Kratos Defense & Security Solutions, Inc. (KTOS) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by and welcome to Kratos Defense & Security Solutions Fourth Quarter 2021 Earnings Conference Call. [Operator Instructions] After the speaker's presentation, there will be a question-and-answer session. [Operator Instructions] I'd now like to turn the conference over to your speaker for today, Marie Mendoza, Senior Vice President and General Counsel. You may begin.

Good afternoon, and thank you for joining us for the Kratos Defense & Security Solutions fourth Quarter and fiscal 2021 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. As we reported today, Kratos finished fiscal '21 with approximately 10.7% organic growth, excluding our training business, which legacy LPTA contracts will be completely out of our financials after Q2 of this year. Our 2021 revenue growth included growth of approximately 24% and 19%, respectively, in our largest businesses, unmanned systems and space, satellite communications and cyber. We reported a fourth quarter book-to-bill ratio of 1.5:1, that includes 2.4:1 in our Unmanned Systems business and 1.2:1 in our KGS segment, positioning the company for continued future organic growth and providing us with confidence in our 2022 forecast that we're providing today. Kratos' Q4 and fiscal 2021 financial performance and our 2022 forecast organic growth are representative of the strength of Kratos' business model and our team, considering the continuing global COVID pandemic and recent Omicron variant impacts, which have spiked for Kratos in Q4, and thus far in Q1 '22. The continued and increasing disruptions in the supply chain and the federal government and our industry also operating without a federal budget and under a CRA since October 1, 2021, all of which Deanna is going to discuss in detail. As we begin 2022, we believe Kratos continues to be uniquely positioned and aligned with the United States and its allies national security priorities, including affordability and rapid development, testing and fielding of hardware products and systems. In the tactical drone area, the customer recently communicated its commitment to and continued prioritization of affordable loyal wingman, force multiplying tactical drones and autonomous systems for the future force structure. These comments include additional new planned for drone program opportunities for the 2023 budget request and potential envisioned concepts of operations, including drones, teaming with multiple manned platforms. For example, the customer noted that loyal wingman drones and demand unmanned teaming may include the F-22, the F-35, the B-21 and the next-generation air dominance or [ N-GAD ] system, as system of system quarterbacks to the drones. These applications are in addition to previously discussed drone loyal wingman or force multiplier applications, including with the F-15 aerial tankers and other manned aircraft. The customer also stated that they envision up to 5 loyal wingman jet drones per manned fighter aircraft which would represent a very large market opportunity. Based on what has recently been communicated, It's possible that in the future, certain Kratos tactical drone initiatives, programs or platforms that you are familiar with may be combined into new programs or prioritized or deprioritized. And you may also become aware of certain additional Kratos drone programs or platforms or systems including from Kratos' Ghost Works. This may occur as the customer prioritizes certain technologies, capabilities, drone systems initiatives, mission requirements, et cetera, as they move toward initial operating capability or IOC and fielding. With the numerous tactical drone programs Kratos has successfully competed for and received, the family of affordable jet drone aircraft we have flying today and additional systems we have in development, including with the customer, we believe that Kratos is uniquely positioned to address this increasing and accelerating market opportunity, including when the customer is ready for scale, production and fielding. Also, with Kratos' operating active tactical and target jet drone production lines at multiple facilities today, where we are producing hundreds of high-performance jet drone aircraft. We also believe that Kratos is further uniquely positioned to support customer requirements if certain geopolitical or other events were to occur, and affordable rapid platform acceleration were necessary. The customer also recently emphasized that national security is of increasing importance, including that certain loyal wingman and other drone programs will be classified at high security levels and no longer routinely discussed publicly. Accordingly, we will be very limited in what we can disclose and discuss publicly going forward from a tactical drone, customer, programmatic and platform perspective, and we will defer to the customer to take the lead in any detailed public communication. Since our last report to you, Kratos' drone initiatives have continue to make progress, including as represented by our financial results, including our Unmanned Systems businesses Q4 24% year-over-year growth rate and a book-to-bill ratio of 2.4:1, and our 2022 tactical drone revenue forecast expected to be greater than 2021, and with the year-over-year future revenue growth trajectory expected to continue in the future. The manufacturer of our first Valkyries of the 12 serial production lot continues, several of which are currently under customer funded contract or commitment, and certain of which now have customer flight scheduled. As I have mentioned previously, once we have an approved 2022 budget and the 2023 budget request and future year's defense program or fight up, we should have the information necessary regarding possibly moving ahead with a second Valkyrie serial production lot, adjusting our current internally funded investment profile for the Valkyrie or for derivatives or for potential other new platforms, including potentially certain Kratos Ghost work initiatives. In the fourth quarter, it was reported that Kratos' X-61A Gremlins drone was successfully recovered in flight by a C-130A aircraft. As Dynetics is the prime on the Gremlins program, we are unable to comment further on Gremlins at this time. The way I will mention that Dynetics is an incredibly important and valuable strategic partner of Kratos, and we are working together on a number of additional exciting initiatives and opportunities. It was recently reported that a Kratos' Air Wolf drone launched an AeroVironment tactical drone in a demonstration, including for drone swarming, range and mission extension capabilities and enhancements, including for AVAV's industry-leading systems. AeroVironment's tactical drone systems are an incredible asset and AVAV is a valuable partner to Kratos in certain scenarios we are working. Kratos' Ghost Works in our industry-leading digital engineering group has been very busy as you can imagine with everything that is going on in the tactical drone area, including as related to Kratos' new [ demo core bond system ], which was recently-unveiled and several others. We are currently under contract and bidding on multiple additional tactical drone opportunities, which are key element of Kratos' '22 and future forecast growth trajectory. Since our last report to you, we have received a $51 million sole-source production contract from the United States Navy for BQM-177 target drone systems, including 50 drones for the navy, 7 drones for Japan and 8 drones for Saudi Arabia. The international customers are of particular importance, representing additional new growth opportunities for Kratos' 177 target drone system. The BQM-177 platform and related Navy program is an important element of Kratos' future growth trajectory, including domestic and international opportunities or the infrastructure to launch, operate and recover Kratos' drones are analogous to the razor and the drones are analogous to the razor blades and a recurring revenue model. The BQM-177 is one of the highest performing unmanned aerial drone systems in the world. And it has just recently entered full-rate production, which is expected to continue sole source to Kratos for many years into the future. As a data point-to-date we have produced over 170, BQM-177 jet drone aircraft. This $51 million sole source US Navy contract award and program along with the $370 million US Air Force sole source Target Drone Award Kratos received late last year, provide us confidence in our 2022 financial forecast and expected future years growth trajectory. As an additional data point on the AVSAT program, we are currently in production year '17 with the BQM-167 for the Air Force, once again sole-source. And to date, we have produced over 500 of the 167 jet drone aircraft. We have a confidential program that also continues to progress, is currently in low rate initial production and is expected to achieve full rate production in the future, sole-sourced to Kratos, which also provides us confidence in our forecast and future year growth trajectory. We are a teammate on another large unmanned aerial drone system program, where it was recently announced that the most recent full-rate production award has now been made by the customer with this program representing an additional key component of our 2022 financial forecast and future growth trajectory. As Kratos is not the prime on this program, we are unable to provide further information at this time. We also just received a contract from a new international customer for Kratos' target drones, infrastructure and support equipment for multiple tens of millions of dollars with this new customer award also providing us confidence in our future financial forecast. Kratos' space, satellite and cyber business with Kratos being the first-to-market industry leader in software-based and defined ground, command, control and telemetry tracking and control systems, is also positioned for future year-over-year growth, which we are forecasting for 2022 over 2021 and continuing thereafter. There are currently approximately 4,500 satellites in orbit today, a number which is expected to grow by some estimates up to 100,000 by 2030. This expected satellite growth is being driven in part by the rapidly dropping cost of launch systems to put satellites into orbit and technological advancements related to the satellites themselves, including smaller, faster, more powerful and capable satellite systems. Satellite operations are also growing in complexity, including proliferated constellations, spectrum management challenges, interference avoidance across LEO, MEO and GEO, high rates of satellite handovers, 5G advancing and more. Kratos' future forecast growth trajectory is tied directly to this large expanding market opportunity, the successful launch and operation of the planned for satellites and the anticipated market penetration and success of our first-to-market products and systems. Our plan continues to be to make internally funded [ R&D ] investments to achieve design-in positions on new satellite constellations and with the operators. And then once the satellites are launched in orbit and operating for Kratos to see revenue growth and margin expansion as we transition from development and testing to operational services. Several of the satellite opportunities we are pursuing and/or teamed on as strategic partners are classified in nature, and therefore, we may be limited in what we can discuss publicly. However, our recent financial performance, including approximately 19% Q4 growth in a rapidly expanding opportunity pipeline provide us confidence in our 2022 and future financial forecast. Since our last report to you, Kratos has made a small tuck-in acquisition, Cosmic AES, which is just an incredible technology-based product and solution provider in the space, signals and cyber domains with Carol and John's culture and commitment to the mission exactly consistent with Kratos'. For example, Cosmic's belief is that actual security needs arise faster than requirements, and Cosmic builds adaptable, mission-driven solutions that empower the war fighter to confront urgent and changing threats in the space and cyber domain, threats that emerged too quickly for the traditional acquisition cycle to address. COSMIC also brings several new customer sets to Kratos with the majority of Cosmic work being classified. Cosmic's margins are currently lower than Kratos' space, satellite and cyber business, including due to the existing nature and maturity of certain work they perform in their contractual arrangements. However, the margins are expected to increase as we move forward, as certain Cosmic work matures or transitions to higher end products and execution delivery. Kratos' Turbine Technologies and engine businesses for drones, missiles powered munitions, space, hypersonic and other systems continues to make progress, including the receipt of our first small cereal production contract for Kratos jet engines. We expect our engine and turbine businesses to generate 2022 over 2021 year-over-year organic revenue growth, including growth in KTT's space, Rocket, hypersonic, MRO and specialty engine areas as multiple established and new rocket system and launch entities, engage Kratos for complex technology and hardware for their propulsion systems. Kratos' Rocket Systems business, which includes and supports target, ballistic missile and hypersonic systems. Our microwave products business, which supports missile radar, space, satellite and communication systems, and our C5ISR business, which supports drone, hypersonic, space, satellite, missile, radar and strategic deterrent systems are each expected to generate year-over-year 2022 over 2021 organic growth based on current backlog and the opportunity pipeline. We recently announced that Kratos' Rocket Systems business is teamed with hypersonics to develop and fly the dark hypersonic drone, which will be powered by the fifth-generation Spartan, zero emission clean hydrogen scramjet engine. The hypersonics scramjet powered dark drone will be multimission-capable and 3D printed out of exquisite materials. Additionally, Kratos' Rocket Systems business is also investing in coordination with the government customer set in the design and development of an additional new affordable hypersonic vehicle named Erinyes, and a complementary affordable boost system. The affordable Kratos designed Boost system will accelerate the Kratos developed and Kratos manufactured Erinyes hypersonic vehicle to speeds greater than Mach 5 before release at which point Erinyes will perform predetermined mission sets. The Kratos Boost system and Kratos Erinyes hypersonic vehicle, which we believe are exactly consistent with recent [ SEC debt ] priorities, including low cost and moving fast, which we have been working on for some time now, continue to make progress as we move towards initial flight. Aerojet Rocketdyne is a key partner to Kratos on certain of our hypersonic rocket system, missile defense and other national security programs. Since our last report to you, Kratos has successfully closed on an additional, very small tuck-in acquisition in the microwave electronics area, CTT. Similar to Cosmic, CTT was a negotiated transaction with the principal, David Tai, with CTT's business being consistent with Kratos' existing microwave products business, including with CTT having a focus on space and satellite systems, which I am very interested in. Also similar to Cosmic, CTT will provide a channel to additional new customer opportunity sets for Kratos with David having built a solid, rapidly growing first-class business and an outstanding team of professionals and employees. In summary, Kratos had a solid 2021, despite the global COVID pandemic, continued and increasing supply chain disruptions and a federal government continuing resolution for our entire fourth quarter. Even with these continuing issues and challenges, we are forecasting year-over-year organic growth for 2022 over 2021 of approximately 5% to 10% or 7% at the midpoint, excluding the training business. Additionally, we have the opportunity for increased future growth in the tactical drone area, once the government moves forward and procures affordable high-performance jet drones, which the customer has recently publicly stated they are planning to do. When the customer makes this decision, Kratos will be ready. For our initial '22 financial guidance, of which Deanna will be providing the details, I want to emphasize a few points. The current CRA has obviously been going on for the past 5 months since October 1, '21 and is currently expected to continue at least through March 11, 2022. The CRA is directly adversely impacting our industry and Kratos, including as related to our 2020 new financial forecast and in particular, our 2022 first quarter, the entirety of which has been covered by a continuing resolution to date. Based on our current backlog forecast, execution and delivery pipeline and with an expected March '22 DoD budget approval, we expect Kratos' second half of '22 to be substantially greater than the first half. Simply stated, we have the programs, the contractual backlog and the visibility for '22. We need the budget, and then we will have a lot of executing to do over the last 9 months of Kratos' fiscal year, assuming we get this budget in March. From an operational standpoint, Kratos' space, satellite and cyber business, our company's largest and very rapidly growing is transitioning from long-cycle dedicated hardware-centric ground infrastructure products and programs to quicker turn software-based and defined virtualized solutions. As we saw most recently in 2021, this new and increasing software element of our satellite business and the related quick customer order development delivery aspect results in cyclicality. Cyclicality of customer orders, revenue generation and profit rates, including around the September 30 federal government fiscal year-end, when the government customer typically obligates substantial funds and make significant procurement decisions to ensure 100% budgeted funding utilization. Also contributing to our space, satellite and cyber businesses cyclicality and expected increased revenue and profit around Kratos' Q3 and Q4 of '22 is a calendar year end is also when non-DoD customers typically procure products and solutions, including for similar budgetary spend reasons. Accordingly, for '22 and going forward, for Kratos' space and satellite and cyber business, we expect to forecast increased revenues and margins in our fiscal Q3 and Q4, with substantially lower expected revenue and margins in Q1 and Q2 to reflect this business cyclicality we have experienced, including just finish 2021. This business cyclicality also impacts the leverage Kratos receives on our fixed overhead, G&A, research and development and other expenditures. As obviously, when we have higher revenues, we generate higher profit margins as we just saw in Q4. We have reflected this expected cyclicality and second half increased operating leverage and anticipated revenue mix for our space, satellite and cyber business in the '22 financial guidance we provided today, which we believe may be even more pronounced this year as a result of the ongoing extended continuing resolution. With that, I'll turn it over to Deanna.

Thank you, Eric. Good afternoon. As we have included a detailed summary of the fourth quarter and fiscal year financial performance and financial guidance in the press release we published earlier today, I will limit my comments to the highlights in my remarks today. Kratos' fourth quarter 2021 revenues of $211.6 million was at the midpoint of our estimated range of $205 million to $215 million. We achieved the midpoint in spite of continued COVID-related supply chain and other delays, which impacted revenues by $11.2 million during the quarter, with the most significant impact in our C5ISR and our international commercial SatCom businesses. Our Q4 '21 consolidated operating income was $9.2 million, up from the fourth quarter of 2020 operating income of $9 million, which includes fourth quarter 2021 increases in R&D of $1.4 million, primarily in our Space and Satellite and Unmanned Systems businesses, and increased SG&A costs of $4.8 million, primarily resulting from our increase in revenues as well as due to increased head count in our Unmanned Systems business, resulting from the growth in this business. In particular, total headcount in our Unmanned Systems business has increased 90 heads from 812 in Q4 of '20 to 902 in Q4 of '21 as this business experienced a 24% increase in revenues from 2020 to 2021 with additional future growth expected. Net loss was $2.6 million for the fourth quarter of '21 and a GAAP loss of $0.02 per share compared to net income of $78.1 million in the fourth quarter of 2020 and GAAP EPS of $0.62, which included a nonrecurring tax credit of $75.3 million. Included in the net income for the fourth quarter was a tax provision of $4.5 million on income tax -- income before taxes of $3 million or an approximate 150% tax provision rate. As a reminder, we have approximately $235 million of U.S. federal net operating losses, which we expect to continue to substantially shield us from domestic-based federal income cash tax payments. We generated adjusted EBITDA of $23.4 million for the quarter at the higher end of our expected range of $20 million to $24 million, which included a more favorable mix of revenues in Kratos' space, satellite and cyber business, resulting primarily from higher margin software sales and work performed on certain confidential programs as well as a more favorable mix in our Microwave Products business. In the fourth quarter, our Unmanned Systems segment reported revenues of $54.4 million, up 9.9% from the fourth quarter of 2020, including ramps in production in certain drone programs, including the BQM-177 and Valkyrie-related work. KGS reported revenues of $157.2 million in the fourth quarter of '21, up from $156.9 million in the fourth quarter of 2020, which included year-over-year growth in our space satellite and cyber business of $14.6 million and in our Microwave Products and Turbine Technologies businesses of $5.4 million, offset by a $9.4 million year-over-year decrease in our training solutions business, resulting primarily from the loss of an international training contract and a year-over-year reduction of $2.5 million in our C5ISR business, resulting primarily from supply chain and COVID-related disruptions. On a pro forma basis, excluding the reduction in our training business, KGS revenue grew organically 6.8% in the fourth quarter of '21 over 2020, including organic growth across our space, satellite and cyber business at 9% and organic growth in our Microwave Products and Turbine Technologies business. As discussed earlier, KGS' fourth quarter revenues were negatively impacted by disruptions and delays in COVID-related supply chain deliveries and other issues, resulting in revenues of approximately $10.7 million expected in the fourth quarter deferred to future periods. KGS' fourth quarter '21 operating income and adjusted EBITDA were positively impacted by a favorable mix of revenues, including increased software product deliveries, which were previously expected in the first quarter of '22, replacing certain lower margin work and hardware products that were originally forecasted for Q4 '21, which are now forecast for execution and delivery in Q1 of '22. FY '21 cash flow from operations improved approximately $10 million to $15 million from our original FY '21 forecast of $20 million to $25 million, primarily due to the estimated investment in nonrecurring engineering in our ballistic missile target business, which was originally forecasted at $10 million compared to the $4 million that was incurred in 2021 as well as additional customer advance payments that were received in 2021. In addition, actual capital expenditures were approximately $9 million to $14 million less than originally forecasted for '21. In summary, these differences in our original 2021 estimates of investments in nonrecurring engineering costs and capital expenditures primarily represent timing differences totaling $15 million to $20 million, whereby these expenditures are now expected to be incurred and funded in '22. Our contract mix for the quarter was 79% fixed price, 18% cost type contracts and 3% time and material contracts. Revenues generated from contracts with the U.S. federal government during the quarter were approximately 66%, including revenues generated from contracts with the DoD, non-DoD federal government agencies and FMS contracts. In Q4, we generated 9% of revenues from commercial customers and 25% from foreign customers. Our backlog at quarter end was $953.9 million, up sequentially from third quarter end backlog of $839.1 million, with consolidated bookings of $323 million and a book-to-bill ratio of 1.5:1 for the fourth quarter. Funded backlog at quarter end was $653.7 million with $300.2 million unfunded. For the 12 months ended December 26, our consolidated book-to-bill ratio was 1:1 with total bookings of $840 million. Moving on to financial guidance. Our fiscal '22 financial guidance we provided today includes our current forecasted business mix and our assumptions related to the expected continued impact of employee absenteeism, supply chain disruptions and related expected price increases, travel restrictions and other COVID-related items that have or are currently impacting the industry and Kratos. In January and February of '22, Kratos experienced a significant increase in the intensity and effects of COVID-19, including the new Omicron variant and the related impact to our employees, absenteeism, consultants vendors, suppliers, customers, et cetera, which impact included loss of weeks of manufacturing and production functions in our unmanned systems, C5ISR and likely products businesses. We have assumed that these COVID-19-related impacts to our business, which are significantly impacting our fiscal first quarter '22 forecast will begin to subside in our second fiscal quarter and continue to improve throughout our fiscal '22. As Eric discussed, there is currently no federal fiscal '22, October 1, '21 to September 30, '22, defense budget in place, and the defense industry is currently operating under a federal budget continuing resolution authorization, which Kratos has been operating under throughout our fourth quarter of fiscal '21 and thus far during our first quarter of fiscal '22. Under a CRA, there are no new start program awards or new programs of record, no increases in production on existing programs and no transition from existing development programs to production among other things, all of which impact Kratos. The effects of the current CRA and continued supply chain delays and disruptions adversely impacted Kratos' fourth quarter of '21 and are expected to adversely impact Kratos' fiscal '22, in particular, first and second quarter financial performance, which current estimated impact has been included in our '22 financial guidance. We currently estimate that the impact to our first quarter revenues is $12 million to $15 million and $2 million to $4 million to our adjusted EBITDA. The existing CRA currently expires on March 11, '22, at which time we have assumed that a federal fiscal '22 defense budget will be approved and become law, which assumption is included in our '22 financial guidance. However, once finalized, the approved and authorized '22 DoD budget may be different and include substantially different funding amounts than what we are currently estimating and its timing is uncertain at this time. Additionally, the longer the CRA continues beyond its current 3/11/22 expiration date, the greater the potential adverse impact to the defense industry and the company. If the current CRA goes substantially beyond the current 3/11 expiration date, we will update our financial guidance when we report our first quarter results, if necessary, at that time. Although we have operated under an extended CRA in previous years, the most recent government DoD fiscal '21 budget from October 1, 2020, to September 30, '21, was signed into law as of October 2020, which meant that the industry and Kratos had a DoD budget for the entire last fiscal year. The situation is much different for fiscal '22 as we have been operating under an extended CRA for over 5 months. In addition, the impact of the extended CRA may be more pronounced for Kratos in '22 due to a number of expected new program starts or expected increases in production lot size quantities and anticipated transition from development efforts to production, including in our unmanned systems, space, satellite and cyber and rocket systems businesses and C5ISR business areas. As a result of these factors, as we have discussed, we are forecasting approximately flat organic growth for our first quarter of '22 at the higher end of our estimated range compared to '21, excluding the contribution from the recent acquisitions of CTT and Cosmic AES of approximately $10 million to $12 million in revenues, offset by the loss of the international trading contracts, which contributed $8.3 million in Q1 of '21. Our quarterly forecasted EBITDA performance is also impacted by these industry and cyclicality factors, including our inability to realize leverage on our fixed G&A, overhead manufacturing and research and development costs, particularly in our 2022 Q1 and Q2 operating period. Additionally, our forecasted first quarter EBITDA is further impacted by our expected mix of revenues, including an increased mix of lower-margin development programs and international commercial satellite hardware programs and an expected reduced volume of higher-margin software solution deliveries, which were delivered earlier than originally anticipated in the fourth quarter of '21. As we continue to transition our space and satellite business from a hardware to software focused solution, financial performance will tend to be more cyclical, lumpy and more sensitive to delivery schedules. As we have discussed before, and I had noted previously, Kratos' FY '22 estimated revenues include the final impact of the 2021 loss of a large international training contract, which contributed approximately $13 million to the company's FY '21 first and second quarter revenues. The loss of this international training contract presents a '22 versus '21 revenue comparison headwind for Kratos in our first and second quarters this year. As I mentioned previously, our fiscal '22 guidance includes an estimated contribution from the recently closed CTT and Cosmic AES acquisitions, which consists of revenue adjusted EBITDA of approximately 45 and $1.5 million to $2 million, respectively. As Eric mentioned, the profit margins for Cosmic are currently lower than our space and satellite business due to the existing nature of work they perform and their contractual arrangements. On a pro forma basis, we are forecasting pro forma organic revenue growth, excluding the loss of the international training contract on a consolidated basis at the midpoint of our $880 million to $920 million range of approximately 7%. For our Unmanned Systems business, we are forecasting annual revenues of $245 million to $255 million, with expected growth in our tactical business from approximately $55 million in 2021 to $70 million to $80 million or over 35% growth at the midpoint range. Our Tactical business grew from approximately $30 million in 2020 to approximately $55 million in '21. The revenue trajectory of our Unmanned Systems business is expected to be more heavily weighted in the second half of '22 with the expected ramp driven by expected funding and related contract awards once a budget is in place. The recent international contract target drone contract that Eric mentioned earlier is not currently expected to contribute to 2022 due to the contractual terms and the new revenue recognition standards under which revenue is currently expected to be recognized as targets are delivered rather than as progress is completed on a percentage of completion basis. For our KGS business, we are forecasting FY '22 revenues of $635 million to $665 million, with pro forma organic revenue growth, excluding our training business of approximately 6% at the range midpoint. The largest piece of our KGS business, our space, satellite and cyber business is forecasted to grow organically approximately 10% with estimated organic revenue growth for fiscal '22 for all Kratos business units expected with the [ exception ] of our training and legacy government services business. As I mentioned earlier, our estimated FY '22 free cash flow includes approximately $15 million to $20 million of a carryover from FY '21, representing nonrecurring engineering investment and capital expenditures that were timing differences that were not funded in 2021, but are expected to be incurred in 2022. We expect '22 capital expenditures to remain elevated at approximately $55 million to $65 million, which includes approximately $25 million to $30 million for expected normal annual maintenance capital expenditures. As Eric stated, our '22 estimated CapEx budget does not currently include an additional [ spinal production line for Valkyrie's ] above the initial 12 production line or other potential investments in tactical drone systems. We will make any necessary changes to our forecast when and if an additional lot of investment is initiated. As we have discussed, we're currently waiting for the CRA to end approval of the 2022 defense budget and the 2023 DoD budget request and Future Years Defense Program submission, each of which program and related funding content may significantly impact Kratos' current '22 and future internally funded investment expectations, in particular with respect to the company's Unmanned Systems business. Accordingly, once these funding commitments become law or a finalized and we have assessed them, we may adjust our currently forecast internal investment and capital expenditure plans. Finally, we also announced today the refinancing of our 6.5% senior notes and $90 million revolving line of credit with a new 5-year $200 million revolving credit facility and 5-year $200 million term loan A. We have drawn approximately $200 million under the Term Loan A and approximately $100 million on the new revolving credit facility with $100 million remaining in borrowing capacity on the revolver. The proceeds of borrowings under the new facilities of $300 million along with cash funded by the company for the premium of 3.25% and accrued interest or approximately $16 million was funded to the trustee for redemption of the company's outstanding $300 million notes, which is expected to close on March 14, 2022. As a result of the refinancing, the company expects to record onetime charges of approximately $13 million to $15 million in its fiscal '22 first quarter comprised of a [ $3.25 million ] call premium and the write-off of the deferred financing costs associated with the original financing transactions. The cost of this refinancing, including the call premium is expected to be recouped in approximately 12 months with expected savings of approximately $10 million to $13 million in cash interest payments annually based on current interest rates and the amount currently drawn. The borrowing rate under the new facilities is at [ SOFR ], which is the replacement of LIBOR, plus certain adjustments, which is currently approximately just over 2% versus the 6.5% under the senior notes. The rate is adjustable, so we will monitor the market closely to determine if hedging would be beneficial in the future. Eric?

Great. Thank you, Deanna. I want to conclude with a couple of thoughts relative to what the employees of the company have accomplished over the past few years. Over the past several years, we've made substantial internally funded investments, including in the development of a suite of affordable high-performance jet drone aircraft that are flying today and that we believe are ready now to be the Pentagon's low-cost attributable force multiplier unmanned combat system. We developed the low-cost rocket system that has had numerous successful missions, including hypersonic, and we are developing a more advanced system and an affordable hypersonic vehicle, Erinyes, with initial flight now being planned. We have developed and are first to market with a truly software-based virtual satellite ground operating command and control TT&C based open architecture system, open space, which we believe will be market disrupting. And we are working to develop a next generation of turbojet, turbofan and other exotic engines for drones, missiles, powered munitions and other systems with the first of our engines now entering limited production for an aerial vehicle with additional production awards expected. We are working closely with our Pentagon customer set and Congress, including to invigorate the U.S. industrial base, increased competition, foster real innovation, drive down costs and secure our country. The [ same quantity ] has a quality all of its own, is becoming more and more relevant every day. And we are accomplishing all of this while we continue to organically grow Kratos' revenue, our profit, our expected cash flows as we reported today with an unwavering focus on delivering value for the shareholders. Thank you to our employees and all Kratos stakeholders who are committed to the successful execution of the mission. And with that, I'll turn it over to the moderator for questions.

[Operator Instructions] Our first question comes from the line of Mike Crawford with B. Riley Securities.

Eric, is the decision on the [ OBSS demo/Gorgon downselect ] expected this year? Or is that a '23 event?

I believe, Mike, the customer announced that it will be Q4 of this year, I believe.

Okay. And then did you say that the CTT and Cosmic AES acquisitions were made in the fourth quarter? Or were some of those acquisitions made in the first quarter? And are there earn-outs associated with them that you can discuss?

Yes. Mike, so the CTT acquisition was performed in the fourth quarter. Part of the purchase price was actually paid though in the first quarter, and the Cosmic acquisition was in our first quarter. And there are no earnouts.

And see they are in the first one closed right at the end of the quarter, right? At the fourth quarter.

Yes.

Yes. Right at the end, Mike, literally, like the last day of the quarter, something like that.

And then combined, you paid [ what for the 2 ]?

About $60 million.

Okay, $60 million. And then just thank you for giving that guidance. Just final question for me would be, what, if anything, should we be looking for not only in this forthcoming delayed government fiscal '22 budget, but also in the soon to emerge '23 budget requests related to Skyborg or anything else that will give us more clarity on where you might be able to go, particularly with tactical unmanned systems?

I believe, Mike, probably right now the most publicly available data point we can talk about relative to that is on the Secretary of the Air Force, where he said that he is looking to put into the 2023 request and the [ related fight ]. Funding for 2 new additional unmanned combat drone aircraft. Okay. In addition to that, for the '23 budget as you, I think you're aware, the NDA signed by the President for the '22. There are a handful of items in there related to current Kratos programs that we're waiting for that would, could potentially fall over into 2023. Those are the 2.

Our next question comes from the line of Christopher Rieger with Berenberg Capital Markets.

So if the current continuing resolution, continues to be pushed out obviously Kratos isn't the only company impacted. So what sort of lingering effects particularly on your supply chain would you anticipate to be the most pronounced and what can you do on your end to sort of mitigate these effects?

Right. We've -- I think we talked about in Q2 of last year and we've continued since then. We've routinely been buying ahead where we can, critical components, critical subsystems for our systems in the past month, relative to our 2022 plan forecast we put out today. We met with all the operating presidents and there are specific areas where we are leaning forward and we're going to try to buy a significant amount of stock. I think we've already placed the orders to get it under contract and get it inherence and fix the pricing because pricing is running on us. And we're doing this ahead of contract awards. We have visibility on the program. It's a Kratos program, but the contract award may not be made yet, where we're leaning forward and making those purchases as well. So those are the key things we have been doing and we're continuing to do to mitigate as much as we can.

Great. Helpful. Just one more. I guess, a bigger picture. With regard to Valkyrie and Skyborg, what needs to occur from here on your end with your partners and at the DoD, in order for Skyborg to become a program of record?

I am unable to address that specifically now. I want to, but I can't -- if you take a look at the recent Secretary of the Air Force comments that these -- I need to wait for the customer to talk about things. Things are moving, and we need to let the customer take point.

Our next question comes from the line of Sheila with Jefferies.

This is actually Ellen on for Sheila. Just looking at the 2022 margin guide, it's implied down about 50 bps at the midpoint. How much of that is mix versus supply chain and CR and all the other onetime items you called out? And can you give us any color across KGS versus unmanned?

Yes. So as you know, in 2021, similar to '20 and '19, we continue to win a significant number of new tactical drone development programs. So for example, at the end of '21, we were awarded OBSS. That's just under a $20 million contract that's going to be substantially [ burned ] in 2022. It's a development program and development programs typically carry lower margins. Also, very importantly, GBSD, where we are teamed underneath Northrop Grumman. GBSD is based on our schedule is going to start significantly ramping in Q3, very significantly. And that's going to continue to ramp Q3, Q4 and then into '22 and beyond. As you know, this is the development phase with Northrop Grumman before production was awarded. Those margins and development programs, we will typically record at a lower revenue rate until we get more comfortable as we head toward production. And then in addition to that, we have won a number of classified programs, okay, including in the space satellite communication and the drone area that are development that are carrying lower margins. So these are all what are forming the foundation why I'm staying with such confidence, our future year growth trajectory is up into the right. because we've been winning these programs, which means we're getting designed in on big potential production programs. That's what's causing the margins coming down a little bit thus far in '22.

And just to add to that, Ellen, related to the supply chain and COVID impact for estimated for fiscal '22, that's $20 million to $25 million on the top line and $5 million to $8 million on the EBITDA line. That's having a pretty significant impact on some of our higher-margin business, especially in our Microwave Products business. So that is impacting -- clearly impacting the margins there and a couple of the other areas, but the most pronounced one is in our Microwave Products business there. And that is impacting the overall rate.

Our next question comes from the line of Peter Arment with Baird.

Can you talk a little bit about the further outlook if we think beyond 2022? I know the target business -- the target drone business you had always thought would ramp to $250 million plus. How do you think about that business now outside of just the tactical?

We're making slow methodical progress toward that. The SSAT getting full rate production and now receiving that most recent production award is going to be an important step for us. That confidential program, that is, in LRIP -- I wish I could give you more information on it, I cannot -- that is heading toward full rate production probably next year. The international contract that I talked about today, if you recall, I mentioned that I think a year ago. And then I said, this one has been tied up because of the change in administration with Department of State. We just got it, okay? We have several others that we're expecting to get. So, those are all trending in the upward direction. In the other direction, we received about 3 years ago a sole-source $100 million -- just under $100 million contract with the government agency for target drones. My opinion, I believe, for funding reasons with this service, it has rolled out thus far much slower than I had originally expected. So that's kind of been going the other direction. Those are the details at the forest over the tree level, the more and more new weapon systems that are being sold, they need to be exercised against target drones. And so, the business, I think, is going to continue to move up and toward to the right.

Just to add to that, the international contract that Eric is mentioning, that has been delayed by about a year. And now that we've received that award though because of the revenue recognition standards, we won't see any contribution in 2022 because there are certain terms under international contracts that typically are on revenue as it shift rather than on a percentage of completion basis. So there will be no contribution in '22, but we'll see that contribution in '23 as we deliver.

And then, just quickly on space growth, I'm sorry if I missed this earlier. How are you looking at the growth there, just given all the activity and how well you're positioned on the kind of redoing a lot of the ground stations? And should we expect to see the margins continue to grind higher from the software perspective?

Yes. So, as we reported today, we just came off 19%. And so, I was chuckling because we do a 1.1 book-to-bill ratio, but that's on a 19% growth rate. You see what I mean. So it's -- we're growing and we're booking a lot of work. I believe this year, and I believe in the next several months, certain customers are going to make some announcements relative to Kratos and what Kratos is doing with those customers that are going to tie directly into where we see this business going over the next several years, okay? We being first to market, as you know, is a key differentiator for us. Against the primes in particular, we need to be first to market to win. Our space team and our satellite team, they're incredible. And being first to market with the software-defined open space virtualization, TT&C and C2 system, it's -- this could be as significant as what we're going to pull off in the unmanned drone area. So, I see continue up and to the right. As I said in my remarks, it's not going to be as smooth as it used to be because these aren't multiyear hardware programs anymore. We're getting designed in and we're shipping more and more software. So over time, margins are going to continue to increase. And the revenue trajectory is going to continue to be up and to the right. And all of that is being supported by those statistics I gave, which are just some of the space and satellite market right now is ripping and our #1 operational challenge is getting the number of people to support it.

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

I just wanted to start off, a bit of a higher-level question. We're obviously in another CR, you've got a number of significant opportunities as you think about sort of your crossing the valley of death. As you think about not only on the tactical drone side, but engines and space and other markets, how would you characterize or maybe rank the opportunity of some of your markets from a timing standpoint? I mean, should we still think about as drones as obviously the next maybe significant catalyst? Or it sounds like maybe there's more opportunity near-term on the space side. I'm just looking for you to maybe sort of recalibrate the expectations here of the different parts of the business.

Yes. I personally continue to believe that on the drone side, we're going to continue to go significantly up and to the right. I mean, the growth numbers that Deanna gave for our tactical drone business, we've gone from $30 million to $55 million to $75 million, can these are all development programs? These development programs are going to turn into production programs? Some of them might be a single or a double, but some are going to be, in my opinion, a home run. And the flurry of public information that just one service, the Air Force, starting, in my opinion, last year in Q4 at the Reagan Institute and it's been accelerating since then with additional new programs. We're clearly in the right place at the right time with the right products. And we're going to do it here. This is going to happen. And as I said in my prepared remarks, when the customer is ready to begin serial production, we'll be ready for them, and I'm not going to get ahead of myself on when that will be. I hope it's sooner rather than later, and I believe it will be. Our space and satellite business. We are in solicitation on a number of programs right now, very large, multiple tens of millions for Kratos, if not more. As I talked about on previous calls, the open architecture approach that we've taken now and the non-program of record-centric approach we've taken on ground systems for the entire market, not a particular program, it's enabling us to address an entire different aspect of the satellite industry we were never able to address before. Those bids are in. And it's possible we'll be sitting here this time next year and you're going to ask me that question. And I'm going to say, space and satellite and drones now are equal because they're bolted in it out of the park. So space and satellite is right there. What we're doing in the hypersonic area? You haven't heard me talk about it much before, I'm not going to talk about it much more than what I said today, but we've been working on our own hypersonic vehicles, systems. And if we're successful, that could be coming up in the next couple of years or so. And then, I see the engines are going to be a slow, steady build. We've received our first production contract. I think by the end of the year, we're going to get another production contract. And then, if funding holds in the '23 budget request that's coming, as I understand, it's going to, '23 and '24 could be breakout years for that business. That's kind of how I see it playing out for us. We've got a handful of horses in the race, and we're going to win some of these races.

And if I could, I apologize if you mentioned this earlier. But Deanna, as we think about the CapEx investment in '22, can you just break that out by maybe either the segments or how we should think about some of the key -- sort of key initiatives on the capital side this year?

So, the guidance we gave is $55 million to $65 million. The normal maintenance CapEx is about $25 million to $30 million. What I would say, the one-offs or the nonrecurring or special items would be, there's approximately $18 million to $20 million related to Valkyrie. So that's the continued build of the original 12 lot. And then there's build-out of skips or secure compartmentalized facilities for our space business as well as our Unmanned Systems business, and that's about $11 million to $13 million. So those are kind of more nonrecurring. And then there is about $5 million to $6 million related to the GBSD program. So those -- that should bridge you to what the normal recurring the $25 million to $30 million and then to get to the midpoint of our $55 million to $65 million CapEx guidance.

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

My first question is for Deanna. I think we've previously talked about, we have -- we know what the contract value is that it's expected for the development stage of GBSD, which is expected to ramp up in the second half of this year. I was just wondering if you guys could put any ballpark around what we should expect in terms of revenues or the ramp-up in the second half of this year for hypersonics?

Unfortunately we are limited in what we can say due to the NDA that we're under. So I can't comment, I'm sorry, Austin.

Okay. My next question is for Eric. So, if we think about the current environment here with Air Wolf, we've discussed that several dozen Air Wolfs are currently being constructed. The Army, of course, has announced that they have it under contract. So, would it be appropriate to think that one of the several new drone programs of records that Secretary Kendall has implied would be in the fiscal year '23 budget request might include Air Wolf?

Austin, I'm sorry. But you're going to be old for 2. I cannot talk about that, I'm sorry. I apologize. I can't talk about this at all.

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

We talk a lot here on the continuing resolution. Obviously that has a deal with the federal government. And I was thinking some of these programs that don't relate to the federal government and one that popped out about a year ago, you guys were talking about your autonomous truck. It was in 8 locations. Eric, you've seen have been very excited about it at the time. And I just wondered if you could give us a little bit more of an update or some color on the status of that program.

Absolutely. I'm glad you asked. We have continued to make very important progress here. As you know -- as a reminder, our competitive differentiator here as we develop the technology in conjunction with the DoD to convert previously manned systems, like a manned tank or a manned combat vehicle or a manned truck, into an unmanned system or an unmanned robot, a KTT. And for competitive reasons, I'm not going to give you the exact precise what we're doing. But I believe, in the next 3, 4, 5 months, we are going to make an announcement or 2 in conjunction with companies that are affiliated, say, with agriculture or with mining and think of lots and lots of vehicles that are not crowded like on a highway. So there's not certain types of approvals that we need, where we are going to be converting these entities, vehicles to robots to perform their work in an agricultural environment or a mining environment, with the wind at our tail here being -- these are very low-cost systems, but also the trucking short, the driver shortage. The driver shortage, I read about it in the Wall Street Journal, but it's very acute. In particular, in the agricultural areas where you need a bunch of drivers for a certain harvest period of time, which is a perfect application for our KTTs. So, I believe we're going to be talking about that. If not, when we announce Q1, I believe hopefully when we announce Q2 and this is going to be exciting for us in our own little way.

And then, in the release, you talked about how expected revenues of about $11.2 million were being deferred into future periods. Last quarter, it was about 8.3%. Maybe you can just give us a little color on the timing of how long those -- you think those are going -- those revenues are being deferred for.

Yes. So I'll give you an example of an area, aluminum. I have come to understand there are 5 aluminum smelters in the United States, and they are booked out 2, 3 years. And so, certain of these programs need aluminum, we've placed our order and we've done internationally too. I don't think I'm allowed to say where we've gone. Same thing, can't get it in for these applications. Those are probably pushed out, I'm going to say, to '23. That's one. Another area in the satellite business and in the microwave business is in field programmable gate arrays, FPGAs, specialized ones for certain applications we have. We're getting quoted beyond 12-month lead times now. And here's something that we've been dealing with. There's really nothing we can do about. We'll have a committed delivery date, and not a month before, not 2 weeks before. The week that we're supposed to get the delivery, we'll get a phone call, can't get it to you, we'll get it to you in 6 months. So, I'm going to say, I don't think we're going to see much of this stuff until late second half of this year, probably 2023, just because we can't get it.

[Operator Instructions] Our next question comes from the line of Pete Skibitski with Alembic Capital.

Hey, guys. Just so we're on the same page with regard to the CR, if we do get a full year CR, is it -- does the bottom end of your guidance kind of contain that scenario? Or is it likely would go below the bottom end of your guidance in that kind of scenario no one wants to contemplate?

I don't even want to think about this. When I don't know something, I'm going to tell you, I don't know. I don't know if some of our programs, especially in the classified area, would be part of reprogramming buckets. You know what I mean, that in the CR, they can do some reprogramming for mission-critical national security, many of which were on, that could help us, I don't know. But our target drone business, where we've won programs, we've won contracts but they need to be funded with '22 money. Those would probably move to the right, certain of the tactical drone ones where we're transitioning from, say, development Phase I to development Phase II or otherwise. Those would probably move to the right. I've read what Northrop has said relative to GBSD that, in summary, not good. So that would probably not be good for the whole team on GBSD. So, not good, and I'll just leave it at that.

I also had a question on a program I'm going to mispronounce many times, Erinyes, the $10 million to $12 million engineering costs for that program. So it's being capitalized, it sounds like, so it's going to flow through cash flow this year, but it won't be much of an EBIT impact this year to spend on it. Is that correct? Am I understanding that?

Right. So that -- go ahead, Deanna.

Yes. So that is not the same program that was referring to the nonrecurring engineering. That's a different program.

Within the same hypersonic bucket, is that right?

Yes, in the same rocket system propulsion, Erinyes. Yes, sir.

Same question. It's being capitalized, but we won't see much of an EBIT impact this year, correct?

Correct. Correct.

Because we own the systems. We own the technology. They're ours. That's correct.

And then, how are you guys thinking about whether it be this unnamed system or Erinyes? How do you think about the market size there? Do you need to win a competitive award? Or are you up something that a government customer is really kind of targeted you for? Can you give us a sense for how big and how near-term those opportunities could be?

The hypersonic area is one of the best-funded highest priority national security areas of the United States today and for the foreseeable future as a result of what the Russia and China are doing. There are hypersonic offensive systems, there are hypersonic defensive systems, there are hypersonic test and evaluation systems, all of these systems are needed now. As you may have seen, the Secretary of Defense called the summit of certain key team members to the -- I think, to the Pentagon. It turned out to be a virtualized meeting relative to hypersonics. I don't believe that this will be the opportunity size, the TAM, total addressable market for us that the drone business is and is going to be, that space and satellite business is going to be, I don't believe that. I do believe it could be $10 million to $50 million a year high-margin business for us because of the nature of what we are doing, which I can't talk about.

Last one for me. The international target contract that you guys just finally got, can you size that? Can you remind us how big that is and over how many years do you expect it to be?

It's approximately $25 million and it's over a few years. And that's all I can say. But similar to the other -- the important -- I want to emphasize this, every chance I get I want to emphasize this on these target drone programs, part of the initial buy is the launch equipment, the flight control equipment, the recovery equipment, that's the razor. And the target drones get shot down, and that's the blades, and that's why these are all so important and tie into that $250 million ultimate target -- untended objective that we're driving towards. So every one of these are critically important, similar to the new Saudi and Japan target drone wins we got with the United States Navy.

Our next question comes from the line of Sam Struhsaker with Truist Securities.

On for Mike Ciarmoli here. I was just wondering, and apologies if I missed this earlier, if you guys can provide any additional details on the revenue contributions for the 2 acquisitions. And maybe a little bit additional detail on -- I know you said the margins would improve moving forward, but maybe a more active time line or just detail that you could provide around that as well.

So, for the full year, the acquisitions are expected to contribute about $45 million in revenues and $1.5 million to $2 million of EBITDA and then, for the first quarter, $10 million to $12 million of revenue.

And on the second part of the question, Sam, on Cosmic, we expect to start seeing margins increase in 2023.

And then, one additional question, if I could sneak it in is regarding labor. I know you guys said the absenteeism was an issue. I am assuming just related to Omicron, people being out sick. But do you guys see any additional issues of that moving forward past first quarter of this year? Or do you feel pretty confident where you sit with that?

Based on the way things are trending for us right now, they're getting better, all right? So, if things don't go sideways on us, we should be in pretty good shape beginning of Q2 April-ish, we should be in pretty good shape. As I indicated -- when I was talking about the space business, our #1 operational challenge is hiring people for the programs we're winning. And I know it's not just Kratos, it's an industry-wide issue. But in the unmanned area, in our space and satellite area, in our hypersonic area, our rocket system area, it's – we are really putting our best foot forward to obtain the right people, in many cases that have the right clearances or can get the right clearance, to execute these programs.

Thank you. I am showing no further questions in the queue. I'd now like to turn the call back over to Eric for closing remarks.

Great. Thank you all for joining us, and we will speak to you when we report Q1. Have a good afternoon.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.