Q2 2023 Kratos Defense & Security Solutions Inc Earnings Call

August 3, 2023

Okay.

Good day, and thank you for standing by and welcome to the host events and security solutions second quarter 2023 earnings Conference call. At this time, all participants are in a listen only mode.

Speaker's presentation there'll be a question and answer session to ask a question. During the session you will need to press star one on your telephone you would there then here an automated message advising you. Your hand is raised to withdraw your question. Please press star one again.

Please be advised that today's conference is being recorded.

Now like to hand, the conference over to your Speaker today Marie Mendoza Senior Vice President General Counsel. Please go ahead.

Thank you.

Good afternoon, everyone and thank you for joining us for the defense and security solutions second quarter 2023 Conference call with me today is Eric Demarco.

As President and Chief Executive Officer, and Deanna Lund credits as 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 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.

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 that I will now turn the call over to Eric Demarco.

Thank you Marie good afternoon.

Q2 came in better than forecasted which provides us additional confidence in achieving our full year 2023 financial objectives.

Including increased second half profitability as our fixed price and other contract mix continues to improve.

We are on plan for 2023 to be a transition year for kratos, including reduced internally funded investments increased year over year financial performance.

<unk> largest business space and satellite communications, which includes our first to market software based open space Virtualized <unk> TMC and ground system products momentum continued including additional new customer awards and several new opportunities. We are now pursuing.

A large number of satellites being launched into Leo MEO and Geo orbit is providing a macro level catalysts for our satellite business in both the commercial and national security areas.

Our open space platform as a representative example of <unk> strategy.

Identifying a potential opportunity area working with the customer credo is making the internally funded investments to be first to market with relevant system software and technology.

<unk> internal funding also enables us to own and protect the proprietary intellectual property, we develop which is an important element in protecting our market leadership position.

Great Us as open space architecture enables us to address both the commercial and the national security areas, providing us a larger overall total addressable market opportunity and the associated scale cost leverage and increased potential margins that come with it.

We are also invested in and self funded <unk> owned and operated global space domain awareness, our SDA network.

Our SDA network monitors the behavior of space based radiofrequency or RF signals to identify critical information about satellites and objects in orbit, including their position maneuvering health proximity to other satellites and more.

<unk> is FDA network includes over 20 worldwide sites currently hosting approximately 150 fixed in <unk>, RF sensors, and antennas, which are capable of detecting and tracking space vehicles, and providing real time data to our customers.

It's been recently reported that the U S space coming and is currently tracking and monitoring more than 28000 space objects of which only approximately 3500 art knowledge active satellites.

With this growing volume of satellites and space objects contributing to credo space domain awareness market opportunity.

<unk> owned and operated one of a kind global SDA system is a clear differentiator technology base capability of our company.

And it's one of Kratos is most valuable assets.

Also providing opportunity for <unk> is that a significant number of new satellites being launched our high throughput software reconfigurable spot beam enabled and more each of which requires a dynamic on the fly reprogrammable ground infrastructure and capability like Credo is open space.

Additionally, the customers increased focus on not being vendor locked to the traditional satellite providers for their ground infrastructure is also providing opportunity for creators.

The large growing and changing global space and satellite market is providing opportunity for every <unk> division, including individually and working together on programs, which has been a key aspect of creators as overall space focus strategic plan.

We expect creative space and satellite business to be one of our company's fastest growers with forecast future year over year increased revenue profit margins and cash flow.

Kratos is engine and propulsion businesses are also well funded growing priority areas with macro catalysts, including increased demand for hypersonic systems missiles drones powered and loitering munitions increased range and power requirements supersonic in space and satellite related propulsion.

<unk> and launch systems.

<unk> turbine technologies is a recognized leading technology disruptor in the propulsion field and we are under contract with certain of the most important highest priority well funded and visible systems platforms and programs and initiatives, including bolt in national security and <unk>.

Partially.

Since our last report to you Katie has reached customer agreement on a potentially very large propulsion system program, which if successful is expected to be an important overall contributor to our company, including a significant financial ramp beginning in 2024 for creators.

Also since our last report.

T T space customer, which we are under contract with successfully received a new manned lunar system program Award, which also could be a significant future contributor to kratos.

Related to drone engines, our house Subcommittee recently requested the Air Force to submit a report on the schedule and plans for funding development testing and establishment of high volume manufacturing of Accretable engine technologies for Ccas.

Greatest as engine businesses are expected to be certain of our fastest future growers and increased margin contributors.

<unk> rocket systems on a rocket motor ballistic missile target hypersonic and other system business.

Is also well positioned from a macro catalysts for priority and funding standpoint, including as related to the recapitalization of strategic weapon systems, the hypersonic ecosystem and strategic deterrence systems.

Representative of our leadership position since our last report tradeoffs as rocket systems business successfully launched a new hypersonic payload for a certain customer.

Additionally, kratos as rocket systems business successfully conducted the first static fire test of the Credo Zeus one solid rocket motor at Aerojet Rocketdyne, Camden, Arkansas facility.

<unk> family of rocket Motors is in direct response to the market need and demand for new affordable solid rocket motors of a particular size class and nature for launch vehicles stages hypersonic ballistic missile target research and other systems in vehicles.

Also for <unk>, <unk>, and our dark Fury hypersonic fliers.

With a successful test of <unk>, one and the upcoming Zeus to test we are planning for Kratos as Aaron's and dark purely hypersonic vehicle flights next year.

<unk> <unk> <unk> and dark purity systems are additional examples of tradeoffs as strategy of proactively working with the user and customer community, making the internal investment to move fast and be first to market far ahead of the traditional government funded competitors with affordable relevant products systems and.

<unk> to rapidly address the customer needs.

As you know what tradeoffs affordability is a technology and we believe that Kratos Zeus there any start purion. Other credo systems are significantly less costly than any existing or planned future relevant systems.

Missile defense hypersonic testing targets and other vehicles are also certain of the highest priority well funded areas in both the 2024 NDA and the related fight up.

<unk> industry, leading target drone business is also being driven by the recapitalization of strategic weapon systems, including radars missiles, directed energy counter drone and other systems, all of which need to be tested and trained against threat representative targets.

<unk> is the sole source or primary high performance jet target drone provider to the United States Air Force Navy Army other agencies and numerous international customers.

Reflective of <unk> industry, leading target drone position since our last report to you. We have received a $95 million single award contract from the United States Army and both the U S Navy and the U S. Air Force have indicated to us that they will in the future be procuring increased target drone quantities.

We are also now awaiting a new target drone system related contract award that we have been informed we have been successful on with our teammates and our partner.

And the tactical drone area.

We recently announced that Kratos and shield AI have teamed up to rapidly integrate shields artificial intelligence into Kratos Valkyrie.

The Credo Shield collaboration is another representative example of tradeoffs as unique disruptive technology focused business model, which also includes working with venture backed private and commercial entities like shield to move faster than traditional government contractors and be first to market with relevant systems.

We worked with a number of smaller technology and software focused companies like shield Paragon defense and others, which provides <unk> with access to unique disruptive capabilities.

Also in the artificial intelligence area yesterday, the United States Air Force announced a successful three hour, Saudi demonstrating the first ever flight of artificial intelligence agents, our algorithms controlling <unk> Valkyrie.

This mission proved out a multi layer framework on an AI ml flown aircraft <unk> Valkyrie and demonstrated the AI ml agents solving tactically relevant challenge problem during actual airborne operations.

Flight on the Eglin testing training complex was the culmination of the previous two years of partnership that began with the Skyboard Vanguard program.

AI will be a critical element of two future war fighting it is evolving at an incredible pace and kratos Valkyrie and certain of our other tactical jet drones and other credo systems are leaders in relative artificial intelligence, enabling areas.

The Air Force announcement of AI successfully piloting <unk> Valkyrie is another publicly available representative milestone of the progress that <unk> tactical drones continue to make with the customer community.

<unk> Valkyrie progress under the Marines collaborative killer program. Similarly also continues to progress.

Since our last report we have now reached agreement with a new national security related customer for payload and mission system integration into <unk> Valkyrie and we have recently received the contract.

This is a new initiative that is highly confidential and if credo and our partner are successful. This program could be a significant contributor for <unk> beginning next year.

We have now also reached agreement with an additional new national security customer and we expect to have contract documents definitive with the contracts office by the end of the government fiscal year 2023.

We also now expect to receive an additional valkyrie related customer contract award by the end of this year.

And based on the March 2024, NDA, we are now hopeful to receive a separate additional largest to date Valkyrie related customer program Award next year.

We have a government customer funded flights with Kratos tactical jet drones over the next several months.

And I encourage you to visit the recently released Air Force Research lab future of artificial intelligence dominated air combat video to see <unk> Valkyrie in flight inaction.

All of the Valkyrie and the AFR, all video or actual real drones, they're not computer generated animation rendition cartoons, where stimulations that certain of our competitors like to propagate.

We also have flight scheduled for later this year and next with the new customer.

That is potentially looking for a future purchase of <unk> Valkyrie is in 2024.

The Valkyrie production run continues with the most recent data indicated continuing valkyrie units unit cost reductions as we progressed through the build and down the learning curve.

I am confident based on the customer and competitive information that we have that kratos has cost points for high performance jet drone aircraft are significantly lower than anything existing planned for in powerpoints that the competition may have.

Directly related to cost.

<unk> Subcommittee has marked the 2024, NDAA, specifically, stating that there will be three categories of drones and not to exceed flyaway cost points. These include expandable at $3 million attributable which is my favorite at $10 million and exquisite at 20.

$5 million.

If this NDA Mark is finalized and the 2020 for budget, which it is expected to be then these drone classifications and cost points will become law.

As a reminder.

Approximate cradles tactical drone cost points are currently air Wolf for tactical fighter jet at 500, K or less make.

<unk> at $2 million or less.

<unk> at $6 5 million or less which each of these drones cost expected to be much lower in quantities.

And our new highly capable fully not fully missionize system, which is a $10 million.

<unk> Ghost works continues to work on the new system.

And we are scheduling a capstone event for this system for either later this year or early next.

It depend on a range of availability.

We announced today <unk> newest most capable valkyrie for the United States Marine Corps will be at the Miramar Air show in September here in San Diego, along with several other Kratos high performance jet powered drone aircraft. These will be the actual aircraft that will be at the show.

We are planning on producing approximately 150 jet drones all in the United States of America, this year, including targets Valkyrie, Mako Air Wolf and others.

We are now positioned to double production to approximately 300 drones annually in 18 months, assuming we received contract award in customer funding.

We are ready to go now and we are clearly in routinely communicating this to the customer community.

As I mentioned before our credo affordability of the technology and may be better maybe someday in the future at some hoped for hypothetical price that's the enemy of good enough and ready to field now in today.

We believe that Kratos is approach is particularly relevant in the tactical drone area with a value of affordable mass in quantities, having a quality all of their own is clear.

Great to see five ISR in our microwave business are both positioned for a strong second half of 2023 with the demand for space satellite missile radar and other systems contributing to the demand for <unk> products and systems.

We've received a large number of new program awards over the past several months and we have a record consolidated backlog and an opportunity pipeline at record.

Accordingly, we are focused on internal execution organic growth with forecasted future year over year revenue EBITDA and cash flow increases with no acquisitions of size expected.

Our primary operational challenge continues to be obtaining training and retaining qualified employees and the related high labor cost for these specialized personnel, including those that can obtain national security clearances.

These and other items were included in our decision to affirm and not to increase our financial forecast with the potential contribution mix shift between kgs on Ku is possible due to potential award and execution timing.

In closing <unk> priorities include supporting the United States National Security.

The U S industrial base.

<unk> technology engineering, math or stem opportunities for the United States and four credits as workers.

Developing dual commercial national security offerings, like Kratos is open space, which drives value for all <unk> customers.

And value generation for all tradeoffs with stakeholders, including the Dod the taxpayer Congress, our employees and our investors.

Diana.

Eric Good afternoon.

We have included a detailed summary of the second quarter financial performance as well as the third quarter and full year 2023 financial guidance in the press release, we published earlier today I will focus on the highlights of my remarks today.

Revenues for the second quarter with $256 9 million up from $224 2 million in the second quarter of 2002, reflecting a 14, 6% increase revenues came in above our forecasted range of $230 million to $240 million and most of our kgs businesses with the most notable increases in our spaces.

Satellite turbine technologies microwave products and <unk> businesses.

Excluding the impact of the <unk> acquisition, which contributed $13.

$1 million in revenues in the second quarter of 2023 as compared to $4 1 million in the second quarter of 2022 greatest as consolidated revenues grew organically 10, 7%, including a 17, 1% organic revenue growth rate in our kgs segment with organic growth.

All businesses within kgs.

Cash flows generated from operations for the quarter of 23 6 million included cash collections, resulting from favorable milestone payment terms, which accelerated receipts into the second quarter, partially offset by working capital requirements to support revenue growth and continued advanced purchases of inventory.

In an effort to mitigate potential supply chain disruptions and delays.

Also included in our working capital uses our continued internal investments of approximately $3 million related to nonrecurring engineering costs to complete new rocket systems, and hypersonic and related products, including <unk> <unk> and <unk>.

John theory system, and continued development and certain software products supporting our open space platform.

Free cash flow generated from operations was $20 7 million after funding capital expenditures of $11 2 million and we see of $8 3 million of proceeds for Valkyrie build as capital assets prior to contract award.

Our contract mix for the second quarter of 2023 was 67% fixed price, 27% cost plus 6% time and material.

Revenues generated from contracts with the U S. Federal government during the quarter were approximately 69%, including revenues generated from contracts with the Dod non Dod federal government agencies and Fms contracts.

In the second quarter of 2003, we generated 11% of revenues from commercial customers and 20% from foreign customers.

We continued to make progress in our hiring and retention of skilled technical labor, including NRC five ISR business with the notable net increase and <unk> ISR head count of 37% since the end of last year, including 18 in the second quarter plus an additional 12 recently clearing the pre hire process.

Yes.

Craig. This is overall total increasing consolidated head count. This year is 152 from 3645 at year end 2022 to $3 797 at the end of the second quarter.

Moving on to financial guidance, our third quarter and affirmed our full year 2023 financial guidance. We provided today includes our current forecasted business mix and our assumptions related to the expected impact of our continued operating challenge related to obtaining and retaining qualified technical personnel.

As well as the lingering impact of supply chain disruptions inflation and related expected costs and price increases that are currently and expected to continue impacting the industry and create us.

Our revenue guidance range for the third quarter of 2023 reflects an approximate 5% to 13% organic increase over the third quarter of 2022.

Based on the current <unk>.

Budgetary environment, we are expecting to be in a continuing resolution for the fourth quarter, which is reflected in our affirmation of our full year revenue guidance.

Based upon funding production delivery and execution schedules are third quarter 'twenty three revenues are expected to be fairly consistent with the second quarter based upon current production and delivery schedules.

<unk> margins to expand in the fourth quarter based upon the expected mix of revenues, including your fixed price contracts, which include more recent cost estimates and more software based content.

Estimated incremental ramp in production in the second half of 2023 are expected to be driven by a handful of key programs in our space and satellite and training C. Five ISR and unmanned systems businesses.

Operating cash flows are expected to be stronger in the fourth quarter driven by the expected expansion in margins and the expected conversion of inventory builds from FY 'twenty, two and the first half of 2023 and based upon estimated miles down payment schedules.

Alright.

Thank you Deanna.

We will turn it back over to the moderator for any questions.

Thank you as a reminder to ask a question. Please press star one on your telephone.

And wait for your name to be announced to withdraw your question. Please press star one again please.

Please standby, while we compile the Q&A roster.

Our first question comes from Joe Gomes with Noble capital Your line is open.

Hi, Good afternoon. This is Josh result, fulfill and then for Joe Joe I'm, Suzanne just on another call.

Hi.

Yeah.

Hmm.

Congratulations on the quarter guys.

It seems like it hit the nail on the head and even more so with the growth.

So.

I just wanted to start off just I actually just kind of going into the growth rate as well.

Obviously, you guys sounded like right around <unk>.

<unk>, 3% to 7% increase over last quarter, and obviously came in and really 15%. So like what was kind of like.

Obviously, the big impact behind that large growth.

Yes, yes it was.

Organic growth literally in every business unit within kgs.

Across the board.

Space satellite training.

T five ISR microwave products turbine technologies and defense rocket.

All across the board.

Okay perfect.

No.

I just wanted to see you guys mentioned last quarter that you guys had during shield was going into kind of.

L. Our IP in the back half of 2023 kind of when you guys kind of expect that again are more towards the third and more towards the fourth.

Okay.

Yeah.

As you know we're partnered with Dianetics on this and they are they're the prime we're building the ground infrastructure for epic and enduring freedom.

I would speak with them things or are consistent with where we were previously there have been no changes.

We expect to begin sometime in the second half of this year, but I just I don't want to get ahead of the prime Theres nothing wrong here I, just don't want to I have respect for the chain of command. So just circle up with lighthouse diabetics on that for the specific please.

Okay.

And then.

This.

And lastly.

Kind of you guys sounded like you guys are really hiring a good amount of people it seems like well over 100 at least.

So.

The market had been favorable towards that for you guys as well as like it hasnt been retention for those employees been extremely positive.

It's the market for the type of employee we're looking for continues to improve.

Over the past several months.

It is still difficult on a cost standpoint.

Very costly, especially for individuals that want to add.

And we'll obtain and retain a security clearance.

So it's getting better it's one of the reasons, we're feeling better about the business in the second half of this year and 2024.

But it is still expensive for people with very specialized capabilities.

So that's the nature of it right now and yes, we have a lot of openings.

If we could fill all the openings, we have based on our existing backlog and not just the backlog. The programs, we have where we're gonna get options exercised and that's not in the backlog yet and we're going to win some big opportunities as I mentioned, we've been told we've won some they're going to be coming out soon we are.

Our growth rate organically, which we're laser focused on could be substantially higher.

Could be but we just can't we can't get the people right now in the industry.

Okay ill jump back into queue, but once again great quarter guys.

Thank you. Thank you.

Thank you one moment for our next question.

Yes.

We have a question from Pete <unk>.

<unk> with <unk> Securities. Your line is open.

Hey, good evening I'm on for Mike <unk> Tonight, Thanks for taking the questions.

First of all I just wanted to ask given that you maintained the full year outlook after putting up a pretty strong quarter was there any pull forward in demand versus what you originally expected or any you know maybe unexpected easing in the supply chain just what drove the outperformance versus what you originally expected to look like.

Yes, it's not it's not really the supply chain.

The supply chain.

As expected and it continues to be challenging alright.

Alright.

Maybe a couple of things move forward, a little bit a couple but the team is executing very very well and as I tried to allude to in my prepared remarks.

The fact that Q2 came in better than we had hoped it gives us higher confidence in the full year, because frankly it takes some pressure off of the year right. Now obviously you guys that could do the math at least on the revenue side and Deanna talked our mix is getting better and better why margins are going to be up.

We continue to do $250 million quarters Q3 Q4.

We're going to drill our guidance.

So there is no ramp there's no hockey stick.

And as Deanna mentioned it as well.

No, we're probably going to have a continuing resolution, we expect to that but what I'm starting to worry about is it going to be worse than a continuing resolution with the government shutdown for a period of time and so were factoring all those things and where we just don't want to get ahead of ourselves we have a lot of good things going on here across the company we were.

To deliver on what we say, that's where our heads at.

Great that's very helpful and then.

There is a follow up just as we think about the opportunities internationally for target drones have you seen any signs of increased momentum for demand on that front either from orders or conversations with potential customers and how are you thinking about the growth trajectory for that business over the next couple of years.

Yeah.

International Park target drone business is continuing to ramp.

It's going to continue to ramp however.

However, as I think I mentioned on the previous call or two.

The big three target drone users in the world or the United States Navy, the United States Air Force in the United States Army.

Obviously, we have all of them then there is the UK Ministry of defense, that's our customer too.

And then just looking at defense budgets globally target drone by country drops off precipitously. After that so we're going to book and we're going to be able to announce a lot of international target drone wins over the next several months and quarters, but the quantities are nice, but they're not the big needle move.

Or is like the U S stuff, they're just not there.

The award that I mentioned in my prepared remarks that we have been informed we've won.

And hopefully it's going to be definitive in the next few weeks.

That can be a needle mover 2020 four 'twenty, five and I can't say much more about it but.

But that's a good one.

Great. Thanks for taking the question.

Yes.

Thank you.

Yes.

We have a question.

Coming from.

Okay.

Mike Crawley.

Crawford from B Riley Securities. Your line is open.

Thank you Eric.

You're talking about a new.

Payload in Michigan integration system customer.

Potentially for Valkyrie and.

No you have a number of customers within the D O D.

There may be military and defense, but.

Would you be able to.

To supply Valkyrie say too another prime.

Yes, we would be able to.

We would be able to provide the valkyrie to another U S. U S. Prime there is there is no prohibition on us doing something like that if the opportunity arose.

And is that something that you would.

Consider to be beneficial given maybe their channels.

The answer is yes, we would definitely consider it.

We're going to do what's right for the business and what's right for the shareholder.

Our model, we have multiple models here at <unk>, one of them, it's better to have part of something that all enough.

And if we could get a big part of something doing something like you were talking about instead of taking a high risk in going out alone we.

Weigh those factors and we'd make the decision. So the answer is yes.

Okay. Thank you and then.

You talked about.

Our plan and Steve family was actually quoted about this and even further too.

Jumbo production of drones in the 150.

<unk> target and tactical aircraft this year.

So 300 within 18 months and I know that you have the space to do that given the Oklahoma facility, where I think you're on your second Valkyrie production spyware right now, but what.

Will this require from a human capital standpoint in terms of.

<unk> number of employees to execute on that plan.

Right, so Mike related to that than I did not say this in my remarks.

We have acquired an additional autoclave.

Specifically for tactical drones.

Our team got an incredible financial deal on it we've got it and it is going in.

On the peak.

People side that is something we're always focusing on bank and additional for what you do what you just framed up on what Steve said and I know, what you're talking about things another.

Approximate 125 people.

Okay.

Thank you and then I have one final question so.

Your.

I would rocket motor.

Partner Aerojet Rocketdyne is now part of L. Three Harris and what if any concessions or.

Assurances do you have.

We're not have from L. Three regarding your ability to continue to get better.

Betty access.

Through a merchant supplier of solid rocket motors for for some of your vehicles.

Right.

So.

Obviously I can't talk about any direct communications that we may or may not have had with anybody youre talking about however.

L three Harris executive leadership.

Upon the close.

Pledged.

This is public they've made a pledge that theyre going to invest in the business.

They're going to be a merchant supplier.

Someone sent me a letter where they communicated to the department of defense, but theyre not going to play any favorites and they are going to continue to treat us all as equal partners.

So.

That's what my friends at all three Harris of set.

Publicly.

To the other part of your question.

<unk>.

Sure.

We of course are very prudent when we're always looking for second sources.

Or backup plans.

And that's across the company and across the business and we'll continue to do that including now in the rocket motor area.

Okay.

Thank you Eric.

Thanks, a lot.

Well.

Thank you.

Yes.

We also have a question from Ken Herbert with RBC capital markets. Your line is open.

Yeah, Hey, Eric good afternoon.

Hey, Ken good afternoon.

Wanted to start off congratulations on the AI Valkyrie flight.

Coming out of that fight the airforce, specifically commented that D C direct.

Transferability or applications of this flight and the technology to the CCA program can you can you provide any more color on how you see <unk> involvement in the CCA program.

Playing out any maybe milestones incremental milestones, we should be we should be thinking about and.

And specifically.

How you see the technology sort of risk initially.

As you look to transfer this into or the air force looks to transfer this to the CCA amongst other areas.

In the future.

Ken I apologize.

I cannot say anything at all about that program.

Oh Im sorry, okay.

Okay.

Okay Fair enough can you can you provide any comments on the test flight in May.

Maybe any of.

Lessons learned in particular or how it completed the flight relative to initial expectations.

From my perspective from our perspective.

The Valkyrie.

Absolutely knocked it out of the park over the three hour flight.

And.

Our customers continue to applaud.

The valkyrie they applaud the aircraft.

Ken I mentioned the video of the Air Force Research Lab video.

It may have had a chance to take a look at it for those of you that haven't I encourage you again to please go take a look at it it will address and answer a lot of the questions.

By the government by the Air Force that Canada is asking that.

Not comfortable talking about publicly.

Can we we continue to make.

Incredible progress.

And the tactical drone area.

As I said about a year ago I thought everything was going to become more classified and that was going to not be able to talk much anymore and thats, where we are which is why I know wherever I can pointing to or identifying what the government is saying theyre not endorsing, but what they are saying.

To try to keep the investors as up to date as.

As possible.

So we're with the U S Marine Corps, we're doing great.

No. It's out there I saw a public thing out there now we're involved with the office of the Secretary of Defense, that's moving forward obviously.

Obviously with the air force in multiple areas.

We feel.

The government moves on their own timeline.

We will not get ahead of ourselves.

But we.

Have a whole family of airplanes flying.

Today, and I mentioned, the cost points I mentioned new stuff.

We're ahead of everybody.

And our plan is to stay ahead of everybody.

Very important person said to me in the past couple of weeks you need to have strategic patients for those of you know me, that's very difficult, but I'm half have strategic patience and we will win.

Okay perfect I appreciate that and if I could maybe just one for Diana.

In the second quarter, it looks like working capital specifically accounts receivable were was a really nice source of cash.

The guidance implies a.

Nice nice inflection in the second half of the year in terms of cash generation are there are there was there anything sort of onetime in the quarter you'd call out around working capital. It was a nice tailwind and how do we think about maybe the upside.

For the full year expectations from a cash standpoint.

Sure.

There are some favorable milestones in the second quarter that did accelerate some receipts that we had originally anticipated in the third quarter.

So that that was favorable in the second quarter in my prepared remarks.

Highlighted Q4, where we expect to working.

Working capital to be.

Beneficial as well in the fourth quarter as based on scheduled milestone payments as well as.

Our expected conversion of some of the inventory builds that we've been building throughout 'twenty two.

Thus far through 2023.

Perfect. Thank you very much thank.

Thank you Youre welcome.

Thank you.

We have a question coming from.

Seth <unk> with Jpmorgan Your line is open.

Okay.

Thanks, very much good afternoon.

And congratulations again.

The latest valve.

Valkyrie flight.

At the risk of asking a question about something that's difficult to talk about.

Just following up on that maybe.

This is higher level.

Can you talk about when we think about the path forward.

With Valkyrie and things that need to be developed in order to see demand really ramp up I assume that some of it is the artificial intelligence capability.

Being developed kind of outside the company.

When you think about the pace of that and how that happens.

How that development.

Past relates to the demand profile.

For Valkyrie.

Those two things kind of linked together and where are we in that now.

Right.

<unk>.

So separately.

Right now.

The valkyrie as a minimum as a low cost affordable minimal viable product is ready to go.

It's ready to go into for certain missions, which is why on the last few calls, including today I continue to call out.

Payloads are being integrated flights are happening tactically operationally relevant flights are happening et cetera.

That minimal viable product the minimalist is very substantive.

I'm sure, it's better than anything that any of our adversaries have.

<unk>.

Yes.

It's ready to go and.

Noodling on the artificial intelligence with up with a very robust improvement augmented autonomous system.

If you remember we first flu manned unmanned teaming in 2015.

And that video you can see a manned harrier manned fighters, sending make goes out deploying things coming back et cetera et cetera. So we've been evolving.

Sure.

Our robust augmented autonomy system for a number of years with the Air Force has announced here with what we're doing with shield et cetera. This is much more sophisticated.

This is this is the artificial intelligence piece.

So with those two data points out there.

I believe and this is my opinion, we are ready to go with virtually every one of our tactical drones accept the newest one.

With with augmented autonomy systems, we've we've deployed payloads, we've deployed weapons, we've deployed tactical drones et cetera, et cetera, et cetera et cetera.

Things are evolving very very quickly.

I will not speak for any of our customers, but but by the the announcement the air Force put out yesterday. Some other things that are going to be coming out soon artificial intelligence is moving ahead rapidly.

I'm not sure where the customer will step in and say good enough ready to go it could be tomorrow. It could be in a month could be in a year I don't know.

But that's the evolving game field, we're in does that does that help.

Yes, absolutely I'm sorry.

And then yes.

Obviously, another key milestone.

In the quarter.

Was the.

This is.

Static test by it.

Yeah.

It seems I guess.

Can you take us through kind of where where things go from here and how you see the hypersonic opportunities playing out I mean, it seems like if we think back several years ago in terms of.

We're hypersonic was supposed to be big picture for.

It seems like.

Maybe some of that Hasnt panned out and maybe some of that is because costs are high.

And so.

Yes.

This is something that that's moving in.

Different direction, but when you think about.

Gaining further acceptance.

With the customer and what future milestones or kind of how do you how do you think about that.

Yep.

So as I mentioned, I, obviously can't get into any detail since our last call.

<unk> had a very successful hypersonic launch of our government customers vehicle.

Very successful.

Things.

Relevant to kratos in the hypersonic area.

Are moving very very quickly and it's it's happening right now and I believe it's because of our affordability, our low cost, which we've demonstrated with low cost ballistic missile targets, which as we all know ballistic missiles for hypersonic speeds when they reenter the maneuverability, which we've done before.

I think low cost is going to win because because the customer community wants to test failed test failed test to get it right. Instead of do a test wait three years to figure out what happened in the test again.

Can't do that philosophy, if theyre real expensive the test felt as Phil we're very low cost, which is one of the reasons why.

Seth I believe we were successful with our partner on winning the Moc TB program the.

Mark TB Testbed program, it's a hypersonic testbed program that kicked in in any detail, but I anticipate this starting next year is going to be one of our biggest growth drivers.

And Zeus one in Zeus too in my opinion are primary reasons why we won in addition to earnings.

Erin <unk>.

Yeah.

Don't quote me on this but it's orders of magnitude it's like one eighth of the cost of what of what anybody else has.

And we're going to fly one.

And dark Fury is coming after it.

And dark Fury is incredibly capable.

And so we're taking the approach here very similar to what we did with the tactical drones.

We took proven existing technology, the target drones, and we modified and adapted it and convert it to tactical.

We're taking our ballistic missile target capabilities, our ballistic missile motors, the Oreo the terrier, one dairy or to the Rab.

We're using those.

We specifically.

Designed aerojet is of course is building a fourth but we own it <unk> too and with the Flyers, we're going to be as far as I know one of the only companies I think there might be one other that has the stack and the front ends in the world.

And Seth you reminded me of something on that.

Next year, we're going to start putting our engines in certain of our target drones. So we are about we are now starting to vertically integrate in the drone area with our own engine and the engine is about a third of the cost of the bill of materials, we're not going to have to pay the gross margin to somebody.

So that's going to we're going to be one of the only companies in the world if not the only one that builds the aircraft and engine.

And also related to that we've stood up.

We're standing up a an organization for casting milling machining and three D printing.

The components for our engines.

So we're not going to have to go outside and be held up by supply chain anymore.

That's going to be up and rolling next year or two.

So I know, that's a long answer but that kind of ties into the vertical integration question, you were asking and that's our vision.

Great. Thanks very much.

Thank you.

Thank you one moment for our next question.

We have a question from Sheila <unk>.

<unk> <unk> with Jefferies. Your line is open.

Yeah.

Thank you good afternoon, Eric and Deanna.

Eric first for Scott.

Happy birthday.

Go ahead ask your question.

Thank you Phil.

Hum.

So on <unk>, you mentioned, a few things youre looking for on the unmanned side.

Two things, we should look for in fiscal 'twenty.

When it comes to crater.

I want it named some things that I think you can see op you want to definitely take a look at.

Target drone target drones, so look at PEO to OE program Executive office to aid in the United States Navy on their target drones.

And so this is unmanned unmanned aerial systems and strike. We're target drones are theyre also going to be doing some other things in there we are heavily involved in that line.

Take a look at the target drone line of the United States Air Force You heard me mentioned in my prepared remarks that.

Lots going on in the world and so a lot more target drones are going to be needed. So I would I would take a look at the target drone areas.

That youll.

You'll be able to see and youll be up I think in the narrative under the <unk>. The program element lines, you'll be able to see narrative that specifically.

Specifically related to.

To create us.

I think I think you'll be able to see.

Under the United States Marine Corps I think.

It'll be narrative that will call out.

Attributable aircraft attributable unmanned aircraft Expeditionary aircraft, that's one to look forward to relative to what we're doing with the United States Marine Corps.

Well, thank you for that.

And then my second question for you is on Kgs, great quarter grew 17% organically you called out basically every business area.

And you even mentioned like if you hadn't been libra, there you'd be higher. So obviously the budget is not growing 17% are you taking share what are some of the key areas where contributed to that growth.

Yeah. So let me handle the bids the programmatic part and then Deanna will handle the numbers.

We absolutely are taking share.

And there are two guys in particular were taken it from.

And that's been our plan.

Where.

<unk>.

The traditional people in legacy people are very hesitant to do anything innovative and come out with any new products because they don't want to cannibalize what they have existing they don't want to cannibalize. It so theyre different incentivized to come up with Virtualized software command and control telemetry tracking.

<unk> modems et cetera for space Communications, Theyre, just not incentivized to do it because they cannibalized.

Well it takes a disruption.

Like <unk>.

Software defined satellites.

Hi definition satellites of high throughput satellites et cetera that needs a whole new generation of ground equipment to give a guy like us in opportunity.

And so we are.

We're definitely taking share and we intend on continuing to do that.

Okay, maybe one last one I'll have Dennis kind of comment on the numbers.

Five years from now how do you think about the fighter program whether it.

Bob B 21 on gang CPA.

Well I'll go back.

Alright, and then any of us.

Sheila right. After you went through the different platforms.

The phone went silent and then.

You came back on so if you could crisply again I'm sorry, what was the question sorry about that.

Five years from now how you think about like the Spider program contribution to <unk>.

I know you Couldnt answer Ken's question I'm asking.

Yes.

Yeah, I'm going to be I'm going to be very aloof on that and I'm going to answer it this way.

We are seeing in the Ukraine.

The quantities matter, especially when it comes to drones.

Hundreds if not thousands of drones are going to be used now people are saying Oh those are propeller planes when you get that because its on land for but in the Pacific.

Take a look at the recent Rand report that came out last week and the Rand report, specifically laid out that to deter and defend Taiwan against somebody.

The best way to do it is to.

Use hundreds if not thousands of high performance jet drones that give the bad Guy a hell of a targeting problem. They have to respect the mall and there are an incredible threats flipped the cost curve on them, where they have to fire something more expensive that you then the drone I also encourage people.

Three Star General High note just retired three weeks ago.

Go take a look at his most recent interviews regarding what he sees the drones are going to be needed in the next three to five years for the Pacific.

And so with that as the backdrop Sheila.

Please that the most important from our aircraft standpoint for credo is going to be our tactical jet drones.

Specifically in the expendable and be a tradable areas.

We intend to be one of the leaders there.

Okay. Thank you.

Yep.

Thank you.

And it looks like.

Our last question comes from.

Yes.

John France, Engelbrecht with Baird. Your line is open.

Good afternoon, Eric.

Congrats on a good quarter I'm on for Peter today.

Tom.

Good afternoon.

You mentioned in the release your bid and proposal pipeline of $10 billion.

Can you just talk more about the potential for new space of broadband and maybe a little bit of information about the adoption of open space, that's going on with customers.

Right.

If you could if you could see me first how much youre Im smiling.

Okay.

Our open space team is incredible.

The technical team the sales team the business development team.

Truly incredible and we have put a tool in their toolbox or an arrow in their quiver.

With this first to market software command and control <unk> modem system et cetera.

That is the exact right answer at the exact right time.

For the type of satellites that are going up today.

We are we are my opinion, we are three or four years ahead of the competition with some of the reasons I said before.

We have extreme high expectations that are being proven out for our satellite and space business.

It's our biggest business and it's going to be our I believe it's going to be our fastest growing.

With incredible margin expansion that we're starting to see it's going to really take off next year then in 'twenty five as the software license model under open space kicks in.

And the vendor lock comment that I made in my prepared remarks.

The satellite operators do not want to be vendor lock to the guys that are building the satellites anymore, where they're tied into the ground equipment forever. They don't want that.

And so we are the independent merchant supplier.

Ground equipment that can interface with the <unk> meals and Geos.

And and we might have a tiger by the tail here and.

And I encourage you all if you Havent go to Intel SaaS website. They have actually put a video on their website. What credo is open space is what it's doing for them, how it's differentiating for them.

And that'll give you an idea of why why you hear a giddy up in my step relevant.

So this but we're feeling very good and a big part of that pipeline.

Importantly, an important part of that pipeline is space and satellite communications with open space content.

Yeah.

Perfect. Thank you thanks for the detail and if I could just have a quick follow up sir thanks.

And then some questions about <unk>.

<unk> and the ability to scale production, but if we could just return to your comments on the doubling of production and I know you have to assume.

<unk> funding comes in.

If you run a move from a 150 to 300, Jay Brian but can you just talk sort of on air with Mako and Valkyrie.

Sort of the lead times that you would.

<unk> to sort of ramp production.

The difference between that.

It's on.

On the Valkyrie right now its 12 to 15 months and it's because of the engine.

And I'm working on fixing that.

And I'm not going to get into too many details on that but that's the big lead time on the Valkyrie. The engines the long lead time on all of them.

But the longest one the vet is the valkyrie the other one I'm going to say are within six months.

But that is the long pole in the tent, it's the engine, which obviously ties right into <unk> engine strategy and why we have engine businesses and why.

Sure.

So optimistic about how good our engine businesses are going to do over the next few years because there isn't in the.

We were fighting terrorists for 20 or 25 years in range and power and when I say power, it's not for US it's electrical power.

To work all the systems on the drones with the power to munitions wasn't important now it's a range of important power's important new engines are important.

Those engines are going to go into drones, that's the plan.

Perfect. Thank you I appreciate it I'll jump back in the queue.

Okay.

Sure.

Thank you and I'm showing no other questions at this time I would like to turn the call back to Eric Demarco for closing comments.

Alright. Thank you everyone for joining us if you have any follow ups other than what we went through please don't hesitate to shoot gather iron note.

We'll we'll plan on chatting with you when we report Q3.

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

[music].

Good day, and thank you for standing by and welcome to the Kratos Defense and security solutions second quarter 2023 earnings Conference call. At this time all participants are in a listen only mode. After the speaker's presentation there'll be a question and answer session to ask a question during the session you'll need to press star one.

One one on your telephone you would there then here an automated message advising you. Your hand is raised to withdraw your question. Please press star one one again please.

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 General Counsel. Please go ahead.

Thank you.

Good afternoon, everyone and thank you for joining us for the cruise defense and security solutions second quarter 2023 Conference call with me today is Eric Demarco, President and Chief Executive Officer, and Deanna Lund credits as 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.

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 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. <unk>.

non-GAAP financial measures should not be considered in isolation from or as a substitute for financial information presented in compliance with GAAP.

Thank you Marie good afternoon.

Q2 came in better than forecasted which provides us additional confidence in achieving our full year 2023 financial objectives.

Including increased second half profitability as our fixed price and other contract mix continues to improve.

We are on plan for 2023 to be a transition year for kratos, including reduced internally funded investments and increased year over year financial performance.

<unk> largest business space and satellite communications, which includes our first to market software based open space Virtualized <unk> TNC and ground system products momentum continued including additional new customer awards and several new opportunities. We are now pursuing.

The large number of satellites being launched into Leo MEO and Geo Orbitz is providing a macro level catalyst for our satellite business in both the commercial and national security areas.

Our open space platform as a representative example of <unk> strategy.

Identifying a potential opportunity area working with the customer credo is making the internally funded investment to be first to market with relevant systems software and technology.

<unk> internal funding also enables us to own and protect the proprietary intellectual property, we develop which is an important element in protecting our market leadership position.

Great Us as open space architecture enables us to address both the commercial and national security areas, providing us a larger overall total addressable market opportunity and the associated scale cost leverage and increase potential margins that come with it.

We are also invested in and self funded <unk> owned and operated global space domain awareness, our SDA network.

Our SDA network monitors the behavior of space based radio frequency RF signals to identify critical information about satellites and objects in orbit, including their position maneuvering health proximity to other satellites and more.

<unk> is FDA network includes over 20 worldwide sites currently hosting approximately 150 fixed since terrible RF sensors, and antennas, which are capable of detecting and tracking space vehicles, and providing real time data to our customers.

It's been recently reported that the U S space coming and is currently tracking and monitoring more than 28000 space objects of which only approximately 3500 art knowledge active satellites.

With this growing volume of satellites and space objects contributing to crate Ocean space domain awareness market opportunity.

<unk> owned and operated one of a kind global SDA system is a clear differentiating technology base capability of our company.

And it's one of the tradeoffs as most valuable assets.

Additionally, the customers increased focus on not being vendor locked to the traditional satellite providers for their ground infrastructure is also providing opportunity for creators.

The large growing and changing global space and satellite market is providing opportunity for every trade offs division, including individually and working together on programs, which has been a key aspect of <unk> overall space focus strategic plan.

We expect <unk> space and satellite business to be one of our company's fastest growers with forecast future year over year increased revenue profit margins and cash flow.

<unk> and launch systems.

Partially.

Since our last report to you <unk> has reached customer agreement on a potentially very large propulsion system program, which if successful is expected to be an important overall contributor to our company, including a significant financial ramp beginning in 2024 for creators.

Also since our last report.

T T space customer, which we are under contract with successfully received a new manned lunar system program Award, which also could be a significant future contributor to kratos.

Great doses engine businesses are expected to be certain of our fastest future growers and increased margin contributors.

<unk> rocket systems on a rocket motor ballistic missile target hypersonic and other system business.

Representative of our leadership position since our last report tradeoffs as rocket systems business successfully launched a new hypersonic payload for a certain customer.

Additionally, kratos as rocket systems business successfully conducted the first static fire test of the Credo Zeus one solid rocket motor at Aerojet Rocketdyne, Camden, Arkansas facility.

<unk> family of rocket Motors is in direct response to the market need and demand for new affordable solid rocket motors of a particular size class and nature for launch vehicle stages hypersonic ballistic missile target research and other systems and vehicles.

And also for <unk>, <unk>, and our dark Fury hypersonic fliers.

With a successful test of <unk>, one and the upcoming Zeus to test we are planning for Kratos as Aaron's and dark purely hypersonic vehicle flights next year.

<unk> to rapidly address the customer needs.

As you know what tradeoffs affordability is a technology and we believe that Kratos Zeus there any stark fury and other credo systems are significantly less costly than any existing or planned future relevance systems.

Missile defense hypersonic testing targets and other vehicles are also certain of the highest priority well funded areas in both the 2024 NDA and the related fight up.

<unk> is the sole source or primary high performance jet target drone provider to the United States Air Force Navy Army other agencies and numerous international customers.

Reflective of <unk> industry, leading target drone position since our last report to you. We have received a $95 million six single award contract from the United States Army and both the U S Navy and the U S. Air Force have indicated to us that they will in the future be procuring increased target drone quantities.

We are also now awaiting a new target drone system related contract award that we have been informed we have been successful on with our teammate and our partner.

And the tactical drone area.

We recently announced that Credo and shield AI have teamed up to rapidly integrate shields artificial intelligence into Kratos Valkyrie.

The Credo Shield collaboration is another representative example of <unk> unique disruptive technology focused business model, which also includes working with venture backed private and commercial entities like shield to move faster than traditional government contractors and be first to market with relevant systems.

We worked with a number of smaller technology and software focused companies like shield Paragon defense and others, which provides <unk> with access to unique disruptive capabilities.

This mission proved out our multilayer framework on an AI ml flown aircraft <unk> Valkyrie and demonstrated the AI ml agents solving a tactically relevant challenge problem during actual airborne operations.

The flight on the Eglin test and training complex was the culmination of the previous two years of partnership that began with the Skyboard Vanguard program.

AI will be a critical element of two future war fighting it is evolving at an incredible pace and kratos Valkyrie and certain of our other tactical jet drones and other critical systems are leaders in relative artificial intelligence, enabling areas.

The Air Force announcement of AI successfully piloting <unk> Valkyrie is another publicly available representative milestone of the progress that kratos tactical drones continue to make with the customer community.

<unk> Valkyrie progress under the Marines collaborative killer program. Similarly also continues to progress.

Since our last report we have now reached agreement with a new national security related customer for payload and mission system integration into <unk> Valkyrie, and we have recently received a contract.

This is a new initiative that is highly confidential and if credo and our partner are successful. This program could be a significant contributor for <unk> beginning next year.

We have now also reached agreement with an additional new national security customer and we expect to have contract documents the phenotype with the contracts office by the end of the government fiscal year 2023.

We also now expect to receive an additional valkyrie related customer contract award by the end of this year.

And based on the March 2024, NDA, we are now hopeful to receive a separate additional largest to date Valkyrie related customer program Award next year.

We have a government customer funded flights with Kratos tactical jet drones over the next several months.

And I encourage you to visit the recently released Air Force Research lab future of artificial intelligence dominated air combat video to see <unk> Valkyrie in flight inaction.

All of the Valkyrie and the <unk> video or actual real drones, they're not computer generated animation rendition cartoons, where stimulations that certain of our competitors like to propagate.

We also have flight scheduled for later this year and next with the new customer that is potentially looking for future purchase of Kratos Valkyries in 2024.

The Valkyrie production run continues with the most recent data indicated continuing valkyrie units unit cost reductions as we progressed through the built in down the learning curve.

Directly related to cost.

Ask subcommittee has marked the 2024, NDAA, specifically, stating that there will be three categories of drones and not to exceed flyaway cost points. These include expandable at 3 million attributable which is my favorite at $10 million and exquisite at 20.

$5 million.

If this NDA Mark is finalized and the 2020 for budget, which it is expected to be then these drone classifications and cost points will become law.

As a reminder.

Approximate cradles tactical drone cost points are currently air Wolf for tactical fighter jet at 500, K or less make.

<unk> at $2 million or less.

<unk> at $6 5 million or less which each of these drones cost expected to be much lower in quantities.

And our new highly capable fully not fully mission <unk> system, which is a $10 million.

<unk> Ghost works continues to work on the new system.

And we are scheduling a capstone event for this system for either later this year or early next.

It's going to depend on a range availability.

We are planning on producing approximately 150 jet drones all in the United States of America, this year, including targets Valkyrie, Mako Air Wolf and others and we are now positioned to double production to approximately 300 drones annually in 18 months.

Looming, we received contract award in customer funding.

We are ready to go now and we are clearly in routinely communicating this to the customer community.

As I mentioned before our credo support ability of the technology and may be better maybe someday in the future at some hoped for hypothetical price.

That is the enemy of the good enough and ready to field now in today.

We believe that Kratos is approach is particularly relevant in the tactical drone area, where the value of affordable mass in quantities, having a quality all of their own is clear.

<unk>, our microwave business are both positioned for a strong second half of 2023 with the demand for space satellite missile radar and other systems contributing to the demand for <unk> products and systems.

We've received a large number of new program awards over the past several months and we have a record consolidated backlog and an opportunity pipeline at record.

Accordingly, we are focused on internal execution organic growth with forecasted future year over year revenue EBITDA and cash flow increases with no acquisitions of size expected.

Our primary operational challenge continues to be obtaining training and retaining qualified employees and the related high labor cost for the specialized personnel, including those that can obtain national security clearances.

These and other items were included in our decision to affirm and not to increase our financial forecast with the potential contribution mix shift between kgs <unk> possible due to potential award and execution timing.

In closing <unk> priorities include supporting the United States National Security.

The U S industrial base Science technology, engineering, math or stem opportunities for the United States and for Kratos as workers.

<unk> dual commercial national security offerings, like Kratos is open space, which drives value for all <unk> customers and.

And value generation for all tradeoffs with stakeholders, including the Doe D. The taxpayer Congress, our employees and our investors.

Diana.

Thank you Eric Good afternoon, as we've included a detailed summary of the second quarter financial performance as well as the third quarter and full year 2023 financial guidance in the press release, we published earlier today I will focus on the highlights of my remarks today.

Revenues for the second quarter with $256 9 million up from $224 2 million in the second quarter of 2002, reflecting a 14, 6% increase.

Revenues came in above our forecasted range of $230 million to $240 million and most of our kgs businesses with the most notable increases in our space and satellite turbine technologies microwave products and <unk> businesses.

Excluding the impact of the <unk> acquisition, which contributed 13.

All businesses within kgs.

Cash flows generated from operations for the quarter of $23 6 million included cash collections, resulting from favorable milestone payment terms, which accelerated receipts into the second quarter, partially offset by working capital requirements to support revenue growth and continued advanced purchases of inventory.

In an effort to mitigate potential supply chain disruptions and delays.

John theory system, and continued development of certain software products supporting our openings based platform.

Free cash flow generated from operations was $27 million after funding capital expenditures of $11 2 million and we see of $8 3 million of proceeds for Valkyrie build as capital assets prior to contract award.

Our contract mix for the second quarter of 2023 was 67% fixed price, 27% cost plus 6% time and material.

In the second quarter of 2003, we generated 11% of revenues from commercial customers and 20% from foreign customers.

We continued to make progress in our hiring and retention of skilled technical labor, including in our <unk> ISR business with the notable net increase in <unk>, our head count of 37% since the end of last year, including 18 in the second quarter plus an additional 12 recently clearing the pre hire process.

Yes.

Gray. This is overall total increasing consolidated head count. This year is 152 from three six to four five at year end 2022 to $3 797 million at the end of the second quarter.

As well as the lingering impact of supply chain disruption inflation and related expected costs and price increases that are currently and expected to continue impacting the industry, including us.

Our revenue guidance range for the third quarter of 2023 reflects an approximate 5% to 13% organic increase over the third quarter of 2022.

Based on the current <unk>.

Terry environment, we are expecting to be in a continuing resolution for the fourth quarter, which is reflected in our affirmation of our full year revenue guidance.

<unk> margins to expand in the fourth quarter based upon the expected mix of revenues, including your fixed price contracts, which include more recent cost estimates and more software based content.

Estimated incremental ramp in production in the second half of 2023 are expected to be driven by a handful of key programs in our space satellite and training <unk> ISR and unmanned systems businesses.

Alright.

Thank you Deanna.

We'll turn it back over to the moderator for any questions.

Okay.

Thank you as a reminder to ask a question. Please press star one on your telephone and.

And wait for your name to be announced to withdraw your question. Please press star one again please.

Please standby, while we compile the Q&A roster.

Our first question comes from Joe Gomes with Noble capital Your line is open.

Hi, Good afternoon. This is Josh for fulfill and then for Joe just on another call.

Hi.

Okay.

Congratulations on the quarter guys.

It seems like it hit the nail on the head and even more so with the growth.

So.

I just wanted to start off just actually just kind of going into the growth rate as well.

Obviously, you guys thought at Blanco right around <unk>.

3% to 7% increase over last quarter, and obviously came in at 15%. So like what was kind of like.

Obviously, the big impact behind that large growth.

Yes, yes it was.

Organic growth literally in every business unit within kgs.

Across the board.

Space satellite training.

<unk> ISR microwave products turbine technologies and defense rocket.

All across the board.

Okay perfect.

No.

I just wanted to see you guys mentioned last quarter that you guys had during shield was going into kind of.

L. Our IP in the back half of 2023 kind of when you guys kind of expect that again are more towards the third and more towards the fourth.

Okay.

Yes.

As you know we're partnered with Dianetics on this and they are the prime we're building the ground infrastructure for epic and dairy and freedom.

I would speak with them things or are consistent with where we are where we were previously there have been no changes.

Okay.

Then.

This.

And lastly.

Kind of you guys. It sounded like you guys are really hiring a good amount of people it seems like well over 100 at least.

So.

The market been just favorable towards that for you guys as well as like it hasnt been pretension for those employees been extremely positive.

It's the market for the type of employee we're looking for continues to improve.

Over the past several months.

It is still difficult on a cost standpoint.

Very costly, especially for individuals that want to add.

And we will obtain and retain a security clearance.

So it's getting better it's one of the reasons, we're feeling better about the business in the second half of this year and 2024.

But it is still expensive for people with very specialized capabilities.

So that's the nature of it right now and yes, we have a lot of openings.

Our growth rate organically, which we're laser focused on could be substantially higher.

Could be but we just can't we can't get the people right now in the industry.

Okay, and then I'll jump back in the queue, but once again great quarter guys.

Thank you. Thank you.

Thank you one moment for our next question.

We have a question from Pete <unk>.

<unk> labs with <unk> Securities. Your line is open.

Hey, good evening I'm on for Mike to Moly Tonight, Thanks for taking the question.

First of all I just wanted to ask given that you maintained the full year outlook after putting up a pretty strong quarter was there any pull forward in demand versus what you originally expected or any maybe unexpected easing in the supply chain just what drove the outperformance versus what you originally expected to look like.

Yes, it's not it's not really the supply chain.

The supply chain.

<unk> is as expected and it continues to be challenging alright.

Alright.

Maybe a couple of things move forward, a little bit a couple but the team is executing very very well and as I tried to allude to in my prepared remarks.

We continue to do $250 million quarters Q3 Q4.

We're going to drill our guidance.

So there is no ramp there's no hockey stick.

And as Deanna mentioned as we all know, we're probably going to have a continuing resolution, we expected that but what I'm starting to worry about is it going to be worse than a continuing resolution until.

Will the government shutdown for a period of time and so were factoring all of those things and where we just don't want to get ahead of ourselves we have a lot of good things going on here across the company.

We want to deliver on what we say, that's where our headset.

Great that's very helpful and then.

As a follow up.

As we think about the opportunities internationally for target drones have you seen any signs of increased momentum for demand on that front either from orders or conversations with potential customers and how are you thinking about the growth trajectory for that business over the next couple of years.

Yep.

International target drone business is continuing to ramp.

It's going to continue to ramp.

However, as I think I mentioned on the previous call or two.

The big three target drone users in the world or the United States Navy, the United States Air Force in the United States Army.

Obviously, we have all of them then there is the UK Ministry of defense, that's our customer too.

Like the U S stuff, they're just not.

The award that I mentioned in my prepared remarks that we have been informed we've won.

And hopefully it's going to be definitive in the next few weeks.

That can be a needle mover 2020 four 'twenty, five and I can't say much more about it.

But that's a good one.

Great. Thanks for taking the question.

Yes.

Thank you.

Yes.

We have a question coming from.

Okay.

Mike Kraft.

<unk> from B Riley Securities. Your line is open.

Thank you Eric.

You're talking about new <unk>.

Payload and mission integration system customer.

Essentially for Valkyrie.

I know you have a number of customers within the Dod.

There may be administering defense, but.

Would you be able.

To supply Valkyrie say too.

Another prime.

Yes, we would be able to.

We would be able to provide the valkyrie to another U S. U S. Prime there is there is no prohibition on us doing something like that if the opportunity arose.

And is that something you would.

Consider to be beneficial given maybe their channels.

The.

Yes, we would definitely consider it.

We're going to do what's right for the business and what's right for the shareholder.

Our model, we have multiple models here at <unk> one of them, it's better to have part of something then all enough of them.

And if we could get a big part of something doing something like Youre talking about instead of taking a high risk in going out alone.

We weigh those factors and we'd make the decision. So the answer is yes.

Okay. Thank you and then.

You talked about.

Our plan and Steve family was actually quoted about this and even further too.

Double production of drones from 150.

Target and tactical aircraft this year too.

300 within 18 months and I know that you have the space to do that given the Oklahoma facility, where I think you're on your second Valkyrie production spyware right now, but what.

Will this require from a human capital standpoint in terms of.

Increased number of employees to execute on that plan.

Right, so Mike related to that than I did not say this in my remarks.

We have acquired an additional autoclave.

Specifically for tactical drones.

Our team got an incredible financial deal on it and we've got it and it is going in.

On the people side that is something we're always focusing on bank and additional for what you do what you just framed up on what Steve said and I know what Youre talking about thanks, another approximate 125 people.

Okay.

Thank you and then I have one final question so.

Your.

Solid rocket motor.

Partner Aerojet Rocketdyne is now part of L. Three Harris and what if any concessions or.

Assurances do you have.

We're not half a mile three regarding your ability to continue to get.

Betty access.

Through a merchant supplier of solid rocket motors for for some of your vehicles.

Right.

So.

Obviously I can't talk about any direct communications that we may or may not have had with anybody youre talking about however.

L three Harris executive leadership.

Lately upon the close.

Pledged.

This is public they made a pledge that theyre going to invest in the business.

They're going to be a merchant supplier.

Someone sent me a letter where they communicated to the department of defense that Theyre not going to play any favorites and they are going to continue to treat us all as equal partners.

So.

That's what my friends at all three Harris of set.

Publicly.

To the other part of your question.

<unk>.

Sure.

We of course are very prudent when we're always looking for second sources.

Or backup plans.

And that's across the company and across the business and we'll continue to do that including now in the rocket motor area.

Okay.

Thank you Eric.

Thanks, a lot.

Well.

Thank you.

We also have a question from Ken Herbert with RBC capital markets. Your line is open.

Yeah, Hey, Eric good afternoon.

Hey, Ken good afternoon.

Wanted to start off congratulations on the AI Valkyrie flight.

Coming out of that fight the airforce, specifically commented that D C direct.

Transferability or applications of this flight and the technology to the CCA program can you can you provide any more color on how you see <unk> involvement in the CCA program.

Playing out any maybe milestones incremental milestones, we should be we should be thinking about and.

And specifically.

How you see the technology sort of risk initially.

As you look to transfer this into or the air force looks to transfer the CCA amongst other areas.

In the future.

Ken I apologize.

I cannot say anything at all about that program.

I'm sorry, okay.

Do it.

Okay Fair enough can you can you provide any comments on the test flight and maybe any of.

Lessons learned in particular or how it completed the flight relative to initial expectations.

From from from my perspective from our perspective.

The Valkyrie.

Absolutely knocked it out of the park over the three hour flight.

And.

Our customers continue to applaud.

The valkyrie they applaud the aircraft.

And I mentioned the video of the Air Force Research Lab video.

It may have had a chance to take a look at it for those of you that haven't I encourage you again to please go take a look at it it will address and answer a lot of the questions.

By the government by the Air Force that Canada is asking that.

Not comfortable talking about publicly.

Can we we continue to make.

Incredible progress.

And then the tactical drone area.

As I said about a year ago I thought everything was going to become more classified and that was going to not be able to talk much anymore and thats, where we are which is why I'm now wherever I can pointing to or identifying what the government is saying theyre not endorsing, but what they are saying.

To try to keep the investors as up to date as.

As possible.

So we are with the U S Marine Corps, we're doing great.

No. It's out there it's I saw public thing out there now we're involved with the office of the Secretary of Defense. That's moving forward, obviously with the air force in multiple areas.

We feel.

The government moves on their own timeline.

We will not get ahead of ourselves.

But we.

Have a whole family of airplanes flying.

Today, and I mentioned, the cost points I mentioned new stuff.

We're ahead of everybody.

And our plan is to stay ahead of everybody.

Very important person said to me in the past couple of weeks you need to have strategic patience for those of you know me, that's very difficult, but I'm haven't have strategic patience and we will win.

Okay perfect I appreciate that and if I could maybe just one for Diana.

In the second quarter, it looks like working capital specifically accounts receivable were was.

It really nice source of cash the.

The guidance implies.

Nice nice inflection in the second half of the year in terms of cash generation are there are there was there anything sort of onetime in there.

You call out around working capital it was a nice tailwind and how do we think about maybe the upside.

For the full year expectations from a cash standpoint.

Sure.

There are some favorable milestones in the second quarter that did accelerate some receipts that we had originally anticipated in the third quarter.

So that that was favorable in the second quarter in my prepared remarks.

<unk> highlighted Q4, where we expect to.

Working capital to be.

Beneficial as well in the fourth quarter as based on scheduled milestone payments as well as <unk>.

Our expected conversion of some of the inventory builds that we've been building throughout 'twenty two.

Thus far through 2023.

Perfect. Thank you very much thank.

Thank you Youre welcome.

Thank you.

We have a question coming from.

Seth Sussman with J P. Morgan your line is open.

Okay.

Thanks, very much good afternoon.

And congratulations again.

The latest valve.

<unk>.

At the risk of asking a question about something.

Difficult to talk about.

Just following up on that maybe but hopefully this is higher level.

Can you talk about when we think about the path forward.

With Valkyrie and things that need to be developed in order to see demand really ramp up.

Assume that some of it is the artificial intelligence capability.

Being developed kind of outside the company.

When you think about the pace of that and how that happens.

How that development.

Past that relates to the demand profile.

For Valkyrie, how do those two things kind of linked together and where are we in that now.

Right.

Tom.

So separately.

Right now.

The valkyrie as a minimum as a low cost affordable minimal viable product is ready to go.

It's ready to go into for certain missions, which is why on the last few calls, including today I continue to call out.

Payloads are being integrated flights are happening tactically operationally relevant flights are happening et cetera.

That minimal viable product and minimal is very substantive.

I'm sure, it's better than anything that any of our adversaries have.

Yes.

It's ready to go and.

Noodling on the artificial intelligence with up with a very robust improvement augmented autonomous system.

If you remember we first flu manned unmanned teaming in 2015.

And that video you can see a manned harrier manned fighters, sending make goes out deploying things coming back et cetera et cetera. So we've been evolving.

Sure.

Our robust augmented autonomy system for a number of years with the Air Force has announced here of what we're doing with shield et cetera. This is much more sophisticated.

This is this is the artificial intelligence piece.

So with those two data points out there.

I believe and this is my opinion.

We are ready to go with virtually every one of our tactical drones accept the newest one.

With with augment that autonomy systems, we've done we've deployed payloads, we've deployed weapons, we've deployed tactical drones et cetera, et cetera, et cetera et cetera.

Things are evolving very very quickly.

I will not speak for any of our customers, but by the the announcement the air Force put out yesterday. Some other things that are going to be coming out soon artificial intelligence is moving ahead rapidly.

Not sure where the customer will step in and say good enough ready to go could be tomorrow. It could be in a month could be any year I don't know.

But that's the evolving game field, we're in does that does that help.

Yes, absolutely absolutely thanks, and then.

Obviously, another key milestone we.

In the quarter.

Was the.

This is.

Static test by it.

It seems I guess.

Can you take us through kind of where where things go from here and how.

How you see the hypersonic opportunities playing out I mean, it seems like if we think back several years ago in terms of.

We're hypersonic was supposed to be big picture for <unk> It seems like.

Maybe some of that Hasnt panned out and maybe some of that is because costs are high.

And so.

This is something that that's moving in a different direction, but when you think about.

Gaining further acceptance.

As with the customer and what future milestones or kind of how do you. How do you think about that.

Yes.

So as I mentioned, I, obviously can't get into any detail since our last call.

<unk> had a very successful hypersonic launch of our government customers vehicle.

Very successful.

Things.

Relevant to kratos in the hypersonic area.

Can't do that philosophy, if theyre real expensive the test felt as Phil we're very low cost, which is one of the reasons why.

Seth I believe we were successful with our partner on winning the market TV program the.

<unk> TB test bed program, it's a hypersonic testbed program that kicked in in any detail, but I anticipate this starting next year is going to be one of our biggest growth drivers.

And Zeus one in Zeus too in my opinion are primary reasons why we won in addition to earnings.

<unk>.

Yeah.

Don't quote me on this but it's orders of magnitude is like one <unk> the cost of what of what anybody else has.

And we're going to fly one.

And dark Fury is coming after it.

And dark periods incredibly capable.

And so we're taking the approach here very similar to what we did with the tactical drones.

We took proven existing technology, the target drones, and we modified it adapted it and converted it to tactical so we're taking our ballistic missile target capabilities, our ballistic missile motors, the Orioles Terrier, one dairy or to the route.

We're using those.

We specifically.

And Seth you reminded me of something on that.

Next year, we're going to start putting our engines in certain of our target drones. So we are we are now starting to vertically integrate in the drone area with our own engine and the engine is about a third of the cost of the bill of materials, we're not going to have to pay the gross margin to somebody.

So that's going to we're going to be one of the only companies in the world if not the only one that build of the aircraft and engine.

And also related to that we've stood up.

We're standing up a an organization for casting milling machining and three D printing.

The components for our engines.

So we're not going to have to go outside and be held up by supply chain anymore.

That's going to be up and rolling next year or two.

So I know thats, a long answer but that kind of ties into the vertical integration question, you were asking and that's our vision.

Great. Thanks very much.

Thank you.

Thank you one moment for our next question.

We have a question from Sheila <unk>.

I'll glue with Jefferies. Your line is open.

Thank you good afternoon, Eric and Deanna.

Eric our stock happy birthday.

Thanks for your question.

Thank you Bill.

So on the back.

You mentioned a few things you are looking for on the unmanned side what would be.

Things, we should look for in the fiscal 'twenty budget when it comes to crater.

I Wanna named some things that I think you can see up you want to definitely take a look at.

Target drone target drone, so look at PEO to OE program Executive office to aid in the United States Navy on their target drones.

And so this is unmanned unmanned aerial systems and strike where target drones are theyre also going to be doing some other things in there we are heavily involved in that line.

Take a look at the target drone line of the United States Air Force.

You heard me mentioned in my prepared remarks that that.

Lots going on in the world and so a lot more target drones are going to be needed. So I would I would take a look at the target drone areas.

That.

Youll be able to see and youll be up I think in the narrative under the Pete the program element lines youll be able to see narrative that specifically.

Specifically related to.

Two to create us.

I think I think.

Youll be able to see.

Under the United States Marine Corps I think.

It'll be narrative that will that will call out.

Attributable aircraft attributable unmanned aircraft Expeditionary aircrafts.

Wanted to look forward to relative to what we're doing with the United States Marine Corps.

Well, thank you for that.

And then second question for you is on Kgs, great quarter grew 17% organically you called out basically every business area.

And you even mentioned like if you had been libra, there you'd be higher. So obviously the budget is not growing 17% are you taking share what are some of the key areas were contributing to that growth.

Yeah. So let me handle the bids the programmatic part and then Deanna will handle the numbers.

We absolutely are taking share.

And there are two guys in particular were taken it from.

And that's been our plan.

Where.

<unk>.

The control modems et cetera for space Communications.

Not incentivized to do it because they cannibalized well it takes a disruption like <unk>.

Software defined satellites.

Hi definition satellites high throughput satellites et cetera that needs a whole new generation of ground equipment to give a guy like us on opportunity.

And so we are.

We're definitely taking share and we intend on continuing to do that.

Okay, and maybe one last one I'll have Dan has done a comment on the numbers.

Five years from now how do you think about the fighter program whether it.

Bob B 21 gang CCA.

I'll go back.

Alright, and then any of that.

Sheila right. After you went through the different platforms.

The phone went silent and then.

You came back on so if you could crisply again I'm sorry, what was the question sorry about that.

No just five years from now how you think about like the biggest Spider program contribution to cleanup.

I know you Couldnt answer Ken's question Barton asking.

Yes.

I'm going to be I'm going to be very aloof on that and I'm going to answer it this way.

We are seeing in the Ukraine.

The quantities matter, especially when it comes to drones.

Hundreds if not thousands of drones are going to be used now people are saying all of those are propeller planes and yeah, I get that because its a land war, but in the Pacific.

Take a look at the recent Rand report that came out last week and the Rand report, specifically laid out that to deter and defend Taiwan against somebody.

The best way to do it is to.

Use hundreds if not thousands of high performance jet drones that give the bad Guy a hell of a targeting problem. They have to respect them all and they are an incredible threat. So you flip the cost curve on them, where they have to fire something more expensive that you then the drone I also encourage people.

Three Star General High note just retired three weeks ago.

Go take a look at his most recent interviews regarding what he sees the drones are going to be needed in the next three to five years for the Pacific.

And so with that as the backdrop Sheila.

Please.

The most important from our aircraft standpoint for credo is going to be our tactical jet drones.

Specifically in the expendable and the attributable areas.

<unk>.

We intend to be one of the leaders there.

Great. Thank you.

Yes.

Thank you.

And it looks like.

Our last question comes from.

Yes.

John France, Engelbrecht with Baird. Your line is open.

Good afternoon, Eric.

<unk>.

Congrats on a good quarter I'm on for Peter today.

Sure.

Good afternoon.

You mentioned in the release.

<unk> pipeline of $10 billion.

Can you just talk more about the potential for new space Awards, and maybe a little bit of information about the adoption of open space, that's going with customers.

Right.

If you could see me first how much I'm smiling.

Okay.

Our open space team is incredible.

The technical team the sales team the business development team, it's truly incredible and we have put a tool in their toolbox or an arrow in their quiver.

With this first to market software command and control <unk> modem system et cetera.

That is the exact right answer at the exact right time.

For the type of satellites that are going up to date.

We are my opinion, we are three or four years ahead of the competition with some of the reasons I said before.

We have extreme high expectations that are being proven out for our satellite and space business.

It's our biggest business and it's going to be our I believe it's going to be our fastest growing.

With incredible margin expansion that we're starting to see it's going to really take off next year then in 'twenty five as the software license model under open space kicks in.

And the vendor lock comment that I made in my prepared remarks.

The satellite operators do not want to be vendor lock to the guys that are building the satellites anymore, where they're tied into the ground equipment forever. They don't want that.

And so we are the independent merchant supplier.

Ground equipment that can interface with the leos meals and Geos.

And and we.

We might have a tiger by the tail here.

And I encourage you all if you Havent go to Intel sets website, they've actually put a video on their website what cradles as open space is what it's doing for them, how it's differentiating for them.

And that will give you an idea of why you hear a giddy up in my stomach relevant.

So we're feeling very good and a big part of that pipeline.

Important an important part of that pipeline is space and satellite communications with open space content.

Perfect. Thank you thanks for the detail and if I could just have a quick follow up Sir there is Vincent.

And then some questions about <unk>.

<unk> and the ability to scale production.

If we could just return to your comments on the doubling of production and I never.

<unk> funding comes in.

If you run a move from a 150 to 300, just Brian but can you just touch sort of on air with Mako and Valkyrie.

Sort of the lead times that you would.

<unk>, you sort of ramp production.

The difference between that.

It's.

On the Valkyrie right now its 12 to 15 months and it's because of the engine.

And I'm working on fixing that.

And I'm not going to get into too many details on that but that's the big lead time on the Valkyrie. The engines the long lead time on all of them.

But the longest one Nevada is the valkyrie the other one I'm going to say are within six months.

But that is the long pole in the tent, it's the engine, which obviously ties right into <unk> engine strategy and why we have engine businesses and why.

Yes.

So optimistic about how good our engine businesses are going to do over the next few years because there isn't in the.

We were fighting terrorists for 20 or 25 years in range and power and when I say power, it's not thrust its electrical power.

To work all the systems on the drones and the power to munitions wasn't important now it's a range of important power's important new engines are important and those engines are going to go into drugs. That's the plan.

Perfect. Thank you I appreciate it I'll jump back in the queue.

Okay.

Thank you and I'm showing no other questions at this time I would like to turn the call back to Eric Demarco for closing comments.

Alright. Thank you everyone for joining us if you have any follow ups other than what we went through please don't hesitate to shoot Gan or iron note.

We'll we'll plan on chatting with you when we report Q3.

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

Q2 2023 Kratos Defense & Security Solutions Inc Earnings Call

Request a DemoDemo

KTOS

Kratos Defense and Security Solutions

Earnings