Kratos Defense & Security Solutions, Inc. Q1 FY2024 Earnings Call

Good day, and thank you for standing by. Welcome to Kratos Defense & Security Solutions First Quarter 2024 Earnings Conference Call. Please note that today's conference is being recorded. I will now hand the conference over to your speaker host, Marie Mendoza, Senior Vice President and General Counsel.

Thank you. Good afternoon, everyone. Thank you for joining us for the Kratos Defense & Security Solutions First Quarter 2024 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, financial guidance and other forward-looking statements 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' positioning as a leading defense technology products and software company focused on obtaining and supporting programs of record organic growth and execution was reflected in our Q1 results. As a public company that reports every three months, Kratos' team's execution is visible to all of our stakeholders and includes industry-leading organic growth, LTM annual positive operating cash flow generation, increased profitability while also making significant internally funded investments in large and growing market areas where Kratos is the industry leader. Accelerating organic growth areas for Kratos include our unmanned jet drone systems, jet engines for drones, missiles, loitering munitions and high-performance systems and microwave electronics for air defense, missile, radar and satellite systems. Kratos' strategy of partnering with large traditional system integrators with Kratos bringing differentiating value, including existing capabilities and a lower cost is also accelerating, including in the drone, hypersonic propulsion system, solid rocket motor and the C5ISR areas. For the first quarter, every Kratos business unit exceeded its revenue or profit forecast or both. We ended Q1 with a backlog of over $1.2 billion, an opportunity pipeline of approximately $11 billion. And with the 2024 U.S. defense budget and the supplemental bill now approved, we have increased confidence in our 2024 financial forecast, which we affirm today and also as we now look towards 2025. Of particular note, Kratos' Unmanned Systems business Q1 organic growth was 21.8%, with bookings of $81 million for a book-to-bill ratio of 1.4:1. And we are forecasting approximate 20% growth for unmanned systems this year, driven by the current geopolitical threat environment. Kratos' unmanned systems Q1 book-to-bill ratio of 1.4 on top of an approximate Q1 22% growth rate is reflective of the demand we are seeing for Kratos' affordable, high-performance jet drone aircraft systems, including certain programs and customers we are unable to publicly disclose, but whose performance is reflected in our financials. There is a generational recapitalization of strategic weapon systems occurring as a result of the increasing global threat environment, including China, Russia, Iran and its proxies and also in North Korea. And we believe that Kratos is uniquely positioned to address the related demand, including with our ready-to-go now in production systems across the portfolio. Priority areas of this recapitalization for the U.S. and its allies, which priorities are routinely reported on in the press include air defense systems, drones, loitering munitions, missiles and engines for these systems, radar, counter UAS space and satellite systems, strategic deterrence, rocket, hypersonic, missile defense, target and training systems. Recent notable items for Kratos include the successful static fire test of Kratos' Zeus 2 Solid Rocket Motor or SRM, with the previous successful static fire test of the Kratos' Zeus 1 SRM, we have placed the initial order for nine combined Zeus 1 and Zeus 2 SRMs with our partner, Aerojet, to address expected initial customer demand for these affordable systems with the first Zeus customer-funded mission now scheduled for later this year. Additionally, Kratos' Erinyes hypersonic flyer is now complete with the first customer funded flight now also scheduled for later this year, which system will include Kratos' integrated multi-stage solid rocket stack. Kratos is one of the very few entities that has a substantially vertically integrated hypersonic system and ballistic missile defense target mission system, including the rocket motors through the front-end payload or the flyer. Kratos' Zeus SRMs and our Erinyes and Dark Fury hypersonic flyers are recent examples of Kratos delivering actual systems, not hoped for someday products or PowerPoints and with Kratos being first to market with relevant systems that the customer wants. Related to Kratos' hypersonic and ballistic missile defense business, we are planning to make significant investments in facilities, machinery equipment, integration assets, rocket and other systems and assets as we position for execution of existing and expecting demand for Kratos' rocket BMD, SRM and hypersonic systems. We expect Kratos' Rocket Systems business, including Kratos' Zeus, Oriole, ARAV, Erinyes, Dark Fury and our other systems to be a key future year growth contributor for Kratos. In our Israeli-based Microwave Electronics business, which significantly outperformed in Q1 and which business is also accelerating. We have received new and increased follow-on orders to existing programs and contracts, including related to missile, radar and air defense systems, including Iron Dome, Iron Sting, Lightning, Arrow, Barak and others. Kratos' Microwave Electronics business is also supporting satellites, space systems and C5ISR programs, including Kratos just recently receiving the initial design order from a new space company for Kratos' products on their satellites. In Kratos' Microwave Electronics business, we are making investments in both new and existing facilities, including space-qualified facilities, plant and equipment in order to successfully execute on the many new and expanded programs we have already received and additional programs we expect to receive. Kratos Turbine Technologies and our Engine business has also been accelerating and significantly outperformed in Q1 with programs and initiatives, including small jet engines for drones, missiles and loitering munitions, engines for hypersonic and supersonic systems and engine and propulsion systems for space and certain classified aerial systems. KTT's Spartan Development Group is under customer-funded contract for a new propulsion system for a classified aircraft and also a separate new Spartan Group propulsion system has now been integrated into a customer's classified drone system and is preparing for initial flight. Both of these new system programs are important contributors to KTT and are expected to grow as these new program systems evolve. We will be making investments in our engine businesses, including for a low-cost manufacturing facility, infrastructure, systems and assets, including related to loitering munition and missile system production contracts, where we are designed in. Certain of which we expect to receive this year now that the funding bills have been approved. We also continue to be on schedule and on budget under a customer-funded contract where we are integrating Kratos' jet engines into certain Kratos high-performance jet drones. Kratos' C5ISR business is also positioned for future growth with programs of record and contracts, including Sentinel, Patriot, IBCS, IFPIC enduring shield, SHORAD and other missile, radar, air defense and counter UAS programs of record. The global demand for air defense, radar and strategic systems is providing a catalyst for C5ISR growth, and I encourage you to take a look at the size, opportunity and quantities related to certain of these programs Kratos supports. Kratos' unique one-of-a-kind owned and operated global space domain awareness or SDA system is an incredibly important Kratos asset, with its data and information being of increasing value to our customers, including as a result of the significant number of additional spacecraft being deployed. Data sales to customers from Kratos' SDA, similar to Kratos' OpenSpace software and license sales are certain of the highest margin in our company and can be contributors to Kratos exceeding our profit forecasts based on mix. Representative of the progress Kratos' OpenSpace virtualized ground system continues to make. Kratos recently demonstrated a fully virtualized SATCOM ground system for the United States Army Futures Command over SES's O3b MEO Constellation, and we also successfully demonstrated fully virtualized SATCOM over MEO for the United States Army. We continue to make significant investments in our first-to-market OpenSpace virtual C2 and TT&C software product family and also at the expansion of our global SDA system. Kratos' Unmanned Systems business highlights we can discuss include Kratos' Valkyrie flying with two F-35 aircraft, successfully demonstrating the ability to deliver an integrated electronic attack capability during a live-fire test event at Eglin Air Force Base with the United States Marine Corps as part of the Penetrating Affordable Autonomous Collaborative Killer Portfolio or PAACK-P program. During the PAACK-P program mission, Kratos' Valkyrie advanced electronic attack payload autonomously detected, identified and geo-located multiple tactically relevant targets of interest, transmitted emitter target track coordinates to collaborative assets and successfully presented non-kinetic electronic attack effects to multiple emitters. The recent M prefects reported for the Marines' MQ-58A Valkyrie means multi-mission in the U.S. military-wide aircraft designation system, with the use of M rather than X indicating a platform intended or in planning for operational use, transitioning from the X or experimental. Kratos' Ghost Works recently had successful ground tests on a new system Valkyrie variant, and we are planning on initial flights in the next few months, pending availability of specific range assets and necessary clearances. We are currently in customer discussions, and we expect to receive our most important Valkyrie-related contract award either late this year or early next year. As a result of the Valkyrie progress and the expectations we have, we are making the internal investment required to accelerate the completion of the current Valkyrie serial production, including multiple variants totaling 24 systems, and we have now begun working with our in-place qualified supply chain and vendor base on pricing out the next Valkyrie production lot beyond the current 24 as most of the 24 are now sold, customer committed or which we believe we have clear customer opportunity line of sight. We have recently been informed that we should be receiving a Kratos Athena drone system-related contract award in the next few months. Also, since our last report to you, Kratos' Apollo drone system had a successful customer-funded demonstration flight with a special payload. Recent world events have generated renewed customer interest in Kratos' Apollo, Athena and other Kratos tactical drone systems. As I have mentioned previously, for customer competitive or security-related reasons, we are unable to discuss certain programs, contracts or initiatives Kratos is involved with, and we will let the financial results provide the progress as reflected in Q1 in our Unmanned Systems business. We are in the planning process to expand our tactical drone production at and other facilities to address the increased and expected demand. So overall, we're focused on the execution of our record backlog and an $11 billion opportunity pipeline, including certain large new program awards we expect to receive over the next few quarters that we are preparing for. Accordingly, we have no significant acquisitions contemplated, potentially only small Kratos business consistent tuck-ins. Virtually every opportunity or initiative we executed our recent equity raise for has either successfully closed or progressed with continued progress expected over the coming months. As I have discussed today, Kratos will be investing in plant facilities, equipment, systems, capital assets and other areas in order to successfully execute on programs we have now received or that we expect to receive. Additionally, we believe that the equity raise was instrumental in Kratos just recently being successfully downselected as the winner on a large new opportunity, which we are currently in negotiations and diligence internally called Prometheus. Next several months, Kratos' base case forecasted growth areas include air defense, turbine technologies, engines, missile, radar and CUAS systems, drones, C5ISR, microwave electronics and training systems. Potential future catalysts and potential upsides to Kratos' base case forecast include tactical drones, BMD rocket and hypersonic systems and jet engines and propulsion systems.

Thank you, Eric. Good afternoon. As we have included a detailed summary of the first quarter financial performance, as well as the initial second quarter and affirmation of the full year 2024 financial guidance in the press release we published earlier today, I will focus on the highlights in my remarks today. Revenues for the first quarter were $277.2 million, exceeding our estimated range of $240 million to $260 million, which includes higher-than-expected performance and delivery across most of our businesses with notable strength in our turbine technologies and Microwave Products businesses. All business units generated organic revenue growth over last year's first quarter, resulting in a 19.5% consolidated organic revenue growth rate, including the impact of the Sierra Technical Services or STS acquisition on a pro forma basis as if acquired at the beginning of 2023. Adjusted EBITDA for the first quarter of '24 was $26 million, exceeding our estimated range of $16 million to $18 million, reflecting the additional revenues as well as a more favorable mix of higher-margin revenues with notable strength in our turbine technologies and microwave products businesses, as well as higher-margin software and data-related content from our satellite business. Positive cash flow from operations generated was $700,000, which includes the impact of working capital requirements related to increases in inventory balances and prepaid assets related to supplier required deposits and prepayments for materials and equipment. Free cash flow used from operations was $15.9 million after funding capital expenditures of $16.6 million. As we planned, we are making investments to expand and build out certain of our manufacturing and production facilities in our microwave products, rocket systems and hypersonic businesses to meet anticipated customer orders and requirements and investing in related new machinery, equipment and systems. We are also continuing to manufacture the two production lots of Valkyries prior to contract award. We also utilized $45 million of the proceeds from the equity offering to pay down all amounts outstanding on our revolving line of credit. Consolidated DSOs or days sales outstanding continued to improve from 109 days in the fourth quarter of 2023 to 107 days in the first quarter of 2024, reflecting the timing of customer milestone payments. Our contract mix for the first quarter of '24 was 68% fixed price, 26% cost plus and 6% time and materials. Revenues generated from contracts with the U.S. Federal Government during the first quarter of '24 were approximately 69%, which includes revenues generated from contracts with the DoD, non-DoD federal government agencies and FMS contracts. In the first quarter of '24, we generated 12% of revenues from commercial customers and 19% from foreign customers. An operational priority remains the hiring and retention of skilled technical labor across the company with total Kratos headcount of 3,986 at the end of the first quarter, up 24% as compared to 3,932 employees at the end of '23. Now moving on to financial guidance. Our initial second quarter '24 financial guidance we provided today includes our current forecasted business mix and expected delivery schedules and our assumptions related to the potential impact of the continued operating challenge related to our obtaining and retaining qualified technical personnel and the related increased cost for those employees across our entire labor base. Our guidance also includes our assumptions related to the continued impact of supply chain disruptions, inflation and related expected cost and price increases. Our second quarter and full year 2024 guidance reflects the impact of certain performance and deliveries made in the first quarter of '24, certain of which had originally been estimated to be executed or delivered in the second quarter of '24.

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

Now the first question is coming from Peter Arment with Baird.

Yes, Eric and Deanna, nice results. Eric, to begin with a broad perspective, you achieved a remarkable 20% organic growth in the first quarter. Considering your guidance of around 10% growth for the year, how should we interpret that, especially since it suggests a decline to high single-digits as we factor in completed budgets, passed supplements, and general demand signals across your businesses? Would you label your top line as conservative, or how would you describe it?

Right. Peter, our backlog and the near-term opportunities for 2024 are clear. The CRA lasted 6 months, and as you know, the government contracting offices need to secure 12 months of funding under contract and obligated within 6 months. We are being cautious. We acknowledge the government's responsibilities; they have significant work ahead. They need to finalize this process and allocate the funds to us.

Yes, that's fair. Regarding the engine opportunities, both Florida Turbine and TDI have significant potential. How do you expect the timeline for these businesses to unfold, considering the substantial investments you are making and your thoughts on their scaling?

Yes. Unless something completely unforeseen occurs this year, KTT and TDI are projected to continue meeting or exceeding our expectations. The programs we've secured across both portfolios are quite impressive. Additionally, we anticipate starting to receive further production programs for engines, missiles, drones, and/or loitering munitions in the second half of this year. The funding is in place, and the customers are committed. I am focused on finalizing contracts and ensuring timely delivery, not only directly to us but also collaborating with the prime contractors. We expect our engine business to be one of the fastest-growing segments of the company over the next several years, closely linked to the forthcoming drone platforms, missile platforms, and loitering munition platforms that are currently receiving attention and are well-publicized, and we are integrated with our turbojets.

Perfect. And just lastly, any update you can give us on kind of positioning around for CCA for Increment 2? I know that, that is something that is tracking for later this year or maybe early next year depending on what happens on sort of timing, but any update you can give us there, that would be helpful.

Yes. The Air Force obviously announced the CCA program is going to be up to 2,000 drones. The Secretary announced last week or the week before last that Increment 1, which was just awarded, which was not in any of our forecasts was not contemplated in any of our numbers, was for 100 planes. We're focused on the other 1,900, which we believe a significant number of which are right in our sweet spot based on type of performance. So that's how we're looking at this, Peter.

And our next question coming from the line of Michael Ciarmoli with Truist Securities.

Nice results. Eric, maybe just to continue on Peter's question there on CCA and you actually said there was news about replicator. Does the Switchblade 600 provide you guys opportunity? I think in the past, you've kind of married that platform with Air Wolf. Any color there?

Michael, I can't comment directly on what was announced recently. I can say that we have launched the AeroVironment drones off of our drones, which gives them extended range and gives them extended capability, and on replicator kind of sort of similar to the CCAs. This award was called Tranche 1, and it was focused on Class I and Class II UAVs. And the second tranche is coming and the third tranche is coming, both of which either in the air system or the propulsion system, we're hoping to be involved. So this is rolling out very similar to how we've been led to expect it would by the government.

Got it. And then you guys talked about a lot of investment, new existing facilities really across multiple lines of business. No change to the CapEx. You obviously did the raise; you've got a significant amount of cash on the balance sheet. Is everything contemplated in the CapEx spend? Is any one of these investments in a certain capability consuming substantially more? Can you maybe give us even directionally size rank order of how much investments kind of in each capability?

Yes. So let's go down the list. The known ones that we're going to be that we've begun or we're going to be beginning: we're standing up two engine manufacturing lines, including a new plant. This is for two different types of engines and it's specifically related to tactical systems, whether it be a drone or loitering munition. We are six months out from hitting a milestone on a much larger engine. We're already under contract; if things go according to plan, then we will have to stand up a third facility for this engine, which is a much larger engine for a manned aircraft. All right?

Okay.

On the hypersonic front, Zeus 2 has successfully completed its static fire test, and we are currently working on building out the integration center for the solid rocket motors and the front-end flyers, including Erinyes and Dark Fury, along with other partners. This process is underway and will be accelerating. A major highlight is our Microwave Electronics business based in Israel, where all metrics, including backlog, pipeline, and revenue, are at record highs and poised to grow even more. We are aware of the factors driving this growth and I have detailed some of the systems we're involved with. There are two facilities I can mention: one is brand new and the other is an expansion of an existing facility to accommodate current systems. By this time next year, we may need to establish yet another facility due to the demand for Microwave Electronics in various Israeli weapon systems. All of this is being carried out under contracts. Regarding another topic, we need to adjust our timeline based on specific customer requirements. We are hopeful to expedite delivery ahead of our previous schedule. Based on our continued successes with other customers, we have begun to engage with the supply chain for the next batch of planes, which may consist of 12 to 24 additional units, although we have not placed any orders yet. Most of these are scheduled for 2020. The most significant item is Prometheus; during the equity raise, I mentioned that it wasn’t finalized yet, and we were still working towards it. We have now been selected and are in an advanced stage of negotiation. We expect to finalize this contract by the end of the year, which could be a major opportunity for us. This endeavor will enhance our backlog and, while it does require substantial investment, it represents a potential game-changing opportunity. Those are the key points.

Got it. That's helpful. Just the last one. On Valkyrie, everything sounds like it's progressing. Obviously, you mentioned the supply chain but I think in your comments you said maybe the order is sliding into '25. It seems like a little bit of disconnect there. I mean, all this interest, but not getting the big orders. How are you get comfortable with all this investment but not having the order in hand yet and still self-funding?

We have two customers with two separate potential orders. I think we’ll secure at least one of them this calendar year and the other in the first half of next year. To be cautious, I’ll say the first quarter of next year for the second one. Unless geopolitical circumstances change, I'm confident we'll move forward. If everything goes as planned, we won’t need to make additional commitments until we get one of those orders, which suggests that it should happen soon.

And our next question coming from the line of Ken Herbert with RBC Capital Markets.

Eric, I wanted to ask you, it's been a couple of quarters now that you've more publicly talked about the shift from a prime to more of a merchant supplier and it clearly sounds like you're getting some traction in a number of these areas. How would you sort of characterize your success in this relative to your plans? And as you think about these new opportunities, maybe what percent would you think about as a merchant supplier or subcontractor relative to sort of ongoing dependence to win things as a prime?

As I mentioned briefly in the last call, we evaluate the likelihood of success and the necessary investment for Kratos to achieve that success. There are specific areas where we excel that differ from others, including certain companies I've talked about in the last couple of weeks. For instance, our strength in the drone sector lies in low-cost reusable, disposable, or treatable drones, and we anticipate securing those programs. Some companies have publicly stated that this is not their area of expertise, as they focus on high-end products. This distinction could create opportunities for collaboration, where the chances of success could be higher together than individually. For example, in the air defense sector, our main partners are in CUAS systems, missile systems, and radar systems, which I refer to as the big three: Raytheon, Northrop, and Lockheed. They are our key collaborators and exceptional to work with. Notably, the Patriot program is a significant initiative for us with Raytheon, the Integrated Battle Command System is important with Northrop, and THAAD and multiple CUAS systems involve Lockheed Martin. We're also partnered with Dynetics on IFPIC and Enduring Shield. Collaborating with these established traditional Prime System Integrators allows us to support them in fulfilling their missions for the customer. This is our approach, and we are focusing on where we see the highest chances of success.

That's helpful. And as I look at the incremental sort of next production lot on the Valkyrie, can you talk at all about for the second '24 how your assumptions around pricing or real pricing that you might achieve on that have evolved or maybe changed or improved since some of the early production lot or the initial production run?

Yes. So I'm talking generally now because it depends on the version or the increment and the capability of the aircraft. So on the learning curves now, depending on quantity, so for example, we submitted a ROM for a few dozen to a customer at $4 million each for a certain variant. There is another variant that's flying today. It's about $5.5 million or $6 million each. And then there's a third one. We haven't talked about it much; I'm not going to get into it a lot here. Hopefully, by the end of the year, I'm going to be able to talk about it. It's closer to $10 million and it's a beast. It depends on quantities, variant and the customer we're working with.

And our next question coming from the line of Mike Crawford with B. Riley Securities.

Can you just run through please some of the top opportunities, including converting Valkyries from CapEx to revenue per second fleet revenue recognition, where you would generate revenue and operating earnings kind of ahead of what you've guided?

Opportunities that are not in the base case?

Yes.

Tactical drones are a key focus, but currently, we aren't producing any as it's still in the research and development phase. Additionally, we have minimal resources allocated for engine production runs we expect to receive. Zeus and the hypersonic flyers are also important areas where we've included nothing previously since the systems weren't complete; they are now. The first flight of one system is scheduled in the coming weeks, with another Zeus-related flight later this year. Once these initial flights occur, there may be opportunities based on the backlog for certain assets that were not included in our plans. Another area of importance is a program for a specific engine where we are under contract. This is one of the largest programs in our Engine group, and the customer has recently requested to expand the scope for another aspect of this engine. If we can hire the necessary personnel, which is a significant challenge, we have the potential to exceed our targets substantially. These four areas are primary opportunities. The most significant concern across our entire portfolio is staffing. If we can recruit and retain the right people, we have the backlog to go beyond our current projections, but it is challenging, especially considering the need for security clearances.

Okay. And then, just one final. Previously, you talked about space, which has been for the past few years here, or it is your biggest and has been among, if not your fastest-growing business. But this year was supposed to be a year of consolidation, whereas flat, yet it was you were up nicely year-over-year in Q1. I'm wondering if you're now expecting a little bit of growth there. And also if you could just tell us a little bit more about this new space customer, what you're doing for them with their satellite?

Yes. Let me take the second one first because it's the easier one. The second one first is, this is an established company. It's a larger profitable company. I said new space; Mike that may have thrown people. It's new to us, but it's not a new space company. It's new to us; it's not a new space company. They're putting up a new constellation and they just selected us in the past couple of three weeks to be part of the Microwave Electronic system actually on the satellite. This could be initially several tens of millions of dollars to us initially. And it's because over the past year and we've tried to lay this out, we've been successful on three or four other satellites with our Microwave Electronic satellite programs. We're getting a reputation now. This is why we're one of the reasons we're expanding our space-qualified facility. This is brand new work, new constellation, large company, public company and it looks very, very, very good for us. On the first part of your question, our Space business. Yes, as you mentioned, last year, our Space business organic growth was like 13% or 15%. We did a little bit in Q1. But as I mentioned on last quarter's call, this is the business within Kratos that absolutely could be and it is being most impacted by the continuing resolution, the delay. Also, as you all may have seen, I knew this, but it's out there publicly now. There's a reprioritization of certain space assets going on within the Air Force, the Space Command, the Space Force. None of this is bad. It means things are going away. But it means decisions haven't been made yet. They're probably not going to be made. And so, things are moving to the right. We factored all of this into our guidance, when we gave it for our Space business. And so the other piece is, as you know, our OpenSpace is virtualized software-defined ground station. Its primary best case scenario is for a software-defined satellite, where software-defined satellites are reconfigurable, reprogrammable depending on the mission. The ground equipment at Kratos is a software you can reconfigure with it. That's why we win right there. As you may have seen, a number of the software-defined satellites, particularly in the commercial area, are being pushed to the right. I believe that Airbus actually came out and talked about it. They were very big customers that are around the world, but were directly related to Airbus and their satellites. That's moved to the right. We built those moves to the right of those launches of those software-defined satellites into our forecast. And so, those are the dynamics we're dealing with. There's a lot going on in the space area, but I'd leave you with this. The number of satellites that are going up and that are forecast to go up militarily, national security and commercially is incredible. It's in the thousands, the tens of thousands, even with optical links, they need touchdown points. We're the touchdown point guy, and that's why we feel good overall about the business.

And our next question coming from the line of Seth Seifman with JPMorgan.

This is Rocco on for Seth. How should we think about the growth trajectory at KGS for the rest of the year? Should we think about sequential growth in the coming quarters or could it possibly take a step back?

In the annual guide we gave, we haven't updated guidance from a quarterly perspective by segment, but the annual guidance we gave was roughly 20%, 25% for unmanned systems. And then that then implied approximately 6% annual growth for KGS. That has remained unchanged with the original annual guidance we gave.

Okay, great. And then can you provide more details about the Apollo and Athena drones and how they compare to Kratos' other offerings?

Yes. These drones are primarily disposable rather than attributable. Like most of our tactical drones, their heritage originates from our target drones. Regarding Athena, I believe we will be able to discuss this platform either next quarter or by the end of the year, depending on customer approval. For Apollo, I am less optimistic about this due to its application. One of the reasons our unmanned drone business is performing well is because of these derivatives of our target drones, and we anticipate continued success in this area moving forward.

Our next question comes from Joe Gomes with NOBLE Capital.

You talked about staffing and Deanna gave us some numbers. How much more staffing do you need to move forward or to get some of these potential business really moving forward?

Let me give you an example, Joe. In one specific KTT program, we could add 30 to 40 more people immediately on a time and materials contract. It's one of the highest margin projects in the company, and we can start them right away. The billing rates are between $200 and $250 an hour. We also have another opportunity in the engine area where we could bring on just under 30 people right now. Moving to the unmanned drone sector, it’s complicated due to the current state of the industry, including issues with overall aircraft. We have a new program on the horizon that could involve about 30 or 40 people to onboard quickly. It’s going to be challenging, and we are collaborating with the customer on how to sequence and onboard these personnel. As a public company, we need to manage this carefully, as we can't afford to just wish we could hire more. We could potentially have 50 engineers available, but they would be an overhead until the program expands, which would affect our margins. However, doing this could accelerate our growth even more. It’s a delicate balance between maintaining quarterly profitability, executing effectively, and onboarding staff for these programs.

And on the supply chain and your vendors, a lot of potential growth here that you talked about, Eric. How confident are you in that they're going to be able to keep up with all this expected growth? Is there going to be any type of bottlenecks there?

That is a good question. In Kratos, we refer to either the directed vendor chosen by the customer or the exclusive vendors that are unique to the U.S. The two areas where we remain vigilant are engines and drones. Regarding engines, as you may remember, we have made and are continuing to make a significant capital investment at our Kratos Manufacturing Center of Excellence, focusing on additive manufacturing, 3D printing, casting, and machining primarily for engines. We are doing everything possible to integrate vertically and reduce risk as much as we can concerning the engine orders we are receiving. In the drone sector, in addition to the autoclave, there are other critical machines and tooling. Some vendors in the U.S. are currently overwhelmed due to CCA, 5GAT, and MGAT, among others. In some cases, we're acquiring the machines and tooling and bringing them in-house to speed up our processes. Initially, we may not do everything in-house, but we want to have a backup plan to avoid issues because, as you know, the most crucial part of a system is often the component that's missing when you're about to finish it. We’re striving to stay ahead of these challenges, but it is demanding.

Our next question coming from the line of Josh Sullivan with The Benchmark Company.

So on the planned KTT low-cost engine facility, what do you see the volume capacity of that facility on an engine unit basis, maybe over the 12 months, 24 months, however you want to characterize it, assuming you could hire everybody you wanted to, as you just mentioned? Are we talking hundreds, thousands? What do you think?

Thousands per year.

And then on the partners for the KTT Spartan programs that you mentioned. Are you partnering with traditional jet engine OEMs or these airframe partners where you're bringing a KTT complete engine?

Josh, and this is partnering. This was small; ask it again, I didn't hear you quite.

So, are you partnering with engine manufacturers with the KTT Spartan program or aircraft, where you're bringing the engine?

We handle most of the design, development, and manufacturing of the engine in-house. We are the main engine system provider for the air framer, which includes drones, missiles, and loitering munitions. However, we do have a partnership in a specific area that is confidential and could potentially lead to significant success if it goes well. Besides this partnership, we are managing all other projects independently.

Thank you. I'm showing no further questions in the queue at this time. I will now turn the call back over to Mr. Eric DeMarco for any closing remarks.

Excellent. Thank you for joining us this afternoon, and we'll look forward to chatting with you when we report second quarter in August. Thank you.

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation. You may now disconnect.