Kratos Defense & Security Solutions, Inc.

Welcome to Kregto's Defense and Security Solutions second quarter 2024 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To participate, you will need to press star 1-1 on your telephone. You will then hear a message advising your hand is raised. To withdraw your question, simply press star 1-1 again. Please be advised that today's conference is being recorded. Now I will pass the call over to the Senior Vice President and General Counsel, Marie Mendoza.

Thank you. Good afternoon, everyone, and thank you for joining us for the Kratos Defense and Security Solutions Second Quarter 2024 Conference Call. With me today is Eric DeMarco, Kratos' President and Chief Executive Officer, and Deanna Lund, Kratos' Executive Vice President and Chief Financial Officer. Before we begin the substance of today's call, I'd like everyone to please take note of the Safe Harbor paragraph that is included at the end of today's press release. This paragraph emphasizes the major uncertainties and risks inherent in the forward-looking statements we will make this afternoon. Please keep these uncertainties and risks in mind as we discuss future strategic initiatives, potential market opportunities, operational outlook, financial guidance, and other forward-looking statements during today's call. Today's call will also include a discussion of non-GAAP financial measures as that term is defined in Regulation G. Non-GAAP financial measures should not be considered in isolation from or as a substitute for financial information presented in compliance with GAAP. Accordingly, at the end of today's press release, we have provided a reconciliation of these non-GAAP financial measures to the company's financial results prepared in accordance with GAAP. With that, I will now turn the call over to Eric DeMarco.

Thanks, Marie. The successful execution of Kratos' strategy and our position as a leading defense and technology hardware and software company is reflected in our Q2 and year to date financial results. Kratos' strategy of making internally funded investments in close collaboration with our partners and customers to rapidly develop engineer field and be first to market with relevant products, systems, and solutions is working for our customers, partners, shareholders, and all of our stakeholders. that Kratos affordability is a technology which is directly related to our strategy of investing our own money, enabling us to move fast, rapidly developing our products for low cost mass production in large quantities and for affordable mass. As we watch peer adversaries in both potential and active conflict, and at the same time see adverse DOD budget and program cost impacts, Kratos is focused on solving these challenges with systems that are truly realizable, near-term achievable, and affordable. At Kratos, we believe that better is the enemy of good enough, and that someday in the future, maybe having the perfect capability or solution that is studied and modeled and then studied again is too late, too expensive, and an abject failure. Recent examples of Kratos' successful strategy execution with relevant working systems include Kratos's Aeronis hypersonic glide vehicle from initial conception to first flight with the Missile Defense Agency and the Navy in approximately 30 months for an approximate $15 million total development cost. Kratos's Zeus family of solid rocket motors from conception to successful static fire in three years for an approximate $23 million investment and now positioned for the Mach TB program hypersonic Aranis missions, and several additional customers. Kratos' Valkyrie runway enabling trolley system, from conception to first flight in effectively 15 months for a few million dollar investment, with Kratos' Ghostworks achieving another important milestone in Valkyrie operational deployment flexibility, which we continue to rapidly mature and demonstrate. Each of these relevant Kratos funded and developed systems are expected to be important contributors to Kratos' business and our future financial growth and profit trajectory based on specific customer orders and feedback and are representative of the value Kratos generates for our stakeholders. In Q2, Kratos' engine and turbine business continued its revenue growth and profit expansion trajectory beating its forecast, including engines for drones, missiles, aircraft, space, hypersonic, supersonic, and other systems. Kratos is the clear industry leader and independent merchant supplier of engines, propulsion, and subsystems in our areas, and we expect continued future growth based on customer demand. We recently announced a Kratos small jet engine partnership with General Electric Aerospace, which is incredibly important to Kratos, with GEA bringing large-scale engine production experience, capital, intellectual property, customer relations, and more, and we are anticipating future production of thousands of low-cost engines in this class for drones and missiles. The GEA partnership is specifically with Kratos' turbine technology business for small turbofan jet engines. and is not related to Kratos' TDI small turbo jet business, which has separate locations, technology, IP, and target market opportunities. As part of Kratos' arrangement with GEA, where we will be sharing future engine production revenue and profit, Kratos, in coordination with GEA, will be making an investment and standing up a new low-cost small engine manufacturing facility as we begin preparation for expected future production. Separately, we are investing and expanding our TDI small turbojet engine production capacity and Kratos's overall hardware and manufacturing capability, including additional additive manufacturing, 3D printing, milling, machining, casting, and forging capabilities, which is part of Kratos's vertical integration initiative. We are establishing new engine production lines related to the many new drone, missile, and loitering munition programs that TDI has, including those that we are designed in on. We are either now in contract negotiations for, and we are hopeful to receive an initial 1,000-unit order with a potential 10,000-plus opportunity in the near future. Kratos Turbine Technologies, TDI and our engine and propulsion system business are currently expected to be some of our company's primary future growth contributors. Kratos' Israeli-based microwave electronics business also exceeded its Q2 forecast, including programs supporting multiple air defense systems, including Iron Dome, Iron Sting, Lightning, Arrow, Barak, and others. Kratos' microwave has also a record backlog and opportunity pipeline, and we are making the investments to increase our facilities, hardware, and manufacturing capacity in order to address existing and forecasted increased future demand, including a space-qualified capability, as a result of certain new satellite systems awards we've received and opportunities. Kratos has deep relationships with Israeli aerospace industries, Rafael and Elbit, and we expect our Israeli business to be one of Kratos' future year-over-year organic growth leaders as we support our important Israeli and international customers. Global air defense system-related demand, including missile, radar, counter unmanned aerial system, and space systems, also contributed to Kratos' C5ISR business exceeding its Q2 forecast, including Patriot, THAAD, SHORAD, indirect fire or IFPIC, IBCS, CUAS, DE, and HPM-related systems. Kratos' C5ISR program's backlog and opportunity pipeline is also at record levels, and C5ISR is expected to be an important future year organic growth contributor as we support our important partners, including Northrop, Lockheed, Raytheon, Dynetics, and others in their national security missions. Kratos' C5ISR backlog and opportunity pipeline is at a record level, and we are making the investments necessary to support our partners and customers, including expanding our C5ISR business's hardware and manufacturing capacity and also including our new Sentinel program facility. Kratos' training systems business is also growing. With increasing margins, as certain programs we have been awarded ramp up, and additional new program wins are expected. The global recapitalization of strategic weapons systems, in addition to the weapons system, requires training systems, with Kratos being an industry leader, with representative Kratos systems including M1 Abrams, Bradley, Blackhawk, and Air Force Global Strike Command systems. Kratos Training System Opportunity Pipeline is one of the strongest in our company as we head into the second half of 2024. Kratos' cybersecurity business, one of the company's most profitable, is also forecasting future growth, including as the DoD's Cyber Maturity Model Certification Program, or CMMC, initiative progresses, with Kratos having some of the industry's most important and critical cybersecurity-related relationships, relevant past performance qualifications and customers. As we have communicated previously, Kratos' space and satellite business, our company's largest, is being adversely impacted by the previous extended 2024 CRA, which delayed and pushed certain government programs or existing program funding to the right, including programs Kratos is or expects to be under contract on, And we are now also assessing the probable upcoming federal fiscal 2025 CRA, which is likely to begin October 1st. Additionally, our satellite business is also being impacted on the commercial side by the highly publicized technology and other issues being experienced by the manufacturers of software-defined satellites, which is delaying the award and or deployment of the related satellite system ground communication infrastructure, including Kratos's. However, we are now in source selection on several DOD, national security, and other program opportunities, certain of which we expect to receive either later this year or early next, which should put Kratos' satellite business back on a growth trajectory. With a large number of LEO, MEO, and GEO constellations and satellites planned for or expected to be launched, we remain confident in the future prospects for our satellite business including our first-to-market virtualized OpenSpace software platform, which is a clear competitive differentiator for our company. Increased demand for our target drone business continued in Q2, with bookings of nearly $130 million and a book-to-bill ratio of 1.5 to 1 for the quarter, and Kratos' unmanned systems bookings being $290 million for the past 12 months. Global weapon, Air defense system and training demand I referred to is contributing to the increased Kratos target drone demand, which is expected to continue both domestically and internationally as air defense systems, missiles, radars, ships, satellites, et cetera, need to be exercised against and warfighters trained against threat representative targets. Kratos' target drone business is expected to be an important future organic growth contributor for our company. On tactical drones, as has been increasingly reported over the past few weeks, including just yesterday, budgets are tight and are expected to get tighter. Affordability matters and is going to matter even more in the future. And we believe that potentially, maybe better someday, is the enemy of good enough and flying today and Kratos remains confident in our success. Apollo is now under contract, and Athena has been down selected and is expected to be under contract this quarter. Kratos Valkyrie is now in source selection on certain opportunities, so I am not able to make any specific program, opportunity, or customer-related comments on Valkyrie at this time. I can say that we have completed our planning for the next serial production run of Valkyries, including with our key suppliers, and we are ready to move forward once we have certain additional information on the potential opportunities, including the final version and capability mix of the aircraft. We are now planning the expansion of our Oklahoma drone manufacturing capacity, including a potential additional facility. with the expansion being for both tactical and target drones, including as certain of our drone systems are utilized for multiple applications or missions based on mission configuration of the system. With a successful Valkyrie flight from the Kratos Trolley launch system, Kratos' Ghostworks is now working on an additional Valkyrie launch capability variant, also in close coordination with the customer. The Valkyrie Trolley Launch System, funded by Kratos, but in close coordination with the customer community, establishes Kratos as the only high-performance jet drone system provider with rail-launched runway independence, traditional runway capability, and soon an additional launch capability. Kratos Ghostworks is also looking ahead at new and evolving weapon systems, their applicability to unmanned systems, including Valkyrie, the impact of artificial intelligence integration, and the potential game-changing impact of a system like this in a peer conflict. Kratos and S.H.I.E.L.D. continue to successfully execute the strategy, with S.H.I.E.L.D. AI routinely flying Kratos' high-performance jet drone systems, including an incredible mission in just the past few days. From my perspective, what S.H.I.E.L.D. is doing is potentially transformative and game-changing, with S.H.I.E.L.D. taking advantage of Kratos having the only high-performance jet drones that have performed hundreds of actual flight missions, with S.H.I.E.L.D.' 's artificial intelligence system flying and flying and learning and learning with the highest performance jet drones in the world, Kratos'. The Marine Corps Miramar Air Show is coming up this September here in San Diego. And in addition to an actual Valkyrie, an actual Airwolf, a Mako aircraft, et cetera, we intend on displaying several other high-performance Kratos jet drone aircraft at the show and also potentially a new Kratos system if we can. Defense budgets are increasing globally, including in the areas of air defense, missiles, radar, space, satellite, hypersonic engines, propulsion systems, C5ISR, microwave electronics, drones, cyber, and training systems, with Kratos being a hardware and software-rich technology company addressing each of these areas and many others. Years of underinvestment in the defense industrial base is and will need to be corrected, and Kratos is participating in this buildup and the recapitalization for the strategic weapons systems. We are making the investments and vertically integrating selectively where it matters to reduce supply chain risk and to also reduce cyber and physical related security risks as we need both surety and security with our supply chain. Producing hardware in large quantities for defense and national security applications that must reliably perform at an affordable cost is hard. and it's a key differentiator for Kratos to our partners and our customers. As you know, the 2024 budget continuing resolution went through March of this year, and another potential 2025 budget continuing resolution is expected to begin October 1st, just two months from now. Irrespective, we remain confident in our 2024 financial guidance, which we affirm today, and we also remain confident and our expected future year-over-year organic growth rate of 10% with the potential to exceed it. As we reported, Kratos' opportunity pipeline is a record $12 billion, and we are in pursuit of certain new large programs as a prime, including classified opportunities in our unmanned systems business and our space, cyber, and training businesses, which are requiring significant Kratos bid and proposal and related investments, including one opportunity, where Kratos' investment in the second half of 24 is expected to be approximately $2 million for this one opportunity. We have no significant acquisitions anticipated, only maybe potentially some very small tuck-ins. Operational challenges include the obtaining and retaining of qualified, experienced personnel, including those willing and able to obtain national security clearances and the related cost of these individuals. Ms. Deanna.