Kratos Defense & Security Solutions, Inc. Q4 FY2022 Earnings Call

Good day and thank you for standing by. Welcome to the Kratos Defense & Security Solutions' Fourth Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Marie Mendoza, Senior Vice President and General Counsel.

Thank you. Good afternoon everyone and thank you for joining us for the Kratos Defense & Security Solutions fourth 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 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. Kratos is positioned as the leading disruptive technology company, designing, developing and fielding relevant systems, products and solutions. This continues to progress, reflecting the trust our customers have in our company. Kratos, along with our strategic partners, vendors and suppliers are aligned and moving rapidly to address the evolving threat, not with PowerPoints, press releases and scripted publications, but with real systems that we will discuss today. We believe that 2023 will be a transition year for Kratos to greater revenue, profit and cash flow with significant prior-year investments in technology, products and systems transitioning from development RDT&E or LRIP to fund the programs, contracts or full-rate production, which will result in increased revenue, profit and operating cash flow for the company. This includes today's announcement that Kratos's BQM-177A unmanned aerial target drone is now entering full production. And Kratos's rocket systems business, where we have also made significant investments, we have now received two important new hypersonic system-related program awards, Mayhem and MACH TB with our partner Dynetics. Under the MACH TB contract, which we announced in November, Kratos and the MACH TB team will work to develop an affordable and responsive Hypersonic Test Bed platform and national hypersonic testing capability in an effort to dramatically increase our nation's capacity for ground and flight testing of hypersonic technologies and payloads. Under the Mayhem, or Expendable Hypersonic Multi-Mission ISR and Strike Program, Kratos will support the Air Force Research Laboratories' development of an air-breathing hypersonic weapons system. Kratos is an industry leader in flight proven agile engineering capabilities with experienced and high-performance propulsion, hypersonics, exotic materials and air vehicle design, which we are applying to win large new program opportunities like Mayhem and MACH TB. Kratos has previously successfully developed and flown several hypersonic systems and our internally funded hypersonic investments and unique and proprietary systems and vehicles including Kratos Zeus and Erinyes, we believe will be disruptive game changers for our customers and our country and are beginning to pay dividends for Kratos' stakeholders including with these recent program awards. Kratos's rocket systems business recently successfully integrated and launched four ballistic missile targets with our government partner, which included the successful intercept test of a medium-range ballistic missile target by a standard missile 3 Block IIA fired from the JS Maya, marking the first time that a Japanese Maya-class destroyer has fired an SM-3 Block IIA. We believe this successful test is representative of Kratos's industry-leading position in the rocket system missile defense and ballistic missile defense areas and of Kratos's affordable, relevant, disruptive high technology rocket systems and we expect Kratos's rocket system business to be one of our fastest growing in 2023 driven by the increased global interest in air and missile defense systems. Kratos recently received the initial $30 million in funding on a new potential $250 million C5ISR production program in the microwave electronics area. This program is classified. Kratos's microwave electronics business had a record backlog at year-end including a focus on missile, air defense and radar systems and we expect this business to be one of our fastest growing for 2023. Kratos and C5ISR business is also expected to be one of our fastest growing in 2023 with expected growth coming from several missile, air defense, radar and other programs, including GBSD Sentinel with our prime strategic partner Northrop Grumman. Other Kratos C5ISR business programs include high Mars, Titan, Patriot, Fad, IBCS. Kratos has recently been selected as the Engine Design Team for Boom-led Collaboration on a new supersonic propulsion system called Symphony, a sustainable and cost-efficient engine for Boom’s planned overture supersonic airliner, with Symphony being a bespoke design, leveraging proven technologies and materials to achieve optimal supersonic performance and efficiency. Boom’s overture new symphony propulsion system is expected to operate at net-zero carbon and meet Chapter 14 noise levels and when compared to derivative approaches, Symphony is also ultimately expected to deliver a 25% increase in time on wing and significantly lower engine maintenance costs, and is also expected to reduce overall airplane operating costs for airline customers by 10%. On the Symphony program, Kratos will utilize its supersonic engine design experience and expertise, working under a standard commercial time and material type contract arrangement with no Kratos investment. The Kratos Symphony team will include key Kratos personnel and engineers that were directly involved in supporting the design of the F-119 and F-135 supersonic engines that power the F-22 and the F-35. Kratos is also supporting Rolls Royce on a B-52 re-engine program with Rolls Royce and B-52 being certain of our most important strategic partners and a program. Another growth area for Kratos is new space and related launch vehicles and propulsion systems where KTT is currently under contract on multiple DoD government and commercial space system-related programs, involving Kratos's hardware and products in support of some of the most technologically advanced propulsion systems in the world. In the drone missile and powered munitions area, Kratos and KTT have made progress over the past several months, including technically delivering engines to a confidential customer for a yet-to-be-announced UAS and receiving word from a customer regarding the future opportunity for up to 1000s of Kratos engines, which we are jointly working to address and KTT is forecast to be one of Kratos's fastest growing businesses in 2023. Kratos's space and satellite communications business, our company's largest is also forecasting significant future organic growth and is expected to generate some of Kratos's highest margins, including as related to Kratos's first-to-market software-based OpenSpace virtualized TTMCC2 and satellite ground systems, which continue to gain market acceptance in both the national security and the commercial market areas. The satellite communications industry is focused on virtualizing the entire ground infrastructure in order to be efficiently compatible with cloud-based and other standardized networks, equipment, and systems, including importantly 5G, which is another Kratos focus area here. Converting hardware to software that is installed and managed remotely via third-party data centers are standard compute devices is expected to provide satellite operators increased flexibility over their networks, improving the response time to customer demands. This conversion to software is exactly what Kratos's OpenSpace and open edge is focused on. For example, today satellite terminals consist of purpose-built hardware components that are limited to performing a dedicated function. For example, a satellite modem performing modulation and demodulation functions until Kratos has open edge satellite terminals, the devices that end users employ at the far edge of the satellite ground network to transmit and receive data have been purpose-built hardware devices that seriously restrict functionality and flexibility at the network's edge. Kratos's open edge disrupts these limitations by employing software, virtualized modems that can run on general purpose off-the-shelf compute devices and open edge is far more powerful and versatile by enabling additional apps to run right at the network's edge. Kratos's open edge uses a different model for operating at the edge, one that employs standards already widely adopted across the larger global telecommunications industry to expand terminal functions and make them more flexible. These standards that Kratos open edge employs are what enable mobile devices such as smartphones to support roaming, use cloud-based functions, interoperate with other networks and do much more. While satellites present a complex technology challenge, the goal of Kratos's OpenSpace and open edge is to help satellite operators make their services as mainstream as cellular communications and to capitalize on new services such as 5G, which is why Intelsat will be one of Kratos's first partners to supplant traditional satellite terminals with Kratos's open edge. I hope you can see why here at Kratos we're so excited about our satellite business's future prospects. Kratos's target drone business is performing well with major Kratos sole-source programs including the Air Force's AFSAT program featuring the Kratos's BQM-167 Target and the United States Navy SSAT program featuring Kratos's 177 target drone, wherein on both program we have recently received additional large production awards. Additionally, and very importantly, the recent United States Navy SSAT177 program award includes target drones or missions for both Australia and Canada, two new Kratos BQM177 target drone customers. We are currently in pursuit of certain new domestic target drone opportunities that if we are successful, could provide the next growth step function for the business. And we have recently seen a number of potential new international target drone opportunities that we believe are a result of current global conflicts and threats, including Ukraine, and the related ongoing global recapitalization of strategic weapon systems. In the tactical drone area, Kratos has recently received a contract for an initial two Valkyries from the United States Marines along with sensors, weapons systems payloads, etc. Under the Affordable Autonomous Cooperative Killers program. The Killers program is a new program for Kratos, which we have not yet been able to formally announce or discuss, and I encourage you to review the Navy contract award announcement and other available publications, including as related to the USMC for additional information, including related to the significance, importance and the future prospects of the sole-source contract award to Kratos. We believe that one of the primary reasons the Killers program was awarded to Kratos sole source is that we have available Valkyries coming off our active production line and that the Valkyries' cost and price points are known, not on a hoped-for PowerPoint slide, which estimated costs our competitors routinely change and increase after the fact of which we believe certain of our customers are beginning to take note. Kratos's Valkyrie is also a demonstrated LO, runway-independent system, not requiring a runway to take off or land and Kratos's jet drones are also routinely ship-launched, all of which we believe are becoming more of a differentiator for Kratos. It was also recently reported that the United States Air Force's 40th flight test Squadron at Eglin Air Force Base has now taken ownership of Valkyrie aircraft with the Valkyries' ability to autonomously operate over vast distances can be evaluated along with certain other objectives. Eglin recently published photographs of Kratos's Valkyrie flying with manned F-16 fighters, emphasizing the Valkyries' rail launch, runway independence and precision parachute recovery, certain of which were approved for us to publish today. None of Kratos's potential competitors have runway-independent capability. With the competing systems currently having or planned to have landing gear dependent on a runway, which I believe will be completely untenable and appear conflict. It was also recently reported that a U.S. government customer is working with multiple industry partners to integrate leading-edge autonomy capabilities into the XQ-58A as Kratos's Valkyrie and all Kratos drones have an open system architecture, meaning a variety of autonomous and AI cores can be integrated into our system. Open System Architecture is another competitive differentiator for Kratos versus our competitors as the customers do not want to be vendor locked. It was recently reported that the Valkyrie has now entered a time-critical test period with a U.S. government customer related to certain manned/unmanned teaming, with flight and testing planned to be completed by the end of this year. The U.S. Air Force has now stated that the Skyborg and the Golden Horde Vanguard programs, both of which Kratos is involved in, are transitioning to become programs of record and are expected to form the nucleus of new combat systems, including collaborative combat aircraft or CCAs. Both Kratos's Valkyrie and the Mako tactical jet drones have performed under the Skyborg program, and the Golden Horde program has demonstrated how a group of unmanned aircraft or weapons can communicate with each other and operate collectively rather than singularly. In addition to the recent Valkyrie contract awards and this progress, we are now in contract negotiations with another new customer on a new program for the acquisition of multiple Valkyries, which we believe we will have under initial contract by the third quarter of this year. Additionally, we are also now currently in contract negotiations with a customer related to Kratos's Valkyries valued at several tens of millions of dollars, which we also expect to be completed and under contract by the third quarter of this year. And we have now also provided a Kratos Valkyrie aircraft to an additional potential new customer for systems assessment and review. And we are in discussions as to potential next steps, including purchasing, leasing services type or other contractual arrangements. And we’re also continuing discussions with another potential new customer related to the acquisition of several Valkyries. It is important to emphasize that with each of these Valkyrie-related opportunities, similar to Kratos's target drone business, it is extremely important that in addition to initial Valkyrie aircraft acquisition, the flight recovery support and other system-related equipment and infrastructure are also being acquired and deployed by the customers. As this upfront investment represents a customer commitment to the system, which returns to the customer is increased obviously by additional future XQ-58A aircraft acquisitions. We are currently performing under multiple Valkyrie-related government-funded contracts or programs with a key element including the continued missionization and operationalization of the Kratos XQ-58A system. We are working closely with our customers on the optimal funding utilization and contract structures, including the funding allocation between acquisition of aircraft, system-related infrastructure, missionization and operationalization in order to achieve the strategic objective. There has also recently been increased interest in certain other Kratos's tactical drone systems in addition to the Valkyrie, which I believe is as a result of what is occurring in Ukraine, also including as related to affordable mass warming and drone attrition rates. So now important like keys to our strategic tactical drone decision-making include Kratos is the only company that has affordable relevant systems flying now, not just PowerPoints, concepts, designs and press releases, and Kratos has active production lines for jet drone aircraft today, with Kratos having produced over 1,100 high-performance unmanned jet target and tactical drone aircraft to date, representing another important competitive advantage for Kratos and another key reason why Kratos customers trust us. We have demonstrated that Kratos is delivering jet drones in quantity now at real known price points. So, as a result of this progress, we've now moved forward with our second serial production run of at least 12 of the next-generation block of Kratos Valkyries. This decision is important for several reasons including having XQ-58A systems available to immediately meet expected customer demand and supporting Kratos's first-to-market leadership position. We also want to ensure that there was no break in the current Valkyrie production line so that we can continue to improve on the learning curve efficiencies and related declining cost experience we have gained and achieve the target costs we are now providing in proposals to potential customers. The cost per pound of Kratos jet drone aircraft we believe is currently far below our competitors. I think we know it and they know it, and we expect to continue to drive Kratos's drone cost down significantly, including with the continued actual production of aircraft to the benefit of Kratos's customers and to the detriment of certain competition, especially when customers compare what it actually costs our competition to produce a jet drone aircraft, not what our competitors say or indicate in their proposals. As I mentioned, this new group of at least 12 serial production Valkyries will be the next block upgrade version, including multiple enhancements based on the numerous successful flights we have completed with our customers. Their input and feedback and also including certain enhancements or modifications that Kratos has ghost Works has been focused on, including to specifically address certain potential competitive adversarial threats, including in the Pacific. I continue to believe that Kratos's air-gapped ghost works entity is truly a crown jewel of Kratos and in my opinion it's a national asset for our country. At Kratos, affordability is a technology and Kratos's ghost works is by far the clear industry leader in high-performance unmanned aerial jet-powered aircraft and systems and the real live application of relevant cost-effective digital engineering practices. So to wrap up, based on our backlog, our significant new program awards and $10 billion opportunity pipeline, we expect up and to the right future organic growth trajectory for Kratos with no currently planned acquisitions as we focus on execution, obtaining and retaining qualified personnel, which remains a primary operational challenge and continuing to bid on and win new program opportunities. As we begin 2023 every Kratos business is expecting organic growth and we are forecasting Kratos's consolidated '23 over '22 revenue growth of approximately 10% with increased margins, reduced internally funded investments and increased cash flow.

Thank you, Eric. Good afternoon. As we have included a detailed summary of the fourth quarter and full year financial performance for FY '22 and first quarter and full year '23 financial guidance in the press release we published earlier today, I will focus on the highlights in my remarks today. Revenues in the fourth quarter were $249.3 million, up from $211.6 million in the fourth quarter of '21, reflecting a 17.8% increase. Excluding the impact of the SRE, Cosmic and CTT acquisitions, which contributed $29.1 million in revenues in the fourth quarter of '22, Kratos revenues grew organically 4.1%. Fiscal year '22 revenues of $898.3 million, increased $86.8 million from $811.5 million or a 10.7% increase. For fiscal '22, excluding the impact of the acquisitions, which contributed revenues of $95.5 million during the year and excluding the impact of the legacy training services business, which was down $21.5 million from $40.1 million compared to FY '21, revenues grew organically 1.7%. Included in operating cash flows for fiscal '22 is approximately $9 million in investments in nonrecurring engineering costs for new rocket systems, hypersonic and related products including for Kratos' Zeus and Erinyes systems, including and directly related to certain received and expected new contract awards in the hypersonic system area. In 2022, in addition to internal R&D costs of $30.3 million incurred in our space and satellite business, we also invested approximately $7.6 million in software development costs related to our OpenSpace virtualized software product. Our contract mix for fiscal '22 were 70% revenues from fixed-price contracts, 24% for cost-plus type contracts and 6% related to time and material contracts. Revenue revenues generated from contracts with the U.S. federal government during the quarter were approximately 70%, including revenues generated from contracts with the DoD, non-DoD federal government agencies and MS contracts. In fiscal '22, we generated 11% of revenues from commercial customers and 19% from foreign customers. Now moving on to financial guidance. Our first quarter and full year '23 financial guidance we provided today includes our current forecasted business mix, and our assumptions related to the expected continued impact of challenges related to obtaining and retaining qualified personnel, supply chain disruptions, inflation and related expected costs and price increases that are currently and expected to continue impacting both the industry and Kratos. Throughout 2022 and in the first quarter of 2023, Kratos has experienced continued impacts from supply chain disruptions including cost increases for materials, supplies, transportation and utilities and fulfillment delays causing increased costs and inefficiencies related to manufacturing, including in our indirect manufacturing rate. As a contract mix is predominantly firm fixed price, we are required to absorb these additional costs until the period of performance is completed on existing backlog and new contracts are negotiated with current pricing. Accordingly, as we transition to new contracts over 2023, we expect margin rates to continue to be lower in the first half of the year and performance on existing backlog is executed with an expectation of margin improvement in the second half of this year, as the mix of newer recently priced contracts are expected to increase. Our revenue guidance range for the first quarter of '23 reflects a 12% to 17% increase over the first quarter of '22, and our annual revenue guidance for fiscal '23 reflects a 9% to 11% increase over fiscal '22 revenues. Consistent with what we have stated on our previous earnings calls, where our forecasts and performance of our tactical unmanned aerial systems business, we remain conservative and will only include contract awards we have received, or with respect to which we are in final negotiations with the customers. Accordingly, included in our guidance range today is a relatively flat revenue of approximately $220 million to $225 million for our unmanned systems division as compared to FY '22. This range includes an estimated increase in Valkyrie related revenues from $32 million in FY '22 to approximately $43 million in FY '23, including the recent U.S. Navy/Marine Corps contract. This forecasted increase is offset by a reduction of approximately $15 million from a non-Valkyrie related tactical development program, as we had previously discussed on our Q3 earnings call that the customer informed us in 2022 that future funding was not available. The FY '23 revenue guidance range for KGS of $760 million to $775 million reflects a 12% to 14% increase from FY '22 revenues, representing forecasted revenue growth across every business unit in KGS. With the most notable forecasted growth in our space and satellite, C5ISR, turbine, microwave products, and hypersonic-related business in rates. Based upon funding production, delivery and execution schedules, second half '23 revenues are expected to ramp and be sequentially greater than the first half of '23, with margins expected to expand in the second half of the year on increased revenue volumes, and based on the expected mix of revenues, including new fixed-price contracts, which include more recent cost estimates. Operating cash flows are expected to be stronger in the second half of the year as well, driven by the expected expansion in margins, and the expected conversion of inventory builds from FY '22 in the first half of 2023. And based upon estimated milestone payment schedules.

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

Thank you. I have a few quick questions. So one, what happens operationally in Oklahoma after this the second 12 Valkyries? I guess that's a block 2 Valkyries production spiral. Particularly if you get these additional orders contracts, you're supposed to have by Q3, like what would be a full-rate one production line, one shift continuous flow of backward production down there.

Okay. So under the current construct, Mike, because if you recall, the facility has a base facility. And then there are contiguous additional facilities that we have options on. Under the current configuration without expanding anymore, okay, and assuming the similar number of tactical fighter jets and fighter jets that we're building in Oklahoma, because we're building those there too. Now, we can do annually 35 to 45 drones a year in the current configuration. We can if we exercise the next option, and we haven't if we do that, we can easily double it very quickly.

Okay. Thank you and just regarding other competitors, with maybe not as affordable aircrafts, but like isn't there like a ghost bat that might be out there today.

Mike, I haven't seen or read anything on the Ghost in 6 months or more. So I'm not sure what's going on with that. Someone sent me something a month or two ago and it said that it was not going to be considered in the U.S. That's something I read. I don't really know, buddy.

Okay. And then just real quick, what should we be looking for in the administration's budget request regarding getting these former Vanguard programs into programs of record, be it and next-generation air dominance or CCA? Is there anything specific relating to Valkyries that we should be looking for or you're hoping to see.

Yes. So in my opinion, based on most recently what Forestar Chief of Staff Brown said last week, he said that when the '24 budget is submitted, and now I understand that's coming in the first or second week of March, that the public, we should all see a significant increase and a significant commitment to CCAs. Chief was talking collaborative combat aircraft. And in that interview that he did, he talked about a family of them of all different types, and sizes and cost points. So based on that, I think that we should all see significant additional funding based on what the chief of staff said.

Yes. Hi, good afternoon, Eric, and Deanna.

Hi, Ken.

Hi, Ken.

Hey, Eric, I wanted to follow-up on your comments on Valkyrie cost? Sounds like you're pushing a lot to take cost out. Can you maybe help with, if you think about the second block versus the first block, how much maybe is cost down? And how much of that are you able to keep versus how much of the lower costs are you sharing with your customer?

Yes, in recent years, due to inflation and rising supply chain and labor costs, our expenses, including the cost of drones, have increased. At the same time, the efficiency in our production rates has improved. We have observed this with our target drones transitioning from development to production and have accumulated the necessary experience and historical data regarding production efficiencies for jet drones. While we anticipate a notable decrease with this 12, it may not be substantial. If we continue on this path, we expect to see a significant reduction as we move to the next block. We have a strong connection to the industry, our customers, and competitors, and we are very confident that our costs per airplane and per pound are considerably lower than what others are quoting, regardless of what they may tell potential customers. Potential customers are starting to realize this, and we aim to leverage this as a competitive advantage, focusing on actual costs rather than misleading forecasts.

That's helpful. And as you think about either now or with Block 3, if you eventually go there, is the Valkyrie profitable on a per-unit basis, or what's it take maybe to get to that point?

It is on the most recent contract awards that are definitely profitable.

Great. That's very helpful. Just one final question. Can you maybe, I mean, great work with the Navy. It sounds like it was a release you put out today. It sounds like there's a lot happening in terms of flight test activity and certainly public discussion around the requirements within CCA and other areas is multiplying. What's been the latest feedback you've been getting from your Air Force customer? And is there any color you can share just around specific within the tactical portfolio, level of enthusiasm and maybe how they're viewing your efforts? And then about green in particular?

Yes. So Mike, I'm going to answer the question not specific to the Air Force, I cannot, as I've talked about before. The things have really been buttoned up here. They've really been buttoned up. So my comments are going to be general to all of our existing customers and the customers that I said today, I expect to have under contract in the second half of this year, here's the feedback. You're the only guys that have a jet aircraft flying today. The propeller planes, they've been great to kill terrorists. They're all going to get shot down. They're not survivable. Tied to a runway is an absolute nonstarter, irrespective of what people say. It's a nonstarter. Obviously, the runways are all targeted. And we that have the information, no, no, the numbers, all right. That quantities matter. We've learned that in the last 12 months in Ukraine, quantities matter. And the only way you can achieve quantities is if you have affordability. And then the last one, Mike is back to Ukraine. The Russians have been using their SU-57, which is equivalent to our F-22, F-35. They've been using their Kinzhal and their Avangard hypersonic weapons. So they've been using their exquisite to no effect on the battlefield because they're too expensive, and they're not enough of them. And I think a lot of people are rethinking a mix of exquisite, one exquisite versus for the same cost 100 jet drones. That's the feedback we're getting. And I think a lot of that is tying into the progress we've made since our last call.

Great. Thanks, Eric.

Okay. Thanks, Ken.

Our next question comes from the line of Seth Seifman with J.P. Morgan.

Oh, hey, thanks and good morning, or good evening, sorry. to have it.

Hi, Seth.

Hi. I wanted to ensure I understood correctly, and I appreciate the segment guidance. Is the Unmanned segment expected to be relatively flat in 2023, in the low 220s?

Its correct. 220 to 225.

With some growth in the tactical drones, what is happening with the target drones in 2023?

Yes, there is approximately a 5% growth assumed in the estimate.

Okay, for the target drone?

For the target drones. Yes.

Okay. And the tactical drones were down, or the tactical drone was going up from 32 to 43? Or was that down from?

No, it's actually down to the Valkyrie related tactical drones from 32 to 43. However, there is a headwind of $15 million due to a non-value related tactical job.

Cool. Understood. Understood. Right. That's helpful. And then just, I guess, if you think about these orders that are coming up, hopefully in the third quarter of this year, and you think about kind of the cycle time for those and then how those get booked eventually as revenue and earnings, should we think about that as something that's going to drive? Is that something that drives 2024? And does it encompass all of the kind of second lot that you're building? Does it kind of take you into the third lot? How should we kind of think about what those quantities might be?

Yes. So, Seth, I went into some detail on the infrastructure, the launch equipment, the flight equipment, the recovery equipment, the sustainment equipment that to operate these jet drones and how the customers now are starting to look at that and they're acquiring that from us. Very similar to the strategic asset we have in our target drone systems getting that infrastructure out there. In addition to that, I went into some detail again, on purpose on the customers are now funding significantly the missionization and operationalization of the aircraft, which all of these obviously strategically are very, very important that they're making the investment in the infrastructure, and they're missionizing and operationalizing the aircraft. So please keep that in mind because as these contracts come, it is not totally clear to me yet how much of it is going to be for aircraft and how much of it is going to be for the support equipment, the launch equipment? The missionization, the operationalization, okay. So with that being said, Deanna, go back on, if they're complete, and the aircraft has done, how that's booked.

Yes, yes. So similar to what we discussed when we started the original, they started as capital expenditures. And when there is a contract that is awarded, and it is related to an aircraft sale, then whatever value or however complete we are on that system would be transferred from capital to inventory, and then that would determine the percent complete from a revenue recognition perspective. So if we're say 50% complete on an aircraft that would transfer over and then 50% of the revenue related to that aircraft would be recorded at the time the contract is awarded.

Right. Got it. Got it. Okay, thanks. And then just to wrap up on this point, I assume in the missionization and kind of support equipment and setting up an infrastructure that that's related on to these aircraft. I imagine, is that another area where you feel like Kratos has an advantage versus the competition, both in terms of where you are in that process and in terms of cost?

Absolutely, Seth. You could see me I'm smiling. The answer is absolutely, yes. Because as I've said, we're the only guys that have anything flying. We're the only one that does runway independence. We're the only one really that has jet high-performance drones. And so for us to get this equipment out there, which of course the pedigree is all the target drones, we know how to do it. We do dozens and dozens of missions a year. We're building over 150 aircraft a year or more. Absolutely, this was finally it appears to be trending in our competitive advantage areas.

Hi, good afternoon, Eric and Deanna.

Hey, Austin. Good evening.

Hi, Austin.

My first question is about Valkyrie. I understand there are limitations to what can be disclosed, but when comparing the Navy to the Air Force, does it seem that the Navy is showing more enthusiasm or aggression towards Valkyrie compared to your other clients? This is especially relevant considering multiple generals have indicated the potential for a Taiwan invasion between 2025 and 2027, and you've mentioned concerns about runway saturation and the importance of being runway-independent. Additionally, the Ghost Bat doesn't meet that requirement. Even if Valkyrie isn't being used as a wingman, looking at the situation in Ukraine where Russia is deploying the Shahed 136 to overwhelm enemy air defenses, it seems clear that Valkyrie could serve as a valuable force multiplier from that standpoint, doesn't it?

Yes, to answer your question, there has been significant movement and momentum over the past four months since we last spoke, including with the Air Force. Look at what we're doing at Eglin with the Air Force and the recent developments regarding our work there. This is very significant for Kratos, and the Air Force continues to be a crucial partner for us. The Navy and Marine Corps are now progressing confidently, as seen publicly, for several reasons I've mentioned. I believe that throughout the rest of this year, we will see considerable additional activity with the Marine Corps, particularly related to the Valkyrie, as they reemphasize their mission and how they plan to execute it, especially in the Pacific. You touched on the key points about why the Valkyrie is advantageous. It is runway independent and very cost-effective, significantly less expensive than alternatives. Currently, momentum seems to be heading in the right direction.

That concludes today's question-and-answer session. I'd like to turn the call back to Eric DeMarco for closing remarks.

Excellent. Thank you all for joining us today. And I know this was longer than usual. I think because it was the end of the year. So it's been 4 months. And we look forward to updating you again in a few months at the end of Q1. Thank you.

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