Kratos Defense & Security Solutions, Inc. Q1 FY2022 Earnings Call

Welcome to the Kratos Defense & Security Solutions First Quarter 2022 Earnings Conference Call. My name is Daryl, and I will be your operator for today's call. At this time, later, we will conduct a question-and-answer session. As a reminder, this conference is being recorded. I will now turn the call over to Marie Mendoza, Senior VP and General Counsel. Marie, you may begin.

Thank you. Good afternoon. Thank you for joining us for the Kratos Defense & Security Solutions first quarter 2022 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 as 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, as 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. Since our last report to you, there have been several positive developments for the industry and in particular, for Kratos, which I will go through today and which provide additional confidence in this year's financial forecast and the future outlook for your company. As we had planned for in our 2022 financial forecast, the 2022 DoD budget was approved in March, which was important for a number of Kratos programs that are in or are transitioning from development or in low-rate initial production and transitioning to full rate production or which are in production and had planned for increases to that production. Q1's book-to-bill ratio was low as expected as we were in the middle of a 6-month CRA. However, coming off of Kratos' Q4 1.5:1 book-to-bill ratio, our Q1 bookings and combined with what I will discuss today, substantially all of Kratos' 2022 revenue and our financial forecast is now either under contract, or there is funding in the 2022 budget and we are awaiting contracts where we have been informed that we have been selected, and we are expecting to receive the contract. So highlights in the 2022 budget related to Kratos include, in the tactical drone area and related to Kratos' 2022 budgeted funding areas which are not classified and which I can discuss include approximately $160 million in aggregate funding for Skyborg, OBSS, attritables, autonomous air combat operations, prototypes, and Air UX, and very importantly, funding for a new Kratos tactical drone customer, which we now expect to be under contract in the second half of this year and expect to be providing several aircraft to in the future. I will reemphasize that these are non-classified publicly available areas only, and importantly, the initial funding amounts in the 2023 budget in these areas are currently expected to be substantially greater based on the initial request than these 2022 amounts I just went through with you. Additionally, the Air Force has stated that many of these current programs, initiatives, and related technology areas will transition into certain new additional tactical drone programs that have now been announced, and we are very excited about this as the momentum for low-cost, high capability force-multiplying drones is clearly accelerating along with additional and increased funding. We are also excited that all of the services, and in particular, the air services elements of the services are now moving towards affordable mass, including low-cost, attritable autonomous drone systems included as reflected in the 2022 budget, the 2023 budget request and the fight, and Kratos with the family of affordable attritable products is positioned to immediately address this expected very large new market area. With the release of the 2022 budget, the 2023 request, and the fight, we have made the decision to maintain the current Valkyrie production run at 12 aircraft for now, certain of which Valkyries are complete and our emission system integration and flight preparation with the customer. Also, based on recent events, including communications from the Pentagon and in close coordination with the Kratos customer, we are now leaning forward with the Kratos GhostWorks resources on an additional new tactical jet drone we are under contract for in order to maintain the schedule for this program per the customer's request. Kratos' GhostWorks also continues to work on several important initiatives, including one specifically targeted at a certain competitor based on information we became aware of, and once we are complete, we expect this initiative to become an important and significant additional advantage and differentiator for Kratos. Additional important funding in the 2022 budget directly related to Kratos and our 22 financial forecast and future expected growth trajectory includes funding for Kratos' U.S. Navy SSAT BQM-177 target drone program which is ramping production with the SAP program expected to be one of Kratos' largest programs for the foreseeable future, which is a key element of Kratos' Q3 to Q4 sequential 2022 revenue and profit increased financial forecast in the second half of the year. We now expect a large additional SSAT production program contract later this year. Funding for the United States Air Force ApapQM167 target drone program, also one of our largest, is a key element of our 2022 financial forecast in the second half. Funding for a confidential program in our Unmanned Systems division, which is currently in low-rate initial production and is expected to transition to full-rate production with increasing quantities and where we are now expecting an additional production contract award and a significant financial increase in the second half of this year. The 2022 budget included funding for GBSD, where Northrop is the prime, under which program we are forecasting a significant ramp-up and increase for Kratos in the second half of this year, with GBSD expected to be one of Kratos' largest and fastest-growing future programs. It is currently a greater than $200 million Kratos program, just beginning, and it is one of Kratos' biggest expected Q3, Q4, and future growth drivers. Similar to GBSD, other large expected to be multibillion-dollar strategic programs of record that Kratos is supporting, which Kratos is now under contract on, or we expect to be under contract on very shortly, include FAD, IBCS, Shore Rad, Q-53, TPS 77, and IFPC with our strategic partner, Leidos and Dynetics. The 2022 budget includes funding for Kratos' Rocket Systems business, including for our new ZS affordable launch system and related to Kratos' new Aranas hypersonic vehicles which are progressing toward initial flight. Like Kratos' tactical drone systems, where we are leveraging our target drone business and experience, we believe our drones are the highest performance drones in the world. Kratos' hypersonic initiative is leveraging our industry-leading affordable rocket launch, ballistic missile target systems, and previous hypersonic program experience to rapidly develop and deliver to the customer a complete affordable hypersonic system capability. Kratos' Rocket Systems business is also engaged with hypersonics in Australia, which recently received its funding and the dark hypersonic drone vehicle. In our Rocket business, we have several launch missions currently scheduled and in the backlog, and we are forecasting additional future missions to be committed by customers throughout '22. The '22 budget also includes funding for certain Kratos-directed energy or laser system initiatives and programs which Kratos products and systems are part of our expected financial ramp in the second half of the year. As I mentioned, in addition to the '22 DoD budget being approved, the initial '23 budget request was released which included substantial or increased funding for hypersonics, tactical drones, GBSD and strategic deterrence, missile defense, space and satellite systems, microwave electronics, and C5ISR, which are all, of course, core Kratos business areas. The global recapitalization of strategic weapon systems has continued to accelerate, including as a result of the Russian war in Ukraine. And as we have discussed with you for quite some time, we believe that Kratos is uniquely positioned for strategic system recapitalization. Kratos' unique positioning for the recapitalization of strategic weapon systems by the U.S. and our allies includes Kratos being the industry leader in affordable targets and target drone systems which simulate adversary missile aircraft drones and other threats, allowing our forces, weapons, and other systems to engage in meaningful defensive exercises. We expect Kratos' target business to continue to grow in the future, and related to this growth, we have recently been informed that we will be receiving a sole-source new approximate $100 million drone-related contract which we expect to receive later this year. We are also currently pursuing three additional brand-new targets-related opportunities, including those related to potentially new peer adversary missile and other airborne threats that have been identified. Kratos' Rocket Systems business is the industry leader in ballistic missile and similar target systems which simulate the threat represented by adversary missiles so that the U.S. and our allies' radar, space-based satellite, defensive, and other systems can exercise and train against them. Similar to Kratos' drone business, we have approximately ten different types of drone aircraft flying today. In Kratos' rocket system business, we have approximately 15 different types of rocket systems flying, including in the target suborbital research, sounding rocket, and hypersonic areas. We believe that Kratos' Rocket Systems business is uniquely positioned in the hypersonic area, similar to our drone business, with our existing proven hypersonic launch system capabilities and with our new and other systems which we are developing along with our government customers and through our partnership with hypersonics and the DART vehicle with this unique propulsion system. In March, we executed an asset purchase agreement to acquire the assets of the Engineering division of Southern Research Institute or SRE, with the closing subject to certain normal conditions which are expected to be satisfied in Q2. Once the close of the acquisition of SRE is completed, Kratos will be the industry leader in the study analysis, assessment, technology review, and testing of special and exotic materials for weapon and space system applications, including hypersonics and strategic deterrent systems. Simply stated, substantially all exquisite or exotic weapon and space-related systems utilize special materials that need to do special things. And SRE positions Kratos directly in the center of virtually all of these past and future activities and substantially all of SRE’s workforce is highly classified. In 2021, SRE generated revenue of approximately $30 million. So with an expected June ‘22 close, this year's financial contribution of SRE to Kratos is not expected to be significant. However, once integrated with Kratos and based on certain funding in the '22 budget that was just approved and what is expected to be included in the final '23 budget and the incredible U.S. national security focus on hypersonics, strategic deterrence, and space-related systems, we expect strong year-over-year revenue and EBITDA growth trajectory for '20 to '23 and future years with expanding margins for SRE. SRE will be integrated into Kratos' rocket system hypersonic business. And once the transaction formally closes, we will be able to provide you with additional information on the business and some of the programs. Kratos' Microwave Electronics business continues to have a near-record or a record backlog, including in the space and satellite areas with substantially all of '22's forecasted revenue currently in backlog. Kratos' space satellite and cyber business, our company's largest, continues to see customer acceptance for our first-to-market virtual software-based open space satellite C2 and TT&C ground system, including OneWeb with which Kratos is now under contract to deliver an advanced spectrum monitoring system to monitor, analyze, and review spectrum to support high quality of service for OneWeb's fleet of low earth orbit satellites. The space and satellite industry end market continues to experience significant growth and expansion, which growth is expected to continue for the long term, and we believe Kratos' industry-leading ground infrastructure systems products, software, and technology uniquely position Kratos to participate and rapidly grow in this area. Accordingly, in addition to our OneWeb contract award, we have also recently just received an additional very large and extremely important new satellite program award, where Kratos is the prime, which we hope will be announced shortly. Additionally, we have just been informed that we have won and should receive in Q2 two additional large brand-new space program opportunities. The potential and expected combined value of just these three new programs to Kratos is several hundreds of millions of dollars of revenue over the program periods. Each of these opportunities includes Kratos' open-space virtualization technology with a significant software component, with each of these being included in our forecasted Q3 and expecting significant Q4 revenue, EBITDA, and profitability increases. Our space satellite and cyber business is an absolutely critical element of Kratos' achieving our financial objectives and expected industry-leading organic growth trajectory. These four new programs, two of which we have received, including OneWeb and two which we have been informed by the customer that we have won and that we expect to receive in Q2, we believe is just the beginning of an incredible disruptive technology growth trajectory for this business and significant value creation for Kratos' stakeholders. Kratos' turbine technology and engine businesses continue to progress with our Turbo Jet and turbofan engines for missile drones and powered munitions. Similar to other Kratos businesses, the recapitalization of strategic weapon systems to address peer threats and the need for jet drones, new improved longer-range, and more powerful cruise missiles and powered munitions also include extended range, our well-funded priority areas, including in the '22 budget and the '23 request. Kratos' engines that are running today are designed into several new missile, drone, and powered munition systems, and we are working to be designed into several other systems and programs. We continue to progress from development and test quantities to expected future serial production. With the execution of the 2022 defense budget, we now expect to receive in the next few months an approximate $50 million sole-source contract for next-generation affordable engine technology and drones. Also, I am able to announce today that Kratos is a key member of the Rolls-Royce team for the recapitalization of the B-52 bomber fleet engines, a reported $2.6 billion program and that Kratos has now received its contract from Rolls-Royce which is expected to be one of Kratos' largest programs and is one of the key elements of Kratos' '22 financial forecast and Q3 to Q4 projected sequential growth as this new large program ramps for Kratos. Additionally, Space Systems, rocket engines, and hypersonic related systems are also providing a growth market opportunity for Kratos' turbine technologies, with the space propulsion area being one of the fastest-growing segments in KTT. We are under NDA now with several of these space customers, certain of which are the highest profile space companies in the industry where Kratos is currently under contract and providing products and solutions for their mission success. From a business opportunity and total addressable market perspective, Kratos' opportunity pipeline has never been stronger, and we continue to receive or be informed that we will be receiving new or additional program or contract awards, many of which are single or sole source. Across the company, we're currently in pursuit of and are in source selection on several program opportunities, certain of which we expect to hear on in the coming weeks and months. And if we are successful, this will be an important catalyst for Kratos and position us for even stronger future organic growth. Kratos' affordable product and system technology portfolio, we believe is second to none in the industry and is a key reason why we expect to generate industry-leading future year organic growth with the ramp beginning in the second half of this year. Simply stated, we believe that Kratos' strategy has enabled us to have the right products and technology, addressing the right needs, missions and requirements at the right time, all at an affordable cost. And on affordability, we believe that affordability will be of increased importance in the future as an increasing amount of U.S. defense budgets are needed for the recapitalization of the strategic triad which is occurring right now and will continue for the next several years. And as the Pentagon continues to embrace quantities of systems as well as technological quality to address both Russia and China. Operationally, we are focused internally and on execution, including as related to the 2022 budget being recently approved in March; we are now working with our customers and contracting offices for Kratos to get under contract and receive funding as quickly as possible to achieve our customer-related contractual and financial objectives. This is particularly important for Kratos' space and satellite business; we have received or have been informed that we will be receiving or expect to receive several significant new program awards which are a key driver for our second half and future forecast and our expected significant future year-over-year organic growth trajectory. Supply chain and COVID related challenges, including those facing customers, employees, suppliers, and other issues, have continued and are expected to continue for the foreseeable future. Additionally, inflationary pressures are increasing, including with suppliers and the workforce where Kratos is doing what is necessary to both retain and obtain employees by paying more and increasing salaries and compensation which is impacting our near-term margins, including Q1 and Q2, but obviously, we have to do this, and we have to do what is required. We need a qualified workforce and the team in place to execute. Also, as Kratos is primarily a product company, with the vast majority of Kratos' contracts and programs being firm fixed price, our ability to pass cost increases on to the customer in the near term is limited under existing contracts or priced options which is currently impacting us, including Q1 and Q2. However, we have included cost escalations into new bids and unpriced options, as well as new opportunities, contracts, and programs which we expect to begin mitigating this impact in Q3. Like all companies in the industry, we are managing our way through these issues, most of which are now expected to continue for the foreseeable future. In closing, the industry now has a '22 budget, a '23 budget request, and a fit-up, each of which are favorable for Kratos, including in the drone space, satellite, and strategic deterrence areas. Irrespective of the macro challenges industry and Kratos are facing, the success of Kratos' strategy is now clearer than ever. With the core Kratos product and technology-focused national security business positioned in a macro growing market with significant budgetary increases expected for the foreseeable future, where Kratos' core business is generating significant revenues and EBITDA, and where we are also positioned for transformative potential future growth with industry-leading products in space, satellites, and drones, we expect the Kratos growth trajectory to begin in the second half of this year and to continue thereafter.

Thank you, Eric. Good afternoon. As we have included a detailed summary of the first quarter financial performance and financial guidance in the press release we published earlier today, I will focus on the highlights in my remarks today. Kratos' first quarter '22 revenues of $196.2 million was at the midpoint of our estimated range of $190 million to $200 million. We achieved the midpoint in spite of continued and increased COVID-related supply chain and other delays which impacted revenues by $15.3 million during the quarter, with the most significant impact in our C5ISR and our international commercial satcom businesses. Our Q1 '22 consolidated operating loss was $1.2 million compared to operating income of $4.9 million in the first quarter of '21, which includes first quarter '22 increases in R&D of $1.2 million, primarily in our Unmanned Systems business, an increase of $800,000 in noncash stock compensation expense, and increased SG&A costs of approximately $5 million, primarily resulting from our recent COSMIC AES and CTT acquisition and, to a lesser degree, reflecting a $1.1 million increase in our Unmanned Systems business. In particular, total headcount in our Unmanned Systems business has increased 74 heads from 842 in Q1 of '21 to 916 in Q1 of '22 which reflects the anticipated year-over-year growth. Net loss was $15.9 million for the first quarter of '22 and a GAAP loss of $0.12 per share compared to net income of $1.9 million in the first quarter of '21 and GAAP EPS of $0.01 per share. Included in the first quarter net loss is a $13 million charge for debt extinguishment related to the redemption of the company's 6.5% senior notes during the quarter. We generated adjusted EBITDA of $13.8 million for the first quarter, exceeding the higher end of our expected range of $10 million to $13 million. Our Unmanned Systems segment reported revenues of $52.6 million in the first quarter of '22 compared to $55.9 million in the first quarter of '21, primarily reflecting the current expected production ramp and cycle on certain programs. KGS reported revenues of $143.6 million in the first quarter of '22 compared to $138.3 million in the first quarter of '21, including a contribution of $14.7 million from the recently acquired COSMIC KDS and CTT entities, offset partially by the loss of an international training contract which contributed revenue of $8.3 million in the first quarter of '21. In '22, KGS revenues were unfavorably impacted by continued and increased supply chain, COVID, and related delays and disruptions which impacted current quarter revenues and favorably by approximately $14.6 million as these revenues were deferred to future periods with the most notable impacts in our commercial satellite and C5ISR businesses. As expected, first quarter '22 operating income and adjusted EBITDA for Unmanned Systems and KGS included a mix of more development-based revenues which are typically lower in margin and due to less leverage on fixed overhead, manufacturing, SG&A, and development infrastructure. Q1 '22 cash flow from operations was a use of $7.9 million, including a use for the increase of inventory balances of $15.3 million during the quarter, primarily in our satellite microwave electronics and C5ISR businesses in anticipation of the ramps in production in the second half of the year, and in part to advance inventory levels in an attempt to mitigate the impact of supply chain disruptions. Our contract mix for the quarter was 68% fixed price, 27% cost plus 5% time and material. Revenues generated from contracts with the U.S. federal government during the quarter were approximately 71%, including revenues generated from contracts with the DoD, non-DoD federal government agencies, and FMS contracts. In Q1 of '22, we generated 10% of revenues from commercial customers and 19% from foreign customers. Our backlog at quarter end was $982.1 million compared to $953.9 million at the end of Q4 '21 with consolidated bookings of $198.2 million and a book-to-bill ratio of 1:1 for the first quarter of '22. Funded backlog at quarter end was $685.7 million, with $296.4 million unfunded. For the 12 months ended March '22, our consolidated book-to-bill ratio was 1.1:1, with total bookings of $873.3 million. Moving to financial guidance. Our second quarter '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 and other COVID-19-related items that have or are currently impacting the industry and Kratos. Throughout the first quarter, Kratos experienced a significant increase in the intensity and effects of COVID-19 and the related impact to our employees, absenteeism, consultants, vendors, suppliers, customers, etc. This impact included loss of weeks of manufacturing and production functions in our Unmanned Systems, C5ISR, and microwave products business. We have assumed that these COVID-19 and supply chain-related impacts to our business, which significantly impacted our fiscal first quarter '22 operations, will continue to have a similar impact in the second fiscal quarter of approximately $15 million to $17 million in revenues and $2 million to $4 million in our adjusted EBITDA. We currently expect the situation to improve significantly in the third quarter. As a result of each of these factors we have discussed, we are forecasting approximately flat organic revenues for our second quarter '22 revenues 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 $13 million in revenues, offset by the loss of the international training contract which contributed approximately $5 million in revenues in Q2 of '21. This should be the last quarter of headwind resulting from the loss of this contract as it was completed in the second quarter of last year. Our quarterly forecasted EBITDA performance is also impacted by these industry and cyclicality factors, including our inability to realize leverage on our fixed SG&A, overhead manufacturing, and research and development costs, particularly in our first and second quarter operating period. Additionally, our forecasted second 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 lower volume of higher-margin software solution deliveries which are expected in the second half of '22 with an expected ramp from the third to the fourth quarter based upon contracts we have been awarded or have been informed we will be awarded. As we continue to transition our space and satellite business from a hardware to software focused solution, we believe our financial performance will tend to be more lumpy and sensitive to delivery schedules. As we mentioned last quarter, we will continue to monitor interest rates since our refinance facility is based on a floating rate of SOFR, which is the replacement of LIBOR with certain adjustments, currently approximately 2.5%. The rate is adjustable, so we will monitor the market closely to determine if hedging would be beneficial in the future, especially since rates have recently increased.

Very good. Thank you, Deanna. We'll turn it back over to the moderator for any questions.

Our first question comes from Sheila Kayal. Go ahead, Sheila.

Hi, Eric, how are you and Deanna? Can you hear me well?

Yes. Hi, Sheila.

To start with a broad overview, given the situation in Ukraine, Kratos is well positioned from a macro perspective. Can you share your insights on future orders and identify which part of your portfolio you believe is best positioned?

Right now, the two best positions are the drones and space and satellite communications; they are really, really well positioned. A very close and car charging third is our combat system, our C5ISR business. The book of business we have and the orders, I think we're going to win over the next 3, 6, 12 months on very large program of record weapon systems is significant; so those are the three.

That's a super helpful answer, Eric. And so on drones, I'm guessing you don't sell any internationally right now. How do you think about the actual pipeline for that and the ability to sell internationally?

Right. In the target drone area, we have multiple international customers. So we have relationships with the customers that would either be or be related to the tactical drone customers internationally. So we have a significant international business at any one point in time with 5 to 10 different international customers. We're right now delivering a significant number of drones internationally. I'm hopeful we have one more box to check, and we're going to be able to report a brand-new multi-tens of millions of dollars, new international target drone customer, hopefully in Q2. So we're very comfortable with our international positioning on both the target and tactical drone side.

Okay. And then, so what ramps from those significantly as we look to 2022 guidance for the second half?

The biggie that jumps to mind right off the bat is GBSD. Now that the budget is in place, our partner, Northrop is phenomenal. It is looking very, very significant. Also coming to mind are those programs I mentioned on space and satellite. I mean the ones that we received the contract on, the two other ones that we've been told we've won and we're going to be receiving the contracts in Q2. The ramp is significant. And as I mentioned in the prepared remarks, a significant part of these is open space. It's software-based which means should be significantly higher margin which is why we're looking at significantly higher margins in the second half of this year.

Okay. Thank you so much.

And our next question comes from Seth. Go ahead, Seth.

Thank you very much. Good afternoon. Following up on open space, Eric, could you provide some insight into how procurements are conducted on both the government and civil sides? What is the process for getting specified in? Also, since this is software-defined, how does your relationship with the customer evolve through this process, and how can we envision a product like open space increasing its market share over time? Does this occur in large increments, or is it more of a gradual improvement? Additionally, where do we find the most opportunities for attracting new customers, particularly on the government side?

Yes, absolutely. New satellite constellations and operators present a significant opportunity for us compared to entering established systems with traditional fixed ground equipment. The number of new constellations being launched, including military, security-related, and commercial ventures, is considerable. Historically, most satellites have been placed in geosynchronous orbit, around 22,000 miles above Earth, where they typically rely on fuel for 15 to 25 years. The ground equipment supplied by traditional providers resembles outdated technology, similar to a 20-year-old 2G cell phone network. This hardware-based setup, with racks of switches, has not changed much since traditional operators lacked incentives to innovate; they preferred to maintain their hardware vendor relationships. In contrast, we've incorporated experts from the commercial sector, including those experienced with 5G networks. We have transformed the old 2G infrastructure into a modern 5G software-based operating system, akin to the operating system on your smartphone. Our open space system is tailored for the ground infrastructure of satellites. We are also moving towards software-based applications, such as modems, allowing for greater efficiency and distribution capabilities while enhancing national security. This new technology, with its open architecture, is exactly what new operators and constellations are seeking. I am genuinely impressed with our team's performance, and I believe once certain awards we've won are announced, the industry will recognize our strong position and the talent we have secured.

Okay, I have a follow-up question. With Secretary Kendall discussing the establishment of unmanned tactical drone programs in the classified sector, how do we plan to keep pace with your activities without a Skyborg Vanguard line? I understand there is still a Skyborg Vanguard line in the budget, but if that's not going to be the central focus, what are our options?

So in the non-classified area, kind of what I tried to do today because I'm trying to be as open as I possibly can, and I will continue to do that. Seth, you are exactly right, what the Secretary has talked about in those programs, they are at a significant classification level. And so my answer to you right now is Kratos will say nothing. And we're going to wait and see how the government does this, how they lead this, and we'll follow that lead. That's all we can do out of respect, obviously, for national security and the Secretary. But what the Secretary is doing is phenomenal. It's incredible what he's trying to do here, including us directly related to Kratos. If you could see me, I'm smiling, and I hope he keeps it up, and I hope he's successful because I think it will be very, very good for the United States of America.

Great. Thank you very much.

And our next question comes from Mike Crawford. Go ahead, Mike.

Thanks. I think OneWeb is in the trailing bookings as of March, that $314 million of trailing bookings in the prior year and in March 31. But the 3 new large open space contracts that are received or expected to be received that could generate hundreds of millions of dollars. What's the duration of those contracts that we should be thinking about for those future revenue?

Think typical government contracts of 3, 5, or 7 years.

Okay. Have you started the second spiral, or are you still focused on the initial spiral of Valkyrie?

Correct. We have not started the second. We are sticking with the initial and I emphasized for now, that could literally change the next time we speak with you.

I think it's been about a year where we've been anticipating the potential like red or adversary type of a purchase order. Is that something that's still on the come? Or has that cooled off at all?

Oh, no. To the contrary, in the budget. Specifically, you can see a line, it's called adversary air unmanned open trend at Air UX. And in the '23 request, there's $67 million for it. So it's coming.

Okay, that's great. Eric, you have these ten different driven systems today and the potential for transitioning these test bed programs to production. Do you expect these to enter production using the airframes and systems currently developed, or do you think they will evolve? In other words, will Valkyrie be a high production run product, or will there be a future iteration of Valkyrie?

I'm thinking about how to express my confidence in Valkyrie's success. I'm more confident than ever that Valkyrie will be very successful, and I should keep it at that for now. If things develop as I expect with a particular customer, I believe I will be able to share more details next time we talk. However, my expectations for Valkyrie's success are very high.

And just feel free to not answer it, if you shouldn’t, but is that the same for Sanitos or for any others? Or are there some that that’s not the case?

Certainly. As I mentioned in the previous call, some programs are being combined or are not funding priorities due to the two new drone programs announced by the Secretary. He has highlighted existing programs like Skyborg and LCAT, which will contribute to the technology that is set to be transitioned. Therefore, the programs we have been working on may wind down or transition into something else.

Okay. And then just last question, you talked about KTT a little bit, but could you just update us on the status of potential material ramp in both low-cost disruptive jet engines as well as actual working hypersonic jet engines that are proprietary to Kratos?

Yes. We have a clear understanding of the first point you mentioned regarding our engines designed for air-breathing cruise missiles, drones, and powered munitions. In the last quarter, we announced that we were starting limited production on a new system. I am optimistic that by next year, we could enter low-rate initial production on one or two anticipated high-volume systems in that category. I remain very hopeful that our KTT's engines and our engine businesses in the drone missile and powered munition sectors will be quite successful. Regarding hypersonics, I can't share much, but our KTT team focusing on space-based engines, including hypersonic vehicle engines, is one of the fastest-growing segments within KTT. I believe it could grow even more quickly, but we face resource limitations across Kratos. By resources, I mean hiring personnel; while opportunities exist, we are limited in what we can disclose about the engine side. However, this business will be quite strong due to the macro-level funding trends.

Can you provide more details about the revenue at SRE? I understand you're paying $80 million for it. Is that business operating with a 10% EBITDA margin?

I need to be careful because the deal is not finalized yet, Mike. As I mentioned in my prepared remarks, once it closes, I will definitely provide more information. However, I don’t want to create any disruptions for anyone at this moment.

All right, great. Thank you.

And our next question comes from Ken Herbert. Go ahead, Ken.

Yes. Hi, thanks. Good evening, Eric and Deanna. Eric, I wanted to ask you first about the fiscal ‘22 budget that was finalized, which includes $160 million for various tactical programs. Can you share your thoughts on the ‘23 request and how you see it progressing through Congress? Specifically, how will that $160 million be allocated in fiscal ‘23?

Right. And so my rough remember of where those items I mentioned for '22 or '23, it increases to like $200 million. So it goes from like $150 million, $160 million to $200 million or $210 million. And Ken, I want to reemphasize again, those are currently the unclassified lines that I can talk about.

Okay. Do you see any of your particular programs? I know they tend to enjoy pretty good congressional support. But any that you’d call out as perhaps with better potential for upside relative to the fiscal ‘23 requests?

I believe that the fiscal '23 request and final budget will align with my expectations, and I feel confident that Valkyrie is finally going to gain momentum. If we are successful with Phase 2 of OBS, it could be highly impactful for us in '23. However, I have less confidence regarding the air area, as I need to see how things will unfold.

Okay, that's great. If I could ask one more question, it seems there are a few contracts you are quite confident about, particularly on the space side, which are important for this year's revenue. Can you provide any insights coming out of this quarter regarding the fiscal '22 guidance, specifically how much is currently in backlog? Also, could you discuss where the risks might be in terms of timing as you consider the revenue expectations that are not yet under contract?

As I've mentioned, we've been informed that we have won and will receive two large contracts, in addition to one we've already received. We expect to get these two more by the end of June, and I fully anticipate that will happen. To your question, if this occurs, I expect it to go as planned. When we speak at the end of Q2, I hope to discuss our strong focus on execution and our efforts to hire and retain the necessary personnel because this is currently a significant challenge. We are facing high demand for talent both in government and commercial technology sectors, particularly in space, satellite communications, rocket engines, and spacecraft.

Okay. Are these commercial contracts recognized as revenue based on the percentage completed, so that if you struggle to ramp up with staffing, it would likely be a challenge for the revenues?

That's going to be a piece of it, Ken, and some of it is going to be software as well. So it's going to be a mix.

Okay, perfect. All right. Well, thank you very much.

And up next, we have Austin Moeller. Go ahead, Austin.

Good afternoon, Eric and Deanna.

Good afternoon.

So my first question here, if we think about 2022, just to broadly summarize what's sort of the print here. Most of the revenue growth opportunity in the latter half of the year is sort of around Northrop's sentinel missile and Nucor warhead transporters, open space and target drones and then most of the margin and EBITDA growth opportunities around open space and the virtualized Satcom equipment?

Yes, sir. You drilled it.

Okay, perfect. And then, I understand the factoring in cost escalations into the new contracts. But what is giving you confidence that your expectation for a second half ‘22 recovery for the supply chain is on track, just because there’s a lot of companies in the sector that are struggling with supply chain right now.

The main challenges we're currently facing in the supply chain are primarily within our Microwave Electronics business, particularly regarding field programmable gate arrays, and to some extent in our space and satellite communications business. In our forecast, we've candidly assumed that the situation in our microwave business won't improve throughout this year. We expect it will remain challenging for the entirety of 2022. However, in areas like aluminum within our C5ISR business, our team has been diligently working to secure our supply, ensuring that, even if conditions do not improve significantly, we have alternative channels and have ordered well in advance to receive the necessary products. Additionally, we've been in ongoing communication with our customers, particularly concerning titanium and other materials. They are suggesting to us that while things may not return to normal in the second half of the year, they are expected to begin trending in a more positive direction, and we've taken that into account in our planning. We really need that improvement to occur in those areas where we have made that assumption.

That's really helpful. Just one last question, if I could. I understand that Valkyrie and its associated programs are delving into classified areas. However, regarding the new Valkyrie customer that you mentioned who is acquiring some aircraft, are they obtaining those from the original production batch of 12, or will they be sourced from a second production line later this year?

They’re going to receive them from the 12. Very importantly, we had not leaned forward and done this, we would not be getting this customer, and often on this customer, and there are going to be a quantity of Valkyries here. It’s not clear to me initially, if it will be a sale or it will be a lease, which is another benefit of why we have these capital assets. And so we’re going to be working with this customer as we head toward contract documentation, if these will be actual sales or to satisfy his requirement both tactical and strategic and looking into ‘23 and ‘24 and should we lease them to him. Hopefully, as the year goes on, we’ll be able to give you additional clarity on that.

Okay. That's really helpful. Thanks for all the color, Eric.

And next, we have Peter Arment. Go ahead, Peter.

Hi, good afternoon, Eric and Deanna. Eric, you've mentioned the challenges with your drone programs in terms of getting past testing and into adoption. How would you describe the current situation on the non-classified side? What is the level of customer enthusiasm, and can you share any specific examples of programs that have advanced in testing? Many of us are eager to understand when we might see an increase in overall volume.

Yes. The valley of death is a significant challenge, particularly when transitioning from research and development aircraft to production programs. It is quite difficult, and many traditional players are trying to maintain their positions during this phase. This is why I consistently stress that we are leading the market with operational airplanes. I just mentioned that we will have a new customer for our Valkyries in the second half of this year, and the funding is secured. This new customer is highly motivated because we offer products, not just concepts, which gives us a competitive edge against traditional companies. I fully support the Secretary's efforts as he has taken charge and is committed to making this progress happen. Recently, a senior leader mentioned the need for numerous affordable, reusable drone types to address challenges from adversaries. The key leadership is now taking action, funding projects, and including them in budgets. Although it's been a lengthy and often frustrating journey, we continue to advance and remain highly competitive in the field of attritable aircraft. That's my response.

Yes. And just as a follow-up, Eric, on just – I know we’ve had a lot of challenges over the last 18 months with COVID on just different testing facilities or testing sites. Have those – has that loosened up a little bit as we think about going into the second half of this year or at least in the middle of this year?

We have not experienced any issues, delays, or cancellations with our flight range time in the past several months. Additionally, our range facility in Oklahoma is going to be an incredibly valuable asset for us in the second half of this year. The ranges are currently very busy and hard to access, but we'll be able to avoid those issues for certain aircraft. This challenge has been eliminated across the board.

Terrific. Thanks, Eric for all the detail.

Yes. Thank you.

And up next, we have Josh Sullivan. Go ahead, Josh.

Hey, good afternoon, Eric, Deanna.

Good afternoon.

Just on KTT, what is the margin profile of the engine opportunities as they move forward? Are they going to be the traditional low teens or any more commercial like margin opportunities picking up?

On the defense side, production will be in the low teens. Currently, development is lower than that due to development contracts being less significant. We have one or two commercial opportunities we're exploring, but if we succeed with the defense contracts, they won't be substantial enough to raise that margin rate above the low teens.

Okay. And then can you just provide some color on what KTT is contributing to the roles offering with the B52?

Yes. What I meant was, I didn’t say that again, buddy.

On the B-52 contract that you're working, what is KTT contributing?

I was very cautious in my comments because we are under a non-disclosure agreement, and I can't share specific details. However, this matter is extremely important and is a major contributor for us starting now. Until I receive approval, I am unable to provide further information.

Got it. Got it. And then maybe on the US program, can you talk about the cost savings versus the legacy programs that you're going to offer? And maybe can you help us kind of size that market number of launches in that value from the market.

Yes. So our strategic partner is Aerojet, and they are working with us. They are building systems for us. And these are to our spec based on our customers, and these are very unique, very low-cost, very specialized systems to put something in the right place at the right time at the right speed. And similar to virtually everything else we try to do, if we're successful, we're going to be successful here, these will be orders of magnitude lower cost than anything anybody else has out there. So I'm very excited about this, and I'm very excited about the funding that came through in the '22 budget for this. Very excited. We got the funding that we needed which is great.

Got it. Thank you for the time.

And our next question comes from Joe Gomes. Go ahead, Joe.

Hey, good afternoon. This is Josh filling in for Joe Gomes.

Hi, Josh. Good afternoon.

So my first question is, I know you guys recently secured a contract for the advanced spectrum monitoring system for OneWeb, specifically related to low orbit constellations. Can you provide more details on that, such as the revenue implications and the additional opportunities it may create?

We recently put out a press release in the last few weeks that involved customer clearance and coordination. Aside from what's mentioned in that release, I'm unable to provide further details. Regarding your second question, I would like to refer back to a previous inquiry we received about a company that is launching a new greenfield constellation intended to engage with us and utilize our open space solution. This is an excellent example of the primary customer opportunities that Kratos has in the open space sector, and we are optimistic about achieving success with them.

Great. And then, I guess another question was just I wanted to see how the transition was going in terms of integration of COSMIC AES and CTT, and obviously now with the SRE. And do you kind of see any future tuck-in acquisitions like these in the future? Does that hold some of your pipeline?

The integration is ongoing and going well. As far as future tuck-ins, we have the SRE one that is hopefully going to close the second quarter at this point.

For us to pursue any opportunities, they must align perfectly with our current efforts, and such opportunities are rare. CTT fits exactly with our microwave focus and includes a satellite component that is relevant to us. Our team has known the founders of COSMIC for quite some time, and this collaboration feels like a natural fit. SRE is engaged in materials for hypersonic systems, strategic deterrence, and space systems, all areas where we are involved. Any additional acquisitions would need to be small and closely aligned with our existing work, ideally bringing in new customers, capabilities, products, or aircraft.

Great. And then I guess, lastly, if I may. I was looking through the Fed firm guidance. And I know you guys kind of dropped down your CapEx. Is there any kind of reason why a little more color on that?

That's actually related to some machinery that we were going to acquire in our C5ISR business, and just due to some supply chain issues, it's actually getting pushed into next year. So that isn't permanently reducing, just moving into next year.

Okay. Thank you so much for the question and for answering my questions.

And up next, we have Pete Skibitski. Go ahead, Pete.

Good afternoon, everyone. Eric, I wanted to touch on the previous discussions regarding Secretary Kendall. I found it interesting when he mentioned a loyal wingman-type drone for both the B-21 and AD, noting that the cost of these drones would be about half the price of the manned aircraft, which are presumably in the hundreds of millions of dollars. Is that accurate in your opinion? Furthermore, should we interpret this to mean that you don't see Kratos competing in that space, but there are plenty of other markets where Kratos will be active? I'm trying to understand the overall reasoning here.

Yes. So the first part of your question, I'm not going to answer because I don't want to speculate anything on the separate carry. But on the second part, what I understand the Secretary is doing. Based on what I know, I am absolutely confident that Kratos can participate in one way, shape, or form with the Secretary's initiatives; absolutely confident.

Okay. Okay. Let me step out to a bigger picture. If we can kind of summarize all the order expectations you have for the balance of the year, the next 3 quarters, any sense for the type of book-to-bill that you guys are expecting for the next 3 quarters that we should expect?

I don't have the exact numbers available, but as I mentioned earlier in my prepared remarks and during the Q&A, we are anticipating a sole source contract worth $100 million for the target drone area that we expect to receive. Additionally, on the space side, we have one contract we've won that is not yet announced and two others we have been informed we will receive, which we hope will add to our totals. Over the remainder of the year, I believe that program bookings will be significant. Specifically, regarding the target drone contract, it will be a single source award of $100 million that will be fulfilled over time. The way this will impact our book-to-bill ratio is uncertain and may depend on funding options among other factors. However, I am confident that our trajectory looks very strong.

Okay. Okay, that’s helpful. And then a more basic question in the rocket support area. I guess I haven’t figured it out, yes, what’s the difference between us and Ares?

So ZS is a launch system, Ares is a vehicle.

Okay. So it has a propulsion aspect to it, Aranas does not have a propulsion aspect to it?

I have to say that it definitely has a propulsion aspect to it. Aranas is a vehicle, and I should leave it at that.

Okay. Are you guys – should we expect first quarter press release-wise was fairly meager, right with the CR, whatnot. Should we expect to see a lot of these announcements made pulled by you guys as they happen in the balance of the year?

I hope we're able to. But if not, like on some of these base ones, my understanding is, I think the customers are going to announce them. And once they announce them, hopefully, we'll be able to announce something or will be able to affirm that. My intuition tells me that's how that's going to go.

Okay. Okay, thanks, guys.

And we have no more questions at this time. I'll turn it back to Eric for closing comments.

Great. Thank you, everybody, for joining us this afternoon. And we’ll circle up with you at the end of Q2. Have a great afternoon. Thank you.

And thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.