Good day, everyone, and thank you for standing by. Welcome to Kratos Defense & Security Solutions Second Quarter 2024 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. Now I will pass the call over to the Senior Vice President and General Counsel, Marie Mendoza.

Thank you. Good afternoon, everyone, and thank you for joining us for the Kratos Defense & Security Solutions second 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 a 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.

Thanks, Marie. The successful execution of Kratos' strategy and our position as a leading defense and technology hardware and software company is reflected in our Q2 and year-to-date financial results. Kratos' strategy of making internally funded investments in close collaboration with our partners and customers to rapidly develop, engineer, field, and be first to market with relevant products, systems, and solutions is working for our customers, partners, shareholders, and all of our stakeholders. At Kratos, affordability is a technology which is directly related to our strategy of investing our own money, enabling us to move quickly and rapidly develop our products to low-cost mass production in large quantities and for affordable mass. As we watch peer adversaries in both potential and active conflict and at the same time, see adverse DoD budget program cost impacts, Kratos is focused on solving these challenges with systems that are truly realizable, near-term achievable, and affordable. At Kratos, we believe that better is the enemy of good enough and that someday in the future, having the perfect capability or solution that is studied and modeled and then studied again is too late, too expensive and an abject failure. Recent examples of Kratos' successful strategy execution with relevant working systems include Kratos' Erinyes hypersonic glide vehicle from initial conception to first flight with the Missile Defense Agency and the Navy in approximately 30 months for an approximate $15 million total development cost. Kratos' Zeus family of Solid Rocket Motors from conception to successful Static Fire in three years for an approximate $23 million investment, and now positioned for the MACH-TB program, hypersonic Erinyes missions, and several additional customers. Kratos' Valkyrie runway enabling trolley system from conception to first flight in effectively 15 months for a few million-dollar investment with Kratos' Ghost Works achieving another important milestone in Valkyrie operational deployment flexibility which we continue to rapidly mature and demonstrate. Each of these relevant Kratos' funded and developed systems are expected to be important contributors to Kratos' business and our future financial growth and profit trajectory, based on specific customer orders and feedback and representative of the value Kratos generates to our stakeholders. In Q2, Kratos' engine and turbine business continued its revenue growth and profit expansion trajectory, beating its forecast, including engines for drones, missiles, aircraft, space, hypersonics, supersonic, and other systems. Kratos is the clear industry leader and independent merchant supplier of engines, propulsion, and subsystems in our areas, and we expect continued future growth based on customer demand. We recently announced the Kratos small jet engine partnership with General Electric Aerospace, which is incredibly important to Kratos with GEA bringing large-scale engine production experience, capital, intellectual property, customer relations, and more. We are anticipating future production of thousands of low-cost engines in this class for drones and missiles. The GEA partnership is specifically with Kratos' turbine technology business for Small Turbo Fan Engines and is not related to Kratos' TDI Small Turbo Jet business, which has separate locations, technology, IP, and target market opportunities. As part of Kratos' arrangement with GEA, we will be sharing future engine production revenue and profit. Kratos, in coordination with GEA, will be making an investment and standing up a new low-cost, small engine manufacturing facility as we begin preparation for expected future production. Separately, we are investing and expanding our TDI Small Turbojet Engine production capacity and Kratos' overall hardware and manufacturing capability, including additional additive manufacturing, 3D printing, milling, machining, casting, and forging capabilities, which is part of Kratos' vertical integration initiatives. We are establishing new engine production lines related to the many new drone, missile, and loitering munitions programs that TDI has, including those that we are designed in on. We are either now in contract negotiations for and we are hopeful to receive an initial 1,000-unit order with a potential 10,000-plus opportunity in the near future. Kratos Turbine Technologies, TDI, and our engine and propulsion system business are currently expected to be some of our company's primary future growth contributors. Kratos' Israeli-based microwave electronics business also exceeded its Q2 forecast, including programs supporting multiple Air Defense Systems, including Iron Dome, Iron Sting, Lightning, Arrow Brock, and others. Kratos' microwave has a record backlog and opportunity pipeline. We are making the investments to increase our facilities, hardware, and manufacturing capacity to address existing and forecasted increased future demand, including a space-qualified capability, as a result of certain new satellite systems, awards we've received, and opportunities. Kratos has deep relationships with Israeli Aerospace Industries, Rafael, and Elbit. We expect our Israeli business to be one of Kratos' future year-over-year organic growth leaders as we support our important Israeli international customers. Global air defense system-related demand, including missile, radar, counter unmanned aerial system, and space systems, also contributed to Kratos' C5ISR business exceeding its Q2 forecast, including Patriot, THAAD, SHORAD, indirect fire or IFPIC, IBCS, CUAS, DE, and HPM related systems. Kratos' C5ISR programs backlog and opportunity pipeline is also at record levels, and C5ISR is expected to be an important future year organic growth contributor, as we support our important partners, including Northrop, Lockheed, Raytheon, Dynetics, and others in their national security missions. Kratos' C5ISR backlog and opportunity pipeline is at a record level, and we are making the investments necessary to support our partners and customers, including expanding our C5ISR business' hardware and manufacturing capacity, and also including our new Sentinel program facility. Kratos' training systems business is also growing, with increasing margins as certain programs we have been awarded ramp-up and additional new program wins are expected. The global recapitalization of strategic weapon systems, in addition to the weapon system, requires training systems, with Kratos being an industry leader with representative Kratos systems, including M1, Abrams, Bradley, Black Hawk, and Air Force Global Strike Command systems. Kratos' training system opportunity pipeline is one of the strongest in our company as we head into the second half of 2024. Kratos' cybersecurity business, one of the company's most profitable, is also forecasting future growth, including as the DoD's cyber maturity model certification program, or CMC initiative progresses, with Kratos having some of the industry's most important and critical cybersecurity-related relationships, relevant past performance qualifications, and customers. As we have communicated previously, Kratos' space and satellite business, our company's largest, is being adversely impacted by the previous extended 2024 continuing resolution, which delayed and pushed certain government programs or existing program funding to the right, including programs Kratos is or expects to be under contract on, and we are now also assessing the probable upcoming federal fiscal 2025 continuing resolution, which is likely to begin October 1. Additionally, our satellite business is also being impacted on the commercial side by the highly publicized technology and other issues being experienced by the manufacturers of software-defined satellites, which is delaying the award and/or deployment of the related satellite system ground communication infrastructure, including Kratos. However, we are now in source selection on several DoD national security and other program opportunities, certain of which we expect to receive either later this year or early next year, which should put Kratos' satellite business back on a growth trajectory. We remain confident in the future prospects for our satellite business, including our first-to-market virtualized open space software platform, which is a clear competitive differentiator for our company. Increased demand for our target drone business continued in Q2, with bookings of nearly $130 million and a book-to-bill ratio of 1.5:1 for the quarter, and Kratos' Unmanned Systems bookings being $290 million for the past 12 months. Global weapon, air defense system, and training demand I referred to is contributing to the increased Kratos target drone demand which is expected to continue, both domestically and internationally, as air defense systems, missiles, radars, ships, satellites, etc., need to be exercised against and warfighters trained against representative targets. Kratos' target drone business is expected to be an important future organic growth contributor for our company. On tactical drones. As has been increasingly reported over the past few weeks, including just yesterday, budgets are tight and are expected to get tighter, affordability matters and is going to matter even more in the future. We believe that potentially maybe better someday is the enemy of good enough in flying today, and Kratos remains confident in our success. Apollo is now under contract and Athena has been downselected and is expected to be under contract this quarter. Kratos Valkyrie is now in source selection on certain opportunities, so I am not able to make any specific program, opportunity, or customer-related comments on Valkyrie at this time. I can say that we have completed our planning for the next serial production run of Valkyries including with our key suppliers and we are ready to move forward once we have certain additional information on the potential opportunities, including the final version and capability mix of the aircraft. We are planning the expansion of our Oklahoma drone manufacturing capacity, including a potential additional facility, with the expansion being for both tactical and target drones. With the successful Valkyrie flight from the Kratos Trolley launch system, Kratos' Ghost Works is now working on an additional Valkyrie launch capability variant, also in close coordination with the customer. The Valkyrie Trolley launch system funded by Kratos but in close coordination with the customer community establishes Kratos as the only high-performance jet drone system provider with rail-launched runway independence, traditional runway capability, and soon an additional launch capability. We continue to successfully execute the strategy with Shield AI routinely flying Kratos' high-performance jet drone systems, including an incredible mission in just the past few days. From my perspective, what Shield is doing is potentially transformative and game-changing, with Shield taking advantage of Kratos having the only high-performance jet drones or performed hundreds of actual flight missions with Shield's artificial intelligence system flying and learning with the highest performance jet drones in the world, Kratos. The Marine Corps Miramar Air Show is coming up this September here in San Diego, and in addition to an actual Valkyrie, and actual Air Wolf, a Mako aircraft, etc., we intend on displaying several other high-performance Kratos jet drone aircraft at the show and also potentially a new Kratos system, if we can. Defense budgets are increasing globally, including in the areas of air defense, missiles, radar, space, satellite hypersonic engines, propulsion systems, C5ISR, microwave electronics, drones, cyber, and training systems, with Kratos being a hardware and software-rich technology company, addressing each of these areas and many others. Years of underinvestment in the defense industrial base is and will need to be corrected, and Kratos is participating in this buildup and the recapitalization for the strategic weapon systems. We are making the investments and vertically integrating selectively where it matters to reduce supply chain risk and to also reduce cyber and physical security risks as we need both surety and security with our supply chain. Producing hardware in large quantities for defense and national security applications that must reliably perform at an affordable cost is hard, and it is a key differentiator for Kratos to our partners and our customers. As you know, the 2024 budget continuing resolution went through March of this year and another potential 2025 budget continuing resolution is expected to begin October 1 just two months from now. Irrespective, we remain confident in our 2024 financial guidance, which we affirm today and we also remain confident in our expected future year-over-year organic growth rate of 10% with the potential to exceed it. As we reported, Kratos' opportunity pipeline is a record $12 billion, and we are in pursuit of certain new large programs as a prime, including classified opportunities in our Unmanned Systems business and our space, cyber, and training businesses, which require significant Kratos bid and proposal and related investments, including one opportunity where Kratos' investment in the second half of 2024 is expected to be approximately $2 million for this one opportunity. We have no significant acquisitions anticipated, only potentially some very small tuck-ins. Operational challenges include the obtaining and retaining of qualified, experienced personnel including those willing and able to obtain national security clearances and the related costs of these individuals.

Thank you, Eric. Good afternoon. As we have included a detailed summary of the second quarter financial performance as well as the initial third quarter and affirmation of the full year 2024 financial guidance in the press release we published earlier today, I will focus on the highlights of my remarks today. Revenues for the second quarter were $300.1 million, exceeding our estimated range of $265 million to $280 million, which includes higher-than-expected performance and delivery across most of our businesses, with notable strength in our unmanned systems, turbine technologies, microwave products, and C5ISR businesses. We made delivery on an international Middle Eastern drone program during the second quarter, which contributed revenues of $17.4 million, which was originally forecasted to be delivered in Q3. As we have discussed on previous calls, revenues under certain international contract awards, due to the contract terms and conditions are recorded as delivered rather than over time on a percentage of completion basis. As a result, the delivery under a contract of size, such as a delivery this quarter, can skew the quarter of delivering over quarter sequential trends. Consolidated organic revenue growth was 16.7% for the second quarter, including the impact of the Sierra Technical Services acquisition on a pro forma basis as if acquired at the beginning of 2023, driven primarily by organic growth in the unmanned systems business of 61.8% as well as notable growth in the turbine technologies, microwave products, and C5ISR businesses in our KGS segment. Adjusted EBITDA for the second quarter of 2024 was $29.9 million, exceeding our estimated range of $20 million to $23 million, reflecting the additional revenues as well as a more favorable mix of higher margin revenues with notable strength in unmanned systems, turbine technologies, microwave products, and our C5ISR businesses as well as higher margin software and data-related content from our satellite business. Cash used in operating activities was $2.7 million, which includes the impact of working capital requirements related to increases in receivables related to the revenue growth, increases in prepaid assets resulting from advanced payments or deposits required by key suppliers, and the reduction of deferred revenue balances or prepaid customer deposits as work has been performed and delivered. We are seeing a trend in our supply chain where certain of our vendors are requiring prepayments or deposits to secure our position, which is adversely impacting the timing of our working capital requirement to deliver our products and solutions. Free cash flow used from operations for the quarter was $15.4 million after funding of CapEx of $12.7 million. As we planned, we are continuing to make investments to expand and build out certain of our manufacturing and production facilities in our Microwave Products, Rocket Systems, and hypersonic businesses to meet existing and anticipated customer orders and requirements, and investing in related new machinery, equipment, and systems. We are also continuing to manufacture the two production lines in Valkyries prior to contract award. Consolidated DSOs or days sales outstanding continued to improve from 107 days in the first quarter of 2024 to 103 days in the second quarter of 2024. Contract mix for the second quarter was 70% fixed price, 24% cost-plus contracts, and 6% time and material contracts. Revenues generated from contracts with the US Federal Government during the second quarter of 2024 was approximately 65%, including revenues generated from contracts with the DoD, non-DoD federal government agencies, and FMS contracts. In the second quarter 2024, we generated 15% of revenues from commercial customers and 20% from foreign customers. An operational priority remains the hiring and retention of skilled technical labor across the company with total Kratos headcount of 4,012 at the end of the second quarter as compared to 3,986 at the end of the first quarter. Now moving to financial guidance. The guidance we provided today includes our expectations and assumptions for our supply chain, execution, employee sourcing, hiring, retention, and the related costs. We have taken into consideration in our firm fiscal 2024 guidance, a federal fiscal year 2025 continuing resolution, no new program contract awards, no increases in existing production contract funding, and no transition from program development to production. Our guidance also reflects the impact of certain performance and deliveries made in the second quarter of certain of which had originally been estimated to be executed or delivered in the third quarter of 2024, the most notable of which was the delivery of the international drone program in the second quarter, which has skewed the sequential quarter trend in our unmanned systems business. We are affirming our annual guidance with revenues for our unmanned systems in the range of $265 million to $275 million, up slightly from our previous range of $260 million to $270 million, with an organic growth rate of 22% to 27% over 23% on a pro forma basis with STS, as if acquired at the beginning of 2023. Our range for KGS business is $860 million to $875 million, slightly down from our previous range of $865 million to $880 million, which reflects increased weakness in our commercial satellite ground equipment business, resulting from the impact of the current industry technical challenges encountered in the manufactured software-defined satellites that have delayed satellite launches and have had a resulting delay in the deployment of our commercial satellite ground equipment, offset by increasing demand for air defense and related systems in our microwave products, Triton Technologies, and C5ISR businesses. Our reaffirmed EBITDA range of $102 million to $107 million includes the expected mix as well as additional $2 million in costs related to the large proposal in our space cyber and training business, which Eric referred to previously.

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

It comes from the line of Michael Ciarmoli with Truist Securities.

Hey, good evening, guys. Thanks for taking the question. Eric, it sounds like you're making a lot of progress on a lot of programs. I guess, just on Valkyrie, you mentioned that one close to source selection. You're moving forward with the second production lot. Can you just give us maybe some sensitivity, I don't know if you or Deanna, if you do get those or if you do get a contract and you put some planes under contract, how that would impact the current guidance, maybe the cash flow and even the revenue impact?

Sure. So Michael, from a revenue perspective, when the contract is awarded whatever the number of aircraft that the award is under contract for those costs that are currently in our PP&E would be transferred to effectively inventory and unbilled receivables and revenue would be recorded for those systems. So if it's, say, five aircraft, then that are in whatever state of completion, those costs would be transferred and then the revenue would be recorded accordingly for whatever percent complete they are at that time. From a receivable or collection perspective, it will depend on the billing milestones that we are able to negotiate with the customer. Depending on if we can get a payment upfront, we obviously always endeavor to do that, but it will depend on what we're able to negotiate.

Okay. Do you think that development and signing will occur in the second half, or is it still unclear at this moment?

It's possible second half. It's probable 2025. No comments. That's where it sits right now, which is why we're just being cautious in our guidance.

Got it. Eric, I think you have discussed various variants and sizes. In your prepared remarks, you mentioned the trolley system. It seems like you have the landing gear in place for Valkyrie, possibly securing a vendor there. Can you share your expectations regarding what the customer is looking for? Is runway independence no longer a priority, or do you simply want to provide the customer with options?

It's the latter, Mike. We're definitely providing various options to different customers with distinct priorities. Today, we have rail-launched and runway-launched drones in operation. Very soon, we'll have a Valkyrie equipped with its own internal gear and weapons flying. Additionally, we're working on another project, and soon we'll showcase the complete portfolio for our diverse customer community.

Okay. Got it. Last one for me. The contract in place with GE Aerospace, I think that replaces a previous joint development, but this one includes kind of a full-scale engine production. Have you spoke to? Or could you speak to the potential economics there? You know, just maybe what that program could look like as it ramps, as it gets into full production? Do you have customers secured already?

So I'll take the last part first. Regarding our customers, we are collaborating with multiple partners, including General Electric. These customers have been engaged with us for several months and are awaiting the engines. This is why both we and GE are very excited, as the technical capabilities and cost aspects of these engines are expected to be available very soon. We believe we will be the first to market with what we consider a transformative family of systems. The economic model is fair, although I cannot disclose details yet due to our NDA. However, I am confident that both we and GE are pleased with the economic split concerning engine production. As you know, at Kratos, we prefer to have a significant share of something rather than a complete ownership of nothing. We are optimistic about our success, especially with GE and our potential customers, along with the major aircraft manufacturers and missile developers.

Got it. Perfect. Thanks, guys.

Thank you. Our next question is from Peter Arment with Baird.

Yes, good afternoon, Eric and Deanna. Eric, Congratulations on the Erinyes hypersonic test flight. Could you maybe talk about how you kind of see future subsequent tests or flights? And how that can play out as we get into maybe even 2025 as this turns into kind of a backlog growth story? And, obviously, you have another vehicle that’s also part of that program.

Erinyes is a hypersonic glide vehicle, and the current public version serves as a test bed. There is an extremely high demand for hypersonic testing in the United States, and there aren't enough test assets available. Government agencies have expressed a desire to conduct tests and flights every week or two, and we now possess the necessary vehicle for that. Since the recent flight, we've received additional orders, and this will be a major growth driver for us. This opportunity is new for us and for the industry. Starting next year, I believe through the MACH-TB program and another program we have, we'll be discussing a second hypersonic vehicle that we plan to fly, which will open up an additional market for us. This is critically important to our future, and I'm glad you asked about it.

So do you anticipate a ramp-up in test activity next year and that have a similar revenue profile?

Absolutely.

Great. And then just on your engine businesses, obviously, a lot of excitement around both of them TDI and Florida Turbine. Can you talk a little bit about how quickly you can scale up? Because I know that the Air Force has kind of put out an RFI on an RFP on the ERAM, Extended Range Attack Munition that's specifically for Ukraine and it feels like that's right in the wheelhouse of TDI, but you've talked about your other partner following and jointly developing systems there. Can you maybe talk about how quickly you can scale up some of these opportunities?

We have been looking at various publicly available programs like MACE, ETV, FrankOne, and CAMs, along with ERAM. Many of these programs require propulsion systems similar to our TDI line. Additionally, we are focusing on our production facility and enhancing our manufacturing capabilities so that we can potentially produce hundreds, or even up to 2,000 units annually. The demand is present in the programs I've mentioned, and we are optimistic about securing a fair share based on our discussions with customers, airframers, and our established positions on certain projects. We are prepared for this scale of production.

Got it. Last one for me. Just could you talk a little bit about your bid pipeline expanded by $1 billion this quarter, went up to $12 billion. What was driving that? Thanks.

Yeah. So Peter, it's in our unmanned group as well as our space and training group and our defense rocket systems group. It's across those three businesses. So it's not one specific area; it's across three.

Thanks, Deanna. Thanks, guys.

Thank you. Our next question is from the line of Sheila Kahyaoglu with Jefferies.

Thank you, guys, and great quarter. Few questions for you, Eric and Deanna. If we could start on that last subject, Peter was just talking about Zeus and Erinyes. How could we think about that hypersonic activity pipeline of a billion dollars? How could we think about that progressing over the next five years? Would it be equally weighted? Or how do we think about that opportunity materializing?

Yeah. If things come together the way we see them coming together, next year it could, in 2025, be an incremental $50 million to $100 million. Then in 2026, it could be an incremental $100 million to $150 million. And then it could be $150 million to $200 million a year thereafter.

Thank you, Eric.

That's what the manifest looks like.

Thank you for that. What do you need to see in order for that to happen?

Budgets in place. No significant changes to the priorities of this customer set. And I'm saying this semi-facetiously, global peace doesn't break out. So Sheila, we're in a really good position because we're first to market with Zeus, Aeronese, and another system that's not public yet. We're in a great spot and these things are flying.

Yeah. No, that makes sense. And in Unmanned, your profitability was really good year-over-year. Is that sort of the level we should expect going forward? Or was this one time?

It will depend on the mix and from a development perspective and the leverage off of the fixed infrastructure costs. Since we did have a sizable international drone delivery this quarter of $17.4 million. So that did drive some of that leverage off of the fixed infrastructure. But it will also depend on the mix of the programs on a quarterly basis.

Got it. Thank you so much.

Thanks. Thank you.

Thank you. Our next question comes from the line of Mike Crawford with B. Riley Securities.

Thank you, just a couple of clarifications first. When you're talking about readying for your next serial production spiral of Valkyries, would that be the third such spiral? Are you talking about the, you're not talking about the second one, you already began, right?

The third.

Right. And then, thank you. And then you talked about expanding Oklahoma for tactical and target drones, but isn't that also where you're standing up the affordable engine production with GE Aerospace?

I'm smiling because I saw that report and news article. Our drone manufacturing facilities are located in Oklahoma City, where we will be expanding both the tactical and target drones, utilizing the existing facility as well as a new facility that we have already identified and are moving forward with. Our current engine business is located outside of Tulsa, Oklahoma, and it is likely that we will establish one of our low-cost turbofans with GE there. The main reason for this is the workforce, as we already have a highly experienced team with engines in that area. We have established networks and supply chains, and it looks very promising that this will be our plan.

And would that workforce also include workers directly or indirectly supplied from GE aerospace?

I can't discuss that yet until the final definitive agreement is executed, and then we will communicate that together. I'm sorry.

Okay. That's fine. And then switching gears a little bit. Could you maybe update us on the lay of the land and solid rocket motor propulsion, where you stand versus competitors, some of which seem to have claims perhaps above means?

Yes. That's actually an excellent question. Rocket motors are hard, and solid rocket motors are extremely hard. And the lay of the land right now is there are two that are qualified in the United States, Aerojet and ATK. Neither one of them are really a merchant supplier because they're embedded in a prime. As you've indicated, there are a number of guys out there. Some of them were like so Ursa Major or Crossbow or Adronus, which is part of . There are a couple of other ones that are coming that they've said they're going to get into this. This is very hard. Unless the rules change, the qualification rules, it takes years to get qualified and it takes years to get qualified and designed and on-system flight testing, etc. The demand is definitely there. There are some guys coming. I will tell you that because of the nature of our business and our customers', being a merchant supplier of solid rocket motors in the United States is something we continue to look at very hard because we would be a true merchant supplier, and we're experts in this area. That's something we're definitely looking at relative to our partnerships with the primes.

Thank you. Just one more question, as we haven't discussed CCA on this call. At some point, will we transition from a more specialized approach to something that has broader applicability? I also read that Ghost Bat is currently not being designed to carry weapons. So, you have multiple platforms that offer that capability, right?

Correct. I noticed that article stating that Boeing's Ghost Bat does not have the capability to carry weapons, which certainly caught my attention, as I understand it has drawn interest from the industry. Yes, several of our aircraft are equipped with deployed weapons, including Valkyrie. We are focused on affordability, attritability, and achieving cost points for affordable mass that can be realized with existing technology, rather than developments that may take up to seven years.

Okay. Thank you, Eric.

Yes.

Thank you. Our next question comes from the line of Seth Seifman with JPMorgan.

Good afternoon. This is Rocco on for Seth.

Yes.

Looking at the Q3 guidance, even with the $17.4 million in international target drone deliveries, sales are projected to decline next quarter sequentially. What is causing this decrease?

So the primary decline in that is in the commercial part of our satellite business. As I've mentioned, it really hit the press in the last three or four weeks. The manufacturers of the software-defined payload satellites are having some incredible technical difficulties, and the satellites are not going up. With the satellite, and Kratos is open space software-defined virtualized ground specifically designed in part to communicate with the software design satellites, I'm talking on the commercial side. We are designed-in. We've won the slots but the operators are making the right business decision by not deploying until the satellites go up. We are being very cautious in our assumptions in the commercial side of our space business. It's being offset by the government side, which is doing great, and it's being offset by other businesses in KGS, which are growing 15%. But that's the primary reason we're going to be very cautious there until some of these commercial satellite issues get resolved.

Right. That makes sense. Then has the outlook for combat drones and Kratos' position in the market changed meaningfully over the last few months?

The situation hasn't changed much. I feel that we are in a stronger position now than before. We have made significant progress, and I believe we are better positioned today than at any point in the past. The emergence of jet drones is real. Looking at the Pacific and the associated areas that will affect survivability, it's clear that Kratos' class of jet drones is the solution. There are an increasing number of war games and reports coming to light, including a recent one from the Mitchell Institute highlighting that having greater quantities will be more effective in deterring and defeating China compared to more sophisticated options. Our focus remains on extendable and attritable drones, which is our area of expertise. They are cost-effective, highly lethal, and very survivable, and I am confident that we will succeed.

Great. Thank you, guys very much.

You got it.

Thank you. Our next question is from Ken Herbert with RBC Capital Markets.

Hi, good afternoon, Eric and Deanna.

Hi, Ken.

Hi, Ken.

I wanted to just follow up. Can you give any indication, I would assume it's factored in the CapEx guide, but the investment you're making specifically in the turbofan engine capacity as you look to scale that up?

Yes. That's roughly about $10 million to $12 million for the year.

Okay. Perfect. You've clearly seen an increase in capital expenditures this year due to additional investments and opportunities. Can you share your thoughts on next year? Will capital expenditures, based on current plans, increase again next year, or is it dependent on contract wins? Or should we consider this year as the peak for capital expenditures?

It is contingent on contract wins. However, I believe there is, I would say in the $70 million to $80 million of the CapEx guide for the year, I would say $40 million to $50 million of that is what I would call investments that are – I don't want to use the word nonrecurring, but that's probably the best word at this point. So what I see is our maintenance CapEx is closer to, call it, $35 million a year. But depending on contract awards and opportunities, there could be opportunities in 2025 that we would make investments for.

Okay. That's very helpful, Deanna. Thanks. And just maybe, Eric, as I look at just such phenomenal growth internationally, I guess, specifically in NATO countries, can you just level set us on what percentage of your sales are into maybe NATO countries or outside of the United States more broadly? And what kind of growth you're seeing in that this year and potentially into next year?

Yes. So our international revenues are about 20% for the quarter.

The growth in Israel and in the systems we are developing for NATO countries is very strong, particularly in air defense, radar systems, and counter UAS systems. For a data point, excluding our space business which I discussed in detail, KGS is growing organically at 15%. A significant portion of this growth comes from our C5ISR business, where we collaborate with Raytheon on Patriot and THAAD, as well as several counter UAS systems. We're also partnering with Dynetics on indirect fires and enduring shield, all related to air defense systems. Additionally, KGS encompasses our Israeli operations, where we support Iron Dome, Arrow, Barak, Lightning, Iron Sting, and virtually every missile and radar system. Our performance is very strong, with a robust backlog and increasing order book potential for the next two years.

That's great. So I guess it'd be fair to say that the international piece of the portfolio probably seems much better growth than sort of the 10% you've talked about for the company over the next few years organically?

Yes. But yes, but. Next year with our partner, Northrop, which is one of the best partners we have. Sentinel is going to start ramping for us in a big way, very significantly, tens and tens of millions incrementally, which of course is U.S.-based. The mix may change, because of these programs we've won.

Great. Thanks, Eric. Very helpful.

Thank you.

Thank you. Our next question is from the line of Josh Sullivan with The Benchmark Company.

Hey. Good evening. Eric, Deanna.

Good evening, Josh.

Hi Josh.

As far as the GE relationship, we hear a lot about tightness in forgings and other aspects of the aerospace supply chain. Do you see this as a hurdle for the GE partnership engines? Or are your designs, just given their lower cost, able to circumvent some of these issues, cater some of these higher volumes?

Yes. Two things. Number one, our designs are definitely able to circumvent some of the issues. However, one of the key attributes and one of the key reasons we did this with GE is because they're the big dog. They're the preeminent, and they have priority. We call them kryptonite parts, with kryptonite vendors on very specialized subsystems and components for the engines via their supply chain and their relationships. That's an incredible value they're going to bring us. It not only brings surety to us but is also bringing surety to the missile guys. These engines are going to go in, and if we get a multi-hundred-a-year order, we're going to be able to source it. We're going to be able to build it. With General Electric behind Kratos or Chronic Kratos, if you want to look at it, that's what's closed in the deal here.

Got it. And then just as far as the loitering munition market, given the increasing use in the battle space, you mentioned you were in contract negotiations. But what's your sense of how quickly this market ramps?

I think it's possible that by the end of this year we will see some progress, and it's likely that it will happen next year. We are going to start receiving the first production orders for turbojets, specifically those with 200 pounds of thrust and below. Initially, we expect a few hundred units, and then the production will increase. In terms of specific programs, if you look at the discussions happening, we anticipate ramping up to several hundreds and potentially around 1,000 units per year over the next few years. This relates to the opportunities we have, many of which were either designed in or are in collaboration with us since we have operational engines. Our pricing is very competitive.

Thanks for the time.

Thank you.

Thank you. Our next question comes from the line of Joshua Zoepfel with NOBLE Capital Markets.

Hi. Good afternoon, guys. Josh turn up for Joe. So you guys basically answered pretty much all of my questions. But just kind of more for a couple of housekeeping ones. You guys talked a little bit about the Prometheus contract you guys were awarded. Is there kind of any progress on that contract? Is it still kind of expected to be contracted by the end of the year?

Yeah. If I said that we had been awarded Prometheus, I misspoke and I apologize, I don't remember doing that, but if I didn't, I apologize. Prometheus is an opportunity that we are working on, okay? We are getting there. We're in the red zone, football term, but it's not complete yet. Again, I apologize for that misunderstanding.

Okay. That's helpful. Thanks for clearing that up. A couple of months ago, or you're talking about in the space satellites, reevaluating space business. Is there any more impact to that reevaluation that has on Kratos itself? Are satellites being pushed even further to the right due to that?

And I want to make sure I understand your question. Are they being pushed to the right because of what...

The Airbus reevaluating its space business as a whole.

Got it. Yes. What's going on with Airbus is definitely impacting the ecosystem and it's definitely impacting Kratos. I feel bad for them and I really hope to get this stuff figured out. I am highly confident we have taken that into consideration in our financial forecast. We've been very fortunate here at Kratos that we have six divisions and 5.5% of them are ripping. The half that is not is tied to commercial software-defined payload satellites right now, which we've taken into consideration. The management team over there in our satellite business, I got to tell you, they have done an incredible job on the resource allocations to our national security programs, our defense programs, and some other things they're working on, like our global space demand awareness network to hold court. Our team is far outperforming them. We have taken it into consideration. As soon as these technical issues with some of these software-defined payload satellites get fixed and the operators can get them, and they get launched, we're going to be in fantastic shape.

Okay. That's helpful. Yeah. Thanks for your time, guys.

You've got it.

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

Hey, good afternoon, guys. I was just wondering if you could quantify the size of the Apollo contract. You said it's on contract now and then was wondering about timing if there is the potential for a larger follow-on in the future?

Right. So think of a couple of tens of millions right now, and that's over a couple of years. If we're successful, there is definitely the opportunity for a larger follow-on here.

Okay. The only other one, I think I know the answer to this, but if we do have potentially a change in administration next year and there's less financial support for the effort in Ukraine, I was just wondering, do you guys have any direct exposure there? Or maybe would you consider kind of near direct exposure?

So our primary exposure relative to what's going on in Ukraine has to do with the NATO countries rearming. I saw the other day that virtually all of them now are over the 2%, and they're increasing with some of them at 4% and 5% like Poland. My opinion is if the Ukrainian situation gets resolved, that in the NATO countries minds does not address the primary threat, which is Russia. I don't believe it impacts us or our customers, our partners on the air defense systems. The number of air defense systems, surface-to-air missile systems, and counter UAS systems that have been ordered and that are coming down the pipeline are stunning to me. I don't think a resolution in Ukraine impacts us because the primary threat or the inherent threat will still be there.

Okay. I appreciate the color. Thanks, guys.

Yes.

Thank you. Our next question comes from the line of Andre Madrid with BTIG.

Hi, everyone. Thanks for taking my question. Looking at the strong unmanned book-to-bill for the quarter, I mean, with the contract, how much, if at all, of this contribution for bookings was from tactical drones?

It was primarily all on the target drone side.

Yes. On a relative basis, it was small. That mix will probably change in either Q3 or Q4. But target drones are doing very well. We're probably going to be in a position relative to that to make an announcement of our largest target drone order ever in the next month or so. We just got it.

Got you. Got you. That's helpful. And then sticking on the side, I mean looking at what you guys announced with the GEK Engine, you guys are saying that's probably going to be in the thrust range of probably less than 3,000. According to the RFI as released on CCA, they're aiming for something between 3 and 8. I know you guys said you could scale up, but kind of piggybacking off of Peter's question earlier, how easy is it to scale up?

I'm sorry on both of those. I can't comment. I can't affirm what you saw. I just can't comment on it. I apologize.

No worries at all. My last question is about hiring at the firm level. How has the progress been specifically on the KTT side, considering that it was a pressure point previously?

Yes, that's a good question. It is very difficult. Turbo machinery engineers, propulsion engineers tie directly into the discussion we've been having here this afternoon. They are in incredible demand, and many of them don't exist anymore. They retired, and they're fishing. This is very challenging and expensive to hire them and keep them both in cash and equity at the executive level. This is a challenge, remains a challenge, and I believe it's going to continue to be a challenge for us and the industry.

Got it. Thank you, both.

Thank you. Our next question comes from the line of Trevor Walsh with Citizens JMP.

Great. Hi team. Thanks for taking my questions today. Eric, I have a follow-up related to your earlier comments on Ukraine, but I want to apply that to Israel. It seems like the Israeli business performed well this quarter. I'm not asking you to predict future developments, but if the situation there improves and tensions ease, what is your outlook for the future of that business in Israel or even for similar systems in other countries? What have you learned about ensuring there are sufficient munitions stored and ready to go, especially if tensions escalate again? What is your perspective on that, given the more optimistic scenario of easing tensions?

Yes, I'll share my opinion. The amount of munitions that have been used recently has been astonishing, depleting years of inventory. This inventory needs to be replenished to sustain a steady defense posture. I don’t foresee any decrease in demand in the coming years, and while it would be great if a resolution occurred, I expect significant month-over-month increases to eventually level off, but at a much higher rate than before October 23. Looking at the international context, we learned from Iran’s first potential strike on Israel, which involved over 500 munitions, including missiles and drones. In Ukraine, more than 10,000 drones are shot down each month, the majority being Class 1, 2, or 3, but a notable number are jets. The lesson is that large quantities can compensate for countries with limited defense budgets that can’t afford sophisticated systems. Those high-end systems will number in the thousands. We're witnessing this in direct orders and collaborations with our key partners where we develop major subsystems. I’ve mentioned before that we're in a situation reminiscent of the Reagan buildup in 1981; we're just in the early stages. However, due to significant consolidation in the defense industry, very few companies are equipped to meet these demands. Manufacturing defense hardware is challenging, and mass production is even more complex. Experienced players like Northrop, Lockheed, Raytheon, Boeing, and Kratos know how to navigate this, and that equipment must perform reliably. I believe this is a key reason our business will remain robust in a challenging environment.

Got it. Really appreciate the color. Then Deanna, maybe one quick follow-up for you. Services revenues looks like it stayed pretty flat quarter-over-quarter, but then margins had a nice little bump up about 200 basis points. Just wondering if there was anything in particular that drove the improvement there on the margin side? Thanks.

Nothing in particular, it was just what the mix was for that quarter that drove that margin expansion.

Got it. Okay. That’s all for me. Appreciate it. Thanks.

Thank you all for joining us, and we'll chat with you at Q3.

And thank you all for participating in today's conference. You may now disconnect.