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spk38: Thank you for standing by and welcome to Kratos Defense and Security Solutions' fourth quarter 2023 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 1 on your telephone. To remove yourself from the queue, you may press star 1 1 again. I would now like to hand the call over to VP and General Counsel, Marie Mendoza. Please go ahead.
spk03: Thank you. Good afternoon, everyone. Thank you for joining us for the Critics Defense and Security Solutions fourth quarter and full year 2023 conference call. With me today is Eric DeMarco, Critics' President and Chief Executive Officer, and Deanna Lund, Critics' 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 DeMarcus.
spk42: Thank you, Marie. Good afternoon, everybody. In 2023, Kratos achieved each of the goals we laid out at the beginning of the year, including 10% organic revenue growth, increased EBITDA with positive cash flow generation, while also making significant internally funded investments in potential transformational growth areas for our company. Expected growth areas include high performance jet drone systems, hypersonic rocket motors and systems, next generation jet engines for drones, missiles and loitering munitions, and open space software for virtualized satellites C2 and TT&C. Kratos' product systems and software, which we envision, design, and engineer from the outset to be produced in large quantities at a low cost are a value-added differentiator for our customers and also importantly for our prime system integrator partners and teammates. Kratos' relationships with the prime system integrators, including our being able to rapidly provide relevant, low-cost, differentiated, and value-enhancing products, hardware, and systems is a key element of Kratos' strategy and it's core to our company's success. At Kratos, we believe that it's better to have a big part of something instead of all of nothing. And based on a program's requirements, including schedule, the potential size of a Kratos investment required, the technical development and financial risk to Kratos, and also expected customer preferences, we may team with one or more of our prime partners on certain program opportunities instead of Kratos priming ourselves. We believe this teaming or partnership approach has been very successful, including recently on a high-profile program. On last quarter's conference call, I mentioned that we were expending significant effort, including bid, proposal, NRE, and other costs in pursuit of certain large opportunities. As an update, we have successfully received potentially the most important of these contracts in Kratos's unmanned systems business with a prime partner. On a second opportunity, a different Kratos prime partner was awarded a new missile defense system-related satellite constellation program where Kratos is responsible for the ground system. Thirdly, we have been informed that a Kratos turbine technologies proposal was accepted and we are now waiting for our customer to receive funding, hopefully in Q3. And finally, Kratos made the decision to pass on an opportunity as a prime due to the size of the Kratos internal investment required, the financial risk to Kratos on this development program, and our assessment of an unacceptable probability of Kratos' win. There are several reasons. additional notable opportunities that Kratos is currently assessing or in pursuit of, including where we are making significant investments, which hopefully we will be able to update you in the future. As we begin 2024, we are under contract on numerous programs of record, either as prime or partnered. These include new programs currently in development, programs transitioning to low rate initial production, programs that are in LRIP and transitioning to full-rate production, and programs that are in full-rate production already, where we expect increased future production quantities. Additionally, Kratos' opportunity pipeline is approximately $11 billion, and our backlog is $1.2 billion, all providing us confidence in our 2024 financial forecast. Additional recent Kratos achievements include a $579 million prime single award Space Force satellite communication system related contract, which we were able to announce today. The Space Force contract covers the command and control consolidation system used for SATCOM telemetry, tracking, command, sustainment, and resiliency. The receipt of this award, which was Kratos' only large outstanding recompete, provides Kratos both future visibility and an opportunity for growth, as reflected by the significant contract ceiling value increase of approximately 50% over the previous contract vehicle, as the number of satellites in orbit has and is expected to continue to increase, contributing to the overall expected increase in this contract's scope. It was reported that Kratos and Boeing have executed a memorandum of understanding for Kratos' TDI J85 jet engines to be the propulsion provider for the Boeing Power Joint Direct Attack Munition. It is anticipated that the powered JDAM will provide air-launched, low-cost standoff capability against land and maritime threats. We received an approximate $23 million prime contract from the United States Marine Corps related to Kratos' Valkyrie tactical drone, and we received significant contract awards related to the Iron Dome and the Patriot air defense systems. It was also reported that Kratos' Terrier Oriel two-stage rocket system was the propulsion system for the VMAX hypersonic system launch. And it was reported that recent testing of a sophisticated AI software aboard an XQ-58A Valkyrie drone will influence how the U.S. Air Force develops and deploys autonomous technologies. For 2024, expected Kratos growth areas, which are included in our base case financial forecast, include turbojet, turbofan, and rocket engines for unmanned aerial drones, loitering munitions, cruise missiles, hypersonic systems, supersonic platforms, space and other systems, increased target drone sales, with target drones being used by the U.S. and our allies to exercise radar, air defense, fighter aircraft, maritime, counter UAS, and other platforms and systems, all of which are in increasing demand globally. Hardware and product sale growth related to air defense, counter UAS, radar, and missile systems, including in Kratos' C5ISR and our microwave electronic products business. These include systems that are currently in theater in both Europe and the Middle East, and we expect the Sentinel program with our prime partner Northrop to also be a 2024 organic growth driver. We expect to see growth in Kratos' space, satellite, and training systems division, including particularly strong growth in virtual augmented reality and other training systems. In 2024, we expect Kratos' first to market virtualized software-based OpenSpace C2 and TT&C Suite to continue to gain customer acceptance and designed in positions. Additionally, we are currently forecasting for 2025 to be an inflection point year for Kratos' satellite business, both in organic revenue growth and in profit generation, based on programs we have successfully received, those we expect to receive, and those we expect to either transition to or begin production or deployment on. In the tactical drone area, we believe that Kratos remains well positioned for this new large and expected to be fast-growing market area, both with Kratos drones and also with Kratos's family of turbojet and our turbofan engines. Tactical drone initiatives we're able to discuss publicly include We are under a funded contract and have completed a successful series of mission system and related flights, including as related to Kratos' Mako tactical jet drone system. We are under a funded contract and are integrating Kratos' jet engines into Kratos' drones. Kratos' Ghostworks is completing ground testing of a new drone-related system at our Burns Flat Range location. which program we expect to transition in the future to a larger range for final system demonstration. We had hoped to transition this system to a larger range in Q4, but we were unable to do so. We are moving rapidly with Shield AI, integrating Shield's artificial intelligence into multiple Kratos jet drones, with flights being held at Kratos's Burns flat-range facility. We are completing production of the last of the initial 12 Valkyries, and we are in production on the second 12 Valkyries, which production rate we are calibrating now based on Kratos' internal resource allocation considerations, including as related to the new funded drone system program we have received. We are under funded contract for a Valkyrie variant where Mission and other systems are being integrated. We are working with the government entity on a separate Valkyrie variant with funded first flights expected in the fourth quarter of this year. And Kratos's Ghostworks is working on an additional Valkyrie variant with new capability, performance, and low cost, we believe will be another step function ahead for Kratos's tactical drone family. There are currently four Valkyrie variants that I can publicly confirm today. and a fifth that Kratos' Ghost Works is currently assessing. We expect to receive the largest Valkyrie-related contract award to date in late 2024, and I am confident that all 24 Valkyries we have produced or plan to complete production on will ultimately be sold or delivered to funded customers. We are establishing an additional production line for the new drone system program that we are under contract on with a partner. We believe that once we have the 2024 U.S. federal budget, that Kratos' Thanatos will receive a funded prime contract. Based on recent events, it is also possible that we will receive a funded prime contract for Kratos' Athena drone program system late this year or early next year. Initial derivatives of both Thanatos and Athena are flying today with customers. I expect Kratos' Valkyrie, Mako, Airwolf, Thanatos, Athena, and other Kratos tactical drones to be successful, and we continue to progress with multiple funded customers, entities, or partners, including for system missionization, concept of operations, payload integration, et cetera. However, we will remain conservative, and we have included no tactical drone production assumptions in Kratos' 2024 base case financial forecast, Only S&T, RDT&E, and similar funded development initiatives or programs. Major initiatives and opportunities Kratos currently plans to invest in or pursue in 2024 include. We are establishing production facilities for Kratos' jet engines, including for missiles, drones, loitering, and powered munitions for several platforms, systems, and opportunities that we are currently investing under-funded development contract on. We are completing Kratos' Sentinel Program ground transporter production facility, which will be one of the largest and advanced technology-secure production facilities in our company, which we are under a funded contract on. We are establishing the production line for the new system in Kratos' unmanned systems division I mentioned previously, which we are under a customer-funded contract and which is one of the most important programs in our company. We're completing the Zeus 1 and Zeus 2 engines and preparing these systems for production and vehicle system integration, including as related to a customer-funded hypersonic program we have and other customer initiatives. We're completing Kratos, Xerones, and Dark Fury hypersonic systems and beginning the build-out of the related production integration facilities also for which we have a funded customer contract. We currently expect to receive in 2024 a customer-funded contract for approximately 25 Kratos Oriole rocket systems, which we will need to prepare for and execute on once received, all related to future launch missions. We are establishing a new space-qualified microwave electronics development and manufacturing facility in Israel, to support new funded space system program awards we have received, others we expect to receive, and we are expanding our existing production and manufacturing facility to meet the increased capacity and production requirements we're seeing. We will also complete enhancements to an expansion of our US-based microwave electronics manufacturing facility. We are establishing the facility and acquiring the machinery and equipment including 3D and additive manufacturing equipment for Kratos' Materials Production Center of Excellence, where we are vertically integrating the production of Kratos' jet engines, space propulsion, and other programs and systems, most of which are already or are expected to be underfunded government contracts. We are also in discussions regarding new teaming or partner agreements related to significantly expanding Kratos' core business areas including product, system, software, and technology, all of which have funded customer support, and this includes KTT, our turbine business, and our blade engine initiative. These examples are representative of the large number of opportunities Kratos has and expects to receive and why 2024 is expected to be a significant internal investment and capital expenditure year as we prepare Kratos to execute on recently received funded programs, and we position Kratos to successfully receive additional expected large new programs. We believe that the industry and Kratos are in a once-in-a-generation global buildup of defense and security due to the geopolitical and overall increased threat environment. As a result of this strategic system buildup, the number and size of the potential opportunities that Kratos has and continues to receive has never been greater, And we expect Kratos' future opportunity set to continue to increase, including based on discussions with our customers and also our prime system integrator partners. Accordingly, Kratos is focused on successful execution of our existing programs and contracts and making the required internally funded investments in order to be qualified to successfully win, pursue and win these new opportunities. Accordingly, Kratos has no plans for any acquisitions of any size. Operational challenges include the obtaining and retaining of qualified personnel, including those willing and able to obtain a national security clearance, and the related high and increasing cost of these individuals and of the supply chain, which is adversely impacting Kratos' margins and also resource and capital allocation management as we execute on existing programs and we pursue new opportunities. For Kratos' 2024 financial plan, we are currently forecasting Q3, and in particular Q4, to be stronger than the first half of the year, which is directly related to the government contracting offices having to get funding under contract in a shortened time period as a result of the current CRA going through at least March 8th or four plus months into government fiscal 2024. If the CRA goes beyond March 8th of this year, we will take a look at the Kratos program portfolio and the facts and circumstances at that time and determine if any adjustment to our forecast is required. Deanna.
spk06: Thank you, Eric. Good afternoon. As we have included a detailed summary of the fourth quarter and full year 2023 financial performance, as well as the initial first quarter and 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 fourth quarter were $273.8 million, exceeding our estimated range of $237 to $257 million, which includes higher than expected performance and delivery in our space and satellite turbine technologies, C5ISR, and microwave products businesses, resulting in 17% organic growth in our KGS segment for the fourth quarter of 2023 as compared to the fourth quarter of 2022. Adjusted EBITDA for the fourth quarter of 2023 was $29.1 million, exceeding our estimated range of $19 to $23 million, reflecting the additional revenues as well as a more favorable mix of revenues including more higher-margin software and data-related content than forecasted in our space and satellite business. Free cash flow generated from operations of $48.1 million after funding capex of $19.3 million came in above our estimated range of break-even free cash flow for the fourth quarter of 2023, reflecting the increased revenues and EBITDA generated during the quarter, as well as favorable timing on accelerated customer milestone payments collected in our turbine technologies, unmanned systems, and space and satellite businesses, which more than offset our previous estimated shift in certain payment milestones in our training solutions and C5ISR businesses. Consolidated DSOs, or day sales outstanding, continued to improve from 119 days in the third quarter to 109 days in the fourth quarter of 23, with approximately $34 million in net cash generation from customer receivables during the fourth quarter, which included certain favorable customer milestone payments. In addition, advanced payments or deferred revenues increased $11 million during the fourth quarter. For full year 2023, revenues were $1.037 billion, or an organic growth rate of 12.6%, above FY22 revenues and above our estimated range of 1 to 1.02 billion, including higher than expected performance and delivery in our space and satellite, turbine technologies, and microwave products businesses. Full year adjusted EBITDA was 95.4 million, above our expected range of 85 to 89 million, reflecting the increased revenues and also a more favorable mix of revenues. Cash flow generated from operations for full year 23 was $65.2 million and free cash flow generated from operations was $21.1 million after funding of capital expenditures of $52.4 million, less $8.3 million in receipts of proceeds for sales of Valkyries that were built as Kratos capital assets. As mentioned earlier, cash flow was positively impacted by favorable customer payment milestone receipts in our turbine technologies, unmanned systems, and space and satellite businesses, which more than offset the shift in previously expected payment milestones in our training solutions and C5ISR businesses. Our contract mix for the fourth quarter of 23 was 71% of revenues generated from fixed price contracts, 24% of our revenues generated from cost plus type contracts, and 5% of revenues generated from time and material contracts. Revenues generated from contracts with the U.S. federal government during the fourth quarter of 2023 were approximately 69%, including revenues generated from contracts with the DOD, non-DOD federal government agencies, and FMS contracts. We generated 13% of revenues from commercial customers and 18% from foreign customers in the fourth quarter. We continue to make progress in our hiring and retention of skilled technical labor across the company with total headcount of 3932 employees at the end of 2023 compared to 3645 at the end of 2022. Now moving on to financial guidance. Our initial first quarter and full year 2024 financial guidance we provided today includes our current forecasted business mix and current delivery schedules and our assumptions related to the expected impact of the continued operating challenge related to our obtaining and retaining qualified technical personnel and the related increased costs for these employees and across our entire labor base. Our guidance also includes our assumptions related to the continued impact of supply chain disruptions, inflation, and related expected costs and price increases. Our first quarter and full year 2024 guidance reflects the impact of certain performance and deliveries in the fourth quarter of 2023, certain of which had been originally estimated to be executed or delivered in the first quarter of 2024. As Eric mentioned earlier, we are forecasting that our unmanned systems business will be one of our leading growth drivers in 2024, which is currently forecasted to generate $260 to $270 million in revenues reflecting approximately 20% to 25% organic growth over 2023. Our 2024 cash flow estimates include investments in elevated capital expenditures, as Eric discussed earlier, on a base case estimated range of $70 to $80 million, which includes a second production build for Valkyries of approximately $20 million in anticipation of customer requirements and demand, approximately $10 to $13 million to expand and build out our microwave Israeli production facilities, which includes expansion and improvements related to being space qualified. Approximately 10 to 12 million to establish Kratos' material production center of excellence, and approximately 5 to 7 million to expand our global satellite sensor network in response to specific customer contractual requirement, which specific expansion costs are expected to be recovered under customer contracts. Importantly, a U.S. government budget was not passed by October 1, 2023, the beginning of federal fiscal year 2024, and as a result, Kratos and the industry are operating under a continuing resolution authorization, which currently expires March 8, 2024, under which no new contracts and no increases in increasing contracts, production, or funding, among other stipulations, is permitted. Kratos' 2024 financial forecast and guidance provided today assumes that the current CRA will be resolved and that a U.S. federal and DOD budget will be in place by March 8th. As a result, similar to Kratos' 2023 quarterly financial trajectory, which fiscal year also experienced a CRA, we are forecasting Kratos' third and fourth financial quarter results of 2024 to be significantly greater than the fiscal first and second quarter results with the fourth quarter expected to be particularly strong in both revenue and EBITDA. If the current CRA goes beyond March 8th, we will evaluate CREDIS' 2024 financial forecast at that time based on the existing facts, circumstances, and expectations.
spk42: Great. Thank you, Deanna. We'll turn it over to the moderator now for questions.
spk38: Thank you. As a reminder, to ask a question, you will need to press star 11 on your telephone. To remove yourself from the queue, you may press star 11 again. Please stand by while we compile the Q&A roster. Our first question comes from the line of Michael Charmoly of Truist Capital. Please go ahead, Michael.
spk35: hey uh good evening guys uh nice results thanks for taking the questions um eric can you just sort of level set us on on some of the the higher profile opportunities i mean we've seen you know the cca i guess has selected five firms i i guess there's going to be a down selected two Um, your, your head of, you know, UAS has said there, you know, you're hopeful of being on the next increment. And then I guess also right along with that replicator kind of tranche one and two, you know, how should we think about, you know, the opportunity set here in the near term?
spk42: We, um, we are the absolute low cost rapid provider of jet drones and That's that's unarguable. It's well known by the government and by the primes. So we we are uniquely positioned, we believe. For every opportunity that's been talked about publicly and some new ones that are coming that have not yet been talked about publicly as either the prime. Or as a key partner with somebody. That's how we see it and. that's on aircraft, on certain classes of them that are coming, not only on the aircraft side, but we're also positioned with our jet engines. So we are uniquely positioned, Mike, for what's going on in the drone area across every service branch.
spk35: Okay. Can you guys, I mean, as you look at the pipeline of opportunities, which, you know, increased significantly, I mean, are Are these two programs in that pipeline?
spk42: I'm not sure. I want to make sure I answer the question, Mike. Are which two programs and which one?
spk35: Collaborative Combat Aircraft and Replicator.
spk42: Yeah.
spk41: Every drone program that's out there, we're expected to be in. I'll leave it at that.
spk35: Okay. Fair enough. And then just on the... You mentioned a couple times about the Valkyrie and different variants. I mean, can you give us a little bit of color on those variants? I mean, I guess since you're still self-funding and using your own CapEx to build these, what are some of the, if you can even talk to the variants? I mean, I'm assuming extended range, different payloads, maybe even landing gear, but are those kind of what customers might be looking for out of the Valkyrie?
spk39: Yes, yes, and yes.
spk35: Okay. Okay. Fair enough. I'll jump back in the queue and keep it at that. Thanks.
spk13: Okay. Thank you.
spk38: Thank you. Our next question comes from the line of Peter Arment. Al Baird, your question, please, Peter.
spk29: Good afternoon, Eric, Indiana. Hi, Eric. Good afternoon.
spk30: On, I guess, you know, the whole teaming approach, can you maybe just give us how this kind of evolved? Is this something you've, you know, kind of been planning or thinking about over the last year? You know, what was the best kind of, I guess, how would you describe it in terms of working with primes versus going it alone?
spk42: Yeah, probably a couple years ago, Peter, when the different classes of the drones that the government was looking at started to get more refined between expendables, attritables, exquisites, we looked at our, and the various weapon systems they would carry, and certain of the characteristics they would have. we huddled internally and we made some strategic decisions that we would, in certain areas that are obvious, like expendables, disposables, attributables, that's like right in our sweet spot. And all things being equal, we would look to prime those. There are some areas we might not if they're carrying certain mission systems that are very unique that the customer wants to have integrated and a prime has that mission system. As you move up the capability ladder, we decided it probably would make more sense from a probability win standpoint. If we looked at it on a biggie and we said, okay, our probability of win is 25%. We have to invest on making this up $100 million if we go at it alone to be the prime. Or our probability of win we think is 90%. We get significant content on something and our investment is significantly less than that. With everything we have going on, we would choose the latter there. And so a couple years ago, we started looking at it that way, and that's an approach we've been taking across Kratos in many areas, drones, hypersonic systems, jet engines. Jet engines, you'll be seeing that, I think, soon. It's the way we're doing it. We're partnering with the best companies in the world, The prime system integrators, and they're our partners, they are the best companies in the world at certain things. No one can do it better. And we partner with them when it increases RP win.
spk30: Certainly seems like an inflection here for your tactical drones. On the jet engine production that you're kind of investing in in CapEx, is that expected to be completed this year, or do we think that this kind of runs into 2025 as well?
spk42: Yep. So on the programs... that we've won, that we're on, and that we have vision that are going into production, those were getting done this year. However, there are several others. There is a lot going on in loitering munitions, cruise missiles, and low-cost jet drones. So probably second half of this year, I think we're going to be awarded production on some others. which means we'll have to establish some additional production lines because it's a different size of engine. So I think this is probably going to be a process probably for the next 24 months, but it will definitely be tied to programs that we're designed in on and going into production. It will not be a build it and hope they come.
spk30: Got it. And just lastly, you've had a flurry of questions. Press releases since, you know, I guess, you know, November, December. And, you know, with some of these large awards. And you got one here in January that you didn't give any kind of timeline on. I think it was the $50 million hardware and radar for CUS. Can you talk a little bit about how these kind of roll out and when do they start to inflect more on the top line? Thanks.
spk42: Yep. So that $50 million one, that's going to roll out starting second half of this year, and it'll be done probably nearly done by the end of 25. I'm expecting, I think we're going to get another one similar size in the next few months. As I mentioned, these systems are deployed in Europe, and they're deployed in the Middle East. The contract we were able to announce today, we just got customer approval, coincidentally, to announce the space one. This one is so important. I'm glad you asked, Pete, from so many angles, as I mentioned. This is the largest re-compete in the company. We don't have any more re-competes of any size for the foreseeable future. So we're bolted in. That's number one. Number two, as I said in my prepared remarks, the ceiling is 50% higher than it was. So it's not just bolted in. It's going to be a massive growth vehicle for us, and it's driven primarily by the number of space systems that are going up into space. That is definitely going to start ramping for us in the second half of this year and into 25 and into 26. We need a budget, budget, budget, budget. So our space business in all of Kratos, not commercially, not like the Intel Sats of the world, but on the military side is the most susceptible in our company to the CRA. Because we've won, as you recall, in 22 and in 23, we've won so many development programs. And that business just did revenue growth of like 15 or 20%. We need the budget for production and deployment. And since we're delayed, that's why I'm looking for that to happen in 25. So that's how I see those rolling out.
spk30: Appreciate it. Congrats on the results. Thank you.
spk38: Thank you. Our next question comes from the line of Seth Siffman of JPMorgan. Your question, please, Seth.
spk14: Thanks very much, and good evening and good results.
spk15: I wanted to ask, so the unmanned business, a very nice amount of growth expected this year, and we've kind of seen things moving at a similar level the past couple of quarters. We'll have a CR kind of in most of the first quarter of 24 here. So, you know, that's probably, once again, a similar level of revenue to what we've seen. It's not a little bit lower seasonally. And so the implication would be that kind of exiting this year would be, you know, a pretty big number from a revenue perspective that, you know, on its own carries a certain amount of growth into 25. Is that kind of a fair estimate? a fair way to think about it.
spk42: Let me restate it for you. Let's take target drones. The target drone business has been ramping, and you can see by world events what's going on there. So that big blob base has been increasing for the past year. It's going to take another significant step function up in 2024 as soon as we get the 2024 budget. Okay, so the base has gone up 23 over 22. The base is going to go up again 24 over 23 as soon as we get the budget. The problem is, let's say we get the budget on March 8th, God willing, the government contracting officers, they've got to basically get 12 months worth of contractual and obligations done in six months. And that's why it pushes out into Q3 and Q4, if that answers your question.
spk15: Oh, yeah, no, totally understood. But then that's at a level in Q4 that, you know, is at a higher level that can drive, you know, a decent amount of growth in 2025.
spk42: Correct. Correct. And that's the right way to look at it. Yes. And so the bow wave from 22 CRA, we saw that. The bow wave from 21 CRA, we saw at the end of 22. The bow away from 22 CRA we saw at the end of 23. The bow away from this one we'll see 24, 25. Exactly correct.
spk15: Okay. And then just backing into, I think, what the number you talked about for unmanned implied would be something like 6% growth or so for government solutions. And just so anything... that, you know, the pieces that are kind of growing more quickly and more slowly than that kind of, you know, 6% average for KGS in 24.
spk42: Yep. As I said, our space business is the one within Kratos that's based on development programs transitioning to deployment is the most susceptible to a CRA. So our space business, which is our biggest, so it's also the hardest to grow on, It's coming off, what did it do, Deanna, 15% or 20%?
spk04: 15% in the quarter.
spk42: It just did 15% organic growth. We are forecasting that primarily due to the CRA to be one of our lowest growers in 2024 because we need to get that budget for these programs we've won to ramp up.
spk23: Got it. Okay. Thanks very much.
spk38: Yep. Thank you. Our next question comes from the line of Mike Crawford of B. Reilly Securities. Your question, please, Mike.
spk18: Thank you. Eric and Deanna, just to help understand the guidance, if you were able to actually contract to sell both Valkyrie production spirals before you're in, what would be the rough delta on additional revenue and maybe more interestingly reduced CapEx?
spk06: Mike, as Eric had mentioned, we are balancing our internal resources on the cadence of that production build for that second lot of Valkyries. So that's a factor that we're taking into consideration. The CapEx that is related to Valkyrie production for 2024 is approximately $20 million. On that cadence, we would expect to continue to build throughout in 2025. And that's based upon just how our internal resources, how we're prioritizing those resources. If those were sold, to the extent they're completed, or to the extent they're percent complete, as we've discussed before, since they would be subject to percentage of completion accounting, then Let's say that let's say that 20 million that we had incurred in 2024 if if if a certain number were sold then the percentage complete related to those aircraft that are sold would be recognized as revenue in 2024 and then dependent on the milestones that were able to negotiate with the customer that would then the cash receipts would fall in whatever period it would fall in, whatever we're able to negotiate from a milestone perspective.
spk42: So, Mike, in a total blue sky world, Deanna, what's the CapEx in Valkyries at the end of the year, at the end of 23?
spk56: It's over $30 million.
spk42: Over $30 million. So, Mike, in a perfect blue sky world, if we got a production order for them all, That $30 million would flip into revenue. And whatever percent of the $20 million in 2024, let's say we're $10 million in, it happens in June, we'd get a pickup of $40 million in revenue. Something like that.
spk18: Okay. Thank you. And then, Eric, when you said you would expect perhaps to potentially contract for this in late 2024, would that be after?
spk42: uh a new government budget that presumably they're going to pass before the end of december when the new congress has to come in no sir it's in the uh the funding's in the current budget um um i'm just planning on the budget being done in early march and as i've been said a few times it's going to take a while for the pro the contracting offices have a lot to do and so it'll take until late in the year
spk18: Okay, that makes sense. And then just switching gears, given just the thousands of missiles that have been expanded in the Mideast, can you comment on your microwave systems backlog?
spk42: Yes. So our microwave electronics business, the biggest part of it, as you know, is in Israel. And we are one of the primary providers on virtually every Israeli missile system and radar system. And the missiles are the ones, obviously, the razor and the razor blade. So think of Iron Dome. We're on the seekers. So Deanna, we're at record levels.
spk07: We're at record backlog level.
spk42: We're at record backlog level. We're at record revenue level. It's looking great for 24. It's looking great for 20. I mean, this is terrible, what's driving this. But our microwave business is doing very well because the Israelis are defending themselves.
spk18: Okay. Thanks. And then just off of this $877 million IDEA IQ where you're pretty much, I think, competing with Northrop, and you said...
spk42: were hoping to get an order for 25 oreo rockets how much are those uh per system right so those would be totally separate from that that's a different customer oh okay totally separate so that would be incremental to that it's a different customer
spk18: And so the IDIQ, that would be for Space Force payload? Correct. Correct.
spk42: That would be under – it's a different customer. Okay. It's not that customer. Nope. So it's incremental. It's in addition to what we get under the $877 million award. Okay. Okay.
spk18: Maybe just one final one. Just today, intraday, there was a pretty big merger announcement with one of your customers, Blue Halo, merging with Eclipse. And I'm wondering if that changed the scope of your $160 million OpenSpace award that you're working with them on the SCAR program.
spk42: Yep, absolutely does not. This is great for Blue Halo. It's great for us. It's great for the company they merged with. This is another up-and-coming company. Disruptive partner of Kratos is in Blue Halo. So no change. And that SCAR program is going to be one of the big drivers for Kratos 2025.
spk18: Excellent. Thank you.
spk41: Yes, sir.
spk38: Thank you. Our next question. comes from the line of Ken Herbert of RBC Capital Markets. Your question, please, Ken.
spk32: Yeah, good afternoon, Eric and Deanna. Hey, Eric.
spk33: Hey, I wanted to follow up on your comments and sort of the shift in strategies. You look to build out more sort of merchant businesses. It sounds like there's a real opportunity within RBC rocket motors, electronic devices, unmanned, other areas to replicate what you've done on the space side. Now, as you think about that and you think about the other opportunities, is there any way you could maybe rank order those other businesses and sort of how far along that curve you think they are to, I guess, what I would call sort of established merchant supplier status? And how does that maybe impact growth of those businesses this year and then, of course, into 2025?
spk42: Yep. Turbojet and turbofan engines for missiles, powered munitions, loitering munitions. We are way up or down the curve, whichever way you want to look at it, relative to being the trusted partner with the prime system integrators with those engines on their weapon systems. And this value proposition I'm going to give you right here is the value proposition we bring to them. Okay. I'm making this up. Raytheon's doing a missile. Northrop's doing a missile. Lockheed's doing a missile. It all needs a 150-pound thrust engine. We build 150-pound thrust engines. They all come to us because we get leverage because we have three orders, one from each of them, which drives the cost down, which makes them more cost-effective for their customer, and it brings value to everybody. So it's a win for us. It's a win for all those three primes in my example, and it's a win for the government. So in turbo jets and turbo fans, for cruise missiles, loitering munitions, and powered munitions. We are moving down the path on that. You saw with the announcement that Boeing made on powered JDAM. As you know, I've talked about before, we're designed in on six different systems, several of which are going to be in production, I think, by the end of this year. And this will be a meaningful revenue driver for us in 2025. And we have clarity on this with the programs. That's number one. Number two is our hypersonic stacks. So I mentioned today the Oriole Terrier stack that launched the French payload that just became public. We do that all the time for a lot of different customers. It's just not announced. With the Zeus motors coming, these can go faster, farther, put heavier payloads in certain places at the right time, the right speed, the right place. We do that for the government, and we do that for the primes. So we are way down the line on that, and since we're orders of magnitude less costly than anybody else out there, including some of these up-and-comers who think they're going to get into the area, we can test, test, test, and test multiple times within a budget for a customer, whether it be the government or a prime, because our price points are so low. So stacks or hypersonic systems, ballistic missile targets, and suborbital vehicles, which, as you know, we can't talk about on this line. So that's right behind the turbo jets and turbofans. The next one, obviously, is microwave electronics. We're a merchant supplier there. That's what we do. Our primary customers are Rafael, Israeli Aerospace Industry, which are the Lockheed, the Raytheon, and the Northrop of Israel. We're going to build that out there, and we're building that out in the U.S., and drones. And drones is one where we absolutely are going to continue to be the prime or our probability of win. And the investment thesis for us is manageable. And we will partner with our big prime teammates. And we have a few of them that are very close with us where it increases the probability of win. It reduces our risk and our financial contribution. And we think we're going to get a big part of something instead of potentially all of nothing. And you're seeing the drone, the drone impact is this year. The rocket motors, we're definitely going to get some of those this year. So you're going to see those sales this year and they'll ramp into 25. So that's how I see it.
spk33: That's great. And if I could, as you think about these markets, you obviously are positioned in some of the faster growing markets, but what's your view on just high level defense spending or investment spending and in not just 24, but over the next couple of years, and to what extent is sort of a flattish budget, if that's the situation we're in, you know, a risk to the timing on some of these programs?
spk42: Yep. So obviously I'm the CEO. I drink the Kool-Aid. I like Senator Wicker. He wants a 5% defense budget. He wants a trillion-dollar defense budget. I love him. And I personally believe that with the threat environment out there that we have, threats aren't going down. They're increasing every day. This is something both parties are going to convalesce around. But let's say that I'm wrong. Low cost is going to win the game. Let's talk drones. Affordability, affordable mass. The Mitchell Institute, they work with the Air Force, came out with a report last week. If you guys haven't seen it, I encourage you to see it. They said we cannot afford exquisite drones en masse. The only way we can defeat certain adversaries is with large quantities of low-cost drones that are rail-launched, that are air-launched, that are attritable, et cetera, to get quantities, which is cost. So in a tightening budget environment for our engines, our turbojets and turbofans, for our hypersonic vehicles and our rocket systems, for our drones, I think that just increases Kratos' winning hand because of our affordability thesis.
spk28: Great. Thanks, Eric, for all the color.
spk38: Yep. Thank you. Stand by for our next question. Our next question comes from the line of Pete Skivitsky of Alembic Global. Your question, please, Pete.
spk31: Yeah, good afternoon, guys. A couple questions on EBITDA margins. Eric, I'm just wondering, if you are a sub on one of these large companies, tactical drone programs, maybe CCA or Replicator. How are you guys thinking about the economics on those as a sub? You know, I think last year, unmanned EBITDA margins were 7%. Probably target drones are above that. You know, in a sub position, if you get enough numbers, can you get to double digits in terms of adjusted EBITDA margins? Or are we going to stick in this range even as a sub?
spk42: Yep. So we are... In the tactical drone area, either as a prime or a sub right now, we are going to be in that range because they're development programs. In development programs, the margin rates are less. You were exactly right what you said on the target drones. In the target drones, we have multiple drones in multiple stages of full-rate production, and that's where you come down the learning curve. You have to share part of that with the government, of course, but you can make low to mid-teen margins. Internationally, In target drones, you can make much higher because it's international. So back to the tactical part of your question. I don't think there's going to be any difference, or if it is, it's going to be around the edges on margins on these. I know it in development because we are where we are. We're a prime in development on some. We're partnered with some other people on others in development. We know what the margins are. They're similar, and I envision it being the exact same once we get into full-rate production. It will not be a difference to us.
spk31: You're saying even in full-rate production, the margins on, you know, they'll be the same as they are today?
spk06: No, in full-rate production, we would expect the margins to expand. What he's saying is in development, we would expect those margins to be similar to the production, the development rates that we would see on the target side. But when we get to production, we would expect to see some expansion.
spk31: Okay. So, so maybe like three years out, we're talking there, there, there's a, uh, a path. Yeah. Okay. I appreciate it. And then similar question, just on similar question on space. I just see you guys talked about the inflection in 25 and it, and it sounds like, um, you know, maybe you're looking for some margin expansion there, partially on, on production, higher deliveries, but you guys have been, you know, investing a lot in open space and we see it hit KGS margin periodically. I'm just wondering, in 2025, should we anticipate, you know, the IR&D that you are spending on open space to decline meaningfully? Or is that going to be kind of steady state and it's more so, you know, we anticipate, you know, deliveries increasing?
spk42: Right. I would not expect it to decline, but I would definitely expect deliveries to increase and the software content of the ground infrastructure to increase, which inherently brings higher margins. That's how I would look at it. It's a hybrid software model where you need continuing sustained R&D to refresh and expand the product portfolio you're bringing to the customer to stay ahead of your competitors.
spk31: Got it. Okay. So the R&D will stay steady state, but as long as the market's hot, you'll have these opportunities for deliveries to be higher.
spk42: Okay. As long as we penetrate that total addressable market we see, we should be in good shape. Yes, sir.
spk31: Got it. Thanks so much, guys.
spk38: Yes, sir. Thank you. Thank you. Our next question comes from the line of Joe Gomes of Noble Capital. Please go ahead, Joe.
spk36: Thank you. Good afternoon and congrats on the quarter.
spk41: Hey, Joe. Good afternoon.
spk36: I just wanted to start on the tactical side there for a second. I saw that Australia is investing another $260 million in the ghost bat. I was just wondering what you see on the competitive side there on tactical.
spk42: So you asked the question. So, yep, Australia is going to pay $260 million in U.S., $400 million Aussie, for three more ghost bats. So obviously that is a much different model than Kratos' model. We were paid for three Valkyries. The first three initial Valkyries was like $40 million. So it's a different paradigm. With a cost share. Yeah, it's a different paradigm, Joe. We're focused on affordability. Effectiveness, affordability, rapid development, get things flying. That model is just different, and I don't focus on it.
spk36: Okay. And then outside of the open space, which obviously is growing nicely there with some of the recent awards you've talked about, what else can you talk about on projects that aren't impacted by the CR. Historically, you've talked a little bit about wireless trucks, just trying to get a little better sense of what else is out there that you're very excited about that we don't have to be dealing with the CR.
spk42: Good question. So 30% of our business is not DOD. So for example, our Israeli business, Microwave electronics, $80 million, $90 million in revenue. Totally unrelated to the U.S. federal government budget. As I mentioned earlier, that business is ripping for the terrible reasons it's ripping. That's going to do great. Contracts like with Intelsat, commercial satellite operators, JSAT, I can go down the list because MonocliffSat, they're not impacted. and we're seeing growth in the commercial satellite area. In our engine area, as you know, we're building engines for under NDAs. Think of virtually every new space company. We are involved in their engines. That is not seeing an issue. Target drones internationally, and you see what's going on in the world. People are buying short-range surface-to-air missile systems. They're buying Patriots. They all need to be exercised against target drones. They're typically exercised against ours. So international target drone business is not tied to the federal budget. So we've got a really good hedge. And typically internationally, we make higher margins than in the U.S. because international customers will pay more for the U.S. stuff. And so we've got a pretty good hedge, which is why as of right now, we're staying with our 10% target for 2024. because that non-DOD business looks really good right now, and why Deanne and I both said, God willing, we'll have a budget by March 8th, but if we don't, we'll revisit it and see what the portfolio looks like, and if we need to update, we will. Great. Thank you for taking the questions.
spk36: Yes, sir. Thank you.
spk38: Thank you. Our next question comes from the line of Sheila Caglioglu of Jefferies. Your question, please, Sheila.
spk09: Thank you. Hey, Eric and Diana, thank you for taking the time. So much has been asked already, but I just wanted to kind of maybe put it all into context if that's possible. Eric, you could hear me, right? Just double checking.
spk50: Yes.
spk09: So maybe if you could just talk about, you know, KGS versus KUS in 2024 and the growth profile of each. KGS has been growing pretty nicely. Do we continue to see that outperform? Maybe if you could just simply rank order the subsegments of where you see the highest growth there just to start.
spk42: Right. To level set, the biggest growth segment we're going to have right now for 2024 is going to be our unmanned systems business. The drones across the portfolio are doing great. And if we get a budget, we could actually beat those numbers in the drone area. All right? So in KGS, I'll let Deanna touch on those, keeping in mind that our space business will be one of the lowest ones because it's impacted the most by the CRA.
spk06: Yes. So as Eric had mentioned, the space business, which is our largest, is impacted by the CRA. So that is what Seth brought up. We're expecting about a 6%. We're forecasting about a 6%. organic growth across KGS, with space being a big portion of that at lower than that 6%. So that would indicate that there are pieces that are growing greater than that rate, which would be our C5ISR business, our turbine business, our microwave electronics business, really across the board. most of the businesses within KGS with the exception of the space business for all the reasons we've talked about since we expect to really see that growth come in play in 2025 as we move on to production on a number of the programs that we've been working on.
spk09: Okay, understood. And then maybe if you could talk about the pipeline. It's stepped up 700 million sequentially just given you know, recent news with CCA and things like that, and you're partnering with folks, maybe can you give us the moving pieces of the pipeline at all?
spk06: And it's actually, you know, from our pipeline perspective, the big increase is not in our unmanned systems business. It's across a number of our businesses within KGS, so in our C5 business, in our turbine business, and our microwave business.
spk42: Sheila, the engine business in particular, the pipeline is incredible right now. Made in the USA engines, turbojets, turbofans, rocket engines, liquid and solid. We're seeing incredible demand there in engines. That's probably the strongest grower for us. from a pipeline standpoint. Microwave electronics is incredibly strong. It grows literally every week as ordinance is expended. As Deanna mentioned in the C5ISR business, I've been through the programs before. We have a number of programs, IBCS, IFPIC, SURE-RAD, all of which are moving into production so those pipelines are now moving from development to production which increases the pipeline that we're designed in so the the kgs business training our training business you know we built training systems for weapon systems weapon systems are back in vogue so our training systems business pipeline is giant it's very big And its growth is one of the strongest in the company, 24 over 23.
spk06: As well as our space business as well. I don't think I've mentioned that before. So the pipeline is up also in our space business.
spk09: Okay. And then last question for me, obviously CapEx jumps up 20 million year over year. Do we think about that as a normalized rate or is it just given what's going on with Valkyrie and my Grave products?
spk06: It goes through all the investment areas that Eric had talked about and the growth areas that we're investing in. So it's across the board. It's in our microwave business. It's Valkyries that we're continuing to build. That's about $20 million. But it's also building out some of our space network, a satellite network that we company own, as well as the manufacturing center of excellence for our turbine engine business. It's really investments that we're making in 2024. Some of it might continue in 2025, but we don't anticipate at that level. So it is continuing. I would not say it's recurring. Sure. Thanks.
spk38: Thank you. I would now like to turn the call back over to Eric DeMarco for closing remarks. Sir?
spk42: Excellent. Thank you all for joining us and for the Q&A session. And we'll touch base with you when we report Q1 in a few months. Have a good day.
spk38: This concludes today's conference call. Thank you for participating. You may now disconnect. Thank you. you Thank you. Thank you. Thank you for standing by and welcome to Kratos Defense and Security Solutions' fourth quarter 2023 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 1 on your telephone. To remove yourself from the queue, you may press star 1 1 again. I would now like to hand the call over to VP and General Counsel, Marie Mendoza. Please go ahead.
spk03: Thank you. Good afternoon, everyone. Thank you for joining us for the Critics Defense and Security Solutions fourth quarter and full year 2023 conference call. With me today is Eric DeMarco, Critics' President and Chief Executive Officer, and Deanna Lund, Critics' 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 DeMarcus.
spk42: Thank you, Marie. Good afternoon, everybody. In 2023, Kratos achieved each of the goals we laid out at the beginning of the year, including 10% organic revenue growth, increased EBITDA with positive cash flow generation, while also making significant internally funded investments in potential transformational growth areas for our company. Expected growth areas include high-performance jet drone systems, hypersonic rocket motors and systems, next-generation jet engines for drones, missiles, and loitering munitions, and open space software for virtualized satellites, C2 and TT&C. Kratos' product systems and software, which we envision, design, and engineer from the outset to be produced in large quantities at a low cost are a value-added differentiator for our customers and also importantly for our prime system integrator partners and teammates. Kratos' relationships with the prime system integrators, including our being able to rapidly provide relevant, low-cost, differentiated, and value-enhancing products, hardware, and systems is a key element of Kratos' strategy, and it's core to our company's success. At Kratos, we believe that it's better to have a big part of something instead of all of nothing. And based on a program's requirements, including schedule, the potential size of a Kratos investment required, the technical development and financial risk to Kratos, and also expected customer preferences, we may team with one or more of our prime partners on certain program opportunities instead of Kratos priming ourselves. We believe this teaming or partnership approach has been very successful, including recently on a high-profile program. On last quarter's conference call, I mentioned that we were expending significant effort, including bid, proposal, NRE, and other costs, in pursuit of certain large opportunities. As an update, we have successfully received potentially the most important of these contracts in Kratos's unmanned systems business with a prime partner. On a second opportunity, a different Kratos prime partner was awarded a new missile defense system-related satellite constellation program where Kratos is responsible for the ground system. Thirdly, we have been informed that a Kratos turbine technologies proposal was accepted and we are now waiting for our customer to receive funding, hopefully in Q3. And finally, Kratos made the decision to pass on an opportunity as a prime due to the size of the Kratos internal investment required, the financial risk to Kratos on this development program, and our assessment of an unacceptable probability of Kratos' win. There are several additional notable opportunities that Kratos is currently assessing or in pursuit of, including where we are making significant investments, which hopefully we will be able to update you in the future. As we begin 2024, we are under contract on numerous programs of record, either as prime or partnered. These include new programs currently in development, programs transitioning to low rate initial production, programs that are in LRIP and transitioning to full-rate production, and programs that are in full-rate production already where we expect increased future production quantities. Additionally, Kratos' opportunity pipeline is approximately $11 billion and our backlog is $1.2 billion, all providing us confidence in our 2024 financial forecast. Additional recent Kratos achievements include a $579 million prime single award Space Force satellite communication system related contract, which we were able to announce today. The Space Force contract covers the command and control consolidation system used for SATCOM telemetry, tracking, command, sustainment, and resiliency. The receipt of this award, which was Kratos' only large outstanding recompete, provides Kratos both future visibility and an opportunity for growth, as reflected by the significant contract ceiling value increase of approximately 50% over the previous contract vehicle, as the number of satellites in orbit has and is expected to continue to increase, contributing to the overall expected increase in this contract's scope. It was reported that Kratos and Boeing have executed a memorandum of understanding for Kratos' TDI J85 jet engines to be the propulsion provider for the Boeing-powered Joint Direct Attack Munition. It is anticipated that the powered JDAM will provide air-launched, low-cost standoff capability against land and maritime threats. We received an approximate $23 million prime contract from the United States Marine Corps related to Kratos' Valkyrie tactical drone, and we received significant contract awards related to the Iron Dome and the Patriot air defense systems. It was also reported that Kratos' Terrier-Oriel two-stage rocket system was the propulsion system for the VMAX hypersonic system launch. And it was reported that recent testing of a sophisticated AI software aboard an XQ-58A Valkyrie drone will influence how the U.S. Air Force develops and deploys autonomous technologies. For 2024, expected Kratos growth areas, which are included in our base case financial forecast, include turbojet, turbofan, and rocket engines for unmanned aerial drones, loitering munitions, cruise missiles, hypersonic systems, supersonic platforms, space and other systems, increased target drone sales, with target drones being used by the U.S. and our allies to exercise radar, air defense, fighter aircraft, maritime, counter UAS and other platforms and systems, all of which are in increasing demand globally. Hardware and product sale growth related to air defense, counter UAS, radar and missile systems, including in Kratos' C5ISR and our microwave electronic products business. These include systems that are currently in theater in both Europe and the Middle East, and we expect the Sentinel program with our prime partner Northrop to also be a 2024 organic growth driver. We expect to see growth in Kratos' space, satellite, and training systems division, including particularly strong growth in virtual augmented reality and other training systems. In 2024, we expect Kratos' first to market virtualized software-based OpenSpace C2 and TT&C Suite to continue to gain customer acceptance and designed in positions. Additionally, we are currently forecasting for 2025 to be an inflection point year for Kratos' satellite business, both in organic revenue growth and in profit generation, based on programs we have successfully received, those we expect to receive, and those we expect to either transition to or begin production or deployment on. In the tactical drone area, we believe that Kratos remains well positioned for this new large and expected to be fast-growing market area, both with Kratos drones and also with Kratos's family of turbojet and our turbofan engines. Tactical drone initiatives we're able to discuss publicly include We are under a funded contract and have completed a successful series of mission system and related flights, including as related to Kratos' Mako tactical jet drone system. We are under a funded contract and are integrating Kratos' jet engines into Kratos' drones. Kratos' Ghostworks is completing ground testing of a new drone-related system at our Burns Flat Range location. which program we expect to transition in the future to a larger range for final system demonstration. We had hoped to transition this system to a larger range in Q4, but we were unable to do so. We are moving rapidly with Shield AI, integrating Shield's artificial intelligence into multiple Kratos jet drones, with flights being held at Kratos's Burns flat-range facility. We are completing production of the last of the initial 12 Valkyries, and we are in production on the second 12 Valkyries, which production rate we are calibrating now based on Kratos' internal resource allocation considerations, including as related to the new funded drone system program we have received. We are under funded contract for a Valkyrie variant where Mission and other systems are being integrated. We are working with the government entity on a separate Valkyrie variant with funded first flights expected in the fourth quarter of this year. And Kratos's Ghostworks is working on an additional Valkyrie variant with new capability, performance, and low cost, we believe will be another step function ahead for Kratos's tactical drone family. There are currently four Valkyrie variants that I can publicly confirm today. and a fifth that Kratos' Ghost Works is currently assessing. We expect to receive the largest Valkyrie-related contract award to date in late 2024, and I am confident that all 24 Valkyries we have produced or plan to complete production on will ultimately be sold or delivered to funded customers. We are establishing an additional production line for the new drone system program that we are under contract on with a partner. We believe that once we have the 2024 U.S. federal budget, that Kratos' Thanatos will receive a funded prime contract. Based on recent events, it is also possible that we will receive a funded prime contract for Kratos' Athena drone program system late this year or early next year. Initial derivatives of both Thanatos and Athena are flying today with customers. I expect Kratos' Valkyrie, Mako, Airwolf, Thanatos, Athena, and other Kratos tactical drones to be successful, and we continue to progress with multiple funded customers, entities, or partners, including for system missionization, concept of operations, payload integration, et cetera. However, we will remain conservative, and we have included no tactical drone production assumptions in Kratos' 2024 base case financial forecast, Only S&T, RDT&E, and similar funded development initiatives or programs. Major initiatives and opportunities Kratos currently plans to invest in or pursue in 2024 include. We are establishing production facilities for Kratos' jet engines, including for missiles, drones, loitering, and powered munitions for several platforms, systems, and opportunities that we are currently investing under funded development contract on. We are completing Kratos' Sentinel Program ground transporter production facility, which will be one of the largest and advanced technology secure production facilities in our company, which we are under a funded contract on. We are establishing the production line for the new system in Kratos' unmanned systems division I mentioned previously, which we are under a customer funded contract and which is one of the most important programs in our company. We're completing the Zeus 1 and Zeus 2 engines and preparing these systems for production and vehicle system integration, including as related to a customer-funded hypersonic program we have and other customer initiatives. We're completing Kratos, Xerones, and Dark Fury hypersonic systems and beginning the build-out of the related production integration facilities also for which we have a funded customer contract. We currently expect to receive in 2024 a customer-funded contract for approximately 25 Kratos Oriole rocket systems, which we will need to prepare for and execute on once received, all related to future launch missions. We are establishing a new space-qualified microwave electronics development and manufacturing facility in Israel, to support new funded space system program awards we have received, others we expect to receive, and we are expanding our existing production and manufacturing facility to meet the increased capacity and production requirements we're seeing. We will also complete enhancements to an expansion of our US-based microwave electronics manufacturing facility. We are establishing the facility and acquiring the machinery and equipment including 3D and additive manufacturing equipment for Kratos' Materials Production Center of Excellence, where we are vertically integrating the production of Kratos' jet engines, space propulsion, and other programs and systems, most of which are already or are expected to be underfunded government contracts. We are also in discussions regarding new teaming or partner agreements related to significantly expanding Kratos' core business areas including product, system, software, and technology, all of which have funded customer support, and this includes KTT, our turbine business, and our blade engine initiative. These examples are representative of the large number of opportunities Kratos has and expects to receive and why 2024 is expected to be a significant internal investment and capital expenditure year as we prepare Kratos to execute on recently received funded programs, and we position Kratos to successfully receive additional expected large new programs. We believe that the industry and Kratos are in a once-in-a-generation global buildup of defense and security due to the geopolitical and overall increased threat environment. As a result of this strategic system buildup, the number and size of the potential opportunities that Kratos has and continues to receive has never been greater, And we expect Kratos' future opportunity set to continue to increase, including based on discussions with our customers and also our prime system integrator partners. Accordingly, Kratos is focused on successful execution of our existing programs and contracts and making the required internally funded investments in order to be qualified to successfully win, pursue and win these new opportunities. Accordingly, Kratos has no plans for any acquisitions of any size. Operational challenges include the obtaining and retaining of qualified personnel, including those willing and able to obtain a national security clearance, and the related high and increasing cost of these individuals and of the supply chain, which is adversely impacting Kratos's margins, and also resource and capital allocation management as we execute on existing programs and we pursue new opportunities. For Kratos' 2024 financial plan, we are currently forecasting Q3, and in particular Q4, to be stronger than the first half of the year, which is directly related to the government contracting offices having to get funding under contract in a shortened time period as a result of the current CRA going through at least March 8th or four plus months into government fiscal 2024. If the CRA goes beyond March 8th of this year, we will take a look at the Kratos program portfolio and the facts and circumstances at that time and determine if any adjustment to our forecast is required. Deanna.
spk06: Thank you, Eric. Good afternoon. As we have included a detailed summary of the fourth quarter and full year 2023 financial performance, as well as the initial first quarter and 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 fourth quarter were $273.8 million, exceeding our estimated range of $237 to $257 million, which includes higher than expected performance and delivery in our space and satellite turbine technologies, C5ISR, and microwave products businesses, resulting in 17% organic growth in our KGS segment for the fourth quarter of 2023 as compared to the fourth quarter of 2022. Adjusted EBITDA for the fourth quarter of 2023 was 29.1 million, exceeding our estimated range of 19 to 23 million, reflecting the additional revenues as well as a more favorable mix of revenues including more higher-margin software and data-related content than forecasted in our space and satellite business. Free cash flow generated from operations of $48.1 million after funding capex of $19.3 million came in above our estimated range of break-even free cash flow for the fourth quarter of 2023, reflecting the increased revenues and EBITDA generated during the quarter, as well as favorable timing on accelerated customer milestone payments collected in our turbine technologies, unmanned systems, and space and satellite businesses, which more than offset our previous estimated shift in certain payment milestones in our training solutions and C5ISR businesses. Consolidated DSOs, or day sales outstanding, continued to improve from 119 days in the third quarter to 109 days in the fourth quarter of 23, with approximately $34 million in net cash generation from customer receivables during the fourth quarter, which included certain favorable customer milestone payments. In addition, advanced payments or deferred revenues increased $11 million during the fourth quarter. For full year 2023, revenues were $1.037 billion, or an organic growth rate of 12.6%, above FY22 revenues and above our estimated range of 1 to 1.02 billion, including higher than expected performance and delivery in our space and satellite, turbine technologies, and microwave products businesses. Full year adjusted EBITDA was 95.4 million, above our expected range of 85 to 89 million, reflecting the increased revenues and also a more favorable mix of revenues. Cash flow generated from operations for full year 23 was $65.2 million and free cash flow generated from operations was $21.1 million after funding of capital expenditures of $52.4 million, less $8.3 million in receipts of proceeds for sales of Valkyries that were built as Kratos capital assets. As mentioned earlier, cash flow was positively impacted by favorable customer payment milestone receipts in our turbine technologies, unmanned systems, and space and satellite businesses, which more than offset the shift in previously expected payment milestones in our training solutions and C5ISR businesses. Our contract mix for the fourth quarter of 23 was 71% of revenues generated from fixed price contracts, 24% of our revenues generated from cost plus type contracts, and 5% of revenues generated from time and material contracts. Revenues generated from contracts with the U.S. federal government during the fourth quarter of 2023 were approximately 69%, including revenues generated from contracts with the DOD, non-DOD federal government agencies, and FMS contracts. We generated 13% of revenues from commercial customers and 18% from foreign customers in the fourth quarter. We continue to make progress in our hiring and retention of skilled technical labor across the company with total headcount of 3932 employees at the end of 2023 compared to 3645 at the end of 2022. Now moving on to financial guidance. Our initial first quarter and full year 2024 financial guidance we provided today includes our current forecasted business mix and current delivery schedules and our assumptions related to the expected impact of the continued operating challenge related to our obtaining and retaining qualified technical personnel and the related increased costs for these employees and across our entire labor base. Our guidance also includes our assumptions related to the continued impact of supply chain disruptions, inflation, and related expected costs and price increases. Our first quarter and full year 2024 guidance reflects the impact of certain performance and deliveries in the fourth quarter of 2023, certain of which had been originally estimated to be executed or delivered in the first quarter of 2024. As Eric mentioned earlier, we are forecasting that our unmanned systems business will be one of our leading growth drivers in 2024, which is currently forecasted to generate $260 to $270 million in revenues reflecting approximately 20 to 25% organic growth over 2023. Our 2024 cash flow estimates include investments in elevated capital expenditures, as Eric discussed earlier, on a base case estimated range of 70 to 80 million, which includes a second production build for Valkyries of approximately 20 million in anticipation of customer requirements and demand, approximately 10 to 13 million to expand and build out our microwave Israeli production facilities, which includes expansion and improvements related to being space qualified. Approximately 10 to 12 million to establish Kratos' material production center of excellence, and approximately 5 to 7 million to expand our global satellite sensor network in response to specific customer contractual requirement, which specific expansion costs are expected to be recovered under customer contracts. Importantly, a U.S. government budget was not passed by October 1, 2023, the beginning of federal fiscal year 2024, and as a result, Kratos and the industry are operating under a continuing resolution authorization, which currently expires March 8, 2024, under which no new contracts and no increases in increasing contracts, production, or funding, among other stipulations, is permitted. Kratos' 2024 financial forecast and guidance provided today assumes that the current CRA will be resolved and that a U.S. federal and DOD budget will be in place by March 8th. As a result, similar to Kratos' 2023 quarterly financial trajectory, which fiscal year also experienced a CRA, we are forecasting Kratos' third and fourth financial quarter results of 2024 to be significantly greater than the fiscal first and second quarter results with the fourth quarter expected to be particularly strong in both revenue and EBITDA. If the current CRA goes beyond March 8th, we will evaluate CREDIS' 2024 financial forecast at that time based on the existing facts, circumstances, and expectations.
spk42: Great. Thank you, Deanna. We'll turn it over to the moderator now for questions.
spk38: Thank you. As a reminder, to ask a question, you will need to press star 11 on your telephone. To remove yourself from the queue, you may press star 11 again. Please stand by while we compile the Q&A roster. Our first question comes from the line of Michael Charmoly of Truist Capital. Please go ahead, Michael.
spk35: Hey, good evening, guys. Nice results. Thanks for taking the questions. Eric, can you just sort of level set us on some of the higher profile opportunities? I mean, we've seen, you know, the CCA, I guess, has selected five firms. I guess there's going to be a down selected two. Your head of UAS has said you're hopeful of being on the next increment, and then I guess also right along with that, replicator kind of tranche one and two. How should we think about the opportunities set here in the near term?
spk42: We are the absolute low-cost, rapid provider of jet drones. And That's unarguable. It's well known by the government and by the primes. So we are uniquely positioned, we believe, for every opportunity that's been talked about publicly and some new ones that are coming that have not yet been talked about publicly as either the prime or as a key partner with somebody. That's how we see it. that's on aircraft, on certain classes of them that are coming, not only on the aircraft side, but we're also positioned with our jet engines. So we are uniquely positioned, Mike, for what's going on in the drone area across every service branch.
spk35: Okay. Can you guys, I mean, as you look at the pipeline of opportunities, which, you know, increased significantly, I mean, our Are these two programs in that pipeline?
spk42: I'm not sure. I want to make sure I answer the question, Mike. Are which two programs and which one?
spk35: Collaborative Combat Aircraft and Replicator.
spk41: Yeah. Every drone program that's out there, we're expected to be in. I'll leave it at that.
spk35: Okay. Fair enough. And then just on the... You mentioned a couple of times about the Valkyrie and different variants. I mean, can you give us a little bit of color on those variants? You know, I mean, I guess since you're still self-funding and using your own CapEx to build these, what are some of the, if you can even talk to the variants, I mean, I'm assuming, you know, extended range, different payloads, you know, maybe even, you know, landing gear, but are those kind of what customers might be looking for out of the Valkyrie?
spk39: Yes, yes, and yes.
spk35: Okay. Okay. Fair enough. I'll jump back in the queue and keep it at that. Thanks.
spk13: Okay. Thank you.
spk38: Thank you. Our next question comes from the line of Peter Arment. Al Baird, your question, please, Peter.
spk29: Good afternoon, Eric, Indiana. Hi, Eric.
spk30: Good afternoon. On, I guess, you know, the whole teaming approach, can you maybe just give us how this kind of evolved? Is this something you've, you know, kind of been planning or thinking about over the last year? You know, what was the best kind of, I guess, how would you describe it in terms of working with primes versus going it alone?
spk42: Yeah, probably a couple years ago, Peter, when the different classes of the drones that the government was looking at started to get more refined between expendables, attritables, exquisites, we looked at our, and the various weapon systems they would carry, and certain of the characteristics they would have. we huddled internally and we made some strategic decisions that we would, in certain areas that are obvious, like expendables, disposables, attributables, that's like right in our sweet spot. And all things being equal, we would look to prime those. There are some areas we might not if they're carrying certain mission systems that are very unique that the customer wants to have integrated, and a prime has that mission system. As you move up the capability ladder, we decided it probably would make more sense from a probability win standpoint. If we looked at it on a biggie and we said, okay, our probability of win is 25%. We have to invest on making this up $100 million if we go at it alone to be the prime. Or our probability of win we think is 90%. We get significant content on something and our investment is significantly less than that. With everything we have going on, we would choose the latter there. And so a couple years ago, we started looking at it that way, and that's an approach we've been taking across Kratos in many areas, drones, hypersonic systems, jet engines. Jet engines, you'll be seeing that, I think, soon. It's the way we're doing it. We're partnering with the best companies in the world, The prime system integrators, and they're our partners, they are the best companies in the world at certain things. No one can do it better. And we partner with them when it increases RP win.
spk30: Certainly seems like an inflection here for your tactical drones. On the jet engine production that you're kind of investing in in CapEx, is that expected to be completed this year, or do we think that this kind of runs into 25 as well?
spk42: Yeah, so on the programs... that we've won, that we're on, and that we have vision that are going into production, those were getting done this year. However, there are several others. There is a lot going on in loitering munitions, cruise missiles, and low-cost jet drones. So probably second half of this year, I think we're going to be awarded production on some others. which means we'll have to establish some additional production lines because it's a different size of engine. So I think this is probably going to be a process probably for the next 24 months, but it will definitely be tied to programs that we're designed in on and going into production. It will not be a build it and hope they come.
spk30: Got it. And just lastly, you've had a flurry of questions. Press releases since, I guess, November, December, and with some of these large awards. And you got one here in January that you didn't give any kind of timeline on. I think it was the $50 million hardware and radar for CUS. Can you talk a little bit about how these kind of roll out, and when do they start to inflect more on the top line? Thanks.
spk42: Yep. So that that that 50 million dollar one that's going to roll out starting second half of this year And it's going to it'll be done probably nearly done by the end of 25 I'm expecting I think we're going to get another one similar size in the next few months as I mentioned these systems are deployed in Europe and they're deployed in the in the Middle East the The contract we were able to announce today, we just got customer approval, coincidentally, to announce the space one. This one is so important. I'm glad you asked, Pete, from so many angles. As I mentioned, this is the largest re-compete in the company. We don't have any more re-competes of any size for the foreseeable future. So we're bolted in. That's number one. Number two, as I said in my prepared remarks, the ceiling is 50% higher than it was. So it's not just bolted in. It's going to be a massive growth vehicle for us, and it's driven primarily by the number of space systems that are going up into space. That is definitely going to start ramping for us in the second half of this year and into 25 and into 26. We need a budget, budget, budget, budget. So our space business in all of Kratos, not commercially, not like the Intelsats of the world, but on the military side is the most susceptible in our company to the CRA. Because we've won, as you recall, in 22 and in 23, we've won so many development programs. And that business just did revenue growth of like 15 or 20%. We need the budget for production and deployment. And since we're delayed, that's why I'm looking for that to happen in 25. So that's how I see those rolling out. Appreciate it.
spk30: Congrats on the results. Thank you.
spk38: Thank you. Our next question comes from the line of Seth Siffman of JPMorgan. Your question, please, Seth.
spk14: Thanks very much, and good evening and good results.
spk15: I wanted to ask, so the unmanned business, a very nice amount of growth expected this year, and we've kind of seen things moving at a similar level the past couple of quarters. We'll have a CR kind of in most of the first quarter of 24 here. So, you know, that's probably, once again, a similar level of revenue to what we've seen. It's not a little bit lower seasonally. And so the implication would be that kind of exiting this year would be, you know, a pretty big number from a revenue perspective that, you know, on its own carries a certain amount of growth into 25. Is that kind of a fair estimate? a fair way to think about it.
spk42: Let me restate it for you. Let's take target drones. The target drone business has been ramping, and you can see by world events what's going on there. So that big blob base has been increasing for the past year. It's going to take another significant step function up in 2024 as soon as we get the 2024 budget. So the base has gone up 23 over 22. The base is going to go up again 24 over 23 as soon as we get the budget. The problem is, let's say we get the budget on March 8th, God willing, the government contracting officers, they've got to basically get 12 months worth of contractual and obligations done in six months. And that's why it pushes out into Q3 and Q4, if that answers your question.
spk15: Oh, yeah, no, totally understood. But then that's at a level in Q4 that, you know, is at a higher level that can drive, you know, a decent amount of growth in 2025.
spk42: Correct. Correct. And that's the right way to look at it. Yes. And so the bow wave from 22 CRA, we saw that. The bow wave from 21 CRA, we saw at the end of 22. The bow away from 22 CRA we saw at the end of 23. The bow away from this one we'll see 24, 25. Exactly correct.
spk15: Okay. And then just backing into, I think, what the number you talked about for unmanned implied would be something like 6% growth or so for government solutions. And just so anything... that, you know, the pieces that are kind of growing more quickly and more slowly than that kind of, you know, 6% average for KGS in 24.
spk42: Yep. As I said, our space business is the one within Kratos that's based on development programs transitioning to deployment is the most susceptible to a CRA. So our space business, which is our biggest, so it's also the hardest to grow on, It's coming off, what did it do, Deanna, 15% or 20%?
spk04: 15% in the quarter.
spk42: It just did 15% organic growth. We are forecasting that primarily due to the CRA to be one of our lowest growers in 2024 because we need to get that budget for these programs we've won to ramp up.
spk23: Got it. Go ahead. Okay. Thanks very much.
spk38: Yep. Thank you. Our next question comes from the line of Mike Crawford of B. Riley Securities. Your question, please, Mike.
spk18: Thank you. Eric and Deanna, just to help understand the guidance, if you were able to actually contract to sell both voucher reproduction spirals before you're in, what would be the rough delta on additional revenue and maybe more interestingly reduced capex?
spk06: Mike, as Eric had mentioned, we are balancing our internal resources on the cadence of that production build for that second lot of Valkyries. So that's a factor that we're taking into consideration. The CapEx that is related to Valkyrie production for 2024 is approximately $20 million. On that cadence, we would expect to continue to build throughout in 2025. And that's based upon just how our internal resources, how we're prioritizing those resources. If those were sold, to the extent they're completed, or to the extent they're percent complete, as we've discussed before, since they would be subject to percentage of completion accounting, then Let's say that 20 million that we had incurred in 2024, if a certain number were sold, then the percentage complete related to those aircraft that are sold would be recognized as revenue in 2024. And then dependent on the milestones that we're able to negotiate with the customer, the cash receipts would fall in whatever period it would fall in, whatever we're able to negotiate from a milestone perspective.
spk42: So, Mike, in a total blue sky world, Deanna, what's the CapEx in Valkyries at the end of the year, at the end of 23?
spk56: It's over $30 million.
spk42: Over $30 million. So, Mike, in a perfect blue sky world, if we got a production order for them all, That $30 million would flip into revenue. And whatever percent of the $20 million in 2024, let's say we're $10 million in, it happens in June, we'd get a pickup of $40 million in revenue. Something like that.
spk18: Okay. Thank you. And then, Eric, when you said you were expecting perhaps to potentially contract for this in late 2024, would that be after?
spk42: uh a new government budget that presumably they're going to pass before the end of december when the new congress has to come in no sir it's in the uh the funding's in the current budget um um i'm just planning on the budget being done in early march and as i've been said a few times it's going to take a while for the pro the contracting offices have a lot to do and so it'll take until late in the year
spk18: Okay, that makes sense. And then just switching gears, given just the thousands of missiles that have been expanded in the Mideast, can you comment on your microwave systems backlog?
spk42: Yes. So our microwave electronics business, the biggest part of it, as you know, is in Israel. And we are one of the primary providers on virtually every Israeli missile system and radar system. And the missiles are the ones, obviously, the razor and the razor blade. So think of Iron Dome. We're on the seekers. So Deanna, we're at record levels.
spk07: We're at record backlog level.
spk42: We're at record backlog level. We're at record revenue level. it's looking great for 24 it's looking great for 20 i mean this is terrible what's going what what's driving this but our our microwave business is is doing very well because the israelis are defending themselves okay thanks and then just off of this uh 877 million idea iq where you're pretty much i think competing with northrop and you said
spk18: You were hoping to get an order for 25 Oriole rockets. How much are those per system?
spk42: Right. So those would be totally separate from that. That's a different customer.
spk17: Oh, okay.
spk42: Totally separate. So that would be incremental to that. It's a different customer.
spk18: And so the IDIQ, that would be for Space Force payload? Correct. Correct.
spk42: That would be under, it's a different customer. It's not that customer. Nope. So it's incremental. It's in addition to what we get under the $877 million award. Okay. Okay.
spk18: Maybe just one final one. Just today, intraday, there was a pretty big merger announcement with one of your customers, Blue Halo, merging with Eclipse. And I'm wondering if that changed the scope of your $160 million OpenSpace award that you're working with them on the SCAR program.
spk42: Yep, absolutely does not. This is great for Blue Halo. It's great for us. It's great for the company they merged with. This is another up-and-coming company. Disruptive partner of Kratos is in Blue Halo. So no change. And that SCAR program is going to be one of the big drivers for Kratos 2025.
spk18: Excellent. Thank you.
spk41: Yes, sir.
spk38: Thank you. Our next question. comes from the line of Ken Herbert of RBC Capital Markets. Your question, please, Ken.
spk32: Yeah, good afternoon, Eric and Deanna. Hey, Eric.
spk33: Hey, I wanted to follow up on your comments and sort of the shift in strategies. You look to build out more sort of merchant businesses. It sounds like there's a real opportunity within RBC rocket motors, electronic devices, unmanned, other areas to replicate what you've done on the space side. Now, as you think about that and you think about the other opportunities, is there any way you could maybe rank order those other businesses and sort of how far along that curve you think they are to, I guess, what I would call sort of established merchant supplier status? And how does that maybe impact growth of those businesses this year and then, of course, into 2025?
spk42: Yep, turbojet and turbofan engines for missiles, powered munitions, loitering munitions. We are way up or down the curve, whichever way you want to look at it, relative to being the trusted partner with the prime system integrators with those engines on their weapon systems. And this value proposition I'm going to give you right here is the value proposition we bring to them, okay? I'm making this up. Raytheon's doing a missile. Northrop's doing a missile. Lockheed's doing a missile. It all needs a 150-pound thrust engine. We build 150-pound thrust engines. They all come to us because we get leverage because we have three orders, one from each of them, which drives the cost down, which makes them more cost-effective for their customer, and it brings value to everybody. So it's a win for us. It's a win for all those three primes in my example, and it's a win for the government. So in turbo jets and turbo fans, for cruise missiles, loitering munitions, and powered munitions. We are moving down the path on that. You saw with the announcement that Boeing made on powered JDAM. As you know, I've talked about before, we're designed in on six different systems, several of which are going to be in production, I think, by the end of this year. And this will be a meaningful revenue driver for us in 2025. And we have clarity on this with the programs. That's number one. Number two is our hypersonic stacks. So I mentioned today the Oriole Terrier stack that launched the French payload that just became public. We do that all the time for a lot of different customers. It's just not announced. With the Zeus motors coming, these can go faster, farther, put heavier payloads in certain places at the right time, the right speed, the right place. We do that for the government, and we do that for the primes. So we are way down the line on that. And since we're orders of magnitude less costly than anybody else out there, including some of these up and comers who think they're going to get into the area. Okay. We can test, test, test, and test multiple times within a budget for a customer, whether it be the government or a prime, because our price points are so low. So stacks, for hypersonic systems, ballistic missile targets, and suborbital vehicles, which, as you know, we can't talk about on this line. So that's right behind the turbo jets and turbofans. The next one, obviously, is microwave electronics. We're a merchant supplier there. That's what we do. Our primary customers are Rafael, Israeli Aerospace Industry, which are the Lockheed, the Raytheon, and the Northrop of Israel. We're going to build that out there, and we're building that out in the U.S., and... Drones. And drones is one where we absolutely are going to continue to be the prime or our probability of win. And the investment thesis for us is manageable. And we will partner with our big prime teammates. And we have a few of them that are very close with us where it increases the probability of win. It reduces our risk and our financial contribution. And we think we're going to get a big part of something instead of potentially all of nothing. And you're seeing the drone, the drone impact is this year. The rocket motors, we're definitely going to get some of those this year. So you're going to see those sales this year and they'll ramp into 25. So that's how I see it.
spk33: That's great. And if I could, as you think about these markets, you obviously are positioned in some of the faster growing markets, but what's your view on just high level defense spending or investment spending and in not just 24, but over the next couple of years, and to what extent is sort of a flattish budget, if that's the situation we're in, you know, a risk to the timing on some of these programs?
spk42: Yep. So obviously I'm the CEO. I drink the Kool-Aid. I like Senator Wicker. He wants a 5% defense budget. He wants a trillion-dollar defense budget. I love him. And I personally believe that with the threat environment out there that we have, threats aren't going down. They're increasing every day. This is something both parties are going to convalesce around. But let's say that I'm wrong. Low cost is going to win the game. The stock drones, affordability, affordable mass. The Mitchell Institute, they work with the Air Force, came out with a report last week. If you guys haven't seen it, I encourage you to see it. They said we cannot afford exquisite drones en masse. The only way we can defeat certain adversaries is with large quantities of low-cost drones that are rail-launched, that are air-launched, that are attritable, et cetera, to get quantities, which is cost. So in a tightening budget environment for our engines, our turbojets and turbofans, for our hypersonic vehicles and our rocket systems, for our drones, I think that just increases Kratos' winning hand because of our affordability thesis.
spk28: Great. Thanks, Eric, for all the color.
spk38: Yep. Thank you. Stand by for our next question. Our next question comes from the line of Pete Skivitsky of Alembic Global. Your question, please, Pete.
spk31: Yeah, good afternoon, guys. A couple questions on EBITDA margins. Eric, I'm just wondering, if you are a sub on one of these large tactical drone programs, maybe CCA or Replicator. How are you guys thinking about the economics on those as a sub? You know, I think last year unmanned EBITDA margins were 7%. Probably target drones are above that. You know, in a sub position, if you get enough numbers, can you get to double digits in terms of adjusted EBITDA margins? Or are we going to stick in this range even as a sub?
spk42: Yep. So we are... In the tactical drone area, either as a prime or a sub right now, we are going to be in that range because they're development programs. In development programs, the margin rates are less. You were exactly right what you said on the target drones. In the target drones, we have multiple drones in multiple stages of full-rate production, and that's where you come down the learning curve. You have to share part of that with the government, of course, but you can make low to mid-teen margins. Internationally, In target drones, you can make much higher because it's international. So back to the tactical part of your question. I don't think there's going to be any difference, or if it is, it's going to be around the edges on margins on these. I know it in development because we are where we are. We're a prime in development on some. We're partnered with some other people on others in development. We know what the margins are. They're similar. And I envision it being the exact same once we get into full rate production. It will not be a difference to us.
spk31: You're saying even in full-rate production, the margins on, you know, they'll be the same as they are today?
spk06: No, in full-rate production, we would expect the margins to expand. What he's saying is in development, we would expect those margins to be similar to the production, the development rates that we would see on the target side. But when we get to production, we would expect to see some expansion.
spk31: Okay. So, so maybe like three years out, we're talking there, there, there's a, uh, a path. Yeah. Okay. I appreciate it. And then similar question, just on similar question on space. I just see you guys talked about the inflection in 25 and it, and it sounds like, um, you know, maybe you're looking for some margin expansion there, partially on, on production, higher deliveries, but you guys have been, you know, investing a lot in open space and we see it hit KGS margin periodically. I'm just wondering, in 2025, should we anticipate, you know, the IR&D that you are spending on open space to decline meaningfully? Or is that going to be kind of steady state and it's more so, you know, we anticipate, you know, deliveries increasing?
spk42: Right. I would not expect it to decline, but I would definitely expect deliveries to increase and the software content of the ground infrastructure to increase, which inherently brings higher margins. That's how I would look at it. It's a hybrid software model where you need continuing sustained R&D to refresh and expand the product portfolio you're bringing to the customer to stay ahead of your competitors.
spk31: Got it. Okay. So the R&D will stay steady state, but as long as the market's hot, you'll have these opportunities for deliveries to be higher. Okay.
spk42: As long as we penetrate that total addressable market we see, we should be in good shape. Yes, sir.
spk31: Got it. Thanks so much, guys.
spk42: Yes, sir.
spk38: Thank you. Thank you. Our next question comes from the line of Joe Gomes of Noble Capital. Please go ahead, Joe.
spk36: Thank you. Good afternoon and congrats on the quarter.
spk41: Hey, Joe. Good afternoon.
spk36: I just wanted to start on the tactical side there for a second. I saw that Australia is investing another $260 million in the ghost bat. I'm just wondering what you see on the competitive side there on tactical.
spk42: So you asked the question. So, yep, Australia is going to pay $260 million in U.S., $400 million Aussie, for three more ghost pets. So obviously that is a much different model than Kratos' model. We were paid for three Valkyries. The first three initial Valkyries was like $40 million. So it's a different paradigm. With a cost share. Yeah, it's a different paradigm, Joe. We're focused on affordability. Effectiveness, affordability, rapid development, get things flying. That model is just different, and I don't focus on it.
spk36: Okay. And then outside of the open space, which obviously is growing nicely there with some of the recent awards you've talked about, what else can you talk about on projects that aren't impacted by the CR? Historically, you've talked a little bit about wireless trucks, just trying to get a little better sense of what else is out there that you're very excited about that we don't have to be dealing with the CR.
spk42: Good question. So 30% of our business is not DOD. So for example, our Israeli business, Microwave electronics, $80, $90 million in revenue. Totally unrelated to the federal government, U.S. federal government budget. As I mentioned earlier, that business is ripping for the terrible reasons it's ripping. That's going to do great. Contracts like with Intelsat, commercial satellite operators, JSAT, I can go down the list because Monoclipsat, they're not impacted. And we're seeing growth. in the commercial satellite area, okay? In our engine area, as you know, we're building engines for, we're under NDAs. Think of virtually every new space company. We are involved in their engines, okay? That is not seeing an issue. Target drones, internationally, and you see what's going on in the world. People are buying short-range surface-to-air missile systems. They're buying Patriots. They all need to be exercising as target drones. They're typically exercised against ours. So international target drone business is not tied to the federal budget. So we've got a really good hedge and typically internationally, we make higher margins than in the U S because international customers will pay more for the U S stuff. And so we've got a pretty good hedge, which is why, as of right now, we're staying with our 10% target for 2024. Because that non-DOD business looks really good right now. And why Deanne and I both said, God willing, we'll have a budget by March 8th. But if we don't, we'll revisit it and see what the portfolio looks like. And if we need to update, we will. Great.
spk36: Thank you for taking the questions. Yes, sir. Thank you.
spk38: Thank you. Our next question comes from the line of Sheila Caglioglu of Jefferies. Your question, please, Sheila.
spk09: Thank you. Hey, Eric, Adriana. Thank you for taking the time. So much has been asked already, but I just wanted to kind of maybe put it all into context if that's possible. Eric, you could hear me, right? Just double checking. Yes. So maybe if you could just talk about, you know, KGS versus KUS in 2024 and the growth profile of each. KGS has been growing pretty nicely. Do we continue to just see that outperform? Maybe if you could just simply rank order the subsegments of where you see the highest growth there just to start.
spk42: Right. To level set, the biggest growth segment we're going to have right now for 2024 is going to be our unmanned systems business. The drones across the portfolio are doing great. And if we get a budget, we could actually beat those numbers in the drone area. All right? So in KGS, I'll let Deanna touch on those, keeping in mind that our space business will be one of the lowest ones because it's impacted the most by the CRA.
spk06: Yes. So as Eric had mentioned, the space business, which is our largest, is impacted by the CRA. So that is what Seth brought up. We're expecting about a 6%. We're forecasting about a 6%. organic growth across KGS, with space being a big portion of that at lower than that 6%. So that would indicate that there are pieces that are growing greater than that rate, which would be our C5ISR business, our turbine business, our microwave electronics business, really across the board. most of the businesses within KGS with the exception of the space business for all the reasons we've talked about since we expect to really see that growth come in play in 2025 as we move on to production on a number of the programs that we've been working on.
spk09: Okay, understood. And then maybe if you could talk about the pipeline. It's stepped up 700 million sequentially just given you know, recent news with CCA and things like that, and you're partnering with folks, maybe can you give us the moving pieces of the pipeline at all?
spk06: And it's actually, you know, from our pipeline perspective, the big increase is not in our unmanned systems business. It's across a number of our businesses within KGS, so in our C5 business, in our turbine business, and our microwave business.
spk42: Sheila, the engine business in particular, the pipeline is incredible right now. Made in the USA engines, turbojets, turbofans, rocket engines, liquid and solid. We're seeing incredible demand there in engines. That's probably the strongest grower for us. from a pipeline standpoint. Microwave electronics is incredibly strong. It grows literally every week as ordinance is expended. As Deanna mentioned in the C5ISR business, I've been through the programs before. We have a number of programs, IBCS, IFPIC, SURE-RAD, all of which are moving into production. So those pipelines are now moving from development to production, which increases the pipeline that we're designed in. So the KGS business, our training business, we built training systems for weapon systems. Weapon systems are back in vogue. So our training systems business pipeline is very big. And its growth is one of the strongest in the company, 24 over 23.
spk06: As well as our space business as well. I don't think I've mentioned that before. So the pipeline is up also in our space business.
spk09: Okay. And then last question for me, obviously CapEx jumps up 20 million year over year. Do we think about that as a normalized rate, or is it just given what's going on with Valkyrie and microwave products?
spk06: It goes through all the investment areas that Eric had talked about and the growth areas that we're investing in. So it's across the board. It's in our microwave business. It's Valkyries that we're continuing to build. That's about 20 million. But it's also building out some of our space network, a satellite network that we company own, as well as the manufacturing center of excellence for our turbine engine business. So it's It's really investments that we're making in 2024. Some of it might continue in 2025, but we don't anticipate at that level. So it is continuing. I would not say it's recurring. Sure. Thanks.
spk38: Thank you. I would now like to turn the call back over to Eric DeMarco for closing remarks. Sir?
spk42: Excellent. Thank you all for joining us and for the Q&A session. We'll touch base with you when we report Q1 in a few months. Have a good day.
spk38: This concludes today's conference call. Thank you for participating. You may now disconnect.
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