Kratos Defense & Security Solutions Q4 2022 Earnings Call Transcript

Quartr
Provided by Quartr
February 23, 2023

Key Takeaways

  • 2023 is positioned as a transition year, shifting from R&D and LRIP to full-rate production—highlighted by the BQM-177A unmanned aerial target entering serial production—to drive higher revenue, profit and cash flow.
  • Kratos won major hypersonic awards (Mayhem, Mach TB) alongside Dynetics and achieved a successful SM-3 Block IIA ballistic missile target intercept test, underscoring its leadership in hypersonics and missile defense.
  • The Space & Satellite Communications segment secured a record backlog and key contracts for OpenSpace/OpenEdge virtualized C2 and ground systems, gaining traction in both national security and commercial markets.
  • The tactical jet drone Valkyrie program advanced with USMC, USAF and Navy orders, commenced Block II serial production and emphasized runway independence, low cost and open-architecture flexibility.
  • Q4 2022 revenues rose 17.8% to $249.3 M (FY 2022: $898.3 M), and FY 2023 revenue guidance of +9–11% is set, but first-half margins will be pressured as fixed-price contracts absorb ongoing supply chain cost increases.
AI Generated. May Contain Errors.
Earnings Conference Call
Kratos Defense & Security Solutions Q4 2022
00:00 / 00:00

There are 11 speakers on the call.

Operator

Day and thank you for standing by. Welcome to the Kratos Defense and Security Solutions 4th Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen only mode. After the speakers' presentation, there will be a question and answer 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 Vice President and General Counsel.

Speaker 1

Thank you. Good afternoon, everyone, and thank you for joining us for the Kratos Defense and Security Solutions 4th Quarter 2022 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.

Speaker 1

Please keep these uncertainties and risks in mind as we discuss future strategic initiatives, potential market opportunities, operational outlook and financial guidance 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 is 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.

Speaker 2

Thank you, Marie. Good afternoon. Kratos' position as the leading disruptive technology company, designing, developing and fielding relevant systems product and solutions continues to progress, reflecting the trust our customers have in your company. Kratos along with our strategic partners, vendors and suppliers are aligned And we're moving rapidly to address the evolving threats, not with PowerPoints, press releases and scripted publications, but with real systems that we will discuss today. We believe that 2023 will be a transition year for Kratos To greater revenue, profit and cash flow, with significant prior year investments in technology, products and systems Transitioning from development, RD, T and E or LRIP to funded programs, contracts or full rate production, which will result in increased revenue, profit and operating cash flow for the company.

Speaker 2

This includes today's announcement that Kratos' BQM-177A unmanned aerial target drone is now entering full production. In Kratos' Rocket Systems business, where we have also made significant investments, we have now received 2 important New hypersonic system related program awards Mayhem and MOC TV with our partner Dynetics. Under the mock TB contract, which we announced in November, Kratos and the mock TB team will work to develop an affordable and responsive hypersonic test platform and national hypersonic testing capability in an effort to dramatically increase our nation's capacity for ground and flight testing of hypersonic technologies and payloads. Under the Mayhem or expendable hypersonic multi mission ISR and Strike program, Kratos will support the Air Force Research Laboratory's development of an air breathing hypersonic weapon system. Kratos is an industry leader in flight proven agile engineering capabilities with experience in high performance propulsion, hypersonics, exotic materials and air vehicle design, which we are applying to win large new program opportunities Like Mayhem and Mach TB, Kratos has previously successfully developed and flown several hypersonic systems And our internally funded hypersonic investments in unique and proprietary systems and vehicles, including Kratos' Zeus and Aranes, We believe we'll be disruptive game changers for our customers and our country and are beginning to pay dividends for Kratos' Stakeholders including with these recent program awards.

Speaker 2

Kratos' Rocket Systems business recently successfully integrated and launched 4 ballistic missile targets with our government partner, which included the successful intercept test of a medium range ballistic missile target By a Standard Missile 3 Block IIA fired from the JS Maya, marking the first time that a Japanese Maya class destroyer Has fired an SM-three Block IIA. We believe this successful test is representative of Kratos' industry leading position In the Rocket System, Missile Defense and Ballistic Missile Defense areas and of Kratos' affordable relevant disruptive high technology rocket systems And we expect Kratos' Rocket System business to be one of our fastest growing in 2023, driven by the increased global interest in air and missile defense systems. Kratos recently received the initial $30,000,000 in funding on a new potential $250,000,000 C5ISR production program in the microwave electronics area. This program is classified. Kratos' Microwave Electronics business had a record backlog at year end, including a focus on missile, air defense and radar systems, and we expect this business to be Kratos' one of our Fastest growing for 2023.

Speaker 2

Kratos' C5ISR business is also expected to be one of our fastest growing in 2023 With expected growth coming from several missile, air defense, radar and other programs, including GBSD Sentinel with our prime strategic partner Northrop Grumman. Other Kratos C5O ISR Business Programs include HIMARS, Titan, Patriot, THAAD, IBCS, IFPIC and SHORAD. Kratos has recently been selected as the engine design team for the Boom led collaboration on a new supersonic propulsion system called Symphony, A sustainable and cost efficient engine for Boom's planned Overtur supersonic airliner with Symphony being a bespoke design, Leveraging proven technologies and materials to achieve optimal supersonic performance and efficiency. Boom's Overture new Symphony propulsion system is expected to operate at net 0 carbon and meet chapter 14 noise levels. And when compared to derivative approaches, Symphony is ultimately expected to deliver a 25% increase in time on wing And significantly lower engine maintenance costs and is also expected to reduce overall airplane operating costs for airline customers by 10%.

Speaker 2

On the Symphony program, Kratos will utilize its supersonic engine design experience and expertise, Working under a standard commercial time and material type contract arrangement with no Kratos investment. The Kratosymphony team will include key Kratos personnel and engineers that were directly involved in supporting the design of the F119 And F-one hundred and thirty five supersonic engines that power the F-twenty two and the F-thirty five. Kratos is also supporting Rolls Royce on a B-fifty two re engine program with Rolls Royce and B-fifty two being certain of KTT's most important strategic partners and the program. Another growth area for Kratos is new space and related launch vehicles and propulsion systems Where KTT is currently under contract on multiple DoD government and commercial space system related programs involving Kratos' hardware and products in support of some of the most technologically advanced propulsion systems in the world. In the drone missile and powered munitions area, Kratos and KTT have made important progress over the past several months, including technically Delivering engines to a confidential customer for a yet to be announced UAS and receiving word from a customer regarding the future opportunity For up to thousands of Kratos' engines, which we are jointly working to address and KTT is forecast to be one of Kratos' fastest growing businesses in 2023.

Speaker 2

Kratos' Space and Satellite Communications business, our company's largest, It's also forecasting significant future organic growth and is expected to generate some of Kratos' highest margins, Including as related to Kratos' first to market software based open space virtualized TTNC, C2 and satellite ground systems, which continue to gain market acceptance in both the national security and the commercial market areas. The satellite communications industry is focused on virtualizing the entire ground infrastructure in order to be efficiently compatible With cloud based and other standardized networks, equipment and systems, including importantly 5 gs, which is another Kratos focus area here. Converting hardware to software that is installed and managed remotely via third party data centers Our standard compute devices is expected to provide satellite operators increased flexibility over their networks, Improving the response time to customer demands. This conversion to software is exactly what Kratos' open space And OpenEdge is focused on, for example, today's satellite terminals consist of purpose built hardware components that are limited to performing a dedicated function, for example, a satellite modem performing modulation and demodulation functions. Until Kratos' OpenEdge, satellite terminals, the devices that end users employ at the far edge of the satellite ground network to transmit and receive data have been purpose built hardware devices that seriously restrict functionality and flexibility at the network's edge.

Speaker 2

Kratos' OpenEdge disrupts these limitations by employing software, virtualized modems that can run on general purpose off the shelf compute devices and OpenEdge adds far more power and versatility by enabling Additional apps to run right at the network's edge. Kratos' OpenEdge uses a different model for operating at the edge, One that employs standards already widely adopted across the larger global telecommunications industry To expand terminal functions and make them more flexible, these standards that Kratos' OpenEdge employees are what enable mobile devices Such as smartphones to support roaming, use cloud based functions, interoperate with other networks and do much more. While satellites present a complex technology challenge, the goal of Kratos' OpenSpace and OpenEdge Is to help satellite operators make their services as mainstream as cellular communications and to capitalize on new services such as 5 gs, which is why Intelsat will be one of Kratos' first partners to supplant traditional satellite terminals with Kratos' OpenEdge. I hope you can see why here at Kratos we're so excited about our satellite business' future prospects. Kratos' target drone business is performing well with major Kratos sole source programs including the Air Force's AFSAT program featuring the Kratos' BQM-one hundred and 7 target and the United States Navy SSAT program featuring Kratos' 177 target drone.

Speaker 2

We're on both programs. We have recently additional large production awards. Additionally and very importantly, the recent United States Navy SSAT-one hundred and seventy seven program award includes target drones or missions for both Australia and Canada, 2 new Kratos BQM-one hundred and seventy seven target drone customers. We are currently in pursuit of certain new domestic target drone opportunities That if we are successful, could provide the next growth step function for the business. And we have recently seen a number of potential new international target drone opportunities that we believe are a result of current global conflicts and threats, including in the Ukraine and the related ongoing global recapitalization of strategic weapon Systems.

Speaker 2

Excuse me. In the tactical drone area, Kratos has recently received a contract for an initial 2 Valkyries from the United States Marines, along with sensors, weapon systems, payloads, etcetera, Under the Affordable Autonomous Cooperative Killers program, the Killers program is a new program for Kratos, Which we have not yet been able to formally announce or discuss. And I encourage you to review the Navy contract award announcement And other available publications, including as related to the USMC for additional information, including related to the believe that one of the primary reasons the Killers program was awarded to Kratos sole source is that we have available now Valkyrie jet drones coming off our active production line and that the Valkyrie's cost and price points are known, not on a hoped for PowerPoint slide, which estimated costs our competitors routinely change and increase after the fact, of which we believe certain of our customers are clearly beginning to take note. Kratos' Valkyrie is also a demonstrated LO, runway independent system, not requiring a runway to take off or land And Kratos' jet drones are also routinely ship launched, all of which we believe are becoming more of a differentiator for Kratos.

Speaker 2

It was also recently reported that the United States Air Force's 40th Flight Test Squadron at Eglin Air Force Base has now taken ownership A Valkyrie Aircraft with Valkyrie's ability to autonomously operate over vast distances can be evaluated along with certain other objectives. Eglin recently published photographs of Kratos' Valkyrie flying with manned F-sixteen fighters And emphasizing the Valkyrie's rail launch, runway independence and precision parachute recovery, certain of which were approved for us to publish today. None of Kratos' potential competitors have runway independent capability. With the competitors competing systems all currently having or plan to have landing gear to be dependent on a runway, which I believe will be completely untenable in a peer conflict. It was also recently reported that a U.

Speaker 2

S. Government customer is working with multiple industry partners To integrate leading edge autonomy capabilities into the XQ-58A as Kratos' Valkyrie and all Kratos drones have Open system architecture, meaning a variety of autonomous and AI cores can be integrated into our system. Open system architecture is another competitive differentiator for Kratos versus our competitors as the customers do not want to be vendor locked. It was recently reported that the Valkyrie has now entered a time critical test period with a U. S.

Speaker 2

Government customer related to certain manned unmanned teaming, which flight and testing are planned to be completed by the end of this year. The U. S. Air Force has now stated that the Skyborg and the Golden Horde Vanguard programs, both of which Kratos is involved in, Are transitioning to become programs of record and are expected to form the nucleus of new combat systems, Including Collaborative Combat Aircraft or CCAs, both Kratos' Valkyrie and the Mako tactical jet drones have performed under the SkyBoard program And the Golden Horde program has demonstrated how a group of unmanned aircraft or weapons can communicate with each other and operate collectively rather than singularly. In addition to the recent Valkyrie contract awards and this progress, We are now in contract negotiations with another new customer on a new program for the acquisition of multiple Valkyries, which we believe we will have under initial contract by the Q3 of this year.

Speaker 2

Additionally, We are also now currently in contract negotiations with the customer, Rolaido to Kratos' Valkyries valued at several tens of 1,000,000 of dollars, which we also expect to be completed and under contract by the Q3 of this year. And we have now also provided a Kratos Valkyrie to an additional potential new customer for systems assessment and review and we are in discussions as to potential next steps including purchasing, leasing, services type or other contractual arrangements. And we are also continuing discussions with Another potential new customer related to the acquisition of several Valkyries. It is important to emphasize that with each of these Valkyrie related opportunities That's similar to Kratos' Target Drone business. It is extremely important that in addition to initial Valkyrie Aircraft acquisition That the flight recovery support and other system related equipment and infrastructure is also being acquired and deployed by the customers.

Speaker 2

As this upfront investment represents a customer commitment to the system, which return to the customer is increased obviously by additional future 58A Aircraft Acquisitions. We are currently performing under multiple Valkyrie related government funded contracts or programs With a key element including the continued missionization and operationalization of the Kratos XQ-58A system And we are working closely with our customers on the optimal funding utilization and contract structures, Including the funding allocation between acquisition of aircraft, system related infrastructure, missionalization and operationalization In order to achieve the strategic objective. There has also recently been increased interest in certain other Kratos' tactical drone systems In addition to the Valkyrie, which I believe is as a result of what is occurring in the Ukraine, also included as related to affordable mass So now importantly, keys to our strategic tactical drone strategic decision making include Kratos is the only company that has affordable relevant systems flying now, not just PowerPoints, concepts, designs and press releases. And Kratos has an active production lines for jet drone aircraft today, with Kratos having produced over 1100 High performance unmanned jet target and tactical drone aircraft to date representing another important differentiated advantage for Kratos Another key reason why Kratos customers trust us, we have demonstrated that Kratos can and is delivering jet drones In quantity now at real known price points.

Speaker 2

So as a result of this progress, We've now moved forward with our 2nd serial production run of at least 12 of the next generation block of Kratos' Valkyries. This decision is important for several reasons, including having XU-58A systems available to immediately meet expected customer demand and supporting Kratos' first to market leadership position. We also want to ensure that there is no break in the current Valkyrie production line So that we can continue to improve on the learning curve efficiencies and related declining cost experience we have gained and achieved the target costs We are now providing in proposals to potential customers. The cost per pound of Kratos jet drone aircraft, We believe it's currently far below our competitors. I think we know it and they know it.

Speaker 2

And we expect continue to drive Kratos' drone cost down significantly, including with the continued actual production of aircraft to the benefit of Kratos' customers And to the detriment of certain competition, especially when the customers compare what it actually cost our competition To produce a jet drone aircraft, not what our competitors say or indicate in their proposals. As I mentioned, this new group of at least 12 Serial production Valkyries will be the next block upgrade version, including multiple enhancements based on the numerous successful flights we have completed with our customers, Their input and feedback and also including certain enhancements or modifications that Kratos' Ghost Works has been focused on, including to specifically address certain potential competitive adversarial threats, including in the Pacific. I continue to believe that Kratos' air gapped ghost works entity is truly a crown jewel of Kratos and in my opinion, the national asset for our country. At Kratos, affordability is a technology and Kratos' Ghostworks is by far the clear industry leader in high performance So to wrap up, based on our backlog, our significant new program awards and $10,000,000,000 opportunity pipeline, We expect an up and to the right future organic growth trajectory for Kratos with no currently planned acquisitions As we focus on execution, obtaining and retaining qualified personnel, which remains a primary operational challenge and continuing to bid on and win new program opportunities.

Speaker 2

As we begin 2023, every Kratos business is expecting organic growth And we are forecasting Kratos' consolidated 'twenty three over 'twenty two revenue growth of approximately 10% With increased margins, reduced internally funded investments and increased cash flow. Deanna?

Speaker 3

Thank you, Eric. Good afternoon. As we have included a detailed summary of the 4th quarter and full year financial performance for FY 'twenty two and Q1 and full year 'twenty three financial guidance in the press release we published earlier today, I will focus on the highlights in my remarks today. Revenues for the Q4 were $249,300,000 up from $211,600,000 in the Q4 of 1, reflecting a 17.8 percent increase. Excluding the impact of the SRE, Cosmic and CTT acquisitions, which contributed $29,100,000 in revenues in the Q4 of 'twenty two.

Speaker 3

Kratos revenues grew organically 4.1%. Fiscal year 'twenty two revenues of $898,300,000 increased $86,800,000 from 811 We also contributed revenues of $95,500,000 during the year and excluding the impact of the legacy training services business, which was down $21,500,000 from $40,100,000 compared to FY 2021, revenues grew organically 1.7%. Included in operating cash flows for fiscal 2022 is approximately $9,000,000 in investments in non recurring engineering costs for new rocket systems, Hypersonic and related products, including for Kratos' Zeus and Aranes systems, including as directly related to certain received and new contract awards in the hypersonic system area. In 2022, in addition to internal R and D costs of $30,300,000 incurred in our Space and Satellite business. We also invested approximately $7,600,000 in software development costs related to our OpenSpace Virtualized Software product.

Speaker 3

Our contract mix for fiscal 2022 was 70% revenues from fixed price Contracts 24% for cost plus type contracts and 6% related to time and material contracts. Revenues generated from contracts with the U. S. Federal Government during the quarter were approximately 70%, including revenues generated from contracts with the DoD, Non DoD Federal Government Agencies and FMS contracts. In fiscal 'twenty two, we generated 11% of revenues from commercial 19% from foreign customers.

Speaker 3

Now moving on to financial guidance. Our Q1 and full year 'twenty three financial guidance It's related to obtaining and retaining qualified personnel, supply chain disruptions, inflation and related expected cost and price increases that are currently and expected to continue impacting both the industry and Kratos. Throughout 2022 and in the Q1 of 2023, Kratos has experienced continued impacts from supply chain disruptions, including cost increases for materials, supplies, transportation and utilities As our contract mix is predominantly from fixed price, we are required to absorb these additional costs until the period of performance is on existing backlog and new contracts are negotiated with current pricing. Accordingly, as we transition to new contracts over 2023, We expect margin rates to continue to be lower in the first half of the year as a period of performance on existing backlog is executed with an expectation of margin improvement in the second half of this year as a mix of newer recently priced contracts are expected to increase. Our revenue guidance range for the Q1 of 'twenty three reflects a 12% to 17% increase over the Q1 of 'twenty two and our annual revenue guidance for fiscal 'twenty three reflects a 9% to 11% increase over fiscal 'twenty two revenues.

Speaker 3

Consistent with what we have stated on our previous earnings calls for our forecasted performance of our tactical unmanned aerial systems We remain conservative and will only include contract awards we have received or with respect to which we are in final negotiations with the customers. Accordingly, included in our guidance range today is a relatively flat revenue of approximately $220,000,000 to 225,000,000 for our Unmanned Systems division as compared to FY 2022. This range includes an estimated increase in Valkyrie related revenues from 32 This forecasted increase is offset by a reduction of approximately $15,000,000 from a non Valkyrie related As we had previously discussed on our Q3 earnings call that the customer informed us in 2022 that future funding was not available. The FY 'twenty three revenue guidance range for KGS of $760,000,000 to $775,000,000 reflects a 12% to 14% increase from FY 2022 revenues, representing forecasted revenue growth across every business Unit in KGS with the most notable forecasted growth in our space and satellite, C5ISR, turbine, microwave products and Hypersonic related business areas. Based upon funding, production, delivery and execution schedules, Second half twenty twenty three revenues are expected to ramp and be sequentially greater than the first half of twenty twenty three with margins expected to expand in the second half The year on increased revenue volumes and based on the expected mix of revenues, including new fixed price contracts, which include more recent cost estimates.

Speaker 3

Operating cash flows are expected to be stronger in the second half of the year as well, driven by the expected expansion in margins and the expected conversion of inventory builds from FY 'twenty two and the first half of twenty twenty three and based upon

Operator

Please standby while we compile the Q and A roster. Our first question comes from the line of Mike Crawford with B. Riley.

Speaker 4

Thank you. I have a few quick questions. So one, what happens operationally in Oklahoma after The second 12 Valkyrie, I guess that's a Block II Valkyrie's production spiral, particularly if you get These additional orders, contracts you're supposed to have by Q3, like what would be a full Ray, one production line, one shift, continuous flow of Valkyrie production down there.

Speaker 2

Okay. So under the current construct, Mike, because if you recall, The facility has a base facility and then there are contiguous additional facilities that we have options on. Under the current configuration without expanding anymore, okay, And assuming the similar number of tactical fire jets and fire jets that we're building in Oklahoma because we're building those there too Now we can do annually 35 to 45 drones a year in the current configuration. We can if we exercise the next option and if we haven't if we do that and We can easily double it very quickly.

Speaker 4

Okay. Thank you. And just regarding other competitors with maybe not as affordable aircrafts, but Like isn't there like a ghost bat that might be out there today?

Speaker 2

Mike, I haven't seen or read anything On the Ghost VAT in 6 months or more. So I'm not sure what's going on With that, someone sent me something a month or 2 ago and it said that it was not going to be considered in the U. S. That's something I read. I don't really know, buddy.

Speaker 4

Okay. And then Just real quick, what should we be looking for in the administration's budget request regarding getting These former Vanguard programs into programs of record, be it N Next Generation Air Dominance or CCA, Is there anything specific relating to Valkyrie that we should be looking for or you're hoping to see?

Speaker 2

Yes. So in my opinion, based on most recently with Forestar Chief of Staff, Brown said last He said that when the 24 budget is submitted, and now I understand that's coming in the 1st or 2nd week of March, That the public, we should all see a significant increase and a significant commitment To CCAs, he was talking Collaborative Combat Aircraft. And in that interview that he did, he talked about A family of them of all different types and sizes and cost points. So based on that, I think that we should all see Significant additional funding based on what the Chief of Staff said.

Speaker 4

Okay, excellent. Thank you very much.

Speaker 2

Yes.

Operator

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

Speaker 5

Yes. Hi, good afternoon, Eric and Deanna.

Speaker 3

Hi, Ken. Hi, Ken.

Speaker 6

Hey, Eric. I wanted

Speaker 5

to follow-up on your comments on Valkyrie cost. It sounds like you're Pushing a lot to take cost out. Can you maybe help with, if you think about the 2nd block versus the 1st block, How much maybe is cost down? And how much of that are you able to keep versus how much of the lower costs are you sharing with your customer?

Speaker 2

Yes. So as you can imagine, in the past couple of years, because of what's going on with inflation and Supply chain and labor costs, everything has gone up including the cost of our drones. That's been happening while the learning curve on the production rate has been coming Down. So we are expecting, and we've seen this with our target drones from development LRIP to production, so we have all the experience and the historical data on these production learning curves on the jet drones. So we expect Not a it will not be a significant drop with this 12, but it will be a drop and the knee in the curve If considering that we continue to do this, we'll come in the next block when and if we decide to do that.

Speaker 2

And then there would be a significant knee in the curve down. And we obviously are very close to the industry. We're very close Less costly than what they really are irrespective of what they're telling potential customers. And the potential customers are either Learning that or they're going to learn it real soon in some instances. And we're really going to push this as you're alluding to as a competitive advantage With actual costs, not forecasts that are based and switched on.

Speaker 5

No, that's helpful. And as you think about either now or With Block III, if you eventually go there, is the Valkyrie profitable on a per unit basis or what's it take maybe to get to that point?

Speaker 2

On the most recent contract awards that absolutely is profitable. Absolutely.

Speaker 5

Great. That's very helpful. Just one final question. Can you maybe, I mean, great work with the Navy. It sounds like and with the release you put out today, it sounds like there's a lot happening in terms of Flight test activity and certainly public discussion around the requirements within CCA and other areas is multiplying.

Speaker 5

What's been the latest feedback you've been getting from your Air Force customer? And is there any color you can share just around Specific within the tactical portfolio, level of enthusiasm and maybe how they're viewing your efforts and then the Valkyrie in particular?

Speaker 2

Yes. So Mike, I'm going to answer the question not specific to the Air Force. I cannot, as I've talked about before, The things have really been buttoned up here. They've really been buttoned up. So my comments are going to be general To all of our existing customers and the customers that I said today, I expect to have under contract in the second half of this year.

Speaker 2

Here's the feedback. You're the only guys that have a jet aircraft flying today. The propeller planes, they've been great to kill terrorists. They're all going to get shot down. They're not survivable.

Speaker 2

Tied to a runway is an absolute nonstarter. Irrespective of what people say, it's a nonstarter. Obviously, the runways are all targeted and we that have the information know the numbers, all right? That quantities matter. We've learned that in the last 12 months in the Ukraine.

Speaker 2

Quantities matter. And the only way you can achieve quantities is if you have affordability. And then the last one, Mike, is back to the Ukraine. The Russians have been using their SU-fifty seven, which is equivalent to our F-twenty two, F-thirty five. They've been using their Kinzhal and their Avangard hypersonic weapons.

Speaker 2

So they've been using their exquisites to no Or little effect on the battlefield because they're too expensive and they're not enough of them. And I think a lot of people are rethinking a mix of Exquisite, one exquisite versus for the same cost, 100 Jet drones. That's the feedback we're getting and I think a lot of that is tying into The progress we've made since our last call. Great. Thanks, Eric.

Speaker 2

Okay. Thanks, Ken.

Operator

Our next question comes from Seth Seifman with JPMorgan.

Speaker 7

Okay. Thanks and good morning or good evening, sorry. I

Speaker 3

have forced

Speaker 7

to have it. Hi. So I wanted to ask about I wanted to make sure I got this right and thank you for providing The segment guidance, the unmanned segment was to be flattish in 2023 In the low 220s?

Speaker 3

Correct. 220 to 225.

Speaker 7

225, right. And so with some growth in the small amount of growth in the tactical drones, What's happening sorry, yes, on the tax levels, what's happening with the target trends in 2023?

Speaker 3

Yes. So we have there is approximately like a 5% growth assumed in the estimate.

Speaker 7

Okay. For the target drones?

Speaker 3

For the target drones, yes.

Speaker 7

Okay. And the tactical drones Or down or the tactical drone was going up from 32 to 43 or was that down from?

Speaker 3

No, it's actually down. So The Valkyrie related tactical drones is from $32,000,000 to $43,000,000 but there's a headwind of $15,000,000 which is a non

Speaker 7

Okay. Got you.

Speaker 3

Okay. Tactical, Joan, yes.

Speaker 7

Cool. Understood. Great. That's helpful. And then just, I guess if you think about these orders that are coming up, hopefully in the Q3 of this year And you think about kind of the cycle time for those and then how those get booked eventually as revenue and earnings.

Speaker 7

Should we think about that as something that's going to drive is that something that drives 2024? And does it encompass All of the kind of second lot that you're building, does it kind of take you into the 3rd lot? How should we kind of think about, what those quantities might be?

Speaker 2

Yes. So Seth, I went into some detail on the infrastructure, The launch equipment, the flight equipment, the recovery equipment, the sustainment equipment that To operate these jet drones and how the customers now are starting to look at that and they're acquiring that from us, very similar The strategic asset we have in our Target Drone Systems, getting that infrastructure out there. In addition to that, I went into some detail again on purpose On the customers are now funding significantly the missionization and operationalization of the aircraft, Which all of these obviously strategically are very, very important that they're making the investment in the infrastructure and they're missionalizing and operationalizing The aircraft. So please keep that in mind because as these contracts come, it is not totally clear to me yet How much of it's going to be for aircraft and how much of it is going to be for the support equipment, the launch equipment, the missionization, the authorization, Okay. So with that being said, Deanna, go back on if they're percent complete and the aircraft is done, How that's booked?

Speaker 3

Yes, yes. So similar to what we discussed when we Started the original 12 lots. So they started as capital expenditures. And when there is a contract that is awarded And it is related to an aircraft sale, then whatever value or however complete we are on that System would be transferred from capital to inventory and then that would determine the percent complete from a revenue recognition So if we're say 50% complete on an aircraft that would transfer over and then 50% of the revenue related That aircraft would be recorded at the time the contract is awarded.

Speaker 7

Right. Got it. Got it. Okay. Thanks.

Speaker 7

And then just to wrap up on this point, I assume In the missionization and kind of support equipment and setting up an infrastructure that's related onto these aircraft, I imagine, Is that another area where you feel like Kratos has an advantage versus the competition both in terms of where you are in that process And in terms of cost?

Speaker 2

You can see me, I'm smiling. The answer is absolutely yes, Because as I've said, we're the only guy that has anything flying. We're the only one that does runway independence. We're the only one really that has jet high performance drones. And so for us to get this equipment out there, which of course the pedigree is all the target drones, we know how to do it.

Speaker 2

We do dozens and dozens of missions a year. We're building over 150 aircraft a year or more. Absolutely. This is finally it appears to be trending in our competitive advantage areas.

Speaker 7

Okay. Excellent. I'll pass this on, but thanks very much.

Speaker 3

Thank you. Thanks, Seth.

Operator

Our next question comes from the line of Noah Poponak with Goldman Sachs.

Speaker 2

Hello, everyone.

Speaker 3

Hi, Noah. Good afternoon.

Speaker 8

Eric, can you just Tell us how many Valkyrie unit deliveries are assumed in the 2023 outlook? And what do you think that does in 2024?

Speaker 2

Right. Yes. Go ahead. I'll have Deanna answer it because there's percent complete.

Speaker 3

Yes. There's percent complete. So but in total, The total revenue base is based on about 3 to 4 aircraft.

Speaker 2

This year? Correct. That's in the forecast.

Speaker 3

That's in the forecast.

Speaker 8

What do you think that looks like next year?

Speaker 2

No, as you know, I'm gun shy and I don't want to get ahead of it anymore. I don't want to do that. Okay.

Speaker 8

That's fair.

Speaker 2

I'm just gunshot man.

Speaker 8

You have a release out About Valkyrie flight testing capability evolution that refers to a focus on experimentation. I guess, why is the focus on experimentation? It Felt like you had established a product with capability that the customer had said they wanted. Why is there still so much evolution and experimentation at this point in the lifecycle of that product versus just buying it?

Speaker 2

My opinion, Eric's opinion, because this is brand new and it's not replacing anything. It's brand new. And as one of the pictures we were approved to put out today, Look how close that F-sixteen is flying to the Kratos Valkyrie. And I believe it's that Comfort level, this is my opinion, the comfort level. And because it's new and it's developing and getting comfortable with That concept of operations.

Speaker 2

That's why I that I believe is the answer to my opinion,

Speaker 7

The

Speaker 2

answer to your question, yes.

Speaker 8

Yes, that makes sense. And I guess you laid out the pieces of unmanned for the year with 5% growth And Target and then I guess tactical is essentially flat with some Valkyrie growth offset by the 15,000,000 That's out. What's the status of tactical that's not Valkyrie? Right. Over the years, there's been a discussion of half a dozen other efforts.

Speaker 8

Where are those?

Speaker 2

Yes. So I have to preface this, Noah, with the Secretary of the Air Force a year ago said I'm coming out with these CCA programs and they're going to be highly classified. They're highly classified. He also said that all or virtually all, I forget his quote, of the current and existing drone programs We'll be feeders and we'll be folded into these classified programs. In other words, putting a classified bubble over virtually Everything, okay.

Speaker 2

In my prepared remarks today, I went out of my way to specifically say That we are making progress with Valkyrie, Mako, tactical fire jet or Airwolf. Those are the areas we're making progress in that I can talk about.

Speaker 8

Got it. Okay. And then just lastly, we'd like to ask about profitability, margins, cash flow. With the margins down last year, if I sort of zoom out And look at margins over time, cash flow over time, many of the last several years, It's GAAP net income that's breakeven or negative. We add back the D and A, we add back the stock comp on the cash flow statement.

Speaker 8

Then there's working capital that's negative and cash flow that's negative. Recognizing A lot of your efforts are early stage. There's a lot of potential long term growth. You have to invest in a lot of that effort. How much longer does the cash flow statement look like that?

Speaker 8

I mean, how long does it take Before there's a consistently positive GAAP net margin, consistently positive cash flow Ed Cardos?

Speaker 3

Yes. Clearly, with 2023, we were expecting to return to cash flow Generation for free cash flow, albeit at a lower level and that's because we are still making some investments and there is still As we transition from development to production, we expect that to increase. 2022 was unfortunately a perfect storm from a cash flow perspective because with The inventory that increases about $24,000,000 for the year to be able to we've done a lot of advanced Inventory purchases to be able to mitigate as much as we could from a supply chain impact, and we're still seeing some of that in the First half of twenty twenty three, we expect that to start converting through the cash cycle and the revenue cycle By the second half of twenty twenty three, but the first half of twenty twenty three is going to be we're still going to see that working capital use. But we do expect that to turn around in 2023 and expect that to improve as we move out of 2023 and into 2024.

Speaker 2

Yes. No, I opened up saying I believe 'twenty three is going to be the transition year Because we've had a number of programs, not all of them as Deanna said, but on a number. We've left development. We're either in LRIP or we're in full rate production. And so 'twenty three is going to I believe is going to be the year where we are returning to sustained Revenue growth, sustained profit growth, positive cash flow and sustained positive cash flow Growth.

Speaker 2

I believe 'twenty three is the year and I can lay that out programmatically.

Speaker 8

Okay, great. Thanks so much for all the detail. I appreciate it.

Speaker 2

Thank you, sir. Thank you.

Operator

Our next question comes from Greg Konrad with Jefferies.

Speaker 6

Good evening.

Speaker 2

Hi, Greg. Hey, Greg. Good afternoon.

Speaker 6

I feel like I have to ask about Valkyrie. Maybe just to kind of summarize What you've talked about, you mentioned a number of Valkyrie applications in the beginning of the call. Is there any way to think about How many efforts are ongoing with Valkyrie across customers? And when you think about that $10,000,000,000 pipeline, How much does Valkyrie contribute to it and maybe how has that trended over the past year?

Speaker 2

That's a loaded question, Greg. On the first part of your Question. As I said in my comments, we are underfunded government Contracts on multiple programs related to Valkyrie, Multiple, more than 3, more than 4 were on multiple, funded. We expect that to increase between now and the end of this year. As I said in the second half of this year, we're in contract negotiations now.

Speaker 2

I wish I could tell you we'd get them done in Q2. I don't think so. I think we'll get them done in Q3 On a few others. So that's going to continue to expand. I'm not going to and I'm sorry, we're not going to comment on what we expect and what we have In our pipeline, it ties into the other to Ken's question and Mike's question and Noah's question.

Speaker 2

I'm gun shy, I'm not going to get ahead of myself. We put together our 2023 plan with an absolute minimum Of tactical revenue, absolute minimum, but every other business in the company is firing on all cylinders, everyone. Our Space business is doing great. Our Engine business is doing great. I can keep going.

Speaker 2

And so we're going to let them all do great. They're going to drive 10% growth or more. And when the tactical stuff happens, Then we'll put it in the numbers.

Speaker 6

I mean, and I guess just a follow-up, I mean, you mentioned all the businesses that Are kind of among the fastest grower and you kind of talked about growth being up into the right. And then just based on kind of your Opportunity commentary, I mean, would you expect unmanned to kind of lead the growth as you get Through 2023 and that's kind of the biggest driver of growth being up into the right as you move forward?

Speaker 2

Okay. If things turn out the way I believe they're going to turn out, yes. But that's not what we're going to forecast until we either sign the contract or we're on we're in the red zone.

Speaker 6

And then maybe just last question non Valkyrie or KUS related. Just thinking about space and you mentioned open space and kind of how that played out in 2022. I think a lot of the Larger contracts that you talked about have been awarded and we've seen a lot of these constellations kind of move forward. What are you seeing in that pipeline in terms of awards as you think about 2023 and kind of ground stations overall?

Speaker 2

Now that question I'll answer. That's the first question. That's right. What is happening in the space area Commercially and National Security is unprecedented. The technological Vision of smaller, faster getting it up into space has turned into reality.

Speaker 2

And all these satellites that are going up into space unless they have optical links and even if they do have optical links at some point, they got to come down to the ground And that's where we is. And this partnership we have with Intelsac. I think they're the largest operator, one of the largest too, okay? This program that's a commercial program. This DoD program we won with Blue Halo SCAR.

Speaker 2

I think our initial piece is 160, 100 some our initial piece. That's a military program. Both have open space. That is so important That we are penetrating both commercial and DoD markets with the software product, which is going to which we're first to market, Which is giving us an incredible competitive advantage over anyone else who we understand are 3 or 4 years away. Our pipeline in our space business, I think is the biggest in the company.

Speaker 2

It is big And it's and we keep winning. I think the book to bill our book to bill each of the last two quarters has been 1.2, 1.3 last year. We're doing it's doing great, which is why I've said, I'm going to say it again, our space our overall space related business, I think I said it's 13%, 14%, 15% growth. I'm sticking with it. And it's all the boats Rise with the tide going up, the tide is going up and I believe we have the prettiest boat of the fleet right now With OpenSpace and OpenEdge.

Speaker 6

I'll leave it at that. Appreciate it. Thanks, Eric. Okay.

Operator

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

Speaker 9

Thank you. Good evening.

Speaker 2

Hey. Good evening. Good day.

Speaker 9

So just wanted to start, last quarter you spent a good amount of time talking about staffing and the difficulties In hiring new staff and some of the challenges there, I was wondering maybe just give us some of an update, more color on your Staffs and staffing and where you might still be challenged in adding staff.

Speaker 3

Yes. Joe, we are seeing some positive traction. We had started to see that when we announced our 3rd quarter results and we have We're trending positively with net adds along the path that and our plan that we had expected now. So The traction has been good. I think with especially with given some of the layoffs across the tech sector that has been beneficial for Our company?

Speaker 2

The check, that's absolutely correct. So overall, definitely improving and trending in the right direction. Yes. Okay. However, in areas like hypersonics and Engineers and technicians getting very high security clearances, including in the manufacturing area, It's very challenging still.

Speaker 2

And let me tell you why, in my opinion. It's because some of these new space companies where people are racing who's going to be tomorrow's first, They are spending an incredible amount of money hiring as many people as they possibly can To beat somebody else to Mars first with their spaceship. And while that's happening, the primes And I can you know the programs as well as I all these programs because of geopolitical events are beginning or ramping up. They're trying to hire the same people too. And so that is still a challenge, very, very significant challenge.

Speaker 2

Let me tell you one of our primary ways that we're being successful. 1 of the primary ways we're being successful As we say, if you come to Kratos, we will not stick you on this program and you'll be on it for 40 years and you'll retire on it, Which if you go to a company making a bomber or submarine or spaceship, that's going to happen. If you come to Kratos, You're going to work on these 4 different drone programs or these 5 different hypersonic programs, etcetera, and that seems to be a winning ticket with at least Some

Speaker 9

people. Okay, great for that. Thank you. And then you made some of the acquisitions, obviously you talked about them and their revenue contribution. I was wondering if maybe you could give us a little more color What kind of synergies you're seeing from these acquisitions?

Speaker 9

Are they opening kind of new that maybe you weren't able to get into previously, now that they're part of the Kratos family, Combined with some of the other things that you're doing, are allowing you to maybe even broaden even further the opportunity set.

Speaker 2

Yes. So Joe, as you know, we're not an acquisitive company. And as I've said, we're not don't expect us to make any acquisitions for the foreseeable future of any We've got an incredible hand of cards right now. We have to execute. So to your question, each of the 3 Are doing incredible in their own way and let me be very specific.

Speaker 2

So Southern Research, As I mentioned when we were acquiring them, I believe they're literally under contract or are familiar with every hypersonic Program or initiative in the United States of America. And if I'm off, I'm off by like 0.1% all right. They were instrumental in Kratos winning mock TV and in Kratos winning Mayhem and they are going to be instrumental in us winning several others that are coming. This is truly a 1 +1equal3. And this is truly I'm not one You see people make acquisitions and they say revenue synergies.

Speaker 2

You're like, what the hell is that? Okay. Well, these are revenue synergies because Together, we are our capabilities were beating the primes. And we have a strategic partner Dynetics. And with Dynetics and with Southern Research, we're unbeat I think we're undefeated.

Speaker 2

We're undefeated. All right. CTT, the microwave business. I'm not going to get into program names, but just recently we were informed 2 new incredible opportunities, multiple 1,000,000 of dollars, I believe we're going to be sole source on both. We are reentering the microwave area with a focus on space because we know space.

Speaker 2

And if you look at the funding documents and you look at missiles, radars and satellites, they all use microwave and microwave electronics, Similar situation as satellite, all the boats are rising with the tide. The Kratos boat with CTT is definitely going to rise with the tide. And microwave businesses typically have some of the highest margins in the industry once they reach critical mass. And the other one, Cosmic, I think 99% of what they do is classified, okay? But They are absolutely instrumental in our penetrating customers we never had access to or could have access to With our open space and other products, I was with them, Deanna and I and the senior team were with them a few weeks ago and it is Excellent, culturally.

Speaker 2

So all 3 are so far so Good. Integrations have gone well. Most importantly, 0 key people have left, none. Everybody appears to be happy. And we all have a common mission is to win.

Speaker 9

Great. Thanks for those insights and thanks for taking the questions. Thank you, sir.

Operator

Our next question comes from the line of Austin Moeller with Canaccord Genuity.

Speaker 10

Hi, good afternoon, Eric and Deanna.

Speaker 2

Hey, Austin. Good evening.

Speaker 10

So just my first question here on Valkyrie. I know there's a lot you can't say, but If you look at Navy versus Air Force, does it seem like the Navy is getting more excited or more aggressive About looking at Valkyrie relative to some of your other customers, just given you've got multiple generals out there that are Saying that they may see a potential Taiwan invasion in the 2025 to 2027 timeline. And You've already discussed the saturation of the runways and the need to be runway independent. And of course, the Ghost Bat doesn't have that. So I mean, Even if it's not being used as a wingman, if we look at what's going on in Ukraine with Russia using the Shahed 136 To saturate enemy air defenses, I mean, clearly it would be valuable as a force multiplier from that perspective, right?

Speaker 2

Yes, yes and yes. And to answer your question, As I alluded to a few minutes ago, over the last 4 months since we last chatted with you all, There has been significant movement and momentum across the board, including the Air Force. I mean, look at the and I can only say what we've been approved to say and what they've put out, but take a look at what we're doing at Eglin with the Air Force. Read closely Some of the things that have come out about what we're doing, what's happening down there, why we're down there, it's To Kratos, it's very significant and the Air Force remains a very important partner of ours. On the NavyMarine Corps, they have announced, as we've seen publicly, they're moving forward with Valkyrie.

Speaker 2

And I went through some of the reasons why. And I believe you're going to see over the balance of this year significant additional activity with the Marine Corps Specifically relative to the Valkyrie, related to their Reemphasizing what their mission is and how they want to execute it, in particular, in the Pacific. You hit the key points, Buddy, on why. The Valkyrie is runway independent. I love it.

Speaker 2

It's runway independent. It's very low cost, orders of magnitude less than what anyone else has on a piece of paper. And momentum appears right now to be moving in the right direction.

Speaker 10

Okay. That's good to hear. And then just my second question here. On the last Earnings call, we talked a lot about supply chain. And so I was just wondering where we at on what you see in terms of supply chain lead times for both FPGAs to support your open space programs like the big Intelsat and the Blue Halo contract And where are we at on supply chain for the Sentinel nuclear missile program?

Speaker 3

So supply chain delays, we are still seeing that 6 to 12 month turnaround on that PGA, so we are continuing to see some disruption, which is one of the reasons we believe Ford on the inventory purchases

Speaker 10

Okay. And then just one last question. The Valkyries for this new Block II production Is that again being funded by you or is that being funded by customer milestone payments?

Speaker 2

So initially on the long leads, It's being funded by us, but we have ours as I opened up with my comments, I did it for a reason, Certain of our key partners, suppliers, they're working with us. And so what that means is I believe That there will be my plan, the business plan is that as we build these, there will be an alignment Of customer funding customer orders as we build these, so we will not have to make as much of a lean forward investment as we did with the initial twelve. That's the plan based on customer input and the discussions and negotiations we've had With certain of the key, I call them the kryptonite suppliers and partners.

Speaker 10

Okay. That's helpful to understand. Thanks for all the color and everything.

Speaker 2

Thank you, sir. Thank you.

Operator

That concludes today's question and answer session. I'd like to turn the call back to Eric DeMarco for closing remarks.

Speaker 2

Excellent. Thank you all for joining us today. And I know this went longer than usual. I think it's because it was the end of the year, so it's been 4 months. And we look forward to updating you again in a few months at the end of Q1.

Speaker 2

Thank you.

Operator

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

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