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

Welcome to the Kratos Defense & Security Solutions First Quarter 2022 Earnings Conference Call. My name is Daryl, and I will be your operator for today's call. [Operator Instructions] As a reminder, this conference is being recorded. I will now turn the call over to Marie Mendoza, Senior VP and General Counsel. Marie, you may begin.

Thank you. Good afternoon. Thank you for joining us for the Kratos Defense & Security Solutions First 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 as 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. Since our last report to you, there have been several positive developments for the industry and in particular for Kratos, which I will go through today and which provide additional confidence in this year's financial forecast and the future outlook for your company. As we had planned for in our 2022 financial forecast, the 2022 DoD budget was approved in March, which was important for a number of Kratos programs that are in or are transitioning from development, are in low rate initial production and transitioning to full rate production, or which are in production and had planned for increases to that production. Q1's book-to-bill ratio was low as expected as we're in the middle of a 6-month CRA. However, coming off of Kratos' Q4 1.5:1 book-to-bill ratio, our Q1 bookings, and combined with what I will discuss today, substantially all of Kratos' 2022 revenue and our financial forecast is now either under contract or there is funding in the 2022 budget and we are awaiting contract or we have been informed that we have been selected and we are awaiting contract or we expect to receive the contract. The highlights in the 2022 budget related to Kratos include, in the tactical drone area and related to Kratos' 2022, the 2022 budgeted funding areas which are not classified and which I can discuss include approximately $160 million in aggregate funding for Skyborg, OBSS, attritables, autonomous air combat operations prototypes, ADAIR-UX, and very importantly, funding for a new Kratos tactical drone customer which we now expect to be under contract in the second half of this year and expect to be providing several Kratos Valkyries to in the future. I will re-emphasize that these are nonclassified, publicly available areas only. And importantly, the initial funding amounts in the 2023 budget in these areas are currently expected to be substantially greater based on the initial request than these 2022 amounts I just went through with you. Additionally, the Air Force has stated that many of these current programs, initiatives and related technology areas will be feeders or transitioned into certain new additional tactical drone programs that have now been announced. And we are very excited about this as the momentum for low-cost, high-capability, force-multiplying drones is clearly accelerating along with additional and increased funding. We are also excited that all of the services, and in particular, the air services elements of the services, are now moving towards affordable mass, including low-cost attritable autonomous drone systems included and reflected in the 2022 budget, the '23 budget request and the FYDP. And Kratos, with a family of affordable attritable jet drones flying today with others in development and with Kratos having several active production lines producing approximately 150 aircraft annually, is positioned to immediately address this expected to be very large new market area. With the release of the 2022 budget, the '23 request and the FYDP, we have made the decision to maintain the current Valkyrie production run at 12 aircraft for now, certain of which Valkyries are complete and are in mission system integration and flight preparation with the customer. Also based on recent events, including communications from the Pentagon and in close coordination with the Kratos customer, we are now leaning forward with the Kratos Ghost Works resources on an additional new tactical jet drone we are under contract for in order to maintain the schedule for this program for the customer request. Kratos' Ghost Works also continues to work on several important initiatives, including one which is specifically targeted at a certain competitor based on information we became aware of. And once we are complete, we expect this initiative to become an important and significant additional advantage and differentiator for Kratos. Additional important funding in the 2022 budget directly related to Kratos and our '22 financial forecast and future year expected future growth trajectory includes: Funding for Kratos' U.S. Navy SSAT BQM-177 target drone program, which is ramping production with the SSAT program expected to be one of Kratos' largest programs for the foreseeable future and which is a key element of Kratos' Q3 to Q4 sequential 2022 revenue and profit increased financial forecast in the second half of the year. We now expect a large additional SSAT production program contract later this year. Funding for the United States Air Force AFSAT BQM-167 target drone program, also one of our largest, which also is a key element of our 2022 financial forecast in second half. Funding for a confidential program in our Unmanned Systems division, with this program currently in low-rate initial production and which program is expected to transition to full rate production with increasing quantities and where we are now expecting an additional production contract award and a significant financial increase in the second half of this year. The 2022 budget included funding for GBSD, where Northrop is the prime, under which program we are forecasting a significant ramp-up and increase for Kratos in the second half of this year, with GBSD expected to be one of Kratos' largest and fastest-growing future programs. GBSD is currently a greater than $200 million Kratos program. It is just beginning and it is one of Kratos' biggest expected Q3, Q4 and future growth drivers. Similar to GBSD, other large expected to be multibillion-dollar strategic programs of record that Kratos is supporting and that Kratos is now under contract on or we expect to be under contract on very shortly include THAAD, IBCS, SHORAD, Q-53, TPS-77 and IFPC with our strategic partner, Leidos and Dynetics. The 2022 budget includes funding for Kratos' rocket systems business, including for our new Zeus affordable launch system and related to Kratos' new Erinyes hypersonic vehicle, which are progressing toward initial flight. Like Kratos' tactical drone systems, where we are leveraging off of our target drone business and experience and where we believe our drones are the highest performance drones in the world, Kratos' hypersonic initiative is leveraging off of our industry-leading affordable rocket launch ballistic missile target systems and previous hypersonic program experience to rapidly develop and deliver to the customer a complete affordable hypersonic system capability. Kratos' rocket systems business is also engaged with Hypersonix in Australia, which recently received its funding in the DART hypersonic drone vehicle. In our rocket business, we have several launch missions currently scheduled and in backlog, and we are forecasting additional future missions to be committed by customers throughout '22. The '22 budget also includes funding for certain Kratos directed energy or laser system initiatives and programs, which Kratos products and systems are part of our expected financial ramp in the second half of the year. As I mentioned, in addition to the '22 DoD budget being approved, the initial '23 budget request was released, which included substantial or increased funding for hypersonics, tactical drones, GBSD and strategic deterrence, missile defense, space and satellite systems, microwave electronics and C5ISR, all, of course, core Kratos business areas. The global recapitalization of strategic weapon systems has continued to accelerate, including as a result of the Russian war in the Ukraine. And as we have discussed with you for quite some time, we believe that Kratos is uniquely positioned for the strategic system recapitalization. Kratos' unique positioning for the recapitalization of strategic weapon systems by the U.S. and our allies includes Kratos being the industry leader in affordable targets and target drone systems, which simulate adversary missile, aircraft, drone and other threats, allowing our forces, weapon and other systems to engage in meaningful defensive exercises. We expect Kratos' target business to continue to grow in the future. And related to this growth, we have recently been informed that we will be receiving a sole-source new approximate $100 million drone-related contract, which we expect to receive later this year. We are also currently in pursuit of 3 additional brand-new targets-related opportunities, including as related to potentially new peer adversary missile and other airborne threats that have been identified. Kratos' rocket systems business is the industry leader in ballistic missile and similar target systems, which simulate the threat represented by adversary missiles so that the U.S. and our allies radar, space-based satellite, defensive and other systems can exercise and train against them. Similar to Kratos' drone business, where we have approximately 10 different types of drone aircraft flying today, in Kratos' rocket system business, we have approximately 15 different types of rocket systems flying, including in the target, suborbital research, sounding rocket and hypersonic areas. We believe that Kratos' rocket systems business is uniquely positioned in the hypersonic area, similar to our drone business, with our existing proven hypersonic launch system capabilities and with our new Zeus, Erinyes and other systems which we are developing along with our government customers and through our partnership with Hypersonix in the DART vehicle with its unique propulsion system. In March, we executed an asset purchase agreement to acquire the assets of the Engineering division of Southern Research Institute or SRE, with the closing subject to certain normal conditions which are expected to be satisfied in Q2. Once the close of the acquisition of SRE is completed, Kratos will be the industry leader in the study, analysis, assessment, technology review and testing of special and exotic materials for weapon and space system applications, including hypersonics and strategic deterrent systems. Simply stated, substantially all exquisite or exotic weapon and space-related systems utilize special materials that need to do special things. And SRE positions Kratos directly in the center of virtually all of these past, present and future, and substantially all of SRE's workforce is highly classified. In 2021, SRE generated revenue of approximately $30 million. So with an expected June '22 close, this year's financial contribution of SRE to Kratos is not expected to be significant. However, once integrated with Kratos and based on certain funding in the '22 budget that was just approved and what is expected to be included in the final '23 budget and the incredible U.S. national security focus on hypersonics, strategic deterrence and space-related systems, we expect 2023 over 2022 and future year-over-year revenue and EBITDA growth trajectory to be strong with expanding margins for SRE. SRE will be integrated into Kratos' rocket system hypersonic business. And once the transaction formally closes, we will be able to provide you with additional information on the business and some of the programs. Kratos' microwave electronics business continues to have a near record or a record backlog, including in the space and satellite areas with substantially all of '22's forecasted revenue currently in backlog. Kratos' space, satellite and cyber business, our company's largest, continues to see customer acceptance for our first-to-market virtual software-based OpenSpace satellite C2 and TT&C ground system, including OneWeb, which Kratos is now under contract with to deliver an advanced spectrum monitoring system to monitor, analyze and review spectrum to support high quality of service for OneWeb's fleet of low-Earth orbit satellites. The space and satellite industry end market continues to experience significant growth and expansion, which growth is expected to continue for the long term. And we believe Kratos' industry-leading ground infrastructure systems products, software and technology uniquely positions Kratos to participate and rapidly grow in this area. Accordingly, in addition to our OneWeb contract award, we have also recently just received an additional very large and extremely important new satellite program award where Kratos is the prime, which we hope will be announced shortly. And additionally, we have just been informed that we have won and should receive in Q2 two additional large brand-new space program opportunities. The potential and expected combined value of just these 3 new programs to Kratos is several hundreds of millions of dollars of revenue over the program periods. And each of these opportunities include Kratos' OpenSpace virtualization technology with a significant software component, with each of these being included in our forecasted Q3 and expect a significant Q4 revenue, EBITDA and profitability increases. Our space, satellite and cyber business is an absolute critical element of Kratos achieving our financial objectives and expected industry-leading organic growth trajectory. And these 4 new programs, 2 of which we have received, including OneWeb and 2 which we have been informed by the customer that we have won and that we expect to receive in Q2, we believe, is just the beginning of an incredible disruptive technology growth trajectory for this business and significant value creation for Kratos' stakeholders. Kratos' turbine technology and engine businesses continue to progress with our turbojet and turbofan engines for missiles, drones and powered munitions. Similar to other Kratos businesses, the recapitalization of strategic weapon systems to address peer threats and the need for jet drones, new improved longer range and more powerful cruise missiles and powered munitions also including extended range are well-funded priority areas, including in the '22 budget and the '23 request. Kratos' engines, which are running today, are designed in on several new missile and drone and powered munition systems, and we are working to be designed in on several other systems and programs. And we continue to progress from development and test quantities to expected future serial production. With the execution of the 2022 defense budget, we now expect to receive in the next few months an approximate $50 million sole-source contract for next-generation affordable engine technology in drones. Also, I am able to announce today that KTT is a key member of the Rolls-Royce team for the recapitalization of the B-52 bomber fleet engines, a reported $2.6 billion program. And that Kratos has now received its contract from Rolls-Royce, which is expected to be one of KTT's largest programs and which is one of the key elements of Kratos' '22 financial forecast and Q3 to Q4 projected sequential growth as this new large program ramps for Kratos. Additionally, space systems, rocket engines and hypersonic-related systems are also providing a growth market opportunity for Kratos' turbine technologies, with the space propulsion area being one of the fastest growing in KTT. We are under NDA now with several of these space customers, certain of which are the highest profile space companies in the industry where Kratos is currently under contract and providing products and solutions for their mission success. From a business opportunity and total addressable market perspective, Kratos' opportunity pipeline has never been stronger. And we continue to receive or be informed that we will be receiving new or additional program or contract awards, many of which are single or sole source. Across the company, we're currently in pursuit of or in source selection on several program opportunities, certain of which we expect to hear on in the coming weeks and months. And if we are successful, will be important catalyst for Kratos and position us for even stronger future organic growth. Kratos' affordable product and system and technology portfolio, we believe, is second to none in the industry and is a key reason why we expect to generate industry-leading future year organic growth with a ramp beginning in the second half of this year. Simply stated, we believe that Kratos' strategy has enabled us to have the right products and technology, addressing the right needs and missions and requirements at the right time, all at an affordable cost. And on affordability, we believe that affordability will be of increased importance in the future as an increasing amount of U.S. defense budgets are needed for the recapitalization of the strategic triad which is occurring right now and which will be continuing for the next several years and as the Pentagon continues to embrace quantities of systems as well as technological quality to address both Russia and China. Operationally, we are focused internally and on execution, including as related to the 2022 budget being recently approved in March. And so we are now working with our customers and contracting offices for Kratos to get under contract and receive funding as quickly as possible in order to achieve our customer-related contractual and financial objectives. This is of particular importance for Kratos' space and satellite business where we have received or have been informed that we will be receiving or expect to receive several significant new program awards, which are a key driver for our second half and future forecast and our expected significant future year-over-year organic growth trajectory. Supply chain and COVID-related, including customer, employer, employee, supplier and other issues have continued and are expected to continue for the foreseeable future. Additionally, inflationary pressures are increasing, including with suppliers and the workforce where Kratos is doing what is necessary to both retain and obtain employees by paying more and increasing salaries and compensation, which is impacting our near-term margins, including Q1 and Q2. But obviously, we have to do this and we have to do what is required. We need a qualified workforce and the team in place to execute. Also, as Kratos is primarily a product company with the vast majority of Kratos' contracts and programs being firm fixed price, our ability to pass cost increases on to the customer in the near term is limited under existing contracts or priced options, which is currently impacting us, including Q1 and Q2. But we have included cost escalations into the new bids and new or unpriced options, new opportunities, contracts and programs which we expect to begin mitigating this impact in Q3. Like all companies in the industry, we are managing our way through these issues, most of which are now expected to continue for the foreseeable future. Okay. In closing, the industry now has a '22 budget, a '23 budget request and a FYDP, each of which are favorable for Kratos, including in the drone, space, satellite and strategic deterrence areas. Irrespective of the macro challenges industry and Kratos are facing, the success of Kratos' strategy is now clearer than ever with the core Kratos product and technology-focused national security business positioned in a macro growing market with significant budgetary increases expected for the foreseeable future, where Kratos' core business is generating significant revenues and EBITDA and where we are also positioned for transformative potential future growth with industry-leading products in space, satellites and drones, which Kratos growth trajectory we expect to begin in the second half of this year and to continue thereafter. I'll turn it over to Deanna now.

Thank you, Eric. Good afternoon. As we have included a detailed summary of the first quarter financial performance and financial guidance in the press release we published earlier today, I will focus on the highlights in my remarks today. Kratos' first quarter '22 revenues of $196.2 million was at the midpoint of our estimated range of $190 million to $200 million. We achieved the midpoint in spite of continued and increased COVID-related, supply chain and other delays, which impacted revenues by $15.3 million during the quarter, with the most significant impact in our C5ISR and our international commercial satcom businesses. Our Q1 '22 consolidated operating loss was $1.2 million compared to operating income of $4.9 million in the first quarter of '21, which includes first quarter '22 increases in R&D of $1.2 million, primarily in our Unmanned Systems business; an increase of $800,000 in noncash stock compensation expense; an increased SG&A cost of approximately $5 million, primarily resulting from our recent Cosmic AES and CTT acquisition and to a lesser degree reflecting a $1.1 million increase in our Unmanned Systems business. In particular, total headcount in our Unmanned Systems business has increased 74 heads from 842 in Q1 of '21 to 916 in Q1 of '22, which reflects the anticipated year-over-year growth. Net loss was $15.9 million for the first quarter of '22 and a GAAP loss of $0.12 per share compared to net income of $1.9 million in the first quarter of '21 and GAAP EPS of $0.01 per share. Included in the first quarter net loss is a $13 million charge for debt extinguishment related to the redemption of the company's 6.5% senior notes during the quarter. We generated adjusted EBITDA of $13.8 million for the first quarter, exceeding the higher end of our expected range of $10 million to $13 million. Our Unmanned Systems segment reported revenues of $52.6 million in the first quarter of '22 compared to $55.9 million in the first quarter of '21, primarily reflecting the current expected production ramp and cycle on certain programs. KGS reported revenues of $143.6 million in the first quarter of '22 compared to $138.3 million in the first quarter of '21, including contribution of $14.7 million from the recently acquired Cosmic AES and CTT entities, offset partially by the loss of an international training contract which contributed revenue of $8.3 million in the first quarter of '21. Q1 '22 KGS revenues were unfavorably impacted by continued and increasing supply chain, COVID and related delays and disruptions, which impacted current quarter revenues unfavorably by approximately $14.6 million as these revenues were deferred to future periods, with the most notable impacts in our commercial satellite and C5ISR businesses. As expected, first quarter '22 operating income and adjusted EBITDA for Unmanned Systems and KGS included a mix of more development-based revenues, which are typically lower in margin and due to less leverage on fixed overhead, manufacturing, SG&A and development infrastructure. Q1 '22 cash flow from operations was a use of $7.9 million, including a use for the increase of inventory balances of $15.3 million during the quarter, primarily in our satellite, microwave electronics and C5ISR businesses in anticipation of the ramps in production in the second half of the year, and in part to advance inventory levels in an attempt to mitigate the impact of supply chain disruptions. Our contract mix for the quarter was 68% fixed price, 27% cost plus, 5% time and material. Revenues generated from contracts with the U.S. federal government during the quarter were approximately 71%, including revenues generated from contracts with the DoD, non-DoD federal government agencies and FMS contracts. In Q1 of '22, we generated 10% of revenues from commercial customers and 19% from foreign customers. Our backlog at quarter end was $982.1 million compared to $953.9 million at the end of Q4 '21, with consolidated bookings of $198.2 million and a book-to-bill ratio of 1:1 for the first quarter of '22. Funded backlog at quarter end was $685.7 million, with $296.4 million unfunded. For the 12 months ended March 27, '22, our consolidated book-to-bill ratio was 1.1:1, with total bookings of $873.3 million. Moving to financial guidance. Our second quarter '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 and other COVID-19-related items that have or are currently impacting the industry and Kratos. Throughout the first quarter, Kratos experienced a significant increase in the intensity and effects of COVID-19 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 microwave products business. We have assumed that these COVID-19 and supply chain-related impacts to our business which significantly impacted our fiscal first quarter '22 operations will continue to have a similar impact in the second fiscal quarter of approximately $15 million to $17 million in revenues and $2 million to $4 million in our adjusted EBITDA. We currently expect the situation to improve significantly in the third quarter. As a result of each of these factors we have discussed, we are forecasting approximately flat organic revenues for our second quarter '22 revenues at the higher end of our estimated range compared to '21, excluding the expected contribution from the recent acquisitions of CTT and Cosmic AES of approximately $10 million to $13 million in revenues, offset by the loss of the international training contract which contributed approximately $5 million in revenues in Q2 of '21. This should be the last quarter of headwind resulting from the loss of this contract as it was completed in the second quarter of last year. Our quarterly forecasted EBITDA performance is also impacted by these industry and cyclicality factors, including our inability to realize leverage on our fixed SG&A, overhead manufacturing and research and development costs, particularly in our first and second quarter operating periods. Additionally, our forecasted second 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 lower volume of higher-margin software solution deliveries which are expected in the second half of '22, with an expected ramp from the third to the fourth quarter based upon contracts we have been awarded or have been informed we will be awarded. As we continue to transition our space and satellite business from a hardware to software-focused solution, we believe our financial performance will tend to be more lumpy and more sensitive to delivery schedules. As we mentioned last quarter, we will continue to monitor interest rates since our refinance facility is based on a floating rate of SOFR, which is the replacement of LIBOR with certain adjustments, which is currently approximately 2.5%. The rate is adjustable so we will monitor the market closely to determine if hedging would be beneficial in the future, especially since rates have recently increased.

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

[Operator Instructions] Our first question comes from Sheila Kahyaoglu.

Just talking about maybe starting out big picture. Obviously, what's happened in Ukraine, Kratos is well positioned from a macro perspective. Can you discuss what you're seeing in terms of future orders? And what part of your portfolio do you think is best positioned?

Right now the 2 best positions are the drones and space and satellite communications. They are really, really well positioned. A very close and hard-charging third is our combat system, our C5ISR business. The book of business we have and the orders, I think, we're going to win over the next 3, 6, 12 months on very large program of record weapon systems is significant. So those are the 3.

That's a super helpful answer. And so on drones, I'm guessing you don't sell any internationally right now. How do you think about the actual pipeline for that and the ability to sell internationally?

Right. In the target drone area, we have multiple international customers. So we have relationships with the customers that would either be or be related to the tactical drone customers internationally. So we have a significant international business at any one point in time with 5 to 10 different international customers. We're right now delivering a significant number of drones internationally. I'm hopeful. We have one more box to check. And we're going to be able to report a brand-new multi-tens of millions of dollars new international target drone customer, hopefully, in Q2. So we're very comfortable with our international positioning on both the target and tactical drone side.

Okay. And then, so what ramps from those significantly as we look to 2022 guidance for the second half?

The biggie that jumps to mind right off the bat is GBSD. Now that the budget is in place, our partner, Northrop, is phenomenal. It is looking very, very significant. Also coming to mind those programs I mentioned on space and satellite. I mean, the ones that we received the contract on. The 2 other ones that we've been told we've won, and we're going to be receiving the contracts in Q2, the ramp is significant. And as I mentioned in the prepared remarks, a significant part of these is OpenSpace. It's software-based which means should be significantly higher margin, which is why we're looking at significantly higher margins, one of the reasons in the second half of this year.

And our next question comes from Seth Seifman.

I guess following up on OpenSpace. Maybe, Eric, if you can refresh us a little bit. Can you tell us a little bit about how the procurements are made there, both on the government and civil side, and kind of what the process is like for getting spec-ed in? And then kind of what the, since it's software-defined, kind of what your relationship is with the customer kind of through the process and kind of how we could think about a product like OpenSpace gaining share over time? Does it happen in kind of big leaps? Is it like a gradual improvement, where is the most target-rich environment in terms of seeking out new customers, including on the government side?

Yes. Absolutely. So clearly for us new satellite constellations, new operators is the greenest field opportunity for us versus trying to get into an established constellation with established traditional legacy fixed ground equipment. The multiple new constellations that are going up, military, other security-related and commercial is significant. And as I've gone through in some detail before, and I'll just touch on lightly here, and the way I analogize it is heretofore, the vast majority of the satellites that went up are in geosynchronous orbit. So they're like 22,000 miles up. They're up there depending on fuel for 15, 20, 25 years. And the ground equipment that typically the traditional primes would provide that put up the satellite is like a 2G cell phone network 20 years ago. It's hardware-based, racks of switches, racks of equipment, et cetera, et cetera. And those traditionals had no incentive or a disincentive to try to innovate anything because they didn't want to disrupt their vendor lock position on the hardware on the ground that was old technology. And that's their mindset. And you know they're program of record focused. They chase programs of record. And that's how they do things. We brought in a bunch of commercial-based technologists, including from the terrestrial cell phone area that had done 5G networks, for example. And in my analogy, we have taken the traditional 2G infrastructure on the ground that's hardware-based and we have virtualized it into a 5G software-based operating system. I analogize OpenSpace to your iPhone's operating system. We've built an OpenSpace operating system for the ground infrastructure for satellites. And now we're taking the applications, which also are all hardware based, think of a modem, and we're software basing them so software apps to run on the software ground equipment that we are providing to new operators. And I've explained to you before, it can be location-based. It can also ride on the web, which is incredible from an efficiency standpoint, but also from a distribution of the assets and protection in the national security standpoint. It's just an incredibly new technology that's open architecture, open space and that new operators, new constellation guys, that's what they want. And right now I am incredibly pleasantly surprised at how well our team is doing. And I believe if certain of these awards that we won can be announced and they are announced, I believe the industry, it's going to be very impressive to the industry who these guys are who we've locked up.

Okay. Okay. Very good. And then one follow-up for me. Now that Secretary Kendall, speaking of programs of record, has talked about wanting to establish unmanned tactical drone programs of record, but that would be in the classified realm. I guess, how are we going to, without a Skyborg Vanguard line, I mean, there is still a Skyborg Vanguard line in the budget, but if that's not going to be where the bulk of the activity is, kind of how can we sort of keep up with what you guys are doing.

So in the nonclassified area, kind of what I tried to do today is I'm trying to be as open as I possibly can, and I will continue to do that. Seth, you are exactly right. What the Secretary has talked about and those programs, they are at a significant classification level. And so my answer to you right now is Kratos will say nothing. And we're going to wait and see how the government, how they lead this and we'll follow that lead. That's all we can do out of respect, obviously, for national security and the Secretary. But what the Secretary is doing is phenomenal. It's incredible what he's trying to do here, including those directly related to Kratos. If you could see me, I'm smiling. And I hope he keeps it up and I hope he's successful because I think it will be very, very good for the United States of America.

And our next question comes from Mike Crawford.

I think OneWeb is in the trailing bookings as of March, of that $314 million of trailing bookings in the prior year and in March 31. But the 3 new large OpenSpace contracts that are received or expected to be received that could generate hundreds of millions of dollars, what's the duration of those contracts that we should be thinking about for those future revenue?

Think typical government contracts of 3, 5 or 7 years.

Okay. Switching to drones, have you started the second spiral or you said you're just sticking with the initial spiral of Valkyrie?

Correct. We have not started the second. We are sticking with the initial. And I emphasized for now. That could literally change the next time we speak with you.

I think it's been about a year where we've been anticipating the potential like red air adversary type of a purchase order. Is that something that's still on the come or has that cooled off at all?

Oh, no. To the contrary, in the budget, specifically, you can see a line that's called adversary air unmanned open for an ADAIR-UX. And in the '23 request, there's $67 million for it. So it's coming.

Okay. That's great. And then, Eric, you have these 10 different drone systems flying today and these potential transitioning of kind of these test bed programs moving towards production, but do you anticipate that those are going to move into production with essentially the airframes and systems that you've developed today? Or do you think that they're going to morph, again, in other words, will Valkyrie be a high production run product or is there going to be some future iteration off of Valkyrie?

I'm thinking of what I can say and what I can't. I'm confident that Valkyrie is going to be very, I should answer it this way, Mike. I'm confident as ever Valkyrie is going to be very, very successful, and I should leave it at that. And if things pan out the way I think they're going to pan out with a certain customer, I believe I'll be able to add additional information to that next time we chat. But I have very high expectations for Valkyrie's success.

And just feel free to not answer if you shouldn't, but is that the same for Thanatos or for any others or are there some that, that's not the case?

Definitely. There are, as I indicated on the last call, there are certain of the programs that are being combined or they're not funding priorities as a result of, this is my opinion now, this is my opinion. In my opinion, as a result of the 2 new drone programs the Secretary has announced and where he has said certain existing programs. And he's mentioned Skyborg. He's mentioned LCAAT. He's mentioned various things. They are going to be feeders and they are going to be fed into. The technology is going to be transitioned, et cetera, or combined with these new ones. And so as I said before, certain of the ones that we have been working on, I believe, my opinion, they will wind down or transition into something else.

Okay. And then just last question. You talked about KTT a little bit, but could you just update us on the status of potential material ramp in both low-cost disruptive jet engines as well as actual working hypersonic jet engine that's proprietary to Kratos?

Yes. We have very good clarity on the former, the first one you mentioned. So for our engines being designed into air breathing cruise missiles, air breathing drones and air breathing powered munitions. As you know, we announced in the last quarter or 2 that we were beginning limited production on a new system of someone. I am hopeful that by next year we could be in LRIP on 1 or 2 of expected to be high-volume systems in that class I just mentioned. So I am as optimistic as ever that KTT's engines and our engine businesses' engines in the drone, missile and powered munition areas are going to be very, very successful. In the hypersonic area, I can't say a lot other than our group in KTT that is specifically focused on space-based engines, which include hypersonic vehicle engines, is one of the fastest-growing businesses in KTT. And it would grow even faster in my opinion but we are resource limited, which is a theme across Kratos right now. And when I say resource, hiring people. So the opportunities are there. But we're a sub so I'll be much more limited than what I can say than on the engine side. But that business is going to be very robust just because of the funding levels at the macro level that are going on.

Actually, if I can sneak in one more. You talked a little bit about the revenue at SRE and I believe you're paying $80 million for it. Is that a 10% EBITDA margin business or?

Because it's not closed yet, Mike, I have to be very cautious. As I said in my prepared remarks, when it closes, then I will absolutely put out more information. But I don't want to disrupt anything with anybody right now.

And our next question comes from Ken Herbert.

Eric, I wanted to ask you first, of the fiscal '22 budget that was finalized, you called out $160 million for a number of the tactical programs that you can talk about. Based on the '23 request and what you think could happen to the '23 request as it moves through Congress, where does that $160 million go in fiscal '23?

Right. And so my rough remember of where those items I mentioned for '22, for '23, it increases to like $200 million. So it goes from like $150 million, $160 million to $200 million or $210 million. And Ken, I want to re-emphasize again, those are currently the unclassified lines that I can talk about.

Yes. Okay. Do you see any of your particular programs, I know they tend to enjoy pretty good Congressional support, but any that you'd call out as perhaps with better potential for upside relative to the fiscal '23 request?

I believe if fiscal '23 request and that final budget comes in as I'm anticipating that Valkyrie is, and this ties into Mr. Crawford's question, that Valkyrie is going to hit its stride. I see that. If we're successful on Phase 2 of OBSS, OBSS will be, if we're successful in Phase 2, very significant for us in '23. And I'm less confident because I just have to see how the chips are going to fall in the ADAIR area.

Okay. That's great. And if I could, just one more. You've got, it sounds like there's a few contracts you're very confident in specifically on the space side that are important to the full year revenue number. Is there any way coming out of this quarter to maybe talk about of the sort of, of the fiscal '22 or the '22 guide, how much is currently in backlog? Or maybe where can the risk be in terms of timing as you think about the revenue expectations that are not yet under contract?

Right. As I mentioned and as you said on the space side, we've been informed we have won and we will receive the 2 large. We received one. We've been informed we're going to receive 2 more no later than the end of June. I fully expect that to happen. So to your question, assuming that happens, I expect it's going to happen. When we speak with you at the end of Q1, excuse me, at the end of Q2, I hope what I'm going to be talking to you about is, we are laser-focused on execution and hiring and retaining the people to execute the programs because that is a big challenge right now, personnel, obtaining and retaining people. And it's both on the government side and the commercial technology side. People in space, in satellite communications, in rocket engines, in spaceships are in big demand right now.

Okay. And are these commercial contracts, is the revenue recognition like percent complete, such that if you have a hard time just ramping up with people that would obviously be a headwind for the revenues?

That's going to be a piece of it, Ken, and some of it is going to be software as well. So it's going to be a mix.

And up next, we have Austin Moeller.

So my first question here, if we think about 2022, just to broadly summarize, what's sort of the print here? Most of the revenue growth opportunity in the latter half of the year is sort of around Northrop's Sentinel missile and nuclear warhead transporters, OpenSpace and target drones and then most of the margin and EBITDA growth opportunity is around OpenSpace and the virtualized satcom equipment?

Yes. Yes, sir. You drilled it.

Okay. Perfect. And then I understand the factoring in cost escalations into the new contracts. But what is giving you confidence that your expectation for a second half '22 recovery for the supply chain is on track just because there's a lot of companies in the sector that are struggling with supply chain right now?

Right. So the primary areas as of right now that we've been struggling in the supply chain are in our microwave electronics business, including field-programmable gate arrays. And to some extent, that's also in our space and satellite communication business. We have, very candidly in our forecast today, and for example, in our microwave business, we have made the assumption in that business it does not get any better for this entire year. So there are certain areas, like in the microwave electronics area, where we're just assuming it's going to be yucky poo-poo for the entire '22. There are other areas, let's talk about like aluminum in our C5ISR business in the aluminum area, where our team has been working like the devil to position themselves that if it doesn't get a lot better, we have avenues, different channels or we've ordered far enough in advance that we're going to receive the product that we should be okay. That we should be. Also, through communications with other of our customers like in the titanium area and in other areas. We're in constant communication with them and they're indicating to us that they believe things have peaked or are peaking. And things should, they're not going to return to normal in the second half, but they're going to start to trend in a better direction in the second half. And we've incorporated that in our plan, too. So we need that to happen in those areas where we've made that assumption.

Okay. That's super helpful. And then just one last question, if I may. I understand sort of Valkyrie is, and its various programs associated with it are sort of going down the rabbit hole into the classified realm. But the new Valkyrie customer that you mentioned that's getting some aircraft, some number of aircraft, are they getting those aircraft from the original production lot of 12 that you're going to have or if that comes in later this year, would that be from a second production lot?

They're going to receive them from the 12. Very importantly, if we had not leaned forward and done this, we would not be getting this customer. And Austin, on this customer, and there are going to be a quantity of Valkyries here, it's not clear to me initially if it will be a sale or it will be a lease, which is another benefit of why we have these capital assets. And so that we're going to be working with this customer as we head toward contract documentation if these will be actual sales or to satisfy his requirement, both tactical and strategic and looking into '23 and '24, should we lease them to him? And so we'll, hopefully, as the year goes on, we'll be able to give you additional clarity on that.

And up next, we have Peter Arment.

Eric, you've talked about kind of a lot of your drone programs, the valley of death trying to get past the testing and into adoption. How do you characterize, kind of what you can talk about, I guess, on the nonclassified side, where things stand when you see customer excitement about it? And ultimately, if you can talk about any specific ones that have kind of moved farther along in testing just because I think a lot of us are trying to kind of see when we start to see a pickup in terms of overall volume.

Yes. The valley of death is real and it's deadly. And going from RDT&E, development aircraft, we'll talk aircraft, for example, but it's the same in certain other areas. We're in prototypes, et cetera, across the valley to production or a program of record, it is extremely difficult. This is very, very sporty. And as you can imagine, it is no secret. You can imagine the traditional players in the area are doing everything they can to destroy you in the valley of death as well. Okay. Peter, this is why I continue to emphasize that we are first to market with airplanes flying today. You just heard me say, we're going to have a new customer. And I mean, brand new for Valkyries in the second half of this year. That funding is there. And this customer is very motivated because we had products, not PowerPoints, which is one of our critical differentiators competitively against the traditionals. What the Secretary is doing, as I said before, I am applauding him incredibly because the top guy has now taken point and has said, I'm going to make this happen. And in the last month or so, the 4-star of PACAF, he did an interview or a speech. And he said, we need, I forget what he said, hundreds or lots and lots of affordable attritable jet drones of various types, reusables, decoys, et cetera, et cetera, to help offset the adversary there. And I could go on, but the top leadership is now not just talking, but they're putting the money in the budgets and they're putting the program element lines in. And so yes, it's been a long time. It's been very frustrating. I'm sure there'll continue to be frustrations. But we continue to make progress and we remain virtually undefeated competitively when they're in our ballpark of attritable aircraft. So that's how I have to answer it.

Yes. And just as a follow-up, Eric, I know we've had a lot of challenges over the last 18 months with COVID on just different testing facilities or testing sites. Has that loosened up a little bit as we think about going into the second half of this year or at least in the middle of this year?

Great question. Yes. We have not, in the past several months, I don't know how many, but it's been several. We have not experienced any issues, delays, cancellations on any range time for any of our flights. And you've reminded me of something. And I believe in the second half of this year, our range facility in Oklahoma at Burns Flat is going to be an incredibly valuable asset for us. And we're going to be able to demonstrate that because the ranges are very, very busy right now and they're very hard to get on. And we will not have to worry about that for certain of our aircraft out at Burns Flat. And so that headwind across the board right now is gone.

And up next, we have Josh Sullivan.

Eric, just on KTT, what is the margin profile of the engine opportunities as they move forward? Are they going to be the traditional low teens or any more commercial like margin opportunities picking up?

Yes. So on the defense side, they will be in production, low teens. In development, right now, obviously, they're lower than that because development contracts are just lower than that. Josh, we have 1 or 2 commercial opportunities we're looking at over there. But if we're successful relative to the defense ones, they won't be significant enough to move that margin rate higher than low teens.

And then can you just provide some color on what KTT is contributing to the Rolls offering with the B-52.

Yes. Josh, say that again, buddy.

On the B-52 contract that you're working, what is KTT contributing?

I was very guarded in what I said because we are under an NDA and I can't say. It's very important and it is a significant contributor for us beginning right now. But until I get clearance, I can't say.

Got it. Got it. And then, well, maybe on the Zeus program, can you talk about the cost savings versus the legacy programs that you're going to offer? And maybe can you help us kind of size that market, number of launches in the market.

Yes. So our strategic partner is Aerojet. And they are working with us. They are building systems for us. And these are to our spec, based on our customers. And these are very unique, very low-cost, very specialized systems to put something in the right place at the right time at the right speed. And similar to virtually everything else we try to do, if we're successful, we're going to be successful here, these will be orders of magnitude similar to our tactical drones, less costly than anything anybody else has out there. So I'm very excited about this, and I'm very excited of the funding that came through in the '22 budget for this, very excited. We got the funding that we needed and which is great.

And our next question comes from Joe Gomes.

This is Joshua Zoepfel filling in for Joe Gomes. So my first question is, I know you guys recently had awarded a contract for the advanced spectrum monitoring system for OneWeb, just sort on the low-Earth orbit constellations. Can you kind of give any more color on that? Like what does this mean revenue-wise and what additional opportunities does it open?

Right. Other than we put that press release out recently in the past 3 or 4 weeks, I think. That required obviously customer clearance and customer coordination. I apologize. You go take a look at that. Other than what's in that release, I can't say any more than what's out there. But to the second part of your question, I will use that as an example to a previous question that we received of a company, an operator, an entity putting up a constellation, a new constellation, a greenfield constellation that was open, no pun intended, to engaging us and using our OpenSpace solution. And so when you think about the potential opportunities that Kratos has in the OpenSpace area, that is an excellent representative example of the type of primary customer we're engaged with, and we're hopeful to be successful with.

Great. And then another question was just I wanted to see how the transition was going in terms of integration of Cosmic AES and CTT and obviously now with the SRE. And do you kind of see any future tuck-in acquisitions like these in the future? Is that like some in your pipeline?

The integration is ongoing and going well. As far as future tuck-ins, we have the SRE one that is, hopefully, it's going to close this second quarter. At this point there's no one.

In order for us to do anything else, as we've said before, it has to be exactly consistent with what we're doing. And those opportunities are few and far between. So CTT is exactly consistent with what we're doing in the microwave area. And it has a space satellite component, which also we're related to. Cosmic, as I think I talked about on the last call, our team has known the founders, the owners personally for a long, long time. They are right in our stack and that is an easy one, okay? SRE, as I mentioned, they're involved with materials or hypersonic systems, strategic deterrence systems, space systems, all of which we're involved in. So if we were going to do another one, it would be small. And it would be exactly consistent with what we're doing that would either bring us a new customer, a new capability, a new product or a new aircraft or something, something like that.

Great. And then I guess, lastly, if I may. I was looking through what you said. You affirmed guidance. And I know you guys kind of dropped down your CapEx. Is there any kind of reason as to why, just a little more color on that?

That's actually related to some machinery that we were going to acquire in our C5ISR business and just due to some supply chain issues, it's actually getting pushed into next year. So that isn't permanently reducing. It's just moving into next year.

And up next, we have Pete Skibitski.

Eric, I wanted to follow on the earlier conversations about Secretary Kendall, just on some of the things you said kind of interesting. He's been talking about a drone, a Loyal Wingman type drone, I guess, for both the B-21 and NGAD. And the comment he made was that the price of those drones will be on the order of 1/2 the price of the manned aircraft themselves, which presumably are in the hundreds of millions of dollars, which it seems like that would put those drones in kind of the exquisite category. First of all, is that true, do you think? And second of all, should we conclude from that, that you don't think Kratos can play in that area, but there are lots of other areas that Kratos will play in? I'm just trying to follow the whole logic there.

Yes. So the first part of your question, I'm not going to answer because I don't want to speculate anything on the Secretary. But on the second part, what I understand the Secretary is doing and based on what I know, I am absolutely confident that Kratos can participate in one way, shape or form with the Secretary's initiatives. Absolutely confident.

Okay. Okay. Let me step out to a bigger picture. If we can kind of summarize all the order expectations you have for the balance of the year, the next 3 quarters, any sense for the type of book-to-bill that you guys are expecting for the next 3 quarters that we should expect?

I don't have the numbers in front of me, but we have a number. As I went through today in the prepared remarks and in the Q&A, we're expecting a sole source $100 million contract for the target drone area that we've been informed we're going to get. I mentioned that on the space side we've got several that, we've got one that we've won that hasn't been announced yet. And we've got 2 that we've been informed we're going to get, that hopefully, we'll get. Those will be additive. I think over the balance of the year, I don't want to be quarterly, bookings, and I'm going to say program bookings, will be significant. And so when I say a program booking, let's go back to this, the target drone one that we've been informed that we're going to get. I know that it will be a single source award and will be $100 million that we'll get. That will be fulfilled over a period of time. I don't know how that will be booked for book-to-bill purposes, depending on funding or options or things like that. But programmatically, trajectory-wise, I believe it's going to be very, very robust.

Okay. Okay. That's helpful. And a more basic question in the rocket support area. I guess I haven't figured it out yet, what's the difference between Zeus and Erinyes?

So Zeus is a launch system. Erinyes is a vehicle.

Okay. So Zeus has a propulsion aspect to it, Erinyes does not have a propulsion aspect to it?

Zeus definitely has a propulsion aspect to it. Erinyes is a vehicle, and I should leave it at that.

Okay. Okay. Okay. And are you guys, should we expect first quarter press release-wise was fairly meager, right, with the CR and whatnot. Should we expect to see a lot of these announcements maybe put up by you guys as they happen in the balance of the year?

I hope we're able to. But if not, like on some of these space ones, my understanding is, I think the customers are going to announce them. And once they announce them, hopefully, we'll be able to announce something or we'll be able to affirm, yes, that's us. My intuition tells me that's how that's going to go.

And we have no more questions at this time. I'll turn it back to Eric for closing comments.

Great. Thank you, everybody, for joining us this afternoon, and we'll circle up with you at the end of Q2. Have a great afternoon. Thank you.

And thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.