues of $157.2 million in the fourth quarter of ‘21, up from $156.9 million in the fourth quarter of 2020, which included year-over-year growth in our space satellite and cyber business of $14.6 million and in our microwave products and turbine technologies businesses of $5.4 million, offset by a $9.4 million year-over-year decrease in our training solutions business resulting primarily from the loss of an international training contract and a year-over-year reduction of $2.5 million in our C5ISR business resulting primarily from supply chain and COVID related disruptions. On a pro forma basis, excluding the reduction in our training business, KGS revenue grew organically 6.8% in the fourth quarter of ‘21 over 2020, including organic growth across our space, satellite and cyber business at 9% and organic growth in our microwave products and turbine technologies business. As discussed earlier, KGS’s fourth quarter revenues were negatively impacted by disruptions and delays in COVID related supply chain deliveries and other issues, resulting in revenues of approximately $10.7 million expected in the fourth quarter deferred to future periods. KGS’s fourth quarter ‘21 operating income and adjusted EBITDA were positively impacted by a favorable mix of revenues, including increased software product deliveries, which were previously expected in the first quarter of ‘22, replacing certain lower margin work and hardware products that were originally forecasted for Q4 of ‘21, which are now forecast for execution and delivery in Q1 of ‘22. FY ‘21 cash flow from operations improved approximately $10 million to $15 million from our original FY ‘21 forecasts of $20 million to $25 million, primarily due to the estimated investment in non-recurring engineering in our ballistic missile target business, which was originally forecasted at $10 million, compared to the $4 million that was incurred in 2021, as well as additional customer advance payments that were received in 2021. In addition, actual capital expenditures were approximately $940 million less than originally forecasted for ‘21. In summary, these differences in our original 2021 estimates of investments in non-recurring engineering costs and capital expenditures primarily represent timing differences totaling $15 million to $20 million whereby these expenditures are now expected to be incurred and funded in ‘22. Our contract mix for the quarter was 79% fixed price, 18% cost type contracts, and 3% time and material contracts. Revenues generated from contracts with the U.S. federal government during the quarter were approximately 66%, including revenues generated from contracts with the DoD, non-DoD, federal government agencies, and FMS contracts. In Q4 we generated 9% of revenues from commercial customers and 25% from foreign customers. Our backlog at quarter-end was $953.9 million, up sequentially from third quarter and backlog of $839.1 million with consolidated bookings of $323 million and a book-to-bill ratio of 1.5 to 1 for the quarter fourth quarter. Funded backlog at quarter end was $653.7 million with $300.2 million unfunded. Moving on to financial guidance. Our fiscal ‘22 financial guidance we provided today includes our current forecasted business mix, and our assumptions related to the expected continued impact of employee absenteeism, supply chain disruptions and related expected price increases, travel restrictions, and other COVID-related items that have or are currently impacting the industry and Kratos. In January and February of ‘22, Kratos experienced a significant increase in the intensity and effects of COVID-19 including the new Omicron variant and the related impact where employees, absenteeism, consultants, vendors, suppliers, customers, etc. Which impact included loss of weeks of manufacturing and production functions in our unmanned systems, C5ISR and microwave products businesses. We have assumed that these COVID-19 related impacts to our business, which are significantly impacting our fiscal first quarter ‘22 forecast will begin to subside in our second fiscal quarter and continue to improve throughout our fiscal ‘22. As Eric discussed, there is currently no federal fiscal ‘22 October 1, ‘21 to September 30, ‘22 defense budget in place and the defense industry is currently operating under federal budget continuing resolution authorization which Kratos has been operating under throughout our fourth quarter of fiscal ‘21 and thus far during our first quarter of fiscal ‘22. Under a CRA there are no new start program awards or new programs of record, no increases in production on existing programs and no transition from existing development programs to production, among other things, all of which impact Kratos. The effects of the current CRA and continuing supply chain delays and disruption adversely impacted Kratos’ fourth quarter of ‘21 and are expected to adversely impact Kratos this fiscal ‘22 in particular first and second quarter financial performance, which current estimated impact has been included in our ‘22 financial guidance. We currently estimate that the impact to our first quarter revenues is $12 million to $15 million and $2 million to $4 million to our adjusted EBITDA. The existing CRA currently expires on March 11, ‘22, at which time we have assumed that a federal fiscal ‘22 defense budget will be approved and become law, which assumption is included in our ‘22 financial guidance. However, once finalized, the approved and authorized ‘22 DoD budget may be different and includes substantially different funding amounts than what we are currently estimating, and its timing is uncertain at this time. Additionally, the longer the CRA continues beyond its current 3-11-22 expiration date, the greater the potential adverse impact to the defense industry and the company. If the current CRA goes substantially beyond the current 3-11 expiration date, we will update our financial guidance when we’ll report our first quarter results if necessary at that time. Although we have operated under an extended CRA in previous years, the most recent government DoD fiscal ‘21 budget from October 1, 2020 to September 30, ‘21 was signed into law as of October 2020, which meant that the industry and Kratos had a DoD budget for the entire last fiscal year. The situation is much different for fiscal 22 as we have been operating under an extended CRA for over five months. In addition, the impact of the extended CRA may be more pronounced for Kratos in ‘22 due to a number of expected new program starts or expected increases in production lot size quantities and anticipated transition from development efforts to production including in our unmanned systems, space, satellite and cyber, and rocket system businesses and C5ISR business areas. As a result of these factors, as we have discussed, we are forecasting approximately flat organic growth for our first quarter of ‘22 at the higher end of our estimated range compared to ‘21, excluding the expected contribution from the recent acquisitions of CTT and Cosmic AES of approximately $10 million to $12 million in revenues, offset by the loss of the International Training contracts, which contributed $8.3 million in Q1 of ‘21. Our quarterly forecasted EBITDA performance is also impacted by these industry and cyclicality factors, including our inability to realize leverage on our fixed G&A, overhead manufacturing and research and development costs, particularly in our 2022 Q1 and Q2 operating periods. Additionally, our forecasts for first quarter EBITDA is further impacted by our expected mix of revenues, including an increased mix of lower margin development programs, and international commercial satellite hardware programs, and an expected reduced volume of higher margin software solution deliveries which were delivered earlier than originally anticipated in the fourth quarter of ‘21. As we continue to transition our space and satellite business from a hardware to software focused solution, financial performance will tend to be more cyclical, lumpy and more sensitive to delivery schedules. As we have discussed before and I had noted previously, Kratos’ FY ‘22 estimated revenues include the final impact of the 2021 loss of a large international training contract, which contributed approximately $13 million to the company's FY ‘21 first and second quarter revenues. The loss of this international training contract presents a ‘22 versus ‘21 revenue comparison headwind for Kratos in our first and second quarters this year. As I mentioned previously, our fiscal ‘22 guidance includes the estimated contribution from the recently closed CTT and Cosmic AES acquisitions, which consists of revenue adjusted EBITDA of approximately $45 million and $1.5 million to $2 million respectively.

Great, thank you Deanna. I want to conclude with a couple of thoughts relative to what the employees of the company have accomplished over the past few years. For the past several years, we've made substantial internally funded investments, including in the development of a suite of affordable high performance jet drone aircraft that are flying today and that we believe are ready now to be the Pentagon's low-cost, credible force multiplier unmanned combat system. We developed the low-cost rocket system that has had numerous successful missions including hypersonic, and we are developing a more advanced system and an affordable hypersonic vehicle, Aeronish, with initial flight now being planned. We have developed and are the first to market with a truly software-based virtual satellite ground operating command and control TT&C based open architecture system in open space, which we believe will be market disrupting. And we are working to develop the next generation of turbojet, turbofan, and other exotic engines for drones, missiles, powered munitions, and other systems with the first of our engines now entering limited production for an aerial vehicle with additional production awards expected. We're working closely with our Pentagon customer set and Congress, including to invigorate the U.S. industrial base, increase competition, foster real innovation, drive down costs and secure our country. The same quantity has a quality all of its own is becoming more and more relevant every day. And we are accomplishing all of this while we continue to organically grow Kratos’ revenue, our profit or expected cash flows as we reported today, with an unwavering focus on delivering value for the shareholders. Thank you to our employees and all the Kratos stakeholders who are committed to the successful execution of the mission. And with that, I'll turn it over to the moderator for questions.

Thank you. Our first question comes from the line of Mike Crawford with B. Riley Securities. Your line is open.

Thank you, Eric. Is the decision on the OBSS Demogorgon Downselect expected this year or is that a 2023 event?

I believe, Mike, the customer announced that it will be Q4 of this year, I believe.

Okay. And then did you say that the CTT and Cosmic AES acquisition were made in the fourth quarter? Or were some of those acquisitions made in the first quarter? And are there earnouts associated with them that you can discuss?

Yeah. Mike, the CTT acquisition was performed in the fourth quarter. Part of the purchase price was actually paid though in the first quarter. And the Cosmic acquisition was in our first quarter. And there are no earnouts.

The first acquisition closed right at the very end of the quarter, literally on the last day of it.

And then combined, you paid one for the two?

Of about $60 million.

Okay. $60 million. And then just thank you for giving that guidance. Just final question for me would be what if anything, should we be looking for not only in this forthcoming delayed government fiscal ‘22 budget, but also in the soon to emerge ‘23 budget requests related to Skyborg or anything else that will give us some more clarity on where you might be able to go particularly with tactical unmanned systems?

I believe, Mike, probably right now, the most publicly available data point we can talk about relative to that is on the Secretary of the Air Force, where he said that he is looking to put into the 2023 request for the related fighter funding for two new additional unmanned combat drone aircraft. In addition to that, for the ‘23 budget as you I think you're aware in the NDA signed by the president for the ‘22 there are a handful of items in there related to current Kratos programs that we're waiting for that could potentially fall over into 2023. Those are the two.

All right, thank you very much.

Thank you.

Thank you. Our next question comes from the line of Christopher Rieger with Berenberg Capital Markets. Your line is open.

Eric and Deanna, good evening. Thank you very much for the time. So, if the current continuing resolution continues to be pushed out, obviously Kratos isn't the only company impacted. So what sort of lingering effects, particularly on your supply chain would you anticipate to be the most pronounced? And what can you do on your end to sort of mitigate these effects?

Right. I think we talked about in Q2 of last year and we've continued since then. We've routinely been buying ahead where we can critical components critical subsystems for our systems in the past month, relative to our 2022 plan forecast we put out today. We met with all the operating presidents and there are specific areas where we are leaning forward, and we're going to try to buy a significant amount of stock. I think we've already placed the orders to get it under contract and get it in here and fix the pricing. Because pricing is running on us. And we're doing this ahead of contract awards. We have visibility on the program. It's a Kratos program, but the contract award may not be made yet where we're leaning forward and making those purchases as well. So those are the key things we have been doing and we're continuing to do to mitigate as much as we can.

Great, thank you helpful. Just one more. I guess, a bigger picture. With regard to Valkyrie and Skyborg, what needs to occur from here on your end with your partners and at the DoD in order for Skyborg to become a program of record?

I cannot address that specifically right now. I want to, but I can't. If you look at the recent comments from the Secretary of the Air Force, I need to wait for the customer to speak on this. Things are progressing, and we need to allow the customer to take the lead.

Okay, fair enough. Thank you very much.

Thank you.

Thank you. Our next question comes from the line of Sheila with Jefferies. Your line is open.

Hi, this is actually Ellen on for Sheila. I'm just looking at the 2022 margin guide. It's implied down about 50 bps at the midpoint. How much of that is mixed versus supply chain and the CR and all the other one-time items you called out? And can you give us any color across KGS versus unmanned?

Yep. So as you know in 2021 similar to 2019, we continue to win a significant number of new tactical drone development programs. So for example, at the end of’21 we were awarded OBSS. That's just under a $20 million contract that's going to be substantially burnt in 2022. It's a development program, and development programs typically carry lower margins. Also, very importantly, GBSD where we are teamed underneath Northrop Grumman. GBSD is based on our schedule is going to start significantly ramping in Q3, very significantly. And that's going to continue to ramp Q3-Q4, and then it's ’22 and beyond. As you know, this is the development phase with Northrop Grumman, before production is awarded. Those margins and development programs, we will typically record at a lower revenue rate until we get more comfortable as we head toward production. And then in addition to that, we have won a number of classified programs, okay, including in the space, satellite communication in the drone area that are development, that are carrying lower margins. So these are all what are forming the foundation why I am saying with such confidence. Our future year growth trajectory is up and to the right. Because we've been winning these programs, which means we're getting designed into big potential production programs. That's what's causing the margins coming down a little bit thus far in ‘22.

Additionally, regarding the supply chain and the impact of COVID for the fiscal year 2022, we estimate it will affect our top-line by $20 million to $25 million and our EBITDA by $5 million to $8 million. This has had a considerable effect on some of our higher margin businesses, particularly in our microwave products sector, where it has noticeably impacted margins. There are a few other areas affected, but the most significant impact is in our microwave products business, which is also influencing the overall rate.

Thanks, helpful. That's it for me.

Great. Thank you.

Thank you. Our next question comes from the line of Peter Arment with Baird. Your line is open.

Yes. Good evening, Eric and Deanna.

Hi, Peter.

Hi, good afternoon.

Hey, Eric, can you discuss the future outlook? Looking beyond 2022, I know you previously believed the target drone business would grow to over $250 million. How do you view that business now, beyond just the tactical aspects?

We are making steady and careful progress. Achieving full rate production for the SSAT and securing the recent production award is a significant milestone for us. There's a confidential program currently in LRIP that I can't provide many details on, but it's expected to transition to full rate production likely next year. Regarding the international contract I mentioned today, I talked about this about a year ago. It was delayed due to changes in the Department of State, but we just received it. We have several more contracts in the pipeline that we anticipate receiving, and those are all looking positive. On the flip side, about three years ago, we were awarded a sole-source contract for nearly $100 million for target drones. Unfortunately, the rollout has been slower than I initially anticipated due to funding issues with this service. That's been a setback. Overall, as more new weapon systems are sold, there will be a growing need for target drones, which I believe will drive business upward in the right direction.

The international contract that Eric mentioned has experienced a delay of about a year. Although we have received the award, we won’t see any revenue contribution in 2022 due to revenue recognition standards. Our international contracts typically recognize revenue as products are shipped rather than on a percentage of completion basis. Therefore, there will be no contribution in 2022, but we expect to see that contribution in 2023 as we deliver.

Okay, that's helpful. Thank you. And then just quickly on space growth. I'm sorry, if I missed this earlier. How are you looking at the growth there just given all the activity and how well you're positioned on the kind of redoing a lot of the ground stations? And should we expect to see the margins continue to grind higher from the software perspective?

Yep. So as we reported today, we just came off 19%. And so, I was chuckling, because we do a 1.1 book-to-bill ratio, but that's on a 19% growth rate. If you see what I mean so we're growing and we're booking a lot of work. I believe, this year and I believe in the next several months, certain customers are going to make some announcements relative to Kratos. And what Kratos is doing with those customers that are going to tie directly into where we see this business going over the next several years. We being first to market as you know, was a key differentiator for us. Against the primes in particular, we need to be first to market to win. Our space team and our satellite team, they're incredible. And being first to market with the software defined open space virtualization, TT&C and C2 system, this could be as significant as what we're going to pull off in the unmanned drone area. So I see continue up into the right. As I said in my remarks, it's not going to be as smooth as it used to be because these aren't multiyear hardware programs anymore. We're getting designed in and we're shipping more and more software. So overtime, margins are going to continue to increase. And the revenue trajectory is going to continue to be up and to the right. And all of that is being supported by those statistics I gave, which are just some of the space and satellite market right now is ripping. And our number one operational challenge is getting the number of people to support it.

Appreciate it. I'll jump back in the queue. Thanks.

Yeah. Thank you.

Thank you. Our next question comes from the line of Ken Herbert with RBC. Your line is open.

Hi, good afternoon, Eric and Deanna.

Hi, Ken.

Hi, good afternoon.

Hey, Eric. I just wanted to start off with a bit of a higher-level question. You were obviously in another CR, you've got a number of significant opportunities. As you think about sort of your crossing this the valley of death. As you think about not only on the tactical drone side, but engines in space and other markets. How would you characterize or maybe rank the opportunity of some of your markets from a timing standpoint? I mean, should we still think about as drones as obviously the next maybe significant catalyst? Or it sounds like maybe there's more opportunity near term on the space side, I'm just looking for you to maybe sort of recalibrate the expectations here of the different parts of the business.

I continue to believe that our drone business will see significant growth. The numbers that Deanna provided for our tactical drone segment show a clear upward trend, moving from $30 million to $55 million and then to $75 million. Ken, these are all development programs that will transition into production programs. While some might yield modest results, I believe others will be major successes. We're witnessing a surge in public interest from the Air Force since last year, especially beginning in Q4 at the Reagan Institute, and this momentum is picking up with new programs. We are definitely positioned well with the right products at the right time, and success is on the horizon. As I mentioned earlier, we will be fully prepared when our customers are ready to initiate production, although I'm hesitant to speculate on the timing. I hope it occurs sooner rather than later, and I have confidence it will. In terms of our space and satellite business, we are currently involved in solicitations for several programs that could be worth tens of millions or more for Kratos. As I've mentioned in past discussions, our open architecture and non-program specific approach for ground systems is allowing us to tap into different facets of the satellite industry that we hadn't been able to access before. We have submitted bids, and next year, when you ask me about these areas, I expect to report that drones, as well as space and satellites, will be on equal footing in terms of importance.

Great, I appreciate that, Eric. Thanks. If I could, I apologize if you mentioned this earlier. Deanna, as we consider the CapEx investment for 2022, could you break that out by segment or explain how we should view some of the key initiatives on the capital side this year?

Sure. So the guidance we gave is 55 to 65. The normal maintenance CapEx is about $25 million to $30 million. What I wouldn't say the one-offs or the non-recurring or special items would be there's approximately $18 million to $20 million related Valkyrie, so that's the continued build of the original 12 lot. And then there's build out to SCFs or Secured Compartmentalized Facilities for our space business, as well as our unmanned systems business. And that's about $11 million to $13 million. So those are kind of more non-recurring, and then there's about $5 million to $6 million related to the GBSD program. So that should bridge you to what the normal recurring the 25-30 and then to get to the midpoint of our 55 to 65 CapEx guidance.

Perfect. Appreciate that. Thanks, Deanna. Thanks, Eric.

Thank you, you too.

Thank you.

Thank you. Our next question comes from the line of Austin Moeller with Canaccord. Your line is open.

Good evening. My first question is for Deanna. We know the expected contract value for the development stage of GBSD, which should ramp up in the second half of this year. Could you provide an estimate of what we might expect in terms of revenues or the ramp-up for Hypersonix in that period?

Unfortunately, we are limited in what we can say due to the NDA that we're under. So I can't comment. I'm sorry, Austin.

Okay. My next question is for Eric. So if we think about the current environment here with AirWolf. We've just discussed that several dozen AirWolf are currently being constructed. The Army, of course, has announced that they have it under contract. So would it be appropriate to think that one of the several new drone programs of records that Secretary Kendall has implied would be in the fiscal year ’23 budget requests might include AirWolf?

Austin, I'm sorry, but you're going to be over two. I cannot talk about that. I'm sorry. I apologize. I can't talk about this at all.

Okay, thank you.

Okay.

Thank you. Our next question comes from the line of Joe Gomes with NOBLE Capital. Your line is open.

Good evening. We talked a lot here on the continuing resolution. Obviously, that has to deal with the federal government. And just thinking, some of these programs that don't relate to the federal government and one that popped out about a year ago, you guys were talking about your autonomous truck was in eight locations. Eric, you seem to have been very excited about it at the time. And I just wonder if you could give us a little bit more of an update or some color on the status of that program?

I'm glad you asked. We've been making significant progress in this area. As a reminder, our competitive advantage lies in a technology we developed with the Department of Defense that allows us to convert manned systems, such as tanks or combat vehicles, into unmanned systems or robots. While I can't disclose specific details for competitive reasons, I believe we will have announcements in the next three to five months in collaboration with companies in agriculture and mining. Many of these vehicles operate in environments where approvals are less stringent, allowing us to transform them into robots for agricultural or mining purposes. Our advantage also includes the fact that these are low-cost systems, especially given the current driver shortage highlighted in The Wall Street Journal. This issue is particularly severe in agricultural sectors that require numerous drivers during harvest seasons, making our kits an ideal solution. We anticipate discussing this further, possibly with our Q1 or Q2 announcements, and it's an exciting development for us.

Thanks for that. In the release, you mentioned that expected revenues of approximately $11.2 million are being deferred to future periods, compared to around $8.3 million last quarter. Could you provide some insight into the timeframe for when you anticipate these revenues will be recognized?

Yup. So I'll give you an example of an area, aluminum. I have come to understand there are five aluminum smelters in the United States, and they are booked out two, three years. And so certain of these programs need aluminum. We've placed our order. And we've gone internationally too, I don't think I'm allowed to say where we've gone. Same thing can't get it in for these applications. Those are probably pushed out, I'm going to say to ’23, that's one. Another area in the satellite business and in the microwave business is in Field Programmable Gate Arrays FPGAs, specialized ones for certain applications we have. We're getting quoted beyond 12 month lead times now. And here's something that we've been dealing with that there's really nothing we can do about, will have a committed delivery date. And not a month before, not two weeks before the week that we're supposed to get the delivery, we'll get a phone call. Can't get it to you, we'll get it to you in six months. So I'm going to say, I don't think we're going to see much of this stuff until late second half this year, probably 2023, just because we can't get it.

Okay, great. Thanks for that. I'll get back in queue.

Good. Thank you.

Thank you. Our next question comes from the line of Pete Skibitski with Alembic Global. Your line is open.

Good afternoon, Eric and Deanna.

Good afternoon, sir.

Hey, everyone. I want to clarify my question regarding the full-year CR. If we do receive that, does the lower end of your guidance account for that situation? Or is it possible that we could drop below the lower end of your guidance in such an undesirable scenario?

I don't even want to think about this. When I don't know something I'm going to tell you. I don't know. I don't know if some of our programs, especially in the classified area would be part of reprogramming buckets. You know what I mean, that in the CR they can do some reprogramming for mission critical national security, many of which we’re on that could help us? I don't know. But our target drone business, where we've won programs, we've won contracts that they need to be funded with ‘22 money, those would probably move to the right. Certainly, the tactical drone ones, where we're transitioning from, say development phase one to development phase two or otherwise, those would probably move to the right. I've read what Northrop has said relative to GBSD that in summary, not good. So that would probably not be good for the whole team on GBSD. So not good. And I'll just leave it at that.

Yeah, fair enough. Fair enough. I also had a question on a program I'm going to mispronounce many times, Aeronish. The $10 million to $12 million engineering costs for that program. So it's being capitalized, it sounds like. So it's going to flow through cash flow this year. But it won't be much of an EBIT impact this year to spend on is that correct? Am I understanding that?

Right, go ahead Deanna. Yeah. So that is not the same program that was referring to the non-recurring engineering. That's a different program.

Within the same hypersonic bucket, is that right?

Yeah. In the same rocket system, propulsion.

Okay. Same question. It's being capitalized, but we won't see much of an EBIT impact this year, correct?

Correct. Correct.

Because we own the systems, we own the technology. They're ours. That's correct.

Okay. That's great. I appreciate it. Last one for me. The International target contract you guys just finally got. Can you size that? How big that is? And over how many years are you expected to be?

It's approximately $25 million and it's over a few years. And that's all I can say.

Okay, thanks, guys.

I want to highlight that in the target drone programs, the initial purchase includes the launch equipment, flight control equipment, and recovery equipment, which is essential. The target drones are shot down, representing the operational aspect. This connection is crucial in reaching our goal of $250 million, and I emphasize the importance of each component, similar to the recent wins we've had in target drones with Saudi Arabia and Japan for the United States Navy.

Perfect, thank you.

Thank you.

Thank you. Our next question comes from the line of Sam Struhsaker with Truist Securities. Your line is open.

Hey, everyone. This is Mike Ciarmoli. I appreciate the opportunity to ask a question. I wanted to see if you could share more details about the revenue contributions from the two acquisitions? Additionally, could you provide any updates regarding the expected improvement in margins, specifically a more accurate timeline or further insights on that topic?

Sure, Sam. So for the full year, the acquisitions are expected to contribute about $45 million in revenues and $1.5 million to $2 million of EBITDA. And then for the first quarter, $10 million to $12 million in revenue.

And on the second part of the question, Sam. On Cosmic, we expect to start seeing margins increase in 2023.

Great, thank you. And then one additional question that I could sneak it in is regarding labor. I know you guys said that the absenteeism was an issue. I'm assuming just related to Omicron people being not sick. But do you guys see any additional issues with that moving forward past the first quarter of this year? Or do you feel pretty confident where you sit with that?

Based on the way things are trending for us right now? They're getting better. All right. So if things don't go sideways on us, we should be in pretty good shape beginning of Q2, April-ish. We should be in pretty good shape. As I indicated, when I was talking about the space business, our number one operational challenge is hiring people for the programs we're winning. And I know it's not just Kratos, it's an industry-wide issue. But in the unmanned area in our space and satellite area, in our hypersonic area, our rocket system area, we're really putting our best foot forward to obtain the right people, in many cases that have the right clearances or can get the right clearance to execute these programs.

Great, thank you.

Thank you.

Thank you. I'm showing no further questions in the queue. I will now like to turn the call back over to Eric for closing remarks.

Right. Thank you all for joining us. And we will speak to you when we report Q1. Have a good afternoon.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.