Kratos Defense & Security Solutions, Inc. Q3 FY2024 Earnings Call

Thank you. Good afternoon, everyone, and thank you for joining us for the crisis, defense and security solutions. Third quarter 2024 conference call. With me today is Eric DeMarco, President and CEO, and Deanna Lund, 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 was 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.

Good afternoon. For the third quarter, Kratos continues to execute, demonstrating the success of our strategy of making internally funded investments to rapidly develop and be first to market with relevant hardware and software for our national security customers. In Q3, every Kratos business unit substantially achieved or exceeded its objectives, with the exception of our commercial satellite business, which continues to be impacted by new entrants, industry disruption and delays, including delays in delivery by the manufacturers of software defined satellites, which I have discussed in detail previously. The ongoing generational recapitalization of strategic weapon systems, including strategic satellite air defense, radar and missile systems, continues to be a catalyst to the current and expected future Kratos financial performance, including our affirmation today of our 2024 financial guidance and our 2025 base case financial forecast expectation of 10% year-over-year revenue growth. As I mentioned on our previous call, in Q3 and Q4 '24 and in Q1 of '25, Kratos is expected to continue to make significant internally funded bid proposals and other expenditures in pursuit of certain new, large single award programs, one of which, with a potential value of approximately $1.5 billion, we hope to be selected on by the end of Q1 of next year. Additionally, we are also hoping to hear on a new single award space opportunity with an initial value in excess of $100 million and a potential future value several orders of magnitude greater than that. We are closely managing these BMP investments related to our financial guidance that we affirmed today and the opportunities we are pursuing to ensure that we can make these investments, pursue these opportunities and also achieve our expected financial guidance range. Though these investments have been and are expected to continue to impact Kratos' near-term profitability and EBITDA, if we are successful, based on the potential size of certain of these opportunities we expect to win, we are looking to potentially increase Kratos' future year-over-year planned revenue growth rate above the current 10% base case forecast in 2026. Virtually every Kratos division has exposure to the rapidly growing air defense systems area, including Kratos microwave electronics, our rocket systems, C5 ISR, space and satellite target drones, turbine technologies and our ballistic missile target business, each of which Kratos is the industry leader. Kratos' microwave electronics business, where we support Iron Dome, Aero Lightning, Iron Sting and other systems has a record backlog and is generating record financial results, which are expected to continue into 2025, including in support of the Israeli Defense Forces and our important partners, including Rafael, Elbit and Israeli Aerospace Industries. To address our Israeli business' record backlog and opportunity pipeline and demonstrating Kratos' commitment to Israel, Kratos is on schedule to open a new manufacturing facility, expand our current manufacturing facility and complete our space qualified facility capability in Israel in Q2, 2025. Additionally, due to customer demand, including as related to missile and radar systems, we are now also planning to open an additional microwave products facility in India in close coordination with both our customers and our partners. Kratos Turbine Technologies and our engine business are also generating record results, including having a record opportunity pipeline with hypersonic, supersonic cruise missiles, loitering munitions, drones and space systems all being expected future growth areas. As a result of the investments we have made, Kratos' small, low-cost turbojet engine facility in Michigan is now capable of producing approximately 10,000 engines annually as we expect to receive engine production contracts for drones, missiles and loitering munitions programs next year. Additionally, we have now identified the site for an additional new small turbo-fan engine production facility, including as related to our partner, GE Aerospace for larger drones, missiles, air vehicles and systems; the demand for jet engines is rapidly growing, and we expect small jet engines, including Kratos' TDI Spartan family of small but mighty first-to-market turbojets that are in production and operational today to be a future growth catalyst and contributor for Kratos. Kratos' C5 ISR business supports air defense, counter UAS, radar missile and strategic programs including Patriot Integrated Battle Command System (IBCs), Indirect Fires Enduring Shield (IFPIC), short range air defense (SHORAD), Sentinel or GBSD, FAD or Terminal High Altitude Area Defense and many others. Since our last quarterly report, Kratos has received a new hypersonic system-related program award, which is expected to be one of Kratos' largest programs over its expected future multi-year period of performance. Additionally, we were just recently informed that Kratos has been down selected on another new major weapons system program hardware opportunity that we also hope to be successful on in 2025. Kratos' new Sentinel Program dedicated facility is planned to be operational mid to late next year, and we expect the Sentinel program to be one of Kratos' largest programs in future year growth contributors. Key Kratos C5 ISR partners and customers include Northrop Grumman, Lockheed, Raytheon and Leidos Dynetics. Kratos' rocket systems business also has several important growth-related program areas, including Aegis, hypersonics, ballistic missile defense targets, sub-orbital vehicles, strategic and nuclear systems and space-related systems. Expected future year growth contributors for Kratos in our rocket system area include our first-to-market Erinyes and Dark Fury hypersonic glide vehicles, the Dark hypersonic system with our partner, Hypersonics, our first-to-market Zeus 1 and Zeus 2 solid rocket motor (SRM) systems and our Oriole SRM system, and also the Terrier and target mission-related systems with our government partners. Since our last quarterly report, and as we announced today, Kratos Zeus 1 and Zeus 2 solid rocket motor stack successfully executed its initial flight, achieving every mission objective with our government partner. Kratos Zeus is a recent example of the value Kratos' business model brings to every Kratos stakeholder with Kratos making the internally funded investments to rapidly develop, field and be first to market with affordable, relevant systems for U.S. national security. We have also recently executed a contract related to certain other Kratos flight vehicle system production and integration, including up to 60 Kratos solid rocket motors. These are different and in addition to Zeus as Kratos' expected future mission launch manifest continues to significantly grow for many different types of SRMs and missions. We have also now identified the site for Kratos' new large hypersonic system franchise, production and integration facility. This will be located in the United States, which site we expect to break ground on by the end of this year, and have operational capability by 2026. We expect Kratos' Rocket Systems, SRMs and Missile Defense related systems business to be a future year-over-year growth contributor for Kratos. Kratos' satellite business on the defense and national security side is performing as expected, and we received and are bidding on several new national security-related opportunities, including where we believe that our first-to-market open space software is a clear competitive differentiator for Kratos. Additionally, Kratos' owned and operated space domain awareness system, where we provide and sell data and information to our partners and customers, is performing well, including the announcement just yesterday by the customer of an approximate $48 million sole-source award. We believe that Kratos' SDA system is well positioned to take advantage of the large number of satellites currently being and expected to be placed into orbit. As was discussed on the Q2 call, the commercial satellite industry, and Kratos' commercial satellite business continues to face disruption and challenges, including those directly related to the new software defined satellite system issues the OEMs are currently experiencing, which are now well publicized and are expected to continue for the foreseeable future. As a result of these industry-related commercial satellite issues, we have been reallocating and are addressing our overall satellite business resources to ensure that we execute as efficiently and cost-effectively as possible. Importantly, Kratos will continue to make targeted investments, including in our proprietary 5G virtualized modem software, SATCOM related and other products where Kratos is first to market and we have a substantial intellectual property position. In space and satellite communications, Kratos has the customers; the total addressable market opportunity, both commercial and government, is large and expected to rapidly grow, and we expect future year organic revenue growth and margin expansion from the business. The global demand for air defense systems is driving demand for Kratos Threat Representative Target Drones, which are used to exercise and test these systems and their crews and we expect our target drone business to be a future grower. Since our last quarterly report, the United States Marine Corps announced that Kratos Valkyrie successfully completed a test flight on September 20, 2024, at Eglin Air Force Base in Florida. This flight was conducted in partnership with the office of the Under Secretary of Defense for Research and Engineering, United States Navy, Air Warfare Center, aircraft division and other industry partners. Additionally, as reported in a 17 October Marine Corps press release, Kratos recent Valkyrie flights with the Marine Corps in cooperation with the United States Air Force at a United States Air Force Base, the Valkyrie successfully demonstrated tactical data link integration and closure of the kill chain. The manned, unmanned teaming concept with Valkyrie and a four ship of F35b was pushed even further in the recent emerald flag exercise. I refer you to the Marine Corps release for full details and photographs on this incredibly successful and relevant mission. This joint collaboration event is part of the Penetrating, Affordable, Autonomous, Collaborative Killer portfolio, or PAC-P program; as you can see, Kratos Valkyrie continues to successfully fly, evolve, and missionize with operational relevance with manned fifth generation and other aircraft and systems with multiple DoD customers and participants, including the Air Force. Also in our tactical drone business, Kratos' Athena Drone program is under contract and expected to contribute in Q4 and into 2025, and Kratos has been informed that our Apollo drone has been selected, and we are in final contract documentation with Apollo expected to begin contributing in 2025. Both the Athena and Apollo opportunities have come in later in '24 than we had initially forecast, and as a result, the contributions from these programs will be less in Q4 than we had originally planned, but the good news is we now have them both under contract, or soon to be. On one of the Valkyrie opportunities, which we were in source selection on which is international, we have been recently informed that we were successful, and I hope by our next report, I can provide an additional update on the Valkyrie selection here. On the second Valkyrie opportunity I previously mentioned, we remain in source selection, with the selection anticipated for Q1 next year. Additionally, there are also now two new tactical jet drone opportunities Kratos is evaluating for potential pursuit, one of which we have just recently submitted a response. Based on the recent events and communications, we remain confident that Kratos' Valkyrie, the lowest cost, most affordable runway flexible, actual flying today, obviously has been flying since 2019 high-performance jet-powered tactical drone will successfully get to production. Kratos' Ghost Works has made rapid progress on the conventional takeoff and landing Valkyrie capability, which development Kratos is internally funding and which we expect to fly in the second half of '25. The complete Valkyrie system is a runway flexible, runway independent system. We are also on track with our customer to fly a new fifth-generation aerial drone in 2025. Kratos' Ghost Works has also made progress with our customer in integrating Kratos jet engines into Kratos tactical and target drones, with initial flights of Kratos jet engines and Kratos' drones planned for the second half of '25. Kratos turbojets, part of our Spartan family of engines, which are manufactured in Michigan, are some of the highest performance per cost in the world, being significantly lower in cost than anything else available in the industry, of which there's very little. As represented in my update, we believe that the market momentum for low cost jet-powered drones is increasing, and that Kratos, which currently manufactures approximately 165 jet drones annually and has approximately 10 different jet drones flying today, is uniquely positioned to address and be successful in this market now and today, not 5 or 10 years from now. Related to drone manufacturing capacity, Kratos is currently positioned with the internally and funded investments we have made and are making, alongside our established and qualified vendor-based supply chain and our existing facilities and options to quickly increase jet drone production to approximately 400 drones a year, including Valkyrie when requested. We expect Kratos' target drone business to be a contributor to Kratos' future organic growth, and we expect Kratos' tactical drone business to potentially be transformational for Kratos' business and our stakeholders in the future. As I mentioned, as we look towards 2025, we remain confident in our long-term base case, 10% organic revenue growth rate, objective and forecast, which for 2025 we expect to provide the details on when we report Q4 after the new administration and Congress is in place, and hopefully when we have better clarity on the current continuing resolution authorization situation. We are internally focused on executing on our record backlog and opportunity pipeline with no significant acquisitions anticipated, only potential small tuck-ins. Operational challenges include obtaining, retaining and the related cost of qualified personnel, which continues to be a headwind to certain of our operations and profit margins due to the increased personnel-related costs and scarcity of resources, and also the current disruption in the commercial satellite industry. As we have previously discussed, our base case forecast does not include any production orders for Kratos tactical drones, only continued research, development, test and evaluation, or RDT&E or science and technology and similar type sales. Irrespective of the administration and U.S. government funding timing issues, with the current geopolitical landscape and threat environment, we believe that we are in the early stages of a Reagan-like defense build-up with increased U.S. and allies' defense and national security budgets for the foreseeable future.

Thank you, Eric, good afternoon. As we have included a detailed summary of the third quarter financial performance as well as the initial fourth 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 third quarter were $275.9 million in our estimated range of $265 million to $280 million, which includes notable strength in organic revenue growth in virtually all of our businesses, including our unmanned systems, turbine technologies, microwave products, C5 ISR defense rocket support and training solutions businesses offset by the expected industry-related impact from OEM delays in the manufacturing delivery of software defined satellites. Adjusted EBITDA for the third quarter of '24 was $24.6 million, exceeding our estimated range of $20 million to $23 million, reflecting a more favorable mix of higher margin revenues, offset partially by increased bid and proposal costs associated with a large potential opportunity. Unmanned systems, organic revenue growth was 8.7% for the third quarter, including the impact of the Sierra Technical Services or STS acquisition on a pro forma basis, as if acquired at the beginning of 2023. Cash generated from operating activities was $6.1 million, which includes the impact of working capital requirements related to increases in prepaid assets, primarily resulting from deposits required for long lead motors and engines related to expected ramps in production, as well as advanced payments required by key suppliers and the reduction of deferred revenue balances or prepaid customer deposits as work has been performed and delivered. Once these motors and engines are completed and delivered to Kratos, the related prepaid deposits will be transferred to our inventory balances. These prepaid assets are investments for inventory we are making for programs either under contract or based upon customer indications of demand and future production and/or deliverables. Free cash flow used from operations was $9.2 million after funding capital expenditures, has $15.3 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 system 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 lots of Valkyries prior to contract award. Based on our current build and construction schedules, approximately $10 million of capital expenditures that were initially expected to be incurred in 2024 are now expected to carry over into 2025. This is offset by the working capital uses related to increases in advance payments and deposits required for long lead production items, which has been more than $10 million for two programs in the first nine months of 2024. Consolidated DSOs, or day sales outstanding, increased from 103 days in the second quarter to 105 days in the third quarter based upon milestone payment schedules. Our contract mix for the third quarter of '24 was 69% of revenues generated from fixed price contracts, 25% from cost type contracts, and 6% related to time and material contracts. Revenues generated from contracts with the U.S. Federal Government during the third quarter of '24 were approximately 67%, including revenues generated from contracts with the DoD, non-DoD federal government agencies and FMS contracts. In the third quarter of '24, we generated 12% of revenues from commercial customers and 21% from foreign customers. An operational priority remains hiring and retention of skilled technical labor across the company, with total Kratos head count of 4047 at the end of the third quarter, as compared to 4012 at the end of the second quarter and 3986 at the end of the first quarter of '24. Now moving on to financial guidance. Our financial guidance we provided today includes our expectations and assumptions for our supply chain execution and for employees. Sourcing, hiring, retention and the related cost. We have also taken into consideration in our affirmed fiscal '24 guidance, a federal fiscal year '25 continuing resolution, or CRA, commencing on October 1 which it has, and under such CRA, no new program contract awards, no increases in existing production contract money and no transition from program development to production.

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

Our first question comes from Michael Ciarmoli from Truist Securities.

Eric, just I mean, we've got, you know, holidays and stuff here, not, not a lot of time for the rest of the year. What's the driver in the wide range for the fourth quarter? And then, I guess, just on, on the '25 initial outlook. Can you give us any color, or, you know, maybe some detail by end market, you know what? What are the leading growth engines what's kind of lagging?

Yes, sir. Hey, Mike, so on the range in the fourth quarter, every year it starts around September 30, with the government fiscal year-end, there's sweep up money, and a lot of customers have some money that they have some priorities on, and this is in particular in our space and satellite business and data purchases, including off of our space domain awareness network, which we've seen virtually every year for the past several years and it's very possible that we're going to get several of those this year, and we just can't plan them. They can come with one week's notice that's the biggest driver on the range are these data sales off the space domain awareness network. That's the big that's that one. On the other one, the big drivers for next year, all right, number one is going to be the air defense system work that's going on. It's incredible I went through some of the air defense just some of the air defense systems run and these are all counter UAS systems. These are big hardware programs. That's really going to be a driver for us the next one. Mike, and I can't emphasize how important Zeus was this. This is a major catalyst for Kratos, our solid rocket motor launch business next year is going to be, it's forecast to be several tens of millions of dollars greater than it was in 2024 and then again, in 2026 I think it's going to be several tens of millions of dollars greater than it's going to be in 2025 based on the launch manifest we're looking at. It's that significant. Okay? And the third one is engines and propulsion systems. Us being first to market with this engine technology, where we're designed in and we're actually flying, is turning out to be a big winner for us, which is why we've spent the money to get the turbojet production facility ready to go up to 10,000 units annually. And we've identified the location for the turbo fan, the bigger jet engine, one with our partner, GE. Those are the big catalysts that we have high confidence in just based on what we've got.

Got it. And then just a bigger picture question you mentioned the Reagan-like buildup. Obviously, it's very early days here post-election. If Musk is serious about cutting government spending, how do you think this will impact defense? He has a proven track record with SpaceX. Does this put the traditional defense contractors at risk? Does it benefit new startups like the ones you’re collaborating with, such as BlueHalo? And where does that leave your company?

I believe that for non-traditional companies like Kratos, Shield, and BlueHalo, the current environment is exceptionally favorable. A few years back, at an Air Force conference, Mr. Musk mentioned that he envisions a future, five years ahead, where unmanned drones will begin to replace manned aircraft. He is also very focused on affordability and maximizing value, which aligns with what Kratos has achieved in drones, hypersonics, and solid rocket motors. At the very least, this situation is neutral for us, but it is more likely to provide significant advantages for new entrants and non-traditional firms like Kratos.

Our next question comes from the line of Peter Arment from Baird.

Eric, it's first time I think I've ever heard you talk about a foreign source selection when you're talking about for your tactical drones, is this like a firm commitment from the customer or do you know the potential quantity? You know any more color on that? That would be helpful?

Yeah. So one of the reasons I mentioned that today, Peter is it's possible, in the next few months, not by us but because of the nature of this, it could become public. And I wanted to make sure you all at least were informed on this. I can't say a lot. I can't get ahead of myself on this. But if you recall, on the last earnings call, I made some comments that on one or two of these new opportunities we're pursuing. As a result of them, we were lining up our supply chain for a third lot of 12 Valkyries. Well, this ties into this, and so we're cautiously optimistic. We have been down selected. We were getting there and that's all I want to say. And we have not included any of this in 2025 none. And so, God willing, if it comes through, this could be a big binary for us.

Right. And then on your, you've given us a lot of information in this release regarding, you know, kind of where all the growth can come from, in terms of capacity and growth in drones and engines on the drone side, the tactical drone, well, I guess the fire jet. There's opportunities with the Navy on the tactical side. Can you give any more color there on how that's progressing?

Apollo and Athena are very relevant in the context of tactical drones. One of them is applicable to a non-Air Force customer, and I must be cautious with my words. We are making progress with Air Wolf, including on an international scale, regarding the tactical fire jet. A key reason for this is that a Valkyrie can travel several thousand miles, whereas a tactical fire jet cannot, making it more acceptable for political and policy reasons. Next year, one of the jet drones powered by our engines will be a tactical fire jet, which will notably enhance performance in electrical subsystems that are highly significant. This relates to your question, and I cannot be more specific than that.

Yeah. Just lastly, you mentioned, you know, the turbojet development and TDI and sounds like the outlook there. Certainly, the capacity is in place. How do you anticipate kind of production ramping up now that you've kind of made that significant investment there?

Yeah. So I think that probably in the first quarter, no, first half, the continuing resolution is directly impacting a couple of these programs. Can't get the money because it's in the 2025 budget. We're going to get some initial LRIP orders. Okay? And late next year, second half next year, we could get a couple more LRIP orders. And based on what we're designed in on these systems, based on what it looks like, we have a new President now, he's going to have a lot of say in the 2026 budget request. So assuming there aren't any draconian changes there, which I don't believe there will be, 2026 could be a breakout year for us in the small jet engine production.

Our next question comes from the line of Ken Herbert from RBC Capital Markets LLC.

Hey, Eric. We've obviously got a new administration coming in as we think about where we see some leadership changes in Congress and what would likely be greater, sort of a greater push for higher defense spending. I know it's obviously early, and you sound like you're alluding to this, and '25 is probably not where we necessarily see this relative to '26 and beyond. But are you prepared now to think about if we're in a situation where we do see call it sort of mid-single digit, real growth in at least U.S., defense spending. What that means to your long-term, 10% top line outlook that you've been delivering to over the last several years?

Yes. So you know, Senator Wicker of Mississippi may very well be the Chairman of the Seminar Services Committee, and that gentleman is a 100% Patriot through and through. If you Google it, you can probably see $1 trillion defense budgets under Wicker. I know he was looking for that recently, which are needed because of the threat profile. And I can go down the list on what people are speculating or are going to have some of these important roles that look like for United States National Security. It's going to be a Grand Slam, which we need right now for the country's sake. Now having said that, affordability is going to be very, very important. It's just going to be, irrespective of defense budgets going up to $950 billion, or $1 trillion. Again, I'm the CEO. I drink the Kool Aid. But based on the programs we've won, the ones that we're going to win in the next three to six months, we know we're going to win. We've been told and based on the opportunity pipeline where this is Strategic Systems, nuclear systems, air defense systems, where we're basically sole source. This is one of the reasons I mentioned that probably in '26 we're going to take up our 10% year-over-year growth number. We're going to. I don't believe it's going to be lack of winning the work. The constraint, or the restraint we're going to have is getting the qualified people, primarily manufacturing people, including those that can get security clearances, because you can imagine with what's going on in the industry, these people are in incredible demand right now by all of us and that's going to be it, but that's Ken why I made the comments on, we're looking to potentially take it up in '26 because of what you just alluded to.

And if I could, it looks like, in terms of profitability within the unmanned segment this year, on an EBIT level, you probably end the year in low single digits in terms of margin, you're outlining, again, significant investments within that segment to support, obviously, the planned growth. Do we see, or should we expect much margin expansion within the unmanned segment in '25 I'm sorry, or can you provide any additional commentary around that?

Obviously, I don't want to get ahead of ourselves since we're not giving guidance yet, Ken, but we would expect to see some margin expansion, just with the leverage off of our fixed infrastructure as we move also from development into production, so we would expect to see some expansion.

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

Thank you given the increase in proliferation of space-based architectures. Could you give us a sense of what your satellite business historically has looked like, broken down between Leo and Geo maybe historically, today and where that might be in the future?

The satellite business has primarily focused on geostationary satellites, which have historically been the majority, launching around 22,500 miles into geosynchronous orbit. This was the standard before factors like Elon Musk's initiatives and the introduction of anti-satellite weapons by Russia and China. Currently, we are shifting towards distributed constellations in low Earth orbit (LEO) and medium Earth orbit (MEO), while still utilizing some geostationary satellites. Many new satellites are being deployed into LEO. However, these LEO satellites face communication challenges over oceans unless equipped with laser cross links. At this moment, due to existing systems and the capabilities of companies like Airbus, Thales, and Boeing, our business still leans heavily towards geostationary satellites. Nevertheless, as the market, especially in tracking networks, increasingly embraces distributed LEOs, we are advancing with this trend. Therefore, we anticipate our satellite mix will progressively shift from geostationary to more LEO and MEO deployments as these systems rollout.

Thank you, Eric. And then just related, the single award, $100 million plus space opportunity that could expand from there, did? Can you say whether that's commercial or sovereign?

It's not commercial.

Okay. Separately, there was a successful joint exercise at the Air Force Base and one flag. While we know the Marines are a customer, the involvement of the Air Force in the joint exercise and the CCA program is uncertain. It seems unlikely that the exquisites will enter volume production, and it's unclear whether the next increment will focus on additional aircraft or be related to counter UAS. Can you provide any comments on that?

My opinion on this, Mike, is the United States Air Force responsibilities are massive, and they're increasing. They're just massive that what they're responsible for and their resources, financial and otherwise, are not adequate for them because of these massive responsibilities. And so they, in my opinion, the Air Force, very smart. They're going to be looking for areas where they can augment systems with lower cost systems that may not be exquisite, but they're very, very capable. I sincerely believe we're going to be part of helping there solve their drone issues from a resourcing standpoint, I believe that, and I'll leave it at that.

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

Apologies if I missed it. Is there any update on Prometheus? I'm smiling.

We are. The last time we talked, I said we were in the red zone. We are on the five yard line. I truly believe that at our next earnings report, if not sooner, independently, because of the significance of this to Kratos and the United States industrial base, that we are going to be able to announce something either we got it in the end zone, or otherwise, I believe we're going to get it in the end zone this. This could be one of the biggest catalysts for Kratos ever. We're almost there, but I don't want to jinx it.

Of course when you think about that, you know kind of 10% next year. And you know what we discussed a little bit earlier about the drivers of that, is that something that where there's, you know, is not factored in, and maybe there's upside related to that?

It is factored at zero. This is so significant to future years and so binary. We're not factoring it at all. It's zero. It is zero in our forecasts.

Okay, got it. And then maybe it's just a follow. I feel like I should know this. But when we think about the producing at the scale of the turbines that you're talking about, what would be the primary destination for that level of production or the kind of top groups of programs that would be the customers for that scale of production?

Low cost cruise missiles. There are a handful or two of brand new low cost cruise missile or similar programs that are underway. They're underway. They're happening. There's not a lot of publicity on them, but they're happening and these are orders of magnitude less, orders and orders of magnitude less costly than existing exquisite cruise missiles. This is clearly affordability, quantity, affordable mass that the military, several branches, are looking at and they're doing it. This is going to happen. This is happening.

Our next question comes from the line of Sheila Kahyaoglu from Jefferies.

Hi guys, Connor, on here for Sheila. Thanks so much for taking my question. Your commentary around the hypersonics pursuits is clearly very positive. I think you previously called out it could be a $1 billion opportunity over the next five years. Can you just give us an update on where the broader hypersonic business stands today and how you think about that trajectory?

Yeah. Okay, so we Kratos' legacy in the hypersonic areas is significant. We're involved. I'll give you some programs: High Fire, High Cause, Fast; those were Kratos launch systems, and Kratos was involved in those. As you may have seen last year, France launched a hypersonic glider. Kratos launched it for them, Kratos system. Heretofore, and also, you know, our ballistic missile targets, ballistic missile re-entry vehicles, they routinely go over Mach 5, 5000 miles an hour. So they're hypersonic. So we're an expert in the field. We just don't propagate it a lot. Our sweet spot in drones right now, contractually, it's target drones in solid rocket motors. It's ballistic missile targets and so you'd think that where would we be? We would be in hypersonic targets. We would be in hypersonic test vehicles. We would be in things like that right now as we speak. And also, similar to what we've done with the target drones where we've now transitioned, augmented to tactical. We also very well may take a look at that in the hypersonic area because we can do things orders of magnitude less costly and faster than anybody else out there.

Got it, that's very helpful. Maybe for my second one. Just to look at the micro-electronics business in a little bit more detail, it's clearly been a strong driver for you guys this year, given the demand in the region. But with all that capacity coming online next year, any way you can frame the growth opportunity for 2025 and beyond?

This business should be a 15% to 20% grower, if not more, for the foreseeable future, to replenish the stocks, the inventories that have been expended over the last 13 months. And then, in addition to that, I mentioned the facility we're standing up in India with partners, with customers. This is not a bit; we don't build it and they will come. We have programs because of everything that's going on in Russia and the Ukraine and what's going on with Israel and Hamas and Hezbollah, India has not talked a lot about relative to China and what's going on relative to rearming there. We are embedded in there, and we see the opportunity there, and that could be the next step function for us in a couple of years as we get online, supporting them.

Our next question comes from Andre Madrid with BTIG.

I wanted to talk on labor. I know you guys have cited this in the past as kind of being a hurdle to really be able to scale the propulsion business, especially at KTT. Can you highlight any progress on recruiting and retaining talent?

We have dozens and dozens of open wrecks right now, especially in the turbo machinery area. And as we've talked about before, the competition is not just only your traditional aerospace guys, but it's these new space companies like SpaceX and others. And I mean it just this is business. We make progress but as we talk about, it's costly, and I'm good for the people, you know, good for good for them, but it's costly. So it's challenging, it's remaining challenging. I believe we're going to receive another very large propulsion system contract on the military side, that's going to get going in January. For us, it's not under contract yet, but it's coming, and we're going to be sole source and we're going to get it staffed, but the margins won't be as strong as we thought because we're going to have to pay to get these experts, and we're going to need like 50 of them to do this new program. So it's hard.

That's fair. No, I totally feel for you there. It's, you know, pretty, pretty industry wide, but I guess pivoting again, I know somebody had mentioned it on the space side. I wanted to drill and look at it more at a BU level, you know, space training and cyber security. It's pretty broad, but it seems like what's happening on the commercial space front is when you think about contract mix, it seems like this is a bigger one. I mean, considering though the breadth of that portfolio, it is the largest that you know, on a BU basis of the entire company, what opportunities are there to kind of offset and expand in other areas, be it defense, be it cyber?

I haven't discussed our training business in detail for several quarters. This includes virtualized training systems, augmented reality training systems, and hardware training systems. For instance, we are involved with the M1 tank and the Bradley, as well as multiple helicopters. As weapon systems are being produced and deployed internationally, the demand for training systems is currently higher than it has been in the last decade. We have two or three bids out right now, and we are preparing to submit another one. Our training business could potentially double in size over the next two years, possibly increasing from 40 to 80, or even reaching 150 if we secure one or two of these opportunities. We are one of only a handful of companies capable of providing these training systems, and we will be discussing this more frequently next year, as it is expected to be a significant contributor and will help counterbalance the challenges in the commercial space sector.

Our next question comes from the line of Joe Gomes from Noble Capital.

Eric, I wonder, see, maybe you could talk a little bit about the international target drone opportunity. I haven't heard a whole lot about that lately. What if anything is going on there that could be exciting for the company?

Yes. So back to air defense systems. You read about the U.S. allies, NATO, other allies, acquiring air defense systems. So THINK systems like Patriot or SHORAD, even the Old Hawk systems that are out there, and I can go on; they all need to be exercised. In addition to that, international customers are now taking F35s. Those systems, those air-to-air missiles need to be exercised. Our international target drone business is experiencing very significant growth, but it's a small piece. The biggest target drone guys in the world are US Navy, the US Air Force, the US Army, okay; so it's like $20 million a year, but it's growing very significantly. Here's the important part: because they're international, the margins are much, much higher than with the U.S. government. And so I would expect for the next several years, and you follow the air defense systems, follow the F35 where they're going. Those are the countries that are buying our target drones and very importantly, they have to put the infrastructure in to launch them, to fly them, to recover them. It's the razor and the razor blade then they get the target drones and they shoot them down, and we ship them more and so it will be one of our strongest growers for the foreseeable future for the reasons I just explained. Thank you all for joining us. Our next scheduled discussion will be when we report Q4 at the end of February, and that's when we will provide detailed financial guidance. Thank you.

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