The next one, obviously, is microwave electronics. We’re a merchant supplier there that’s what we do. Our primary customers are Rafael, Israeli Aerospace Industry, which are the Lockheed, the Raytheon, and the Northrop of Israel. We’re going to build that out there, and we’re building that out in the U.S. and drones. And drones is one where we absolutely are going to continue to be the prime, or our probability of win. And the investment thesis for us is manageable. And we will partner with our big prime teammates, and we have a few of them that are very close with us, where it increases the probability of win, it reduces our risk and our financial contribution. And we think, we’re going to get a big part of something, instead of potentially all of nothing.
And you’re seeing the drone impact is this year. The rocket motors, we’re definitely going to get some of those this year. So you’re going to see those sales this year, and they’ll ramp into ’25. So that’s how I see it.
Ken Herbert: That’s great. And if I could, as you think about these markets, you obviously are positioned in some of the faster-growing markets, but what’s your view on just high-level defense spending, or investment spending in, not just ’24, but over the next couple of years? And to what extent is sort of a flattish budget, if that’s the situation we’re in, a risk to the timing on some of these programs?
Eric DeMarco: Yes. So obviously, I’m the CEO. I drink the Kool-Aid. I like Senator Wicker. He wants a 5% defense budget. He wants a trillion-dollar defense budget. I love him. And I personally believe that with the threat environment out there that we have, threats aren’t going down, they’re increasing every day. This is something both parties are going to convalesce around, right. But let’s say that I’m wrong, right. Low cost is going to win the game. Let’s talk drones. Affordability. Affordable mass. The Mitchell Institute, they work with the Air Force, came out with a report last week. If you guys haven’t seen it, I encourage you to see it. They said we cannot afford exquisite drones in mass. The only way we can defeat certain adversaries, is with large quantities of low-cost drones that are rail-launched, that are air-launched, that are attritable, et cetera, to get quantities, which is cost.
So in a tightening budget environment for our engines, our turbojets and turbofans, for our hypersonic vehicles and our rocket systems, for our drones, I think that just increases Kratos’ winning hand, because of our affordability thesis.
Ken Herbert: Great. Thanks, Eric, for all the color.
Eric DeMarco: Yes.
Operator: Thank you. Standby for our next question. Our next question comes from the line of Pete Skibitski of Alembic Global. Your question, please, Pete.
Pete Skibitski: Yes, good afternoon, guys.
Eric DeMarco: Hi.
Pete Skibitski: Couple questions on EBITDA margins. Eric, I’m just wondering, if you are a sub on one of these large tactical drone programs, maybe CCA or Replicator, how are you guys thinking about the economics on those as a sub? I think last year, unmanned EBITDA margins were 7%. Probably target drones were above that. In a sub position, if you get enough numbers, can you get to double-digits in terms of adjusted EBITDA, or are we going to stick in this range even as a sub?
Eric DeMarco: Yes. So we are – in the tactical drone area, either as a prime or a sub right now, we are going to be in that range, because they’re development programs. In development programs, the margin rates are less. You were exactly right what you said on the target drones. In the target drones, we have multiple drones in multiple stages of full rate production, and that’s where you come down the learning curve. You have to share part of that with the government, of course, but you can make low to mid-teen margins. And internationally, in target drones, you can make much higher, because it’s international. So back to the tactical part of your question. I don’t think there’s going to be any difference, or if it is, it’s going to be around the edges on margins, on these.
I know it in development, because we are where we are. We’re a prime in development on some. We’re partnered with some other people on others in development. We know what the margins are. They’re similar, and I envision it being the exact same once we get into full rate production. It will not be a difference to us.
Pete Skibitski: You’re saying even in full rate production, the margins on – they’ll be the same if you have open AI?
Eric DeMarco: Yes, no I think…
Deanna Lund: No, in full rate production, we would expect the margins to expand. What he’s saying is in development, we would expect those margins to be similar to the production that the development rates that we would see on the target side.
Pete Skibitski: Got it.
Deanna Lund: But when we get to production, we would expect to see some expansion.
Pete Skibitski: Okay. So maybe like three years out, we’re talking there’s a – yes, okay. I appreciate it. And then, similar question just on space. I just see you guys talked about the inflection in ’25, and it sounds like maybe you’re looking for some margin expansion there, partially on production, higher deliveries. But you guys have been investing a lot in OpenSpace, and we see it hit KGS margin periodically. I’m just wondering, in 2025, should we anticipate the IR&D that you are spending on OpenSpace to decline meaningfully? Or is that going to be kind of steady state, and it’s more so we anticipate deliveries increasing?
Eric DeMarco: Right. I would not expect it to decline, but I would definitely expect deliveries to increase and the software content of the ground infrastructure to increase, which inherently brings higher margins. That’s how I would look at it. It’s a hybrid software model where you need continuing sustained R&D, to refresh and expand the product portfolio you’re bringing to the customer, to stay ahead of your competitors.
Pete Skibitski: Got it. Okay. So the IR&D will stay steady state, but as long as the market is hot, you’ll have these opportunities for deliveries to be higher? Okay.
Eric DeMarco: As long as we penetrate that total addressable market we see, we should be in good shape. Yes, sir.
Pete Skibitski: Got it. Thanks so much, guys.
Eric DeMarco: Yes, sir.
Deanna Lund: Thank you.
Operator: Thank you. Our next question comes from the line of Joe Gomes of NOBLE Capital. Please go ahead, Joe.
Joe Gomes: Thank you. Good afternoon, and congrats on the quarter.
Eric DeMarco: Hi, Joe. Good afternoon.
Joe Gomes: I just wanted to start on the tactical side there for a second. I saw that Australia’s investing another $260 million in the Ghost Bat. I was just wondering, what you see on the competitive side there on tactical?
Eric DeMarco: So you asked the question. So yes, Australia is going to pay $260 million in U.S. AUS$400 million for three more Ghost Bats. So obviously that is a much different model than Kratos’ model. We were paid for three Valkyries, the first three initial Valkyries, was like $40 million. So it’s a different paradigm.
Deanna Lund: With the cost share.
Eric DeMarco: Yes, it’s a different paradigm, Joe. We’re focused on affordability, effectiveness, affordability, rapid development, get things flying. That model’s just different, and I don’t focus on it.
Joe Gomes: Okay. And then outside of the OpenSpace, which obviously is growing nicely there with some of the recent awards you’ve talked about. What else can you talk about on projects that, aren’t impacted by the CR? Historically, you’ve talked a little bit about wireless trucks, just trying to get a little better sense of, what else is out there that you’re very excited about that, we don’t have to be dealing with CR?
Eric DeMarco: Good question. So 30% of our business is not DoD. So for example, our Israeli business, microwave electronics, $80 million, $90 million in revenue. Totally unrelated to the – U.S. federal government budget. As I mentioned earlier, that business is ripping for the terrible reasons it’s ripping. That’s going to do great. Contracts like with Intelsat, commercial satellite operators, JSAT, I can go down the list, because Monacosat, they’re not impacted. And we’re seeing growth in the commercial satellite area, okay. In our engine area, as we’re building engines for – we’re under NDAs. Think of virtually every new space company. We are involved in their engines, okay that is not seeing an issue. Target drones, internationally, and you see what’s going on in the world.
People are buying short-range surface-to-air missile systems. They’re buying Patriots. They all need to be exercised against target drones. They’re typically exercised against ours. So international target drone business is not tied to the federal budget. So, we’ve got a really good hedge. And typically, internationally, we make higher margins than in the U.S., because international customers will pay more for the U.S. stuff. And so, we’ve got a pretty good hedge, which is why as of right now, we’re staying with our 10% target for 2024, because that non-DoD business looks really good right now. And why Deanna and I both said, God willing, we’ll have a budget by March 8. But if we don’t, we’ll revisit it and see what the portfolio looks like.
And if we need to update, we will.
Joe Gomes: Great. Thank you for taking the questions.
Eric DeMarco: Yes, sir. Thank you.
Operator: Thank you. Our next question comes from the line of Sheila Kahyaoglu of Jefferies. Your question, please, Sheila.
