Kratos Defense and Security Solutions Inc

NASDAQ:KTOS

Earnings Call Analysis

Impressive Q4 Revenue Growth and Strong 2024 Forecast

Q4 revenues hit $273.8 million, surpassing estimates and indicating a 17% organic growth in the KGS segment over the previous year. Adjusted EBITDA reached $29.1 million, again exceeding forecasts. With a free cash flow of $48.1 million and a decrease in days sales outstanding, the yearly revenues reached over $1 billion, showing a 12.6% organic growth. Looking ahead, the 2024 guidance anticipates significant growth driven by the Unmanned Systems business, projecting revenues between $260 million and $270 million.

Upcoming Contract Awards and Product Line Expansion

Looking into the future of defense contracting, anticipation buzzes as Kratos expects to secure its largest contract award related to the Valkyrie drone by late 2024. This aligns with the completion of 24 Valkyries set to be sold and delivered to various funded partners and customers. The company is setting up an additional production line for a new drone system under contract, eyeing the prospect of receiving a funded prime contract for both the Thanatos program once the U.S. federal budget is approved, and possibly for the Athena drone system potentially within late 2023 or early 2024. These tactical drones, including Valkyrie, Mako, Air Wolf, Thanatos, Athena, and others, are poised for success with multiple funded customers already involved.

Defense Industry Growth and Market Expansion

The company identifies itself at the center of a generational surge in the defense and security sector, driven by a heightened global threat landscape. This environment has expanded Kratos' range of opportunities like never before, with a robust increase in the scale and number of potential contracts, fostering a climate for continual growth in the company's future opportunities.

Diversified Revenue Sources and Workforce Growth

Kratos reports generating 13% of its fourth-quarter revenues from commercial customers and 18% from foreign clients. The company is also making strides in hiring, growing its workforce to 3,932 employees at the end of 2023, up from 3,645 the previous year, showcasing its commitment to scaling up operations to meet the increasing demands.

Financial Guidance Amid Operational Challenges

The initial first quarter and full-year financial guidance for 2024 presented by Kratos take into account the expected mix of their business, current delivery schedules, and impacts from the ongoing struggle to hire and retain qualified technical personnel. Moreover, the guidance includes anticipated effects of supply chain disruptions, inflation, and consequent cost and price increments expected to occur. Revenues forecast for the Unmanned Systems business are expected to be a key growth driver, projecting revenues of $260 million to $270 million and signifying an organic growth of approximately 20% to 25% over 2023.

Capital Expenditures and Recovery Plans

Kratos plans substantial capital investments, with an estimated range of $70 million to $80 million in various initiatives. This includes $20 million for the Valkyrie production, $10 million to $13 million for the Microwave Israeli production facility, $10 million to $12 million for establishing a Material Production Center of Excellence, and $5 million to $7 million for expanding a global satellite sensor network. The company expects to recuperate these expansion costs under customer contracts.

Forecast Adjustments Tied to Government Funding

The forecast for 2024 is underpinned by the assumption that the continuing resolution authorization, which constrains the approval of new contracts and funding increases, will be resolved by March 8. There is an expectation for considerably higher financial results in the last half of 2024, with the fourth quarter projected to show particularly strong revenue and EBITDA. Should the resolution continue past the expected date, Kratos anticipates reevaluating its financial forecast in accordance with the then-prevailing facts, circumstances, and expectations.

Earnings Call Transcript 2023-Q4

[Operator]

Thank you for standing by, and welcome to Kratos Defense & Security Solutions Fourth Quarter 2023 Earnings Conference Call. [Operator Instructions]. I would now like to hand the call over to VP and General Counsel, Marie Mendoza. Please go ahead.

[Marie Mendoza, executive]

Thank you. Good afternoon, everyone. Thank you for joining us for the Kratos Defense & Security Solutions Fourth Quarter and Full Year 2023 Conference Call. With me today is Eric DeMarco, Kratos' President and Chief Executive Officer; and Deanna Lund, Kratos' Executive Vice President and Chief Financial Officer.

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

Please keep these uncertainties and risks in mind as we discuss future strategic initiatives, potential market opportunities, operational outlook, 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, executive]

Thank you, Marie. Good afternoon, everybody. In 2023, Kratos achieved each of the goals we laid out at the beginning of the year, including 10% organic revenue growth, increased EBITDA with positive cash flow generation while also making significant internally funded investments in potential transformational growth areas for our company.

Expected growth areas include high-performance jet drone systems, hypersonic rocket motors and systems, next-generation jet engines for drones, missiles and loitering munitions and OpenSpace software for virtuated satellites C2 and TT&C.

Kratos' product systems and software, which we envision design and engineer from the outset to be produced in large quantities at a low cost or a value-added differentiator for our customers and also importantly, for our prime system integrator partners and teammates.

Kratos' relationships with the prime system integrators, including our being able to rapidly provide relevant, low-cost, differentiated and value-enhancing products, hardware and systems, is a key element of Kratos' strategy and its core to our company's success.

At Kratos, we believe that it's better to have a big part of something instead of all of nothing. And based on a program's requirements, including schedule, the potential size of a Kratos investment required, the technical development and financial risk to Kratos and also expected customer preferences, we may team with one or more of our prime partners on certain program opportunities instead of Kratos priming ourselves.

We believe this teaming or partnership approach has been very successful, including recently on a high-profile program.

On last quarter's conference call, I mentioned that we were expending significant effort, including bid, proposal, NRE and other costs in pursuit of certain large opportunities. As an update, we have successfully received potentially the most important of these contracts in Kratos' Unmanned Systems business with a prime partner.

On a second opportunity, a different Kratos prime partner was awarded a new missile defense system related satellite constellation program where Kratos is responsible for the ground system.

Thirdly, we have been informed that a Kratos Turbine Technology's proposal was accepted, and we are now waiting for our customer to receive funding, hopefully in Q3.

And finally, Kratos made the decision to pass on an opportunity as a prime due to the size of the Kratos internal investment required, the financial risk to Kratos on this development program and our assessment of an unacceptable probability of Kratos win.

There are several additional notable opportunities that Kratos is currently assessing or in pursuit of, including where we are making significant investments, which hopefully we will be able to update you in the future.

As we begin 2024, we are under contract on numerous programs of record, either as prime or partnered. These include new programs currently in development, programs transitioning to low rate initial production, programs that are in LRIP and transitioning to full rate production and programs that are in full rate production already, where we expect increased future production quantities.

Additionally, Kratos' opportunity pipeline is approximately $11 billion and our backlog is $1.2 billion, all providing us confidence in our 2024 financial forecast. Additional recent Kratos achievements include a $579 million prime single-award Space Force satellite communication system-related contract, which we were able to announce today.

The Space Force contract covers the command and control consolidation system used for SATCOM telemetry, tracking, command, sustainment and resiliency.

The receipt of this award, which was Kratos' only large outstanding recompete, provides Kratos both future visibility and an opportunity for growth as reflected by the significant contract ceiling value increase of approximately 50% over the previous contract vehicle as the number of satellites in orbit it has and is expected to continue to increase, contributing to the overall expected increase in this contract's scope.

It was reported that Kratos and Boeing have executed a memorandum of understanding for Kratos' TDI-J85 jet engines to be the propulsion provider for the Boeing Power Joint Direct Attack Munition.

It is anticipated that the powered JDAM will provide air-launched low-cost standoff capability against land and maritime threats. We received an approximate $23 million prime contract from the United States Marine Corps related to Kratos' Valkyrie tactical drone, and we received significant contract awards related to the Iron Dome and the Patriot Air Defense Systems.

It was also reported that Kratos' Terrier Oriole 2-stage rocket system was the propulsion system for the V-MAX hypersonic system launch. And it was reported that recent testing of a sophisticated AI software aboard an XQ-58A Valkyrie drone will influence how the U.S. Air Force develops and deploys autonomous technologies.

For 2024, expected Kratos growth areas, which are included in our base case financial forecast include turbojet, turbofan and rocket engines for unmanned aerial drones, loitering munitions, cruise missiles, hypersonic systems, supersonic platforms, space and other systems, increased target drone sales with target drones being used by the U.S. and/or allies to exercise radar, air defense, fighter aircraft, maritime, counter UAS and other platforms and systems, all of which are in increasing demand globally.

Hardware and product sales growth related to air defense, counter UAS, radar and missile systems, including in Kratos' C5ISR and our microwave electronic products business. These include systems that are currently in theater in both Europe and the Middle East, and we expect the Sentinel program with our prime partner, Northrop to also be a 2024 organic growth driver.

We expect to see growth in Kratos' Space Satellite and Training Systems division, including particularly strong growth in virtual augmented reality and other training systems. In 2024, we expect Kratos' first-to-market virtualized software-based OpenSpace C2 and TT&C suite to continue to gain customer acceptance and designed and positions.

Additionally, we are currently forecasting for 2025 to be an inflection point year for Kratos' satellite business, both in organic revenue growth and in profit generation based on programs we have successfully received, those we expect to receive and those we expect to either transition to or begin production or deployment on.

In the tactical drone area, we believe that Kratos remains well positioned for this new large and expected to be fast-growing market area, both with Kratos drones and also with Kratos' family of turbojet and our turbofan engines.

Tactical drone initiatives we are able to discuss publicly include, we are under a funded contract and have completed a successful series of mission system and related flights, including as related to Kratos' Mako Tactical Jet Drone System. We are under a funded contract and are integrating Kratos' jet engines into Kratos' drones.

Kratos' Ghost Works is completing ground testing of a new drone-related system at our Burns Flat Range location, which program we expect to transition in the future to a larger range for final system demonstration, we had hoped to transition the system to a larger range in Q4, but we were unable to do so.

We are moving rapidly with Shield AI, integrating Shield's artificial intelligence into multiple Kratos jet drones with flights being held at Kratos' Burns Flat Range facility. We are completing production of the last of the initial 12 Valkyries and we are in production on the second 12 Valkyries, which production rate we are calibrating now based on Kratos' internal resource allocation considerations, including as related to the new funded drone system program we have received.

We are underfunded contract for a Valkyrie variant where mission and other systems are being integrated. We are working with the government entity on a separate Valkyrie variant with funded first flights expected in the fourth quarter of this year and Kratos' Ghost Works is working on an additional Valkyrie variant, with new capability, performance and low cost, we believe, will be another step function ahead for Kratos' tactical drone family.

There are currently 4 Valkyries variants that I can publicly confirm today and a fifth that Kratos' Ghost Works is currently assessing. We expect to receive the largest Valkyrie-related contract award to date in late 2024, and I am confident that all 24 of Valkyries we have produced or plan to complete production on, will ultimately be sold and delivered to funded customers.

We are establishing an additional production line for the new drone system program that we are under contract on with the partner. We believe that once we have the 2024 U.S. federal budget that Kratos' Thanatos will receive a funded prime contract.

Based on recent events, it is also possible that we will receive a funded prime contract for Kratos' Athena drone program system late this year or early next year. Initial derivatives of both Thanatos and Athena are flying today with customers.

I expect Kratos' Valkyrie, Mako, Air Wolf, Thanatos, Athena and other Kratos tactical drones to be successful and we continue to progress with multiple funded customers, entities or partners, including for system missionization, concept of operations, payload integration, et cetera.

However, we will remain conservative, and we have included no tactical drone production assumptions in Kratos' 2024 base case financial forecast, only S&T, RDT&E and similar funded development initiatives or programs.

Major initiatives and opportunities Kratos currently plans to invest in or pursue in 2024 include, we are establishing production facilities for Kratos' jet engines, including for missiles, drones, loitering and powered munitions for several platforms, systems and opportunities that we are currently underfunded development contract on.

We are completing Kratos' Sentinel Program Ground Transporter production facility, which will be one of the largest and advanced technology secure production facilities in our company, which we are under a funded contract on.

We are establishing the production line for the new system in Kratos' Unmanned Systems division I mentioned previously, which we are under a customer-funded contract and which is one of the most important programs in our company.

We're completing the Zeus 1 and Zeus 2 engines and preparing these systems for production and vehicle system integration, including as related to a customer-funded hypersonic program we have and other customer initiatives.

We're completing Kratos' Erinyes and Dark Fury hypersonic systems and beginning the buildout of the related production integration facilities, also for which we have a funded customer contract.

We currently expect to receive in 2024, a customer-funded contract for approximately 25 Kratos Oriole Rocket Systems, which we will need to prepare for and execute on once received, all related to future launch missions.

We are establishing a new space qualified microwave electronics development and manufacturing facility in Israel to support new funded space system program awards we have received, others we expect to receive, and we are expanding our existing production and manufacturing facility to meet the increased capacity and production requirements we're seeing.

We will also complete enhancements too and expansion of our U.S. based microwave electronics manufacturing facility. We are establishing the facility and acquiring the machinery and equipment, including 3D and additive manufacturing equipment for Kratos' materials production center of excellence, where we are vertically integrating the production of Kratos' jet engines, space propulsion and other programs and systems, most of which are already or are expected to be underfunded government contracts.

We are also in discussions regarding new teaming or partner agreements related to significantly expanding Kratos' core business areas, including product, system software and technology, all of which have funded customer support and this includes KTT, our turbine business and our Blade Engine Initiative.

These examples are representative of the large number of opportunities Kratos has and expects to receive and why 2024 is expected to be a significant internal investment in capital expenditure year as we prepare Kratos to execute on recently received funded programs, and we positioned Kratos to successfully receive additional expected large new programs. We believe that the industry and Kratos are in a once-in-a-generation global buildup of defense and security due to the geopolitical and overall increased threat environment.

As a result of this strategic system buildup, the number and size of the potential opportunities that Kratos has and continues to receive has never been greater and we expect Kratos' future opportunity set to continued increase, including based on discussions with our customers and also our prime system integrator partners.

Accordingly, Kratos is focused on successful execution of our existing programs and contracts and making the required internally funded investments in order to be qualified to successfully win, pursue and win these new opportunities.

Accordingly, Kratos has no plans for any acquisitions of any size. Operational challenges include the obtaining and retaining of qualified personnel, including those willing and able to obtain a national security clearance and the related high and increasing cost of these individuals and of the supply chain, which is adversely impacting Kratos' margins and also resource and capital allocation management as we execute on existing programs and we pursue new opportunities.

For Kratos' 2024 financial plan, we are currently forecasting Q3 and in particular, Q4 to be stronger than the first half of the year, which is directly related to the government contracting offices, having to get funding under contract in a shortened time period as a result of the current CRA going through at least March 8 or 4-plus months into government fiscal 2024.

If the CRA goes beyond March 8 of this year, we will take a look at the Kratos program portfolio and the facts and circumstances at that time and determine if any adjustment to our forecast as required, Deanna?

[Deanna Lund, executive]

Thank you, Eric. Good afternoon. As we have included a detailed summary of the fourth quarter and full year 2023 financial performance, as well as the initial first quarter and 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 fourth quarter were $273.8 million, exceeding our estimated range of $237 million to $257 million which includes higher-than-expected performance and delivery in our space and satellite, turbine technologies, C5ISR and microwave products businesses, resulting in 17% organic growth in our KGS segment for the fourth quarter of 2023 as compared to the fourth quarter of 2022.

Adjusted EBITDA for the fourth quarter 2023 was $29.1 million, exceeding our estimated range of $19 million to $23 million reflecting the additional revenues as well as a more favorable mix of revenues, including more higher-margin software and data-related content than forecasted in our space and satellite business.

Free cash flow generated from operations of $48.1 million after funding CapEx of $19.3 million came in above our estimated range of breakeven free cash flow for the fourth quarter of 2023, reflecting the increased revenues and EBITDA generated during the quarter as well as favorable timing on accelerated customer milestone payments collected in our turbine technologies, unmanned systems and space and satellite businesses, which more than offset our previous estimated shift in certain payment milestones in our training solutions and C5ISR businesses.

Consolidated DSOs or days sales outstanding, continued to improve from 119 days in the third quarter to 109 days in the fourth quarter of '23, with approximately $34 million in net cash generation from customer receivables during the fourth quarter, which included certain favorable customer milestone payments.

In addition, advanced payments or deferred revenues increased $11 million during the fourth quarter. For full year 2023, revenues were $1.037 billion or an organic growth rate of 12.6% above FY '22 revenues and above our estimated range of $1 billion to $1.02 billion, including higher-than-expected performance and delivery in our space and satellite, turbine technologies and microwave products businesses.

Full year adjusted EBITDA was $95.4 million, above our expected range of $85 million to $89 million reflecting the increased revenues and also a more favorable mix of revenues.

Cash flow generated from operations for full year '23 was $65.2 million and free cash flow generated from operations was $21.1 million after funding of capital expenditures of $52.4 million, less $8.3 million receipts of proceeds for sales of Valkyries that were built as Kratos capital assets.

As mentioned earlier, cash flow was positively impacted by favorable customer payment milestone receipts in our turbine technologies, unmanned systems and space and satellite businesses, which more than offset the shift in previously expected payment milestones in our training solutions and C5ISR businesses.

Our contract mix for the fourth quarter of '23 was 71% of revenues generated from fixed-price contracts, 24% of our revenues generated from cost-plus type contracts and 5% of revenues generated from time and material contracts.

Revenues generated from contracts with the U.S. federal government during the fourth quarter of 2023 were approximately 69%, including revenues generated from contracts with the DoD, non-DoD federal government agencies and FMS contracts.

We generated 13% of revenues from commercial customers and 18% from foreign customers in the fourth quarter. We continue to make progress in our hiring and retention of skilled technical labor across the company, with total headcount of 3932 employees at the end of 2023 compared to 3645 at the end of 2022.

Now, moving on to financial guidance. Our initial first quarter and full year 2024 financial guidance we provided today includes our current forecasted business mix and current delivery schedules and our assumptions related to the expected impact of the continued operating challenge related to our obtaining and retaining qualified technical personnel and the related increased cost for these employees and 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 first quarter and full year 2024 guidance reflects the impact of certain performance and deliveries in the fourth quarter of 2023, certain of which had been originally estimated to be executed or delivered in the first quarter of 2024.

As Eric mentioned earlier, we are forecasting that our Unmanned Systems business will be one of our leading growth drivers in 2024, which is currently forecasted to generate $260 million to $270 million in revenues, reflecting approximately 20% to 25% organic growth over 2023.

Our 2024 cash flow estimates include investments in elevated capital expenditures, as Eric discussed earlier, on a base case estimated range of $70 million to $80 million, which includes the second production build for Valkyries of approximately $20 million in anticipation of customer requirements and demand, approximately $10 million to $13 million to expand and build out our Microwave Israeli production facility, which includes expansion and improvements related to being space qualified, approximately $10 million to $12 million to establish Kratos' Material Production Center of Excellence and approximately $5 million to $7 million to expand our global satellite sensor network in response to specific customer contractual requirement, which specific expansion costs are expected to be recovered under customer contracts.

Importantly, a U.S. government budget was not passed by October 1, 2023, the beginning of federal fiscal year 2024 and as a result, Kratos and the industry are operating under a continuing resolution authorization which currently expires March 8, 2024, under which no new contracts and no increases in increasing contracts, production or funding among other stipulations is permitted.

Kratos' 2024 financial forecast and guidance provided today assumes that the current CRA will be resolved and that a U.S. federal and DoD budget will be in place by March 8. As a result, similar to Kratos' 2023 quarterly financial trajectory, which fiscal year also experienced a CRA, we are forecasting Kratos' third and fourth financial quarter results of 2024 to be significantly greater than the fiscal first and second quarter results with the fourth quarter expected to be particularly strong in both revenue and EBITDA.

If the current CRA goes beyond March 8, we will evaluate Kratos' 2024 financial forecast at that time based on the existing facts, circumstances and expectations, Eric?

[Eric DeMarco, executive]

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

[Operator]

Thank you. [Operator Instructions]. Our first question comes from the line of Michael Ciarmoli of Truist Capital.

[Michael Ciarmoli, analyst]

Eric, can you just sort of level, set us on some of the higher profile opportunities. I mean, we've seen the CCA, I guess as selected 5 firms. I guess there's going to be a down selected two your head of UAS has said you're hopeful of being on the next increment? And then I guess also right along with that replicator kind of tranche 1 and 2, how should we think about the opportunity set here in the near term?

[Eric DeMarco, executive]

We are the absolute low-cost rapid provider of jet drones. And that's unarguable. It's well known by the government and by the primes. So, we are uniquely positioned, we believe, for every opportunity that's been talked about publicly and some new ones that are coming that have not yet been talked about publicly as either the prime or as a key partner with somebody.

That's how we see it. That's on aircraft. On certain classes of them that are coming, not only on the aircraft side, but we're also positioned with our jet engines. So, we are uniquely positioned, Mike, for what's going on in the drone area across every service branch.

[Michael Ciarmoli, analyst]

Can you guys, I mean, as you look at the pipeline of opportunities, which increased significantly, I mean, are these 2 programs in that pipeline?

[Eric DeMarco, executive]

I'm not sure or which, I want to make sure I answer the question, Mike, or which 2 programs and what--

[Michael Ciarmoli, analyst]

Collaborative combat aircraft and replicator.

[Eric DeMarco, executive]

Yes. Every drone program that's out there we're expected to be in. I'll leave it at that.

[Michael Ciarmoli, analyst]

And then, you mentioned a couple of times about the Valkyrie and different variants. I mean, can you give us a little bit of color on those variants. I mean, I guess since you're still self-funding and using your own CapEx to build these, what are some of the -- if you can even talk to the variance. I mean, I'm assuming extended range, different payloads, maybe even landing gear, but are those kind of what customers might be looking for out of the Valkyrie?

[Eric DeMarco, executive]

Yes, yes and yes.

[Operator]

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

[Peter Arment, analyst]

Eric, on, I guess, the whole teaming approach, can you maybe just give us how this kind of evolved? Is this something you've kind of been planning or thinking about over the last year? What was the best kind of, I guess, how would you describe it in terms of working with primes versus going it alone?

[Eric DeMarco, executive]

Yes, probably a couple of years ago, Peter, when the different classes of the drones that the government was looking at, started to get more refined between expendables, attritable, exquisites and the various weapon systems they would carry and certain of the characteristics they would have.

We huddled internally, and we made some strategic decisions that we would, in certain areas that are obvious, like expendables, disposables, attritables that's like right in our sweet spot. And all things being equal, we would look to prime those. There are some areas we might not if they're carrying certain mission systems that are very unique that the customer wants to have integrated and a prime has that mission system.

As you move up the capability ladder, and we decided it probably would make more sense from a probability win standpoint. If we looked at it on a biggi and we said, okay, our probability of win is 25%. We have to invest on making this up $100 million if we go out of a loan to be the prime or our probability of when we think is 90%. We get significant content on something, and our investment is significantly less than that.

With everything we have going on, we would choose the latter there. And so, a couple of years ago, we started looking at it that way, and that's an approach we've been taking across Kratos in many areas, drones, hypersonic systems, jet engines, you'll be seeing that, I think, soon. It's the way we're doing it.

We're partnering with the best companies in the world, the prime system integrators, and they are our partners, they are the best companies in the world at certain things. No one can do it better, and we partner with them when it increases our PWin.

[Peter Arment, analyst]

Certainly it seems like an inflection year for your tactical drones. On your the jet engine production that you're kind of investing in CapEx, is that expected to be completed this year or do we think that this kind of runs into '25 as well?

[Eric DeMarco, executive]

Yes. So, on the programs that we've won that we're on and that we have vision that are going into production, those we're getting done this year.

However, there are several others. There is a lot going on in loitering munitions, cruise missiles and low-cost jet drones so probably second half of this year, I think we're going to be awarded production on some others, which means we'll have to establish some additional production lines because it's a different size of engine.

So, I think this is probably going to be a process, probably for the next 24 months, but it will definitely be tied to programs that we're designed in on and going into production. It will not be a build it and hope they come.

[Peter Arment, analyst]

And just lastly, you've had a flurry of press releases since, I guess, November, December and with some of these large awards and you got one here in January that you didn't give any kind of time line on I think it was a $50 million, the hardware and radar for CUS. Can you talk a little bit about how these kind of roll out? And when do they start to inflect more on the top line?

[Eric DeMarco, executive]

Yes. So that $50 million one that's going to roll out starting second half of this year, and it will be done probably nearly done by the end of '25. I'm expecting -- I think we're going to get another one similar size in the next few months.

As I mentioned, these systems are deployed in Europe, and they're deployed in the Middle East. The contract we were able to announce today, we just got customer approval coincidentally to announce the space on. This one is so important. I'm glad you asked, Peter, from so many angles, as I mentioned, this is the largest recompete in the company. We don't have any more recompetes of any size for the foreseeable future. So, we're bolted in. That's number one.

Number two, as I said in my prepared remarks, the ceiling is 50% higher than it was. So it's not just bolted in. It's going to be a massive growth vehicle for us, and it's driven primarily by the number of space systems that are going up in the space. That is definitely going to start ramping for us in the second half of this year and into '25 and into '26. We need a budget, budget, budget, budget.

So, our space business in all of Kratos, not commercially, not like the Intel SaaS of the world. But on the military side is the most susceptible in our company to the CRA because we've once, as you recall, in '22 and '23, we won so many development programs. And that business adjusted revenue growth of like 15% or 20%, okay? We need the budget for production and deployment. And since we're delayed, that's why I'm looking that to happen in '25. So, that's how I see those rolling out.

[Operator]

Our next question comes from the line of Seth Seifman of JPMorgan.

[Seth Seifman, analyst]

Good results. I wanted to ask, so the unmanned business, a very nice amount of growth expected this year and we've kind of seen things moving at a similar level the past couple of quarters. We'll have a CR kind of in most of the first quarter of '24 here. So that's probably, once again, a similar level of revenue to what we've seen, it's not a little bit lower seasonally. And so, the implication would be that kind of exiting this year would be a pretty big number from a revenue perspective. That, on its own, carries a certain amount of growth into '25. Is that kind of a fair way to think about it?

[Eric DeMarco, executive]

Let me restate it for you. Let's take target drones. The target drone business has been ramping, and you can see by world events what's going on there. So, that big blob base has been increasing for the past year. It's going to take another significant step function up in 2024 as soon as we get the '24 budget, okay?

So the base has gone up '23 over '22, the base is going to go up again '24 over '23 as soon as we get to the budget. The problem is, let's say, we get the budget on March, 8, God willing, the government contracting officers, they've got to basically get 12 months' worth of contractual and obligations done in 6 months. And that's why it pushes out into Q3 and Q4, if that answers your question.

[Seth Seifman, analyst]

Yes. But then that's at a level in Q4 is at a higher level that can drive a decent amount of growth in 2025.

[Eric DeMarco, executive]

Correct. And that's the right way to look at it. Yes. And so, the bio wave from '22 CRA we saw that, the bio wave '21 CRA, we saw at the end of '22. The bio wave from '22 CRA, we saw at the end of '23. The bio wave from this one will see '24-'25, exactly correct.

[Seth Seifman, analyst]

And then just backing into, I think, what the number you talked about for unmanned implied would be something like 6% growth or so for government solutions. And just so, anything that the pieces that are kind of growing more quickly and more slowly than that kind of 6% average for KGS in '24.

[Eric DeMarco, executive]

Yes. As I said, our space business is the one within Kratos that's based on development programs transitioning to deployment, is the most susceptible to a CRA. So, our space business, which is our biggest, so it's also the hardest to grow on just its coming off, what did it do Deanna 15% or 20%?

[Deanna Lund, executive]

15% in the quarter.

[Eric DeMarco, executive]

Adjusted 15% organic growth. If we are forecasting that primarily due to the CRA to be one of our lowest growers in 2024 because we need to get that budget for these programs we've won to ramp up.

[Operator]

Our next question comes from the line of Mike Crawford of B. Riley Securities.

[Michael Crawford, analyst]

Eric and Deanna, just to help understand the guidance. If you were able to actually contract to sell both Valkyrie production spirals before year-end, what would be the rough delta on additional revenue and maybe more interestingly, reduced CapEx?

[Deanna Lund, executive]

Mike, as Eric had mentioned, we are balancing our internal resources on the cadence of that production build for that second lot of Valkyrie. So, that's a factor that we're taking into consideration the CapEx that is related to Valkyrie production for 2024 is approximately $20 million.

On that cadence, we would expect to continue to build throughout in 2025, and that's based upon just how our internal resources, how we're prioritizing those resources. If those were sold to the extent they're completed or to the extent they're percent complete, as we've discussed before, since they would be subject to percentage of completion accounting, then let's say that $20 million that we had incurred in 2024, a certain number were sold, then the percentage complete related to those aircraft that are sold would be recognized as revenue in 2024.

And then depending on the milestones that we're able to negotiate with the customer, the cash receipts would fall in whatever period it would fall in whatever we're able to negotiate from a milestone perspective.

[Eric DeMarco, executive]

So, Mike, in a total blue sky world -- Deanna what's the CapEx in Valkyries at the end of the year, at the end of '23.

[Deanna Lund, executive]

It's over $30 million.

[Eric DeMarco, executive]

Over $30 million.

[Deanna Lund, executive]

So, Mike, in a perfect blue sky world, if we got a production order from all, that $30 million would flip into revenue and whatever percent of the $20 million in 2024, let's say we're $10 million in, it happens in June, we'd get a pickup of $40 million in revenue, something like that.

[Michael Crawford, analyst]

And then Eric, when you said you would expect perhaps to potentially contract with this in late '24, would that be after a new government budget that presumably they're going to pass before the end of December when the new Congress comes in?

[Eric DeMarco, executive]

No, sir. It's in the fundings in the current budget. I'm just planning on the budget being done in early March. And as I've said a few times, it's going to take a while for the contracting offices have a lot to do and so, it will take until late in the year.

[Michael Crawford, analyst]

And then just switching gears, given just the thousands of missiles that have been expended in the Mid-East, can you comment on your microwave systems backlog?

[Eric DeMarco, executive]

Yes. Our Microwave Electronics business, the biggest part of it, as you know, is in Israel. And we are one of the primary providers on virtually every Israeli missile system and radar system. And the missiles are the ones obviously the razor and the razor blade. So, think of Iron Dome, we're on the seekers. So, Deanna, what are record levels?

[Deanna Lund, executive]

We're a record backlog level.

[Eric DeMarco, executive]

We're record backlog level, we're record revenue level. It's looking great for '24. It's looking great for -- I mean this is terrible, what's driving this. But our microwave business is doing very well because the Israelis are defending themselves.

[Michael Crawford, analyst]

And then just off of this $877 million IDIQ, where you're pretty much, I think, competing with Northrop. And you said you were hoping to get an order for '25 Oriole rockets, how much of those per system?

[Eric DeMarco, executive]

Right. So, those would be totally separate from that. That's a different customer. Totally separate. So, that would be incremental to that. It's a different customer.

[Michael Crawford, analyst]

And so, the IDIQ that would be for Space Force payloads record, what would the years [indiscernible]

[Eric DeMarco, executive]

It's a different customer. It's not that customer. It is incremental. It's in addition to what we get under the $877 million award.

[Michael Crawford, analyst]

Maybe just one final one is, just today and today, there was a pretty big merger announcement with one of your customers, BlueHalo merging with the Eqlipse. And I'm wondering if that changes the scope of your $160 million OpenSpace award that you're working with them on the SCAR program?

[Eric DeMarco, executive]

Absolutely, does not. This is great for BlueHalo. It's great for us. It's great for the company they merged with. This is another up-and-coming disruptive partner of Kratos is in BlueHalo. So, no change and that SCAR program is going to be one of the big drivers for Kratos 2025.

[Operator]

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

[Kenneth Herbert, analyst]

I wanted to follow up on your comments on the sort of the shift in strategy. You look to build out more sort of merchant businesses. It sounds like there's a real opportunity within rocket motors, electronic devices, unmanned, other areas to replicate what you've done on the space side.

Now, as you think about that and you think about the other opportunities, is there any way you could maybe rank order those other businesses? And sort of how far along that curve you think they are to, I guess, what I would call sort of established merchant supplier status. And how does that maybe impact growth of those businesses this year and then, of course, into '25?

[Eric DeMarco, executive]

Yes. Turbojet and turbofan engines for missiles, powered munitions, loitering munitions. We are way up or down the curve, whichever way you want to look at it, relative to being the trusted partner with the prime system integrators with those engines on their weapon systems. And this value proposition I'm going to give you right here is the value proposition we bring to them.

I'm making this up, Raytheon is doing a missile. Northrop is doing a missile, Lockheed is doing a missile. It all needs 150-pound thrust engine. We build 150-pound thrust engines. They all come to us because we get leverage because we have 3 orders, one from each of them, which drives the cost down, which makes them more cost effective for their customer and it brings value to everybody.

So, it's a win for us. It's a win for all those 3 primes in my example, and it's a win for the government. So, in turbojets and turbo fans for cruise missiles, loitering munitions and powered munitions we are moving down the path on that. You saw with the announcement that Boeing made on powered JDAM as you know, I've talked about before, we're designed in on 6 different systems, several of which are going to be in production, I think, by the end of this year, and this will be a meaningful revenue driver for us in 2025 and we have clarity on this with the programs. That's number one.

Number two is our hypersonic stack. So, I mentioned today the Oriole Terrier stack that launched the French payload that just became public, okay? We do that all the time for a lot of different customers. It's just not announced with the Zeus motors coming. These can go faster, farther, put heavier payloads in certain places at the right time and the right speed, the right place.

We do that for the government, and we do that for the primes. So, we are way down the line on that. And since we are orders of magnitude less costly than anybody else out there, including some of these up and comers who think they're going to get into the area, we can test, test, test and test multiple times within a budget for a customer, whether it be the government or a prime because our price points are so low.

So, stacks for hypersonic systems, ballistic missile targets and suborbital vehicles, which, as you know, we can't talk about on this line. So, that's right behind the turbojets and turbofans.

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 and 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 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.

[Kenneth Herbert, analyst]

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, executive]

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 $1 trillion defense budget, I love them. 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.

But let's say that I'm wrong, all right? Low cost is going to win the game. Afford the stock 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 turbojet 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.

[Operator]

Our next question comes from the line of Pete Skibitski of Alembic Global.

[Peter Skibitski, analyst]

A couple of 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 are above that. In a sub position, if you get enough numbers, can you get to double digits in terms of adjusted EBITDA margins or are we going to stick in this range even as a sub?

[Eric DeMarco, executive]

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 and 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 a part of that with the government, of course, but you can make low to mid-teen margins. And internationally, in target roads, 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 is 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.

[Peter Skibitski, analyst]

You're saying even in full rate production, they'll be the same as [indiscernible]

[Deanna Lund, executive]

No, on 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, the development rates that we would see on the target side, but when we get to production we would expect to see some expansion.

[Peter Skibitski, analyst]

So, maybe like 3 years out, we're talking there is a path, yes, okay, I appreciate that. And then similar question 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, executive]

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.

[Peter Skibitski, analyst]

So, that R&D will stay steady state, but as long as the market is hot, you'll have these opportunities for deliveries to be higher?

[Eric DeMarco, executive]

As long as we penetrate that total addressable market we see, we should be in good shape. Yes, sir.

[Operator]

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

[Joseph Gomes, analyst]

Congrats on the quarter. I just wanted to start on the tactical side there for a second. I saw that Australia is investing another $260 million in the Ghost Bat. I was just wondering what you see on the competitive side there on tactical.

[Eric DeMarco, executive]

So, you asked the question. So yes, Australia is going to pay $260 million in U.S. and AUD400 million for 3 more Ghost Bats. So, obviously, that is a much different model than Kratos' model. We were paid for 3 Valkyries. The first 3 additional Valkyries was like $40 million. So, it's a different paradigm.

[Deanna Lund, executive]

With the cost share.

[Eric DeMarco, executive]

Yes, it's a different paradigm, Joe. We're focused on affordability, effectiveness, affordability, rapid development, get things flying. That model is just different, and I don't focus on it.

[Joseph Gomes, analyst]

And then, outside of the OpenSpace, which obviously is growing nicely there with some of the recent awards we'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 doing CR?

[Eric DeMarco, executive]

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 federal government, U.S. federal government budget as I mentioned earlier that 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 go down the list as MonacoSAT, they're not impacted. And we're seeing growth in the commercial satellite area. In our engine area, as you know, we're building engines for or 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 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, well, 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.

[Operator]

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

[Sheila Kahyaoglu, analyst]

So much has been asked already, but I just wanted to kind of maybe put it all into context if that's possible. Eric, you could hear me right? Just double checking. So maybe if you could just talk about KGS versus KUS in 2024 and the growth profile of each KGS has been growing pretty nicely. Do we continue to see that outperform and you rank maybe if you could just simply rank order the subsegments of where you see the highest growth there to just do start?

[Eric DeMarco, executive]

Right. So, to level set, the biggest growth segment we're going to have right now for 2024 is going to be our Unmanned Systems business.

The drones across the portfolio are doing great. And if we get a budget, we could actually beat those numbers in the drone area, all right? So, in KGS, I'll let Deanna touch on those, keeping in mind that our space business will be one of the lowest ones because it's impacted the most by the CRA.

[Deanna Lund, executive]

Yes. So, as Eric had mentioned, the space business, which is our largest is impacted by the CRA. And what Seth brought up, we're forecasting about a 6% organic growth across KGS with space being a big portion of that at lower than that 6%.

So, that would indicate that there are pieces that are growing greater than that rate, which would be our C5ISR business, our turbine business, our microwave electronics business, really across the board, most of the businesses within KGS with the exception of the space business for all the reasons we've talked about since we expect to really see that growth come in play in 2025 as we move on to production on a number of the programs that we've been working on.

[Sheila Kahyaoglu, analyst]

And then maybe if you could talk about the pipeline, it stepped up $700 million sequentially, just given recent news with CCA and things like that and you're partnering with folks. Maybe can you give us the moving pieces of the pipeline at all?

[Deanna Lund, executive]

It's actually from our pipeline perspective, the big increase is not in our Unmanned Systems business. It's across a number of our businesses within KGS. So, in our C5 business in our turbine business and our microwave business.

[Eric DeMarco, executive]

Sheila, the engine business, in particular. The pipeline is incredible right now, made in the U.S.A. engines, turbojets, turbofans, rocket engines, liquid and solid. We're seeing incredible demand there in engines. That's probably the strongest grower for us from a pipeline standpoint.

Microwave electronics is incredibly strong. It grows literally every week as ordinance has expanded. As Deanna mentioned in the C5ISR business, I've been through the programs before, we have a number of programs, IBCS, FPIC, SHORAD, all of which are moving into production. So, those pipelines are now moving from development to production, which increases the pipeline and we're designed in.

So, the KGS business, our training business, we built training systems for weapon systems. Weapon systems are back in Vogue. So, our training systems business pipeline, it's very big, and its growth is one of the strongest in the company, '24 over '23.

[Deanna Lund, executive]

As well as our space business as well. I don't think I have mentioned that before. I said the pipeline is up also in our space business.

[Sheila Kahyaoglu, analyst]

And then last question for me. Obviously, CapEx jumps up $20 million year-over-year. Do we think about that as a normalized rate or is it just given what's going on with Valkyrie and migrated products?

[Deanna Lund, executive]

It goes through all the investment areas that Eric had talked about in the growth areas that we're investing in. So, it's across the board. It's in our microwave business. It's Valkyries that we're continuing to build. That's about $20 million, but it's also building out some of our space network, a satellite network that we company own as well as the Manufacturing Center of Excellence for our turbine engine business.

So, it's really investments that we're making in 2024. Some of it might continue in '25, but not that note. We don't anticipate at that level. So, it is continued. Yes, I would not say it's recurring.

[Operator]

Thank you. I would now like to turn the call back over to Eric DeMarco for closing remarks. Sir?

[Eric DeMarco, executive]

Excellent. Thank you all for joining us and for the Q&A session, and we'll touch base with you when we report Q1 in a few months. Have a good day.

[Operator]

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