Good day, and thank you for standing by. Welcome to Kratos Defense & Security Solutions First Quarter 2024 Earnings Conference Call. [Operator Instructions] Please note that today's conference is being recorded. I will now hand the conference over to your speaker host, Marie Mendoza, Senior Vice President and General Counsel. Please go ahead.

Thank you. Good afternoon, everyone. Thank you for joining us for the Kratos Defense & Security Solutions First 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.

Thank you, Marie. Good afternoon. Kratos' positioning as a leading defense technology products and software company focused on obtaining and supporting programs of record organic growth and execution was reflected in our Q1 results. As a public company that reports every 3 months, Kratos' team's execution is visible to all of our stakeholders and includes industry-leading organic growth, LTM annual positive operating cash flow generation, increased profitability while also making significant internally funded investments in large and growing market areas where Kratos is the industry leader. Accelerating organic growth areas for Kratos include our unmanned jet drone systems, jet engines for drones, missiles, loitering munitions and high-performance systems and microwave electronics for air defense, missile, radar and satellite systems. Kratos' strategy of partnering with large traditional system integrators with Kratos bringing differentiating value, including existing capabilities and a lower cost is also accelerating, including in the drone, hypersonic propulsion system, solid rocket motor and the C5ISR areas. For the first quarter, every Kratos business unit exceeded its revenue or profit forecast or both. We ended Q1 with a backlog of over $1.2 billion, an opportunity pipeline of approximately $11 billion. And with the 2024 U.S. defense budget and the supplemental bill now approved. We have increased confidence in our 2024 financial forecast, which we affirm today and also as we now look towards 2025. Of particular note, Kratos' Unmanned Systems business Q1 organic growth was 21.8%, with bookings of $81 million for a book-to-bill ratio of 1.4:1. And we are forecasting approximate 20% growth for unmanned systems this year, driven by the current geopolitical threat environment. Kratos' unmanned systems Q1 book-to-bill ratio of 1.4 on top of an approximate Q1 22% growth rate is reflective of the demand we are seeing for Kratos' affordable, high-performance jet drone aircraft systems, including…

Thank you, Eric. Good afternoon. As we have included a detailed summary of the first quarter financial performance as well as the initial second quarter and affirmation of the full year 2024 financial guidance in the press release we published earlier today, I will focus on the highlights in my remarks today. Revenues for the first quarter were $277.2 million, exceeding our estimated range of $240 million to $260 million, which includes higher-than-expected performance and delivery across most of our businesses with notable strength in our turbine technologies and Microwave Products businesses. All business units generated organic revenue growth over last year's first quarter, resulting in a 19.5% consolidated organic revenue growth rate, including the impact of the Sierra Technical Services or STS acquisition on a pro forma basis as if acquired at the beginning of 2023. Adjusted EBITDA for the first quarter of '24 was $26 million, exceeding our estimated range of $16 million to $18 million, reflecting the additional revenues as well as a more favorable mix of higher margin revenues with notable strength in our turbine technologies and microwave products businesses, as well as higher margin software and data-related content from our satellite business. Positive cash flow from operations generated was $700,000, which includes the impact of working capital requirements related to increases in inventory balances and prepaid assets related to supplier required deposits and prepayments for materials and equipment. Free cash flow used from operations was $15.9 million after funding capital expenditures of $16.6 million. As we planned, we are making investments to expand and build out certain of our manufacturing and production facilities in our microwave products, rocket systems and hypersonic businesses to meet anticipated customer orders and requirements and investing in related new machinery, equipment and systems. We are also continuing to manufacture the…

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

[Operator Instructions] Now first question coming from the line of Peter Arment with Baird.

Yes, Eric and Deanna, nice results. Eric, maybe just to start at a high level, just when we think about -- you had really strong 20% organic growth here in the first quarter, and if we think about your guidance of approximately 10% growth on the top line for the year, how do we think about that just given you -- that would be -- growth would be kind of down ticking to the high single-digits when we think about budgets have passed, supplemental has been passed and just kind of the demand signals that you're seeing for across the board in your businesses? Would you consider your top line conservative? Or just how would you frame it?

Right. Peter, the -- our backlog and the near-term opportunities -- 2024, we've got 2020 site on it, we've got it. The CRA went 6 months, as you know, the government contracting offices have got to get 12 months' worth of money under contract and obligated in 6 months. And we're being cautious here. We are just being cautious. We've got it in front of us, the government -- and I'm not putting anything on them, they got a lot of work to do. They got to get this under contract and out to all of us.

Yes. That's fair. And then just regarding your -- the engine opportunities, both Florida Turbine and TDI both have significant opportunities. How do you -- how are you kind of expecting kind of the time line to go on some of these businesses in terms of you're making a lot of investments and just sort of thinking about how they'll scale up.

Yes. Unless something totally unexpected happens this year, KTT and TDI, they're going to continue to meet or exceed our expectations. The programs that we've won across both portfolios are very, very impressive. That does not include where we expect in the second half of this year to begin receiving additional production programs for engines, for missiles, drones and/or loitering munitions. The funding is there, the customers are there. I'm tying into my -- getting things under contract and getting them out, not just direct to us, but also we're working with the prime. We expect for the next several years, our engine business is to be some of the strongest growers in the company, and it ties directly into the drone platforms, the missile platforms and the loitering munition platforms that are coming down the pipe, they're in the public, they're in the press today, and we're designed in with our turbojets.

Perfect. And just lastly, any update you can give us on kind of positioning around for CCA for Increment 2? I know that, that is something that is tracking for later this year or maybe early next year depending on what happens on sort of timing, but any update you can give us there, that would be helpful.

Yes. The Air Force obviously announced the CCA program is going to be up to 2,000 drones. The Secretary announced last week or the week before last, that Inc.(1) which was just awarded, which was not in any of our forecasts was not contemplated in any of our numbers, was for 100 planes. We're focused on the other 1,900, which we believe a significant number of which are right in our sweet spot based on type of performance. So that's how we're looking at this, Peter.

And our next question coming from the line of Michael Ciarmoli with Truist Securities.

Nice results. Eric, maybe just to continue on Peter's question there on CCA and you actually said there was news about replicator. Does the Switchblade 600 provide you guys opportunity? I think in the past, you've kind of married that platform with Air Wolf. Any color there?

Michael, I can't comment directly on what was announced recently. I can say that we have launched the AeroVironment drones off of our drones, which gives them extended range and gives them extended capability, and on replicator kind of sort of similar to the CCAs. This award was called Tranche 1, and it was focused on Class I and Class II UAVs. And the second tranche is coming and the third tranche is coming, both of which either in the air system or the propulsion system, we're hoping to be involved. So this is rolling out very similar to how we've been led to expect it would by the government.

Got it. And then you guys talked about a lot of investment, new existing facilities really across multiple lines of business. No change to the CapEx. You obviously did the raise, you've got a significant amount of cash on the balance sheet. Is everything contemplated in the CapEx spend? Is any one of these investments in a certain capability consuming substantially more? Can you maybe give us even directionally size rank order, how much investments kind of in each capability?

Yes. So let's go down the list. The known ones that we're going to be that we've begun or we're going to be beginning, we're standing up 2 engine manufacturing lines, including a new plant. And this is for 2 different types of engines and it's specifically related to tactical systems, whether it be a drone or loitering munition or a powered munition. We are 6 months out from hitting a milestone on a much larger engine. We're already under contract that if things go according to plan, then we will have to stand up a third facility for this engine, which is a much larger engine for a manned aircraft, all right?

Okay.

Okay. So that's those. On the hypersonic side, with Zeus 2 successful on the static fire, we are, as we speak, building out the integration center for the solid rocket motors and the front end flyers, Erinyes and Dark Fury and also other people. That is happening. That will be accelerating. One of the biggest ones, Michael, is our Israeli-based Microwave Electronics business. Everything is at a record high. Backlog is at a record high, pipeline is at a record high, revenue is at everything and it's only beginning. We all know why and I've listed some of the systems we're on. And so, we -- there are 2 that I can talk about, 2 facilities we're standing on. One is a brand new one for something and another one is an expansion of an existing one for existing systems. It's possible that, by this time next year, we may have to stand up another one and this is for the demand of the Microwave Electronics that are going on the various weapon systems in Israel, okay. So again these are all done under contracts. The next one is the [ valve growth. ] Two things. As I said, we're having to pull to the left now based on a certain specific customer. Hopefully, we're going to get this done. We're going to have to deliver these out sooner than we anticipated. Based on successes we continue to have with other customers, that's why we've begun -- we haven't ordered it yet, have not made the orders yet, but we've begun going to the supply chain for the next lot of planes, which depending on how things work out will be 12 or 24 more. Again, those are all, I'm going to call it, either done or 2020. Probably the biggest one is Prometheus, which in the equity raise, I walked people through that it was not done, that we were on a football game. We weren't quite in the red zone yet. We've been down selected. We won. We're in the red zone. And hopefully, this will get done and be contracted by the end of this year. This could be the largest opportunity. This is an area that we're in already. This brings a backlog. This is not a build it and they will come, but it will require a significant investment for this potential game-changing opportunity. Those are the primary items, Mike.

Got it. That's helpful. Just the last one. On Valkyrie, everything sounds like, it's progressing. Obviously, you mentioned the supply chain, but I think in your comments, you said, maybe the order is sliding into '25. It seems like a little bit of disconnect there. I mean, all this interest, but not getting the big orders. How are you get comfortable with all this investment, but not having the order in hand yet and still self-funding?

All right. So Mike, we have 2 customers for 2 separate orders, 2 separate potential orders, all right. It looks -- I'm trying to be cautious. I think we're going to get at least one of them this calendar year and the other one in the first half of next year. I'm going to be cautious and say first half -- first quarter, excuse me, first quarter of next year just to be cautious. But we're again, unless something changes geopolitically, we're confident, we're going to be moving ahead here. If timing works out, Mike, the way I think it's going to work out, we're not going to have to pull the trigger on the additional ones, until we get one of those which you can understand means that hopefully it's close.

And our next question coming from the line of Ken Herbert with RBC Capital Markets.

Eric, I wanted to ask you, it's been a couple of quarters now that you've more publicly talked about the shift from a prime to more of a merchant supplier and it clearly sounds like, you're getting some traction in a number of these areas. How would you sort of characterize your success in this relative to your plans? And as you think about these new opportunities, maybe what percent would you think about as a merchant supplier or subcontractor relative to sort of ongoing dependence to win things as a prime?

As I talked about a little bit on the last call, Ken, we sit back and we look at probability of win and the required Kratos investment to win it. There were certain areas that are our sweet spot that are not other sweet spots, certain companies of which talked about in the past 2 weeks. For example, our sweet spot in the drone area are low cost reusable, disposable or treatable drones. That's our sweet spot. We expect to win those programs. Certain companies in the past we -- publicly they discussed that that's not their sweet spot, their sweet spot is exquisite. So there would be an area where it might make sense for a partnership one way or the other, where the probability of win together is higher on one if not on the other. There's an example, okay. In the air defense area, I mean, our primary partners in air defense systems, CUAS systems, missile systems, radar systems, or I'll call them the big 3. It's Raytheon, Northrop and Lockheed. They are our true partners and they're great to work with, and in no particular order, Patriot is a significant Kratos program. That's Raytheon. Integrated Battle Command System is a very significant program, that's Northrop. THAAD and multiple CUAS systems, Lockheed Martin. IFPIC, Enduring Shield, were partnered with Dynetics. And each one of those, it made all the sense in the world to partner with, these are outstanding legacy traditional Prime System Integrators, where we win and we can support all of them and help them to execute their mission for the customer. That's how we're looking at it and we're trying to pick our spot for the highest probability of win.

That's helpful. And as I look at the incremental sort of next production lot on the Valkyrie, can you talk at all about for the second '24, how your assumptions around pricing or real pricing that you might achieve on that have evolved or maybe changed or improved since some of the early production lot or the initial production run?

Yes. So I'm talking generally now, because it depends on the version or the increment and the capability of the aircraft. So on the learning curves now, depending on quantity, so for example, we submitted a ROM for a few dozen to a customer at $4 million each for a certain variant. There is another variant that's flying today. It's about $5.5 million or $6 million each. And then there's a third one. We haven't talked about it much. I'm not going to get into it a lot here. Hopefully, by the end of the year, I'm going to be able to talk about it. It's closer to $10 million and it's a beast. It depends on quantities, variant and the customer we're working with.

And our next question coming from the line of Mike Crawford with B. Riley Securities.

Can you just run through please some of the top opportunities, including converting Valkyries from CapEx to revenue per second fleet revenue recognition, where you would generate revenue and operating earnings kind of ahead of what you've guided?

Opportunities that are not in the base case?

Yes.

Okay. So tactical drones is #1. We have no production of tactical drones in the base case. It's still RDT&E and S&T. That's number one. Number two is these engine production runs. We have very little, if anything, in there for these engine production runs we're hoping to receive. Number three, it's Zeus and the hypersonic flyers. We've included nothing because the systems weren't done, now they're done. The first flight of a system is coming up in the next several weeks and the first flight of another system, Zeus related, is later this year. Okay, now that these systems have worked and I believe once we do these initial flights, it's possible based on the backlog for certain types of assets that need to be flown, that could be an upper that is absolutely not in our plan. A fourth one, it's a program we're under contract for on a certain engine. It's one of the largest programs in our Engine group. The customer has recently come to us and asked us for expanded scope for a different aspect of this engine to pull it into the left. If we can hire the people, and that's a big challenge, Mike, we can hire the people that will absolutely give us opportunity to beat our numbers soundly. Those are 4 areas right off the top of my head. The biggest -- Mike, the biggest item across the entire portfolio is people. If we could obtain and retain the people, we've got the backlog to exceed what we've got out there. But it's challenging, especially with the people that have security that need to have security clearances.

Okay. And then, just one final. Previously, you talked about space, which has been for the past few years here, or it is your biggest and has been among, if not your fastest growing business. But this year was supposed to be a year of consolidation, whereas flat, yet it was you were up nicely year-over-year in Q1. I'm wondering if you're now expecting a little bit of growth there. And also if you could just tell us a little bit more about this new space customer, what you're doing for them with their satellite?

Yes. Let me take the second one first, because it's the easier one. The second one first is, this is an established company. It's a larger profitable company. I said new space, Mike that may have thrown people. It's new to us, but it's not a new space company. It's new to us, it's not a new space company. They're putting up a new constellation and they just selected us in the past couple of 3 weeks to be part of the Microwave Electronic system actually on the satellite. This could be initially several tens of millions of dollars to us initially. And it's because over the past year and we've tried to lay this out, we've been successful on 3 or 4 other satellites with our Microwave Electronic satellite programs. We're getting a reputation now. This is why we're one of the reasons we're expanding our space qualified facility. This is brand new work, new constellation, large company, public company and it looks very, very, very good for us. On the first part of your question, our Space business. Yes, as you mentioned, last year, our Space business organic growth was like 13% or 15%. We did a little bit in Q1. But as I mentioned on last quarter's call, this is the business within Kratos that absolutely could be and it is being most impacted by the continuing resolution, the delay. Also as you all may have seen, I knew this, but it's out there publicly now. There's a reprioritization of certain space assets going on within the Air Force, the Space Command, the Space Force. None of this is bad. It means things are going away. But it means decisions haven't been made yet. They're probably not going to be made. And so, things are moving to…

And our next question coming from the line of Seth Seifman with JPMorgan.

This is Rocco on for Seth. How should we think about the growth trajectory at KGS for the rest of the year? Should we think about sequential growth in the coming quarters or could it possibly take a step back?

In the annual guide we gave, it's -- we haven't updated guidance from a quarterly perspective [Technical Difficulty] by segment, but the annual guidance we gave was roughly 20%, 25% for unmanned systems. And then that then implied approximately 6% annual growth for KGS. That has remained unchanged with the original annual guidance we gave.

Okay, great. And then can you provide more details about the Apollo and Athena drones and how they compare to Kratos' other offerings?

Yes. These are more on the disposable side than the attributable side. Similar to virtually all of our other tactical drones, their legacy came from our target drones. On one of them on Athena, I believe that, either next quarter or by the end of the year, we are going to be able to actually talk about this platform. I'm hoping to if the customer will allow it. On Apollo, I doubt it, because very candidly, I doubt it, based on the application. And what's happening there is one of the reasons -- 2 of the reasons. One of the reasons why our unmanned drone business is doing so well because of these derivatives of our target drones and what we expect them to continue to do going forward.

[Operator Instructions] Our next question coming from the line of Joe Gomes with NOBLE Capital.

You talked about staffing and Deanna gave us some numbers. How much more staffing do you need to move forward or to get some of these potential business really moving forward?

On one particular -- let me give you an example, Joe. On one particular KTT program, we could take 30 to 40 additional right now, time and material contract. It's one of the highest margin in the company and put them to work. It rates $200 to $250 an hour. We've got another one in the engine area. It's just under 30 people we could put to work immediately. Let's go to the unmanned drone area. It's very challenging here because of what's going on in the industry, not just with drones, overall aircraft, what's going on with aircraft. There's a program that we're about to get. I believe it's 30 people or 40 people right out of the chute. It's going to be a challenge and we're working that with the customer on potentially how to sequence them in and on board them, because obviously we're a public company, we don't have the luxury of going, I wish we could do this. We could go out and we could have 50 of these types of engineers on the bench. They'd be an overhead until the program ramped up, which would impact our margins. But if we could do that, we could even further accelerate the growth rate. But it's a balancing act between quarterly profitability, quarterly execution and onboarding these people for these programs.

And on the supply chain and your vendors, a lot of potential growth here that you talked about, Eric. How confident are you in that, they're going to be able to keep up with all this expected growth? Is there going to be any type of bottlenecks there?

Great. That is a great question. So in Kratos, we call either the directed vendor by the customer or the sole source, one of a kind that only exists in the United States kryptonite vendors. The 2 areas for these where we are constantly on alert are the engines and the drones. These are the two. Let me talk about both of them. On the engine area, as if you recall, we have made and we're continuing to make a significant capital investment at a Kratos Manufacturing Center of Excellence. This is additive manufacturing, 3D printing, casting, machining, primarily for engines. We are doing everything we can, where we can to vertically integrate and get vertically in it. We can't do it for everything, but to get vertically integrated to derisk as much as we can in front of these engine orders that we're getting and that are coming. That's number one. In the drone area, in addition to the autoclave, there are certain other machines, tooling that are critical. There are certain vendors in the United States that are just overwhelmed right now because of CCA, because of 5GAT, because of MGAT, I can go on and on. In certain of those areas, we're actually bringing -- we're acquiring the machines. We're acquiring the tooling. We're bringing them in-house and we're getting up to speed. We can transition, maybe not to do it primarily initially, but to have a backup plan that we don't get in trouble, because as you know, what's the most important part of a system, it's the one you don't have, when you're about to complete it. We're trying to stay on top of it, but it's challenging.

Our next question coming from the line of Josh Sullivan with The Benchmark Company.

So on the planned KTT low cost engine facility, what do you see the volume capacity of that facility on an engine unit basis, maybe over the 12 months, 24 months, however you want to characterize it, assuming you could hire everybody you wanted to, as you just mentioned? Are we talking hundred, thousands? What do you think?

Thousands per year.

And then on the partners for the KTT Spartan programs that you mentioned. Are you partnering with traditional jet engine OEMs or these airframe partners where you're bringing a KTT complete engine?

Josh, and this is partnering. This was small, ask it again, I didn't hear you quite.

So, are you partnering with engine manufacturers with the KTT Spartan program or aircraft, where you're bringing the engine?

Okay. On the vast majority of what we're doing in the engine area as far as designing the engine, developing the engine and manufacturing the engine, we're doing it ourselves. We are the primary engine system provider to the air framer and the air framer being the drone, the missile, the loitering munition, okay. However, there is a certain area, where we have -- we have a -- we are partnered. I can't get into it under an NDA, but we're partnered on a certain class of engines that both of us believe if we're successful on, this could be a grand slam. In one area, we've got a partner and all the others, we're doing it alone.

Thank you. I'm showing no further questions in the queue at this time. I will now turn the call back over to Mr. Eric DeMarco for any closing remarks.

Excellent. Thank you for joining us this afternoon, and we'll look forward to chatting with you when we report second quarter in August. Thank you.

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation. You may now disconnect.