Kratos Defense & Security Solutions, Inc. (NASDAQ:KTOS) Q1 2024 Earnings Call Transcript

Kratos Defense & Security Solutions, Inc. (NASDAQ:KTOS) Q1 2024 Earnings Call Transcript May 7, 2024

Kratos Defense & Security Solutions, Inc. misses on earnings expectations. Reported EPS is $0.00919 EPS, expectations were $0.05. KTOS isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day. Thank you for standing by. Welcome to Kratos Defense & Security Solutions First Quarter 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] I would now hand the call over to your host, Marie Mendoza, Senior Vice President and General Counsel. Please go ahead.

Marie Mendoza: Thank you. Good afternoon, everyone. Thank you for joining us for the Kratos Defense & Security Solutions first quarter 2024 conference call. With me today is Eric DeMarco, Kratos’ President and Chief Executive Officer; and Deanna Lund, Kratos’ Executive Vice President and Chief Financial Officer. Before we begin the substance of today’s call, I’d like everyone to please take note of a Safe Harbor paragraph that is included at the end of today’s press release. This paragraph emphasizes the major uncertainties and risks inherent in the forward-looking statements we will make this afternoon. Please keep these uncertainties and risks in mind, as we discuss future strategic initiatives, potential market opportunities, operational outlook, financial guidance and other forward-looking statements during today’s call.

Today’s call will also include a discussion of non-GAAP financial measures, as that term is defined in Regulation G. Non-GAAP financial measures should not be considered in isolation from or as a substitute for financial information presented in compliance with GAAP. Accordingly, at the end of today’s press release, we have provided a reconciliation of these non-GAAP financial measures to the company’s financial results prepared in accordance with GAAP. With that, I will now turn the call over to Eric DeMarco.

Eric DeMarco: Thank you, Marie. Good afternoon. Kratos is positioning as a leading defense technology products and software company, focused on obtaining and supporting programs of record organic growth and execution was reflected in our Q1 results. As a public company that reports every three months, Kratos’ team’s execution is visible to all of our stakeholders and includes industry leading organic growth, LTM annual positive operating cash flow generation, increased profitability, while also making significant internally funded investments in large and growing market areas, where Kratos is the industry leader. Accelerating organic growth areas for Kratos include our unmanned jet drone systems, jet engines for drones, missiles, loitering munitions and high performance systems and microwave electronics for air defense, missile radar and satellite systems.

Kratos’ strategy of partnering with large traditional system integrators with Kratos bringing differentiating value including existing capabilities and a lower cost is also accelerating, including in the drone, hypersonic, propulsion system, solid rocket motor and the C5ISR areas. For the first quarter, every Kratos business unit exceeded its revenue or profit forecaster bolt. We ended Q1 with a backlog of over $1.2 billion, an opportunity pipeline of approximately $11 billion and with the 2024 U.S. Defense Budget and The Supplemental Bill now approved, we have increased confidence in our 2024 financial forecast, which we affirm today and also as we now look towards 2025. Of particular note, Kratos’ unmanned systems business Q1 organic growth was 21.8% with bookings of $81 million for a book-to-bill ratio of 1.41.

We are forecasting approximate 20% growth for unmanned systems this year, driven by the current geopolitical threat environment. Kratos’ unmanned systems Q1 book-to-bill ratio of 1.4 on top of an approximate Q1 22% growth rate is reflective of the demand we are seeing for Kratos’ affordable high performance jet drone aircraft systems, including certain programs and customers we are unable to publicly disclose, but which performance is reflected in our financials. There is a generational recapitalization of strategic weapon systems occurring as a result of the increasing global threat environment, including China, Russia, Iran and its proxies and also North Korea. We believe that Kratos is uniquely positioned to address the related demand, including with our ready-to-go now in production systems across the portfolio.

Priority areas of this recapitalization for the U.S. and its allies, which priorities are routinely reported on in the press, include air defense systems, drones, loitering munitions, missiles and engines for these systems, radar, counter UAS space and satellite systems, strategic deterrence, rocket hypersonic, missile defense target and training systems. Recent notable items for Kratos include the successful static fire test of Kratos’ Zeus 2 solid rocket motor or SRM. With the previous successful static fire test of the Kratos Zeus 1 SRM, we have placed the initial order for nine combined Zeus 1 and Zeus 2 SRMs with our partner Aerojet to address expected initial customer demand for these affordable systems, with the first Zeus customer funded mission now scheduled for later this year.

Additionally, Kratos’ Erinyes hypersonic flyer is now complete with the first customer funded flight now also scheduled for later this year, which system will include a Kratos integrated multistage solid rocket stack. Kratos is one of the very few entities that has a substantially vertically-integrated hypersonic system and BMD target mission system, including the rocket motors through the front end payload or the flyer. Kratos’ Zeus SRMs and our Erinyes and Dark Fury Hypersonic Flyers a recent example of Kratos delivering actual systems not hoped for someday products or PowerPoints and with Kratos being first to market with relevant systems that the customer wants. Related to Kratos’ hypersonic and ballistic missile defense business, we are planning to make significant investments in facilities, machinery, equipment, integration assets, rocket and other systems and assets, as we position for execution of existing and expecting demand for Kratos’ rocket, BMD, SRM and hypersonic systems.

We expect Kratos’ rocket systems business including Kratos’ Zeus, Oriole, ARAB, Erinyes, Dark Fury and our other systems to be a key future year growth contributor for Kratos. In our Israeli-based Microwave Electronics business, which significantly outperformed in Q1 and which business is also accelerating, we have received new and increased follow-on orders to existing programs and contracts, including as related to missile, radar and air defense systems, including Iron Dome, Iron Sting, Lightning, Aero, Barak and others. Kratos’ Microwave Electronics business is also supporting satellite, space system and C5ISR programs, including Kratos just recently receiving the initial design order from a new space company for Kratos’ products on their satellites.

In Kratos’ Microwave Electronics business, we are making investments in both new and existing facilities, including space qualified facilities, plant and equipment in order to successfully execute on the many new and expanded programs we have already received and additional programs we expect to receive. Kratos Turbine Technologies and our Engine business has also been accelerating and significantly outperformed in Q1, with programs and initiatives including small jet engines for drones, missiles and loitering munitions, engines for hypersonic and supersonic systems and engine and propulsion systems for space and certain classified aerial systems. KTT’s Spartan Development Group is under customer funded contract for a new propulsion system for a classified aircraft and also a separate new Spartan Group propulsion system has now been integrated into a customer’s classified drone system and is preparing for initial flight.

Both of these new system programs are important contributors to KTT and are expected to grow as these new program systems evolve. We will be making investments in our engine businesses including for a low cost manufacturing facility, infrastructure, systems and assets, including as related to loitering munition and missile system production contracts, where we are designed in, certain of which we expect to receive this year now that the funding bills have been approved. We also continue to be on schedule and on budget under a customer-funded contract where we are integrating Kratos’ jet engines into certain Kratos high performance jet drones. Kratos’ C5ISR business is also positioned for future growth with programs of record and contracts including Sentinel, Patriot, IBCS, IFPIC enduring shield, SHORAD and other missile radar air defense and counter UAS programs of record.

The global demand for air defense, radar and strategic systems is providing a catalyst for C5ISR growth, and I encourage you to take a look at the size, opportunity and quantities related to certain of these programs Kratos supports. Kratos’ unique, one of a kind owned and operated global space domain awareness or SDA system is an incredibly important Kratos asset with its data and information being of increasing value to our customers, including as a result of the significant number of additional spacecraft being deployed. Data sales to customers from Kratos’ SDA, similar to Kratos’ OpenSpace software and license sales, are certain of the highest margin in our company and can be contributors to Kratos exceeding our profit forecasts based on mix.

Representative of the progress Kratos’ OpenSpace virtualized ground system continues to make, Kratos recently demonstrated a fully virtualized SATCOM ground system for the United States Army Futures Command over SES’s O3b MEO Constellation and we also successfully demonstrated fully virtualized SATCOM over LEO for the United States Army. We continue to make significant investments in our first-to-market OpenSpace virtual C2 and TT&C software product family and also at the expansion of our global SDA system. Kratos’ Unmanned Systems business highlights we can discuss include: Kratos’ Valkyrie flying with two F-35 aircraft, successfully demonstrating the ability to deliver an integrated electronic attack capability during a live fire test event at Eglin Air Force Base with the United States Marine Corps as part of the Penetrating Affordable Autonomous Collaborative Killer Portfolio or PAACK-P program.

During the PAACK-P program mission, Kratos’ Valkyrie advanced EA payload autonomously detected, identified and geo-located multiple tactically relevant targets of interest, transmitted emitter target track coordinates to collaborative assets and successfully presented non-kinetic electronic attack effects to multiple emitters. The recent M Prefects reported for the Marines’ MQ-58A Valkyrie means multi mission in the U.S. Military Wide Aircraft Designation System with the use of M rather than X indicating a platform intended or in planning for operational use, transitioning from the X or experimental. Kratos’ Ghost Works recently had successful ground tests on a new system Valkyrie variant, and we are planning on initial flights in the next few months pending availability of a specific range, asset and necessary clearances.

We are currently in customer discussions and we expect to receive our most important Valkyrie related contract award either late this year or early next year. As a result of the Valkyrie progress and the expectations we have, we are making the internal investment required to accelerate the completion of the current Valkyrie serial production, including multiple variants totaling 24 systems. We have now begun working with our in place qualified supply chain and vendor base on pricing out the next Valkyrie production lot beyond the current ’24 as most of the ’24 are now sold, customer committed, or which we believe we have clear customer opportunity line of sight. We have recently been informed that, we should be receiving a Kratos Athena drone system related contract award in the next few months.

And additionally, since our last report to you, Kratos’ Apollo drone system had a successful customer-funded demonstration flight with a special payload. Recent world events have generated renewed customer interest in Kratos’ Apollo, Athena and other Kratos tactical drone systems. As I have mentioned previously, for customer, competitive or security related reasons, we are unable to discuss certain programs, contracts or initiatives Kratos is involved with, and we will let the financial results provide the progress, as reflected in first quarter in our Unmanned Systems business. We are in the planning process to expand our tactical drone production at other facilities to address the increased and expected demand. Overall, we’re focused on execution of our record backlog and $11 billion opportunity pipeline, including certain large new program awards, we expect to receive over the next few quarters that we are preparing for.

Accordingly, we have no significant acquisitions contemplated potentially only small Kratos business consistent tuck-ins. Virtually every opportunity or initiative we executed our recent equity raise for, has either successfully closed or progressed with continued progress expected over the coming months. As I have discussed today, Kratos will be investing in plants, facilities, equipment, systems, capital assets and other areas in order to successfully execute on programs we have now received or that we expect to receive. Additionally, we believe that the equity raise was instrumental in Kratos just recently being successfully down selected as the winner of large new opportunity which we are currently in negotiations in diligence internally called Prometheus.

Next several months, Kratos’ base case forecasted growth areas include air defense, turbine technologies, engines, missile, radar and CUA systems, drones, C5ISR, Microwave Electronics and Training Systems. Potential future catalysts and potential upsides to Kratos’ base case forecast include tactical drones, BMD Rocket and Hypersonic Systems and Jet Engines and Propulsion Systems. Deanna?

Deanna Lund: Thank you, Eric. Good afternoon. As we have included a detailed summary of the first quarter financial performance as well as the initial second quarter and affirmation of the full year 2024 financial guidance in the press release we published earlier today, I will focus on the highlights in my remarks today. Revenues for the first quarter were $277.2 million exceeding our estimated range of $240 million to $260 million which includes higher than expected performance and delivery across most of our businesses with notable strength in our Turbine Technologies and Microwave Products businesses. All business units generated organic revenue growth over last year’s first quarter, resulting in a 19.5% consolidated organic revenue growth rate, including the impact of the Sierra Technical Services, or STS, acquisition on a pro form a basis as if acquired at the beginning of 2023.

Adjusted EBITDA for the first quarter of ’24 was $26 million exceeding our estimated range of $16 million to $18 million reflecting the additional revenues as well as a more favorable mix of higher margin revenues with notable strength in our Turbine Technologies and Microwave Products businesses as well as higher margin software and data related content from our satellite business. Positive cash flow from operations generated was $700,000, which includes the impact of working capital requirements related to increases in inventory balances and prepaid assets related to supplier required deposits and prepayments for materials and equipment. Free cash flow used from operations was $15.9 million after funding capital expenditures of $16.6 million.

As we planned, we are making investments to expand and build out certain of our manufacturing and production facilities in our microwave products, rocket system and hypersonic businesses to meet anticipated customer orders and requirements and investing in related new machinery, equipment and systems. We are also continuing to manufacture the two production lots of Valkyries prior to contract award. We also utilized $45 million of the proceeds from the equity offering to pay down all amounts outstanding on our revolving line of credit. Consolidated DSOs or days sales outstanding continued to improve from 109 days in the fourth quarter of 2023 to 107 days in the first quarter of 2024, reflecting the timing of customer milestone payments. Our contract mix for the first quarter of ’24 was 68% fixed price, 26% cost plus and 6% time and materials.

Revenues generated from contracts with the US Federal Government during the Q1 of ’24 were approximately 69%, which includes revenues generated from contracts with the DoD, non-DoD federal government agencies and FMS contracts. In the first quarter of ’24, we generated 12% of revenues from commercial customers and 19% from foreign customers. An operational priority remains the hiring and retention of skilled technical labor across the company, with total Kratos headcount of 3,986 at the end of the first quarter of ’24 as compared to 3,932 employees at the end of ’23. Now moving on to financial guidance. Our initial second quarter ’24 financial guidance we provided today includes our current forecasted business mix and expected delivery schedules and our assumptions related to the potential impact of the continued operating challenge related to our obtaining and retaining qualified technical personnel, and the related increased cost for those employees across our entire labor base.

Our guidance also includes our assumptions related to the continued impact of supply chain disruptions, inflation and related expected cost and price increases. Our second quarter and full year 2024 guidance reflects the impact of certain performance and deliveries made in the first quarter of ’24, certain of which had originally been estimated to be executed or delivered in the second quarter of ’24. Eric?

Eric DeMarco: Thank you, Deanna. We’ll turn it over now to the moderator for questions.

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Q&A Session

Operator: [Operator Instructions] First question coming from the line of Peter Arment with Baird.

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

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

Peter Arment: That’s fair. And then just regarding your, the engine opportunities, both Florida Turbine and TDI both have significant opportunities. How are you kind of expecting kind of the timeline to go on some of these businesses in terms of you’re making a lot of investments and just sort of thinking about how they’ll scale up?

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

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

Eric DeMarco: The Air Force obviously announced the CCA program is going to be up to 2,000 drones. The Secretary announced last week or the week before last that Inc. 1, which was just awarded, which was not in any of our forecasts, was not contemplated in any of our numbers was for 100 planes. We’re focused on the other 1900, which we believe a significant number of which are right in our sweet spot, based on type of performance. That’s how we’re looking at this, Peter.

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

Michael Ciarmoli: Good evening, guys. Thanks for taking the questions. Nice results. Eric, maybe just to continue on Peter’s question there on CCA and you actually said, there was news about Replicator. Does the Switchblade 600 provide you guy’s opportunity? I think in the past, you’ve kind of married that platform with Air Wolf. Any color there?

Eric DeMarco: Michael, I can’t comment directly on what was announced recently. I can say that, we have launched the AeroVironment drones off of our drones, which give them extended range and give them extended capability. On Replicator, kind of sort of similar to the CCAs. This award was called Tranche 1 and it was focused on Class 1 and Class 2 UAVs. The second tranche is coming and the third tranche is coming, both of which either in the air system or the propulsion system we are hoping to be involved. This is rolling out very similar to how we’ve been led to expect it would by the government.

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

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

Michael Ciarmoli: Okay.

Eric DeMarco: Okay. So that’s those. On the hypersonic side, with Zeus 2 successful on the static fire, we are, as we speak, building out the integration center for the solid rocket motors and the front end flyers, Erinyes and Dark Fury and also other people. That is happening. That will be accelerating. One of the biggest ones, Michael, is our Israeli-based Microwave Electronics business. Everything is at a record high. Backlog is at a record high, pipeline is at a record high, revenue is at everything and it’s only beginning. We all know why and I’ve listed some of the systems we’re on. There are two that I can talk about, two facilities we’re standing on. One is a brand new one for something and another one is an expansion of an existing one for existing systems.

It’s possible that, by this time next year, we may have to stand up another one and this is for the demand of the Microwave Electronics that are going on the various weapon systems in Israel. Again these are all done under contracts. The next one is the [valve core]. Two things. As I said, we’re having to pull to the left now based on a certain specific customer. Hopefully, we’re going to get this done. We’re going to have to deliver these out sooner than we anticipated. Based on successes we continue to have with other customers, that’s why we’ve begun — we haven’t ordered it yet, have not made the orders yet, but we’ve begun going to the supply chain for the next lot of planes, which depending on how things work out will be 12 or 24 more.

Again, those are all, I’m going to call it, either done or 2020. Probably the biggest one is Prometheus, which in the equity raise, I walked people through that it was not done, that we were on a football game. We weren’t quite in the red zone yet. We’ve been down selected. We won. We’re in the red zone. And hopefully, this will get done and be contracted by the end of this year. This could be the largest opportunity. This is an area that we’re in already. This brings a backlog. This is not a build it and they will come, but it will require a significant investment for this potential game-changing opportunity. Those are the primary items, Mike.

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

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

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

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

Eric DeMarco: As I talked about a little bit on the last call, Ken, we sit back and we look at probability of win and the required Kratos investment to win it. There were certain areas that are our sweet spot that are not other sweet spots, certain companies of which talked about in the past two weeks. For example, our sweet spot in the drone area are low cost reusable, disposable or treatable drones. That’s our sweet spot. We expect to win those programs. Certain companies in the past, publicly they discussed that that’s not their sweet spot, their sweet spot is exquisite. There would be an area where it might make sense for a partnership one way or the other, where the probability of win together is higher on one if not on the other.

There’s an example, okay. In the air defense area, I mean, our primary partners in air defense systems, CUAS systems, missile systems, radar systems, or I’ll call them the big three. It’s Raytheon, Northrop and Lockheed. They are our true partners and they’re great to work with, and in no particular order, Patriot is a significant Kratos program. That’s Raytheon. Integrated Battle Command System is a very significant program, that’s Northrop. THAAD and multiple CUAS systems, Lockheed Martin. IFPIC, Enduring Shield, were partnered with Dynetics. Each one of those, it made all the sense in the world to partner with, these are outstanding legacy traditional Prime System Integrators, where we win and we can support all of them and help them to execute their mission for the customer.

That’s how we’re looking at it and we’re trying to pick our spot for the highest probability of win.

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

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

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

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

Eric DeMarco: Opportunities that are not in the base case?

Mike Crawford: Yes.

Eric DeMarco: Okay. Tactical drones is number one. We have no production of tactical drones in the base case. It’s still RDT&E and S&T. That’s number one. Number two is these engine production runs. We have very little, if anything, in there for these engine production runs we’re hoping to receive. Number three, it’s Zeus and the hypersonic flyers. We’ve included nothing because the systems weren’t done, now they’re done. The first flight of a system is coming up in the next several weeks and the first flight of another system, Zeus related, is later this year. Now that these systems have worked and I believe once we do these initial flights, it’s possible based on the backlog for certain types of assets that need to be flown, that could be an upper that is absolutely not in our plan.

A fourth one, it’s a program we’re under contract for on a certain engine. It’s one of the largest programs in our Engine group. The customer has recently come to us and asked us for expanded scope for a different aspect of this engine to pull it into the left. If we can hire the people, and that’s a big challenge, Mike, we can hire the people that will absolutely give us opportunity to beat our numbers soundly. Those are four areas right off the top of my head. Mike, the biggest item across the entire portfolio is people. If we could obtain and retain the people, we’ve got the backlog to exceed what we’ve got out there. But it’s challenging, especially with the people that have security that need to have security clearances.

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

Eric DeMarco: Yes. Let me take the second one first, because it’s the easier one. The second one first is, this is an established company. It’s a larger profitable company. I said new space, Mike that may have thrown people. It’s new to us, but it’s not a new space company. It’s new to us, it’s not a new space company. They’re putting up a new constellation and they just selected us in the past couple of three weeks to be part of the Microwave Electronic system actually on the satellite. This could be initially several tens of millions of dollars to us initially. It’s because over the past year and we’ve tried to lay this out, we’ve been successful on three or four other satellites with our Microwave Electronic satellite programs.

We’re getting a reputation now. This is why we’re one of the reasons we’re expanding our space qualified facility. This is brand new work, new constellation, large company, public company and it looks very, very, very good for us. On the first part of your question, our Space business. Yes, as you mentioned, last year, our Space business organic growth was like 13% or 15%. We did a little bit in Q1. But as I mentioned on last quarter’s call, this is the business within Kratos that absolutely could be and it is being most impacted by the continuing resolution, the delay. Also as you all may have seen, I knew this, but it’s out there publicly now. There’s a reprioritization of certain space assets going on within the Air Force, the Space Command, the Space Force.

None of this is bad. It means things are going away. But it means decisions haven’t been made yet. They’re probably not going to be made. Things are moving to the right. We factored all of this in to our guidance, when we gave it for our space business. The other piece is, as you know, our OpenSpace is virtualized software defined ground station. Its primary best case scenario is for a software defined satellite, where software defined satellite is reconfigurable, reprogrammable depending on the mission. The ground equipment at Kratos is a software you can reconfigure with it. That’s why we win right there. As you may have seen, a number of the software defined satellites, particularly in the commercial area, are being pushed to the right. I believe that Airbus actually came out and talked about it.

They were very big customers around the world, but were directly related to Airbus and their satellites. That’s moved to the right. We built those moves to the right of those launches of those software defined satellites into our forecast. Those are the dynamics we’re dealing with. There’s a lot going on in the space area, but I’d leave you with this. The number of satellites that are going up and that are forecast to go up militarily, national security and commercially is incredible. It’s in the thousands, the tens of thousands, even with optical links, they need touchdown points. We’re the touchdown point guy and that’s why we feel good overall about the business.

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

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

Deanna Lund: In the annual guide we gave, we haven’t updated guidance from a quarterly perspective by segment, but the annual guidance we gave was roughly 20%, 25% for unmanned systems. And then that then implied approximately 6% annual growth for KGS. That has remained unchanged with the original annual guidance we gave.

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

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

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

Joe Gomes: Good evening. Thanks for taking my questions. You talked about staffing and Deanna gave us some numbers. How much more staffing do you need to move forward or to get some of these potential business really moving forward?

Eric DeMarco: Let me give you an example, Joe. On one particular KTT program, we could take 30 to 40 additional right now, time and material contract. It’s one of the highest margin in the company and put them to work. It rates $200 to $250 an hour. We’ve got another one in the engine area. It’s just under 30 people we could put to work immediately. Let’s go to the unmanned drone area. It’s very challenging here because of what’s going on in the industry, not just with drones, overall aircraft, what’s going on with aircraft. There’s a program that we’re about to get. I believe it’s 30 people or 40 people right out of the chute. It’s going to be a challenge and we’re working that with the customer on potentially how to sequence them in and on board them, because obviously we’re a public company, we don’t have the luxury of going, I wish we could do this.

We could go out and we could have 50-ish of these types of engineers on the bench. They’d be an overhead until the program ramped up, which would impact our margins. But if we could do that, we could even further accelerate the growth rate. But it’s a balancing act between quarterly profitability, quarterly execution and onboarding these people for these programs.

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

Eric DeMarco: That is a great question. In Kratos, we call either the directed vendor by the customer or the sole source, one of a kind that only exists in the United States kryptonite vendors. Two areas for these where we are constantly on alert are the engines and the drones. These are the two. Let me talk about both of them. On the engine area, as if you recall, we have made and we’re continuing to make a significant capital investment at a Kratos Manufacturing Center of Excellence. This is additive manufacturing, 3D printing, casting, machining, primarily for engines. We are doing everything we can, where we can to vertically integrate and get vertically in it. We can’t do it for everything, but to get vertically integrated to derisk as much as we can in front of these engine orders that we’re getting and that are coming.

That’s number one. In the drone area, in addition to the autoclave, there are certain other machines, tooling that are critical. There are certain vendors in the United States that are just overwhelmed right now because of CCA, because of 5GAT, because of MGAT, I can go on and on. In certain of those areas, we’re actually bringing — we’re acquiring the machines. We’re acquiring the tooling. We’re bringing them in-house and we’re getting up to speed. We can transition, maybe not to do it primarily initially, but to have a backup plan that we don’t get in trouble, because as you know, what’s the most important part of a system, it’s the one you don’t have, when you’re about to complete it. We’re trying to stay on top of it, but it’s challenging.

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

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

Eric DeMarco: Thousands per year.

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

Eric DeMarco: Josh, this is partnering. This was small, ask it again, I didn’t hear you quite.

Josh Sullivan: Are you partnering with engine manufacturers with the KTT Spartan program or aircraft, where you’re bringing the engine?

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

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

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

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