Kratos Defense & Security Solutions, Inc.

Good day and thank you for standing by. Welcome to Kratos Defense and Security Solutions third 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 ask a question during the session, you will need to press star 11 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 11 again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Marie Mendoza, Senior VP and General Counsel. Please go ahead.

Thank you. Good afternoon, everyone, and thank you for joining us for the Chris Defense and Security Solutions Third Quarter 2024 Conference Call. With me today is Eric DeMarco, CRADA's President and Chief Executive Officer, and Deanna Lund, CRADA's 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.

Good afternoon. For the third quarter, Kratos continued to execute, demonstrating the success of our strategy of making internally funded investments to rapidly develop and be first to market with relevant hardware and software for our national security customers. In Q3, every Kratos business unit substantially achieved or exceeded its objectives, with the exception of our commercial satellite business, which continues to be impacted by new entrance, industry disruption, and delays, including delays in delivery by the manufacturers of software-defined satellites, which I have discussed in detail previously. The ongoing generational recapitalization of strategic weapons systems including strategic, satellite, air defense, radar, and missile systems, continues to be a catalyst to the current and expected future Kratos financial performance, including our affirmation today of our 2024 financial guidance and our 2025 base case financial forecast expectation of 10% year-over-year revenue growth. As I mentioned on our previous call, In Q3 and Q4-24 and in Q1 of 25, Kratos is expected to continue to make significant internally funded bid proposal and other expenditures in pursuit of certain new large single award programs, one of which with a potential value of approximately $1.5 billion, we hope to be selected on by the end of Q1 of next year. We are also hoping to hear on a new single award space opportunity with an initial value in excess of $100 million and a potential future value several orders of magnitude greater than that. We are closely managing these BMP investments related to our financial guidance that we affirmed today and the opportunities we are pursuing to ensure that we can make these investments, pursue these opportunities, and also achieve our expected financial guidance range. Though these investments have been and are expected to continue to impact Kratos' near-term profitability and EBITDA, if we are successful, based on the potential size of certain of these opportunities we expect to win, we are looking to potentially increase Kratos' future year-over-year planned revenue growth rate above the current 10% base case forecast in 2026. Virtually every Kratos division has exposure to the rapidly growing air defense systems area, including Kratos microwave electronics, our rocket systems, C5ISR, space and satellite, target drones, turbine technologies, and our ballistic missile target business, each of which Kratos is the industry leader. Kratos' microwave electronics business, where we support Iron Dome, Arrow, Lightning, Iron Sting, and other systems, has a record backlog and is generating record financial results, which are expected to continue into 2025, including in support of the Israeli Defense Forces and our important partners, including Rafael, Elbit, and Israeli Aerospace Industries. To address our Israeli business's record backlog on Opportunity Pipeline and demonstrating Kratos' commitment to Israel, Kratos is on schedule to open a new manufacturing facility expand our current manufacturing facility, and complete our space-qualified facility capability in Israel in Q2 2025. Additionally, due to customer demand, including as related to missile and radar systems, we are now also planning to open an additional microwave product facility in India in close coordination with both our customers and our partners. Kratos Turbine Technologies and our engine business is also generating record results, including having a record opportunity pipeline with hypersonic, supersonic, cruise missiles, loitering munitions, drones, and space systems all being expected to future growth areas. As a result of the investments we have made, Kratos' small, low-cost turbojet engine facility in Michigan is now capable of producing approximately 10,000 engines annually, as we expect to receive engine production contracts for drones, missiles, and loitering munitions programs next year. Additionally, we have now identified the site for an additional new small turbofan engine production facility, including as related to our partner GE Aerospace, for larger drones, missiles, air vehicles, and systems. The demand for jet engines is rapidly growing, and we expect small jet engines, including Kratos TDI Spartan family of small but mighty first-to-market turbojets that are in production and operational today, to be a future growth catalyst and contributor for Kratos. Kratos' C5ISR business supports air defense, counter-UAS, radar missile, and strategic programs, including Patriot, Integrated Battle Command System or IBCS, Indirect Fires Enduring Shield or IFPIC, Short Range Air Defense or SHORAD, Sentinel or GBSD, THAAD or Terminal High Altitude Area Defense, and many others. Since our last quarterly report, Kratos has received a new hypersonic system-related program award, which is expected to be one of Kratos' largest programs over its expected future multi-year period of performance. Additionally, we were just recently informed that Kratos has been down selected on another new major weapons system program hardware opportunity that we also hope to be successful on in 2025. Kratos' new Sentinel program dedicated facility is planned to be operational mid to late next year, and we expect the Sentinel program to be one of Kratos' largest programs and future year growth contributors. Key Kratos C5ISR partners and customers include Northrop Grumman, Lockheed, Raytheon, and Leidos Dynetics. Kratos' rocket systems business also has several important growth-related program areas, including Aegis, hypersonics, ballistic missile defense targets, suborbital vehicles, strategic and nuclear systems, and space-related systems. Expected future year growth contributors for Kratos in our rocket system area include our first-to-market Aranis and Dark Fury hypersonic glide vehicles, the Dark hypersonic system with our partner hypersonics, our first-to-market Zeus 1 and Zeus 2 solid rocket motor or SRM systems, and our Oriel SRM system, and also the Terrier and Target mission-related systems with our government partners. Since our last quarterly report, and as we announced today, Kratos' Zeus 1 and Zeus 2 solid rocket motor stacks successfully executed its initial flight, achieving every mission objective with our government partner. Kratos' Zeus is a recent example of the value Kratos' business model brings to every Kratos stakeholder, with Kratos making the internally funded investments to rapidly develop, field, and be first to market with affordable relevant systems for U.S. national security. We have also recently executed a contract related to certain other Kratos flight vehicle system production and integration, including up to 60 Kratos solid rocket motors. These are different, and in addition to Zeus, as Kratos' expected future mission launch manifest continues to significantly grow, for many different types of SRMs and missions. We have also now identified the site for Kratos' new large hypersonic system franchise production and integration facility. This will be located in the United States, which site we expect to break ground on by the end of this year and have operational capability in 2026. We expect Kratos' rocket systems, SRMs, and missile defense related systems business to be a future year-over-year growth contributor for Kratos. Kratos' satellite business on the defense and national security side is performing as expected, and we received and are bidding on several new national security related opportunities, including where we believe that our first-to-market open space software is a clear competitive differentiator for Kratos. Additionally, Kratos' owned and operated space domain awareness system, where we provide and sell data and information to our partners and customers, is performing well, including the announcement just yesterday by the customer of an approximate $48 million sole source award. We believe that Kratos' SDA system is well positioned to take advantage of the large number of satellites currently being and expected to be placed into orbit. As was discussed on the Q2 call, the commercial satellite industry and Kratos' commercial satellite business continues to face disruption and challenges, including those directly related to the new software-defined satellite system issues the OEMs are currently experiencing, which are now well publicized and which are expected to continue for the foreseeable future. As a result of these industry-related commercial satellite issues, We have been reallocating and are addressing our overall satellite business resources to ensure that we execute as efficiently and cost-effectively as possible. Importantly, Kratos will continue to make targeted investments, including in our proprietary 5G, virtualized modem software, SATCOM-related and other products, where Kratos is first to market and we have a substantial intellectual property position. In space and satellite communications, Kratos has the customers. The total addressable market opportunity, both commercial and government, is large and expected to rapidly grow. And we expect future year organic revenue growth and margin expansion from the business. The global demand for air defense systems is driving demand for Kratos' threat representative target drones, which are used to exercise and test these systems and their crews. And we expect our target drone business to be a future grower. Since our last quarterly report, the United States Marine Corps announced that Kratos Valkyrie successfully completed a test flight on September 20, 2024, at Eglin Air Force Base in Florida. This flight was conducted in partnership with the Office of the Undersecretary of Defense for Research and Engineering, the United States Naval Navy Air Warfare Center Aircraft Division, and other industry partners. Additionally, As reported in a 17 October Marine Corps press release, Kratos' recent Valkyrie flights with the Marine Corps in cooperation with the United States Air Force and at a United States Air Force base, the Valkyrie successfully demonstrated tactical data link integration and closure of the kill chain. The manned unmanned teaming concept with Valkyrie and a four ship of F-35Bs was pushed even further in the recent Emerald Flag exercise. I refer you to the Marine Corps release for full details and photographs of this incredibly successful and relevant mission. This joint collaboration event is part of the Penetrating Affordable Autonomous Collaborative Killer Portfolio, or PACP, program. As you can see, Kratos Valkyrie continues to successfully fly, evolve, missionize, with operational relevance, with manned fifth generation and other aircraft and systems, with multiple DOD customers and participants, including the Air Force. Also in our tactical drone business, Kratos' Athena drone program is under contract and expected to contribute in Q4 and into 2025. And Kratos has been informed that our Apollo drone has been selected, and we are on final contract documentation with Apollo expected to begin contributing in 2025. Both the Athena and Apollo opportunities have come in later in 2024 than we had initially forecast. And as a result, the contributions from these programs will be less in Q4 than we had originally planned. But the good news is we now have them both under contract or soon to be. On one of the Valkyrie opportunities, which we were in source selection on, which is international, We have been recently informed that we were successful. And I hope by our next report, I can provide an additional update on the Valkyrie selection here. On the second Valkyrie opportunity I previously mentioned, we remain in source selection with the selection anticipated for Q1 next year. Additionally, there are also now two new tactical jet drone opportunities Kratos is evaluating for potential pursuit. one of which we have just recently submitted a response. Based on the recent events and communications, we remain confident that Kratos' Valkyrie, the lowest cost, most affordable, runway flexible, actual flying today, obviously has been flying since 2019, high performance jet powered tactical drone will successfully get to production. Kratos' Ghostworks has made rapid progress on the conventional takeoff and land Valkyrie capability. which development Kratos is internally funding and which we expect to fly in the second half of 2025. The complete Valkyrie system is a runway-flexible, runway-independent system. We are also on track with our customer to fly a new fifth-generation aerial drone in 2025. Kratos's Ghostworks has also made progress with our customer in integrating Kratos's jet engines into Kratos tactical and target drones with initial flights of Kratos' jet engines and Kratos drones planned for the second half of 25. Kratos' mil-spec turbojets, part of our Spartan family of engines, which are manufactured in Michigan, are some of the highest performance per cost in the world, being significantly lower in cost than anything else available in the industry, of which there's very little. As is represented in my update, we believe that the market momentum for low-cost jet-powered drones is increasing and that Kratos, which currently manufactures approximately 165 jet drones annually and has approximately 10 different jet drones flying today, is uniquely positioned to address and be successful in this market now and today, not five or 10 years from now. Related to drone manufacturing capacity, Kratos is currently positioned with the internally and funded investments we have made and are making, and along with our established and qualified vendor base, supply chain, and our existing facilities and options to quickly increase jet drone production to approximately 400 drones a year, including Valkyrie when requested. We expect Kratos' target drone business to be a contributor to Kratos' future organic growth. We expect Kratos' tactical drone business to potentially be transformational for Kratos' business and our stakeholders in the future. As I mentioned, as we look towards 2025, we remain confident in our long-term base case 10% organic revenue growth rate objective and forecast, which for 2025 we expect to provide the details on when we report Q4 2021. after the new administration and Congress is in place, and hopefully when we have better clarity on the current continuing resolution authorization situation. We are internally focused on executing on our record backlog and opportunity pipeline with no significant acquisitions anticipated, only potential small tuck-ins. Operational challenges include obtaining, retaining, and the related cost of qualified personnel, which continues to be a headwind to certain of our operations and profit margins due to the increased personnel-related costs and scarcity of resources and also the current disruption in the commercial satellite industry. As we have previously discussed, our base case forecast does not include any production orders for Kratos Tactical Drones, only continued research development, test and evaluation, or RDT&E, or S&T science and technology and similar type sales. Irrespective of the administration and U.S. government funding timing issues with the current geopolitical landscape and threat environment, we believe that we are in the early stages of a Reagan-like defense buildup with increased U.S. and allies defense and national security budgets for the foreseeable future. This is Deanna.