Good day and thank you for standing by. Welcome to the Kratos Defense & Security Solutions' Fourth Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session.

[Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Marie Mendoza, Senior Vice President and General Counsel..

Thank you. Good afternoon everyone and thank you for joining us for the Kratos Defense & Security Solutions fourth quarter 2022 conference call. With me today is Eric DeMarco, Kratos’ President and Chief Executive Officer; and Deanna Lund, Kratos’ Executive Vice President and Chief Financial Officer.

Before we begin the substance of today’s call, I’d like everyone to please take note of the Safe Harbor paragraph that is included at the end of today’s press release. This paragraph emphasizes the major uncertainties and risks inherent in the forward-looking statements we will make this afternoon.

Please keep these uncertainties and risks in mind as we discuss future strategic initiatives, potential market opportunities, operational outlook and financial guidance during today’s call. Today’s call will also include a discussion of non-GAAP financial measures, as that term is defined in Regulation G.

Non-GAAP financial measures should not be considered in isolation from or as a substitute for financial information presented in compliance with GAAP. Accordingly, at the end of today’s press release, we have provided a reconciliation of these non-GAAP financial measures to the company’s financial results prepared in accordance with GAAP.

With that I will now turn the call over to Eric DeMarco..

Thank you, Marie. Good afternoon. Kratos is positioned as the leading disruptive technology company, designing, developing and fielding relevant systems product and solutions, continues to progress, reflecting the trust our customers have in your company.

Kratos along with our strategic partners, vendors and suppliers are aligned and removing rapidly to address the evolving threat, not with PowerPoint's, press releases and scripted publications, but with real systems that we will discuss today.

We believe that 2023 will be a transition year for Kratos to greater revenue, profit and cash flow with significant prior year investments in technology, products and systems, transitioning from development RDT&E or LRIP to fund the programs, contracts or full rate production, which will result in increased revenue, profit and operating cash flow for the company.

This includes today's announcement that Kratos's BQM-177A unmanned aerial target drone is now entering full production. And Kratos's rocket systems business where we have also made significant investments, we have now received two important new hypersonic system related program awards, Mayhem and MACH TB with our partner Dynetics.

Under the MACH TB contract, which we announced in November, Kratos and the MACH TB team will work to develop an affordable and responsive Hypersonic Test Bed platform and national hypersonic testing capability in an effort to dramatically increase our nation's capacity for ground and flight testing of hypersonic technologies and payloads.

Under the Mayhem, or Expendable Hypersonic Multi-Mission ISR and Strike Program, Kratos will support the Air Force Research Laboratories development of an air breathing hypersonic weapons system.

Kratos is an industry leader in flight proven agile engineering capabilities with experienced and high performance propulsion, hypersonics, exotic materials and air vehicle design, which we are applying to win large new program opportunities like Mayhem and MACH TB.

Kratos has previously successfully developed and flown several hypersonic systems and are internally funded hypersonic investments and unique and proprietary systems and vehicles including Kratos Zeus and Erinyes, we believe will be disruptive game changers for our customers and our country and are beginning to pay dividends for Kratos' stakeholders including with these recent program awards.

Kratos's rocket systems business recently successfully integrated and launched four ballistic missile targets with our government partner, which included the successful intercept test of a medium range ballistic missile target by a standard missile 3 Block IIA fired from the JS Maya, marking the first time that a Japanese Maya-class destroyer has fired an SM-3 Block IIA.

We believe this successful test is representative of Kratos's industry leading position in the rocket system missile defense and ballistic missile defense areas and of Kratos's affordable, relevant, disruptive high technology rocket systems and we expect Kratos's rocket system business to be one of our fastest growing in 2023 driven by the increased global interest in air and missile defense systems.

Kratos recently received the initial $30 million in funding on a new potential $250 million C5ISR production program in the microwave electronics area. This program is classified.

Kratos's microwave electronics business had a record backlog at year-end including a focus on missile, air defense and radar systems and we expect this business to be Kratos's one of our fastest growing for 2023.

Kratos and C5ISR business is also expected to be one of our fastest growing in 2023 with expected growth coming from several missile, air defense, radar and other programs, including GBSD Sentinel with our prime strategic partner Northrop Grumman. Other Kratos C5ISR business programs include high [ph] Mars, Titan, Patriot, Fad, IBCS [indiscernible].

Kratos has recently been selected as the Engine Design Team for Boom-led Collaboration on a new supersonic propulsion system called Symphony, a sustainable and cost-efficient engine for booms planned overture supersonic airliner, with Symphony being a bespoke design, leveraging proven technologies and materials to achieve optimal supersonic performance and efficiency.

Booms overture new symphony propulsion system is expected to operate at net zero carbon and meet Chapter 14 noise levels and when compared to derivative approaches, Symphony is also ultimately expected to deliver a 25% increase in time on wing and significantly lower engine maintenance costs, and is also expected to reduce overall airplane operating costs for airline customers by 10%.

On the Symphony program, Kratos will utilize its supersonic engine design experience and expertise, working under a standard commercial time and material type contract arrangement with no Kratos investment.

The Kratos Symphony team will include key Kratos personnel and engineers that were directly involved in supporting the design of the F-119 and F-135 supersonic engines that power the F-22 and the F-35.

Kratos is also supporting Rolls Royce on a B-52 re-engine program with Rolls Royce and B-52 being certain of [indiscernible] most important strategic partners and a program.

Another growth area for Kratos is new space and related launch vehicles and propulsion systems were KTT is currently under contract on multiple DoD government and commercial space system related programs, involving Kratos's hardware and products in support of some of the most technologically advanced propulsion systems in the world.

In the drone missile and powered munitions area, Kratos and KTT have made progress over the past several months, including technically delivering engines to a confidential customer for a yet to be announced UAS and receiving word from a customer regarding the future opportunity for up to 1000s of Kratos engines, which we are jointly working to address and KTT is forecast to be one of Kratos's fastest growing businesses in 2023.

Kratos's space and satellite communications business, our company's largest is also forecasting significant future organic growth and is expected to generate some of Kratos's highest margins, including as related to Kratos's first to market software based OpenSpace virtualized TTMCC2 [ph] and satellite ground systems, which continue to gain market acceptance in both the national security and the commercial market areas.

The satellite communications industry is focused on virtualizing the entire ground infrastructure in order to be efficiently compatible with cloud based and other standardized networks, equipment and systems, including importantly 5G, which is another Kratos focus area here.

Converting hardware to software that is installed and managed remotely via third-party data centers are on standard compute devices is expected to provide satellite operators increased flexibility over their networks, improving the response time to customer demands.

This conversion to software is exactly what Kratos's OpenSpace and open edge is focused on for example, today satellite terminals consist of purpose built hardware components that are limited to performing a dedicated function.

For example, a satellite modem performing modulation and demodulation functions until Kratos has open edge satellite terminals, the devices that end users employ at the far edge of the satellite ground network to transmit and receive data have been purpose built hardware devices that seriously restrict functionality and flexibility at the network's edge.

Kratos's open edge disrupts these limitations by employing software, virtualized modems that can run on general purpose off to shelf compute devices and open edge as far more power versatility by enabling additional apps to run right up the network's edge.

Kratos's open edge uses a different model for operating at the edge, one that employs standards already widely adopted across the larger global telecommunications industry to expand terminal functions and make them more flexible.

These standards that Kratos is open edge employees are what enable mobile devices such as smartphones to support roaming, use cloud-based functions, interoperate with other networks and do much more.

Well satellites present a complex technology challenge, the goal of Kratos's OpenSpace and open edge is to help satellite operators make their services as mainstream as cellular communications and to capitalize on new services such as 5G, which is why Intelsat will be one of Kratos's first partners to supplant traditional satellite terminals with Kratos's open edge.

I hope you can see why here at Kratos we're so excited about our satellite business's future prospects.

Kratos's target drone business is performing well with major Kratos sole source programs including the Air Force's AFSAT program featuring the Kratos's BQM-167 Target and the United States Navy SSAT program featuring Kratos's 177 target drone, wherein on both program we have recently received additional large production awards.

Additionally, and very importantly, the recent United States Navy SSAT177 program award includes target drones or missions for both Australia and Canada, two new Kratos BQM177 target drone customers.

We are currently in pursuit of certain new domestic target drone opportunities that if we are successful, could provide the next growth step function for the business.

And we have recently seen a number of potential new international target drone opportunities that we believe are a result of current global conflicts and threats, including in the Ukraine, and the related ongoing global recapitalization of strategic weapon systems.

In the tactical drone area, Kratos has recently received a contract for an initial two Valkyries from the United States Marines along with sensors, weapons systems payloads, et cetera Under the Affordable Autonomous Cooperative Killers program.

The Killers program is a new program for Kratos, which we have not yet been able to formally announce or discuss, and I encourage you to review the Navy contract award announcement and other available publications, including as related to the USMC for additional information, including related to the significance, importance and the future prospects of the sole source contract award to Kratos.

We believe that one of the primary reason the Killers program was awarded to Kratos' sole source is that we have available now Valkyrie jet drones coming off our active production line and that the Valkyries cost and price points are known not on a hoped for PowerPoint slide, which estimated costs our competitors routinely change and increase after the fact of which we believe certain of our customers are clearly beginning to take note.

Kratos's Valkyrie is also a demonstrated LO, runway independent system, not requiring a runway to take off or land and Kratos's jet drones are also routinely ship launched, all of which we believe are becoming more of a differentiator for Kratos.

It was also recently reported that the United States Air Force's 40th flight test Squadron at Eglin Air Force Base has now taken ownership of Valkyrie aircraft with the Valkyries ability to autonomously operate over vast distances can be evaluated along with certain other objectives.

Eglin recently published photographs of Kratos's Valkyrie flying with manned F-16 fighters, and emphasizing the Valkyries rail launch, runway independence and precision parachute recovery, certain of which were approved for us to publish today. None of Kratos's potential competitors have runway independent capability.

With the competitors competing systems all currently having or planned to have landing gear to be dependent on a runway, which I believe will be completely untenable and appear conflict.

It was also recently reported that a U.S government customer is working with multiple industry partners to integrate leading edge autonomy capabilities into the XQ-58A as Kratos's Valkyrie and all Kratos drones have an open system architecture, meaning a variety of autonomous and AI cores can be integrated into our system.

Open System Architecture is another competitive differentiator for Kratos versus our competitors as the customers do not want to be vendor locked.

It was recently reported that the Valkyrie has now entered a time critical test period with a U.S government customer related to certain manned, unmanned teaming, which flight and testing are planned to be completed by the end of this year.

The U.S Air Force has now stated that the Skyborg and the Golden Horde Vanguard programs both of which Kratos is involved in are transitioning to become programs of record and are expected to form the nucleolus of new combat systems, including collaborative combat aircraft or CCAs.

Both Kratos's Valkyrie and the Mako tactical jet drones have performed under the Skyborg program, and the Golden Horde program has demonstrated how a group of unmanned aircraft or weapons can communicate with each other and operate collectively rather than singularly.

In addition to the recent Valkyrie contract awards and this progress, we are now in contract negotiations with another new customer on a new program for the acquisition of multiple Valkyries, which we believe we will have under initial contract by the third quarter of this year.

Additionally, we are also now currently in contract negotiations with the customer, laid out to Kratos's Valkyries valued at several tens of millions of dollars, which we also expect to be completed and under contract by the third quarter of this year.

And we have now also provided a Kratos Valkyrie aircraft to an additional potential new customer for systems assessment and review. And we are in discussions as to potential next steps, including purchasing leasing services type or other contractual arrangements.

And we're also continuing discussions with another potential new customer related to the acquisition of several Valkyries.

It is important to emphasize that with each of these Valkyrie-related opportunities that’s similar to Kratos's target drone business, it is extremely important that in addition to initial Valkyrie aircraft acquisition, that the flight recovery support and other system related equipment and infrastructure is also being acquired and deployed by the customers.

As this upfront investment represents a customer commitment to the system, which returned to the customer is increased obviously by additional future XQ-58A aircraft acquisitions.

We are currently performing under multiple Valkyrie-related government funded contracts or programs with a key element including the continued missionization and operationalization of the Kratos XQ-58A system.

And we are working closely with our customers on the optimal funding utilization and contract structures, including the funding allocation between acquisition of aircraft, system related infrastructure, missionization and operationalization in order to achieve the strategic objective.

There has also recently been increased interest in certain other Kratos's tactical drone systems in addition to the Valkyrie, which I believe is as a result of what is occurring in the Ukraine, also included as related to affordable mass warming and drone attrition rates.

So now important like keys to our strategic tactical drone strategic decision making include Kratos is the only company that has affordable relevant systems flying now, not just PowerPoints, concepts, designs and press releases, and Kratos has an active production lines for jet drone aircraft today, with Kratos having produced over 1,100 high performance unmanned jet target and tactical drone aircraft to date, representing another important differencing competitive advantage for Kratos and another key reason why Kratos customers trust us.

We have demonstrated that Kratos [indiscernible] is delivering jet drones in quantity now at real known price points. So, as a result of this progress, we've now moved forward with our second serial production run of at least 12 of the next generation block of Kratos Valkyries.

This decision is important for several reasons including having XQ-58A systems available to immediately meet expected customer demand and supporting Kratos's first to market leadership position.

We also want to ensure that there was no break in the current Valkyrie production line so that we can continue to improve on the learning curve efficiencies and related declining cost experience we have gained and achieve the target costs we are now providing in proposals to potential customers.

The cost per pound of Kratos jet drone aircraft we believe is currently far below our competitors.

I think we know it and they know it, and we expect to continue to drive Kratos's drone cost down significantly, including with the continued actual production of aircraft to the benefit of Kratos's customers and to the detriment of certain competition, especially when the customers compare what it actually costs our competition to produce a jet drone aircraft, not what our competitors say or indicate in their proposals.

As I mentioned, this new group of at least 12 serial production Valkyries will be the next block upgrade version, including multiple enhancements based on the numerous successful flights we have completed with our customers.

Their input and feedback and also including certain enhancements or modifications that Kratos has ghost Works has been focused on, including to specifically address certain potential competitive adversarial threats, including in the Pacific.

I continue to believe that Kratos's air gapped ghost works entity is truly a crown jewel of Kratos and in my opinion it's a national asset for our country.

At Kratos, affordability as a technology and Kratos's ghost works is by far the clear industry leader in high performance unmanned aerial jet powered aircraft and systems and the real live application of relevant cost effective digital engineering practices.

So to wrap up, based on our backlog, our significant new program awards and $10 billion opportunity pipeline, we expect up and to the right future organic growth trajectory for Kratos with no currently planned acquisitions as we focus on execution, obtaining and retaining qualified personnel, which remains a primary operational challenge and continuing to bid on and win new program opportunities.

As we begin 2023 every Kratos business is expecting organic growth and we are forecasting Kratos's consolidated '23 over '22 revenue growth of approximately 10% with increased margins, reduced internally funded investments and increased cash flow.

Deanna?.

Thank you, Eric. Good afternoon. As we have included a detailed summary of the fourth quarter and full year financial performance for FY '22 and first quarter and full year '23 financial guidance in the press release we published earlier today, I will focus on the highlights in my remarks today.

Revenues in the fourth quarter were $249.3 million, up from $211.6 million in the fourth quarter of '21, reflecting a 17.8% increase. Excluding the impact of the SRE, Cosmic and CTT acquisitions, which contributed $29.1 million in revenues in the fourth quarter of '22. Kratos revenues grew organically 4.1%.

Fiscal year '22 revenues of $898.3 million, increased $86.8 million from $811.5 million or a 10.7% increase.

For fiscal '22, excluding the impact of the acquisitions, which contributed revenues of $95.5 million during the year and excluding the impact of the legacy training services business, which was down $21.5 million from $40.1 million compared to FY '21. Revenues grew organically 1.7%.

Included in operating cash flows for fiscal '22 is approximately $9 million in investments in nonrecurring engineering costs for new rocket systems, hypersonic and related products including for Kratos' Zeus and Erinyes systems, including and directly related to certain received and expected new contract awards in the hypersonic system area.

In 2022, in addition to internal R&D costs of $30.3 million incurred in our space and satellite business. We also invested approximately $7.6 million in software development costs related to our OpenSpace virtualized software product.

Our contract mix for fiscal '22 were 70% revenues from fixed price contracts, 24% for cost plus type contracts and 6% related to time and material contracts.

Revenue revenues generated from contracts with the U.S federal government during the quarter were approximately 70%, including revenues generated from contracts with the DoD, non-DoD, federal government agencies and MS contracts. In fiscal '22, we generated 11% of revenues from commercial customers and 19% from foreign customers.

Now moving on to financial guidance.

Our first quarter and full year '23 financial guidance we provided today includes our current forecasted business mix, and our assumptions related to the expected continued impact of challenges related to obtaining and retaining qualified personnel, supply chain disruptions, inflation and related expected costs and price increases that are currently and expected to continue impacting both the industry and Kratos.

Throughout 2022 and in the first quarter of 2023, Kratos has experienced continued impacts from supply chain disruptions including cost increases for materials, supplies, transportation and utilities and fulfillment delays causing increased costs and inefficiencies related to manufacturing, including in our indirect manufacturing rate.

As a contract mix is predominantly firm fixed price, we are required to absorb these additional costs until the period of performance is completed on existing backlog and new contracts are negotiated with current pricing.

Accordingly, as we transition to new contracts over 2023, we expect margin rates to continue to be lower in the first half of the year and [indiscernible] performance on existing backlog is executed with an expectation of margin improvement in the second half of this year, as a mix of newer recently priced contracts are expected to increase.

Our revenue guidance range for the first quarter of '23 reflects a 12% to 17% increase over the first quarter of '22, and our annual revenue guidance for fiscal '23 reflects a 9% to 11% increase over fiscal '22 revenues.

Consistent with what we have stated on our previous earnings calls, where our forecasts and performance of our tactical unmanned aerial systems business, we remain conservative and will only include contract awards we have received, or with respect to which we are in final negotiations with the customers.

Accordingly, included in our guidance range today is a relatively flat revenue of approximately $220 million to $225 million for our unmanned systems division as compared to FY '22.

This range includes an estimated increase in Valkyrie related revenues from $32 million in FY '22 to approximately $43 million in FY '23, including the recent U.S Navy/Marine Corps contract. This forecasted increase is offset by a reduction of approximately $15 million from a non-Valkyrie related tactical development program.

As we had previously discussed on our Q3 earnings call that the customer informed us in 2022 that future funding was not available. The FY '23 revenue guidance range for KGS of $760 million to $775 million reflects a 12% to 14% increase from FY '22 revenues, representing forecasted revenue growth across every business unit in KGS.

With the most notable forecasted growth in our space and satellite, C5ISR, turbine, microwave products, and hypersonic related business in rates.

Based upon funding production, delivery and execution schedules, second half '23 revenues are expected to ramp and be sequentially greater than the first half of '23, with margins expected to expand in the second half of the year on increased revenue volumes, and based on the expected mix of revenues, including new fixed price contracts, which include more recent cost estimates.

Operating cash flows are expected to be stronger in the second half of the year as well, driven by the expected expansion in margins, and the expected conversion of inventory builds from FY '22 in the first half of 2023. And based upon estimated milestone payment schedules.

Eric?.

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

Thank you. I have a few quick questions. So one, what happens operationally in Oklahoma after this the second 12 Valkyries? I guess that's a block to Valkyries production spiral.

Particularly if you get these additional orders contracts, you're supposed to have by Q3, like what would be a full rate one production line, one shift continuous flow of backward production down there..

Okay. So under the current construct, Mike, because if you recall, the facility has a base facility. And then there are contiguous additional facilities that we have options on.

Under the current configuration without expanding anymore, okay, and assuming the similar number of tactical fighter jets and fighter jets that we're building in Oklahoma, because we're building those there too. Now, we can do annually 35 to 45 drones a year in the current configuration.

We can if we exercise the next option, and we haven't if we do that, and we can easily double it very quickly..

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

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

Okay. And then just real quick, what should we be looking for in the administration's budget request regarding getting these former Vanguard programs into programs of record, be it and next generation air dominance or CCA? Is there anything specific relating to Valkyries that we should be looking for or you're hoping to see..

Yes. So in my opinion, based on most recently what Forestar Chief of Staff Brown said last week, he said that when the '24 budget is submitted, and now I understand that's coming in the first or second week of March, that the public, we should all see a significant increase and a significant commitment to CCAs.

Chief was talking collaborative combat aircraft. And in that interview that he did, he talked about a family of them of all different types, and sizes and cost points. So based on that, I think that we should all see significant additional funding based on what the chief of staff said..

Okay, excellent. Thank you very much..

Yes..

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

Yes. Hi, good afternoon, Eric, and Deanna..

Hi, Ken..

Hi, Ken..

Hey, Eric, I wanted to follow-up on your comments on Valkyrie cost? Sounds like you're pushing a lot to take cost out.

Can you maybe help with, if you think about the second block versus the first block, how much maybe is cost down? And how much of that are you able to keep versus how much of the lower costs are you sharing with your customer?.

Yes. So as you can imagine, in the past couple of years, because of what's going on with inflation, and supply chain and labor costs, everything's gone up, including the cost of our drones, that's been happening while the learning curve on the production rate has been coming down.

So we are expecting, and we've seen this with our target drones from development to [indiscernible] to production. So we have all the experience and the historical data on these production learning curves on the jet drones. So we expect not to say it will not be a significant drop with this 12. But it'll be a drop in the knee and the curve.

If consider -- considering that we continue to do this, we'll come in the next block when and if we decide to do that. And then there would be a significant knee and the curve down.

And we, obviously are very close to the industry, we're very close to the customers and our competitors, we are highly confident that cost per aero plane and cost per pound, we are orders of magnitude less costly than what they really are, irrespective of what they're telling potential customers.

And the potential customers are either learning that or they're going to learn it real soon in some instances. And we're really going to push this as you're alluding to as a competitive advantage with actual costs, not forecasts that are bait and switched on..

That's helpful.

And as you think about either now or with Block 3, if you eventually go there, is the Valkyrie profitable on a per unit basis, or what's it take maybe to get to that point?.

It -- on the most recent contract awards that absolutely is profitable. Absolutely..

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

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

Yes. So Mike, I'm going to answer the question not specific to the Air Force, I cannot, as I've talked about before. The things have really been buttoned up here. They've really been buttoned up.

So my comments are going to be general, to all of our existing customers and the customers that I said today, I expect to have under contract in the second half of this year, here's the feedback. You're the only guys that have a jet aircraft flying today. The propeller planes, they've been great to kill terrorists. They're all going to get shot down.

They're not survivable. Tied to a runway is an absolute non starter, irrespective of what people say. It's a non starter. Obviously, the runways are all targeted. And we that have the information, no, no, the numbers, all right. That quantities matter. We've learned that in the last 12 months in the Ukraine, quantities matter.

And the only way you can achieve quantities, is if you have affordability. And then the last one, Mike is back to the Ukraine. The Russians have been using their SU-57, which is equivalent to our F-22, F-35. They've been using their Kinzhal and their Avangard hypersonic weapons.

So they've been using their exquisite to know or little effect on the battlefield because they're too expensive, and they're not enough of them. And I think a lot of people are rethinking a mix of exquisite, one exquisite versus for the same cost 100 jet drones. That's the feedback we're getting.

And I think a lot of that is tying into the progress we've made since our last call..

Great. Thanks, Eric..

Okay. Thanks, Ken..

Our next question comes from Seth Seifman with J.P. Morgan..

Oh, hey, thanks and good morning, or good evening, sorry. [Indiscernible] to have it..

Hi, Seth..

Hi. So I wanted to ask about -- I wanted to make sure I got this right, and thank you for providing the segment guidance. The Unmanned segment was to be flattish in '23.

in the kind of low 220s?.

Its correct. 220 to 225..

225, right.

And so with some growth in the -- small amount of growth in the tactical drones, what's happening? I'm sorry, in the [indiscernible] what's happening with the target drones in '23?.

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

Okay, for the target drone?.

For the target drones. Yes..

Okay.

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

No, it's actually down to the Valkyrie related tactical drones is 32 -- from 32 to 43. But there's a headwind of $15 million, which is a non-value related tactical job, yes..

Cool. Understood. Understood. Right. That's helpful.

And then just, I guess, if you think about these orders that are coming up, hopefully in the third quarter of this year, and you think about kind of the cycle time for those and then how those get booked eventually as revenue and earnings, should we think about that as something that's going to drive? Is that something that drives 2024? And does it encompass all of the kind of second lot that you're building? Does it kind of take you into the third lot? How should we kind of think about what those quantities might be?.

Yes. So, Seth, I went into some detail on the infrastructure, the launch equipment, the flight equipment, the recovery equipment, the sustainment equipment that to operate these jet drones and how the customers now are starting to look at that and they're acquiring that from us.

Very similar to the strategic asset we have in our target drone systems getting that infrastructure out there.

In addition to that, I went into some detail again, on purpose on the customers are now funding significantly the missionization and operationalization of the aircraft, which all of these obviously strategically are very, very important that they're making the investment in the infrastructure, and their missionilizing and operationalizing the aircraft.

So please keep that in mind because as these contracts come, it is not totally clear to me yet. How much of it's going to be for aircraft and how much of it is going to be for the support equipment, the launch equipment? The missionization, the operationalization, okay.

So with that being said, Deanna, go back on, if they're [indiscernible] complete, and the aircraft has done, how that’s booked..

Yes, yes. So similar to what we discussed when we started the original [indiscernible], they started as capital expenditures.

And when there is a contract that is awarded, and it is related to an aircraft sale, then whatever value or however complete we are on that system would be transferred from capital to inventory, and then that would determine the percent complete from a revenue recognition perspective.

So if we're say 50%, complete on an aircraft that would transfer over and then 50% of the revenue related to that aircraft would be recorded at the time the contract is awarded..

Right. Got it. Got it. Okay, thanks. And then just to wrap up on this point, I assume in the missionization and kind of support equipment and setting up an infrastructure that that's related on to these aircraft.

I imagine, is that another area where you feel like Kratos has an advantage versus the competition, both in terms of where you are in that process and in terms of cost?.

Absolutely, Seth. You could see me I'm smiling. The answer is absolutely, yes. Because as I've said, we're the only guy that has anything flying. We're the only one that does runway independence. We're the only one really that has jet high performance drones.

And so for us to get this equipment out there, which of course the pedigree is all the target drones, we know how to do it. We do dozens and dozens of missions a year. We're building over 150 aircraft a year or more. Absolutely, this was finally it appears to be trending in our competitive advantage areas..

Okay, excellent. I'll pass it on. Thanks very much..

Thank you..

Thanks, Seth..

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

Hello, everyone..

Hi, Noah..

Good afternoon..

Eric, can you just tell us how many Valkyrie unit deliveries are assumed in the '23 outlook? And what do you think that does in 2024?.

Right. Go ahead, I will have Deanne answer, because there is [indiscernible] complete..

Yes, there is [indiscernible] complete. So, but in total, the total revenue base is based on about three to four aircraft..

This year?.

Correct..

That's in the forecast..

That's in the forecast..

What do you think that looks like next year?.

Noah, as you know, I'm gun shy and I don't want to get ahead of it anymore. I don't want to do that..

Okay. That’s fair..

I'm just gun shy, man..

You have a release out about Valkyrie flight testing capability evolution that refers to a focus on experimentation. I guess, why is the focus on experimentation? I felt like you had established a product with capability that the customer had said they wanted.

Why is there still so much evolution and experimentation at this point in the lifecycle of that product versus just buying it?.

My pick, my opinion, Eric's opinion, because this is brand new, and it's not replacing anything. It's brand new. And as one of the pictures we were approved to put out today, look how close that F-16 is flying to the Kratos Valkyrie. And I believe it's that comfort level, this is my opinion, the comfort level.

And because it's new and it's developing and getting comfortable with that concept of operations. That that's why I -- that I believe is the answer to my opinion, the answer to your question..

Yes, that makes sense. And then, I guess you laid out the pieces of unmanned for the year with 5% growth in target. And then I guess tactical is essentially flat with some Valkyrie growth offset by the 15 million that's out.

What -- what's the status of tactical that's not Valkyrie, right, over the years, there's been a discussion of half a dozen other efforts.

Where are those?.

Yes. So I have to preface this Noah with the Secretary of the Air Force a year ago, said I'm coming out with the CCA programs and they're going to be highly classified. They're highly classified.

He also said that all or virtually all I forget his quote of the current and existing drum programs will be feeders and will be folded into these classified programs. In other words, putting a classified bubble over virtually everything, okay.

In my prepared remarks today, I went out of my way to specifically say that we are making progress with Valkyrie, [indiscernible], tactical fire Jet Air Wolf [ph]. Those are the areas we're making progress and I can talk about..

Got it. Okay. And then just lastly, we'd like to ask about profitability, margins, cash flow with the margins down last year, if I sort of zoom out and look at margins over time, cash flow over time, many of the last several years, it's GAAP net income, that's breakeven or negative.

We add back the DNA, we add back the stock comp on the cash flow statement. Then there's working capital that's negative, and cash flow that's negative, recognizing a lot of your efforts are early stage, there's a lot of potential long-term growth, you have to invest in a lot of that effort.

How much longer does the cash flow statement look like that? I mean, how long does it take before there's consistently positive GAAP net margin, consistently positive cash flow at Kratos?.

Yes, clearly, with 2023-ish, we're expecting to return to cash flow generation for free cash flow, albeit at a lower level. And that's because we are still making some investment and there is still as we transition from development to production, we expect that to increase. There.

2022 was, unfortunately a perfect storm from a cash flow perspective, because the inventory that increases about $24 million for the year to be able to -- we've done a lot of advanced inventory purchases to be able to mitigate as much as we could from a supply chain impact. And we're still seeing some of that in the first half of '23.

We expect that to start converting through the cash cycle and the revenue cycle by the second half of '23. But the first half of '23 is going to be -- we're still going to see that that working capital use, but we do expect that to turn around in '23 and expect that to improve as we move out of '23 and into '24..

Yes, no eye on. I opened up saying I believe '23 is going to be the transition year, because we've had a number of programs, not all of them, as Deanna said, but on a number. We've left development were either [indiscernible] we're in full rate production.

And so '23 is going to, I believe is going to be the year where we are returning to sustained revenue growth, sustained profit growth, positive cash flow and sustained positive cash flow growth. I believe '23 is the year and I can lay that out programmatically..

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

Thank you, sir..

Thank you..

Our next question comes from Greg Konrad with Jefferies..

Good evening..

Hi, Greg..

Hey, Greg, good afternoon..

I feel like I have to ask about Valkyrie. Maybe just to kind of summarize, what you've talked about. You mentioned a number of Valkyrie applications in the beginning of the call.

Is there any way to think about how many efforts are ongoing with Valkyrie, across customers? And when you think about that $10 billion pipeline, how much does Valkyrie contribute to it? And maybe how is that trended over the past year?.

That's a loaded question, Greg. On the first part of your question, as I said in my comments, we are underfunded government contracts on multiple programs related to Valkyrie, multiple, more than three, more than four, we are on multiple funded. We expect that to increase between now and the end of this year.

Because as I said, in the second half of this year, we're in contract negotiations. Now, I wish I could tell you we get them done in Q2. I don't think so. I think we'll get them done in Q3 on a few others. So that's going to continue to expand.

I'm not going to end up -- sorry, we're not going to comment on what we expected and what we have in our pipeline. It ties into to the other -- to Ken's question and Mike's question and Noah's question. I'm gun shy, I'm not going to get ahead of myself. We put together our 2023 plan with an absolute minimum of tactical revenue. Absolute minimum.

But every other business in the company is firing on all cylinders, everyone. Our space business is doing great, our engine business is doing great. I can keep going. And so, we're going to let them all do great. They're going to drive 10% growth or more. And when the tactical stuff happens, then we'll put it in the numbers..

I mean, and I guess just a follow-up, I mean, you mentioned all the businesses that are kind of among the fastest grower and you kind of talked about growth being up into the right. And then just based on kind of your opportunity commentary, I mean, would you expect unmanned to kind of lead the growth as you get through 2023.

And that's kind of the biggest driver of growth being up until the right as you move forward?.

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

And then maybe just last question non-Valkyrie or KUS [ph] related. Just thinking about space and you mentioned OpenSpace and kind of how that played out in 2022. I think a lot of the larger contracts that you talked about have been awarded. And we've seen a lot of these constellations kind of move forward.

What are you seeing in that pipeline in terms of awards as you think about 2023 and kind of ground stations overall?.

Now that question, I'll answer. That's a fair question. That's right. What is happening in the space area, commercially and national security is unprecedented. The technological vision of smaller, faster getting it up into space has turned into reality.

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

This DoD program we won with BlueHalo SCAR, I think our initial piece is 160 -- some -- our initial piece, that’s a military program, both have OpenSpace.

That is so important that we are penetrating both commercial and DoD markets with the software product, which is -- which were first to market, which is giving us an incredible competitive advantage over anyone else, who we understand are 3 or 4 years away. Our pipeline in our space business, I think is the biggest in the company. It is big.

And it's -- and we keep winning. I think the book-to-bill -- our book-to-bill into last two quarters have been 1.2, 1.3 last year. We're doing -- it's doing great, which is why I've said I'm going to say it again, our space because our overall space related business, I think I said is 13%, 14%, 15% growth, I'm sticking with it.

And it's all the boats rise with the tide going up, the tide is going up. And I believe we have the prettiest boat of the fleet right now with OpenSpace and open edge..

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

Okay..

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

Thank you. Good evening..

Good evening..

Hey, good day..

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

Yes, Joe, we are seeing some positive traction. We had started to see that when we announced our third quarter results and we have -- we're trending positively with net adds along the path that and our plan that we had expected now. So the traction has been good.

I think with -- especially with given some of the layoffs across the tech sector that has been beneficial for our company..

The -- that's absolutely correct. So overall, definitely improving and trending in the right direction, okay. However, in areas like hypersonics and engineers and technicians getting very high security clearances, including in the manufacturing area, it's very challenging still. And let me tell you why.

In my opinion, it's because some of these new space companies where people are racing, who's going to be to Mars first, they are spending an incredible amount of money hiring as many people as they possibly can to beat somebody else to Mars first with their spaceship.

And while that's happening, the primes and I can -- you know the programs as well as I, all these programs because of geopolitical events are beginning or ramping up, they're trying to hire the same people too. And so that is still a challenge. Very, very significant challenge. Let me tell you one of our primary ways that we're being successful.

One of the primary ways we're being successful is we say if you come to Kratos, we will not stick you on this program and you'll be on it for 40 years and you'll retire on it. Which if you go to a company making a bomber or submarine or spaceship that's going to happen.

You come to Kratos, you're going to work on these four different drilling programs, are these five different hypersonic programs, et cetera? And that seems to be a winning ticket with at least some people..

Okay, great for that. Thank you. And then you made some of the acquisitions obviously talked about them and the revenue contribution.

I was wondering maybe you could give us a little more color on what kind of synergies you're seeing from these acquisitions? Are they opening kind of new opportunities that maybe you weren't able to get into previously? Now that they're part of the Kratos family, combined with some of the other things that you're doing, are allowing you to maybe even broaden even further the opportunity set?.

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

So Southern Research, as I mentioned, when we were acquiring them, I believe they're literally under contract, or are familiar with every hypersonic program or initiative in the United States of America and [indiscernible] by like 1/10 of 1%. All right. They were instrumental in Kratos winning MACH TB and in Kratos winning Mayhem.

And they are going to be instrumental in us winning several others that are coming. This is truly a one plus one equal three. And this is truly -- I'm not want to -- you see people make acquisitions and they say revenue synergies, like, what the hell is that? Okay.

Well, these are revenue synergies, because together, we -- our capabilities were beating the primes. And we have a strategic partner Dynetics. And with Dynetics and with Southern Research, we worked -- we are unbeat, I think we're undefeated. All right. CTT the microwave business.

I'm not going to get into program names, but just recently we were informed of two new incredible opportunities, multiple millions of dollars, I believe were some of the sole source on both. We are reentering the microwave area with a focus on space because we know space.

And if you look at the funding documents, and you look at missiles and radars and satellites, they all use microwave and microwave electronics. Similar situation with satellites. All the boats are rising with the tide. The Kratos boat with CPT is definitely going to rise with the tide.

And microwave businesses typically have some of the hard -- highest margins in the industry once they reach critical mass. And the other one cosmic. I think 99% of what they do is classified, okay. Okay. But they are absolutely instrumental in our penetrating customers we never had access to or could have access to with our OpenSpace and other products.

I was with them. Deanna and I and the senior team were with them a few weeks ago. And it is excellent, culturally. So all three are so far so good. Integrations have gone well. Most importantly, zero key people have left, none. Everybody appears to be happy. And we have -- we all have a common mission is to win..

Great. Thanks for those insights. And thanks for taking the questions..

Thank you, sir..

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

Hi, good afternoon, Eric and Deanna..

Hey, Austin. Good evening..

Hi, Austin..

So just my first question here on Valkyrie.

I know there's a lot you can't say, but if you look at Navy versus Air Force, does it seem like the Navy is getting more excited or more aggressive about looking at Valkyrie relative to some of your other customers just given you've got multiple generals out there that are saying that they may see a potential Taiwan invasion in the 2025 to 2027 timeline and you've already discussed the saturation of the runways and the need to be one way independent.

And of course the Ghost path doesn't have that. So I mean, even if it's not being used as a wing man if we look at what's going on in Russia -- in Ukraine with Russia using the shithead 136 to saturate enemy air defenses, I mean, clearly it would be valuable as a force multiplier for that perspective, right..

Yes, yes and yes. And to answer your question, as I alluded to a few minutes ago, over the last 4 months since we last chatted with you all, there has been significant movement and momentum across the board, including the Air Force.

I mean, look, at the -- and I can only say what we've been approved to say and what they've put out, but take a look at what we're doing at Eglin with the Air Force, read closely, some of the things that have come out about what we're doing, what's happening down there, why we're down there.

It's -- to Kratos, it's very significant and the Air Force remains a very important partner, a very important partner of ours. The Navy/Marine Corps, they have now as we've seen publicly, they're moving forward without worry. And I went through some of the reasons why.

And I believe you're going to see over the balance of this year, significant additional activity with the Marine Corps relative -- specifically relative to the Valkyrie related to their reemphasizing what their mission is and how they want to execute it, in particular in the Pacific. You hit the key points, buddy on why.

The Valkyrie is runway independent. I love it. It's runway independent. It's very low-cost. Orders of magnitude less than what anyone else has on a piece of paper. And momentum appears right now to be moving in the right direction..

Okay, that's good to hear. And then just my second question here. On the last earnings call, we talked a lot about supply chain.

And so I was just wondering, where are we at, on what you see in terms of supply chain lead times for both FPGAs to support your OpenSpace programs like the big Intelsat and the BlueHalo contract? And where are we at on supply chain for the central nuclear missile program?.

So supply chain delays, we are still seeing that 6 to 12 month turnaround on that at PGA. So we are continuing to see some disruption, which is one of the reasons we believe, Board on the inventory purchases to try to mitigate that as much as possible to not disrupt our delivery schedules..

Okay. And then just one last question. With Valkyries for this new block chain production lot is that, again being funded by yours, is that being funded by customer milestone payments. So, initially, on the long leads, it's being funded by us, but we have ours -- as I opened up with my comments, I did it on for a reason.

Certain of our key partners, suppliers, they're working with us. And so what that means is, I believe that there will be in my plan, the business plan is that as we build these, there will be an alignment of customer funding customer orders as we build these.

So we will not have to make as much of a lean forward investment as we did with the initial 12. That's the plan based on customer input. And the discussions and negotiations we've had with certain of the key I call them the kryptonite suppliers and partners..

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

Thank you, sir..

Thank you..

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

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

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