Rocket Lab - Q2 2023

Transcript

Operator (participant)

Thank you for standing by. My name is Adam, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Rocket Lab Q2 2023 earnings call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press the star followed by one on your telephone keypad. If you'd like to withdraw your question, press star one again. Thank you. I'd now like to turn the call over to Colin Canfield, Investor Relations Manager. Please go ahead.

Colin Canfield (Investor Relations Manager)

Thank you, Adam. Hello, everyone. We're glad to have you join us today for today's conference call to discuss Rocket Lab second quarter 2023 financial results. Before we begin the call, I'd like to remind you that our remarks may contain forward-looking statements that relate to the future performance of the company. These statements are intended to qualify for the safe harbor protection from liability established by the Private Securities Litigation Reform Act. Any such statements are not guarantees of future performance. Factors that could influence our results are highlighted in today's press release, and others are contained in our filings with the Securities and Exchange Commission. Such statements are based upon information available to the company as of date, the date hereof, and are subject to change for future developments. Except as required by law, the company does not undertake any obligation to update these statements.

Our remarks and press release today may also contain non-GAAP financial measures, measures with the meaning of Regulation G enacted by the SEC. Included in such release and our supplementary materials are reconciliations of these historical non-GAAP financial measures to the comparable financial measures calculated in accordance with GAAP. This call is also being webcast, although due to technical difficulties with our conference call provider, we will post a copy of the presentation on our website at a later time. Our presenters today are Rocket Lab Founder and Chief Executive Officer, Peter Beck, and Chief Financial Officer, Adam Spice. After our prepared comments, we will take questions. Now, let me turn the call over to Mr. Beck.

Peter Beck (Founder and CEO)

Thanks very much, Colin, welcome, everybody, thank you for joining us. Today's presentation, we'll go over our key business accomplishments for the second quarter of 2023, as well as further achievements we've made since the end of the quarter. Adam will then take us through our financial results for the second quarter before covering the financial outlook for Q3 2023. After that, we'll take questions and finish today's call with the nearer-term conferences we'll be attending. All right, on to what we achieved in the second quarter for the year. Starting with our launch business, in May, we successfully launched both NASA TROPICS missions, and in June, we launched our inaugural hypersonics mission from NASA Wallops. NASA selected us to launch TROPICS in November, late last year, after the initial launch provider was unable to meet the mission and schedule requirements.

Within six months of contract award, we had successfully launched both missions, enabling these critical storm monitoring satellites to get onto orbit in time for the hurricane season. We're incredibly, incredibly proud to deliver mission success for NASA once again and further demonstrate the reliability and proven capability that Electron delivers to our civil and defense customers. We also followed up the two TROPICS missions with a successful HASTE mission. HASTE is our Hypersonic Suborbital Testbed variant Electron, and it fills a very real and urgent need for our government customers. The acceleration of hypersonic system technology development is a significant national priority, but testing opportunities remain limited, particularly in real flight scenarios beyond wind tunnels. With the HASTE launch completed in June from LC-2 in Wallops, Virginia, we unlocked a new critical national capability, enabling rapid and cost-effective, cost-effective hypersonic testing.

We're, we're incredibly excited about what that brings for our customers, as well as, as well as additional total addressable market that looks to grow rapidly ahead of strategic and civil needs. All this while leveraging our existing Electron architecture and continued R&D investment in our Kick Stage capabilities. Expanded propulsion manufacturing capability. We're also excited about our acquisition of Virgin Orbit's 144,000 sq ft Long Beach facility, leased production, lease, and production equipment, which we're already hard at work configuring for our Archimedes and Rutherford production. Overall, we estimate that the $16.1 million price paid for this would have represented around $100 million of value versus having to purchase new, while approximately $80 million derived from acquired machinery and equipment, and the remaining $20 million from the tenant leasehold improvements.

We believe this asset purchase enables significant savings for Neutron and supports future scaling as we work towards first launch. Neutron testing. Speaking of Neutron, we want to highlight some of the major development, testing, and construction milestones we've reached for Neutron and its infrastructure. You may have noticed, we recently released some updated renders for Neutron, which created some online buzz around design changes. These include adapted landing legs for optimized for barge landings to increase launch availability, as well as the adaption of Neutron's Hungry Hippo fairing from 4 sections to 2, allowing for simpler mechanism. These design changes were actually made some months ago as part of our iterative testing and analysis program and some direct customer feedback, but the artwork really just hadn't kept up with pace with the real vehicle.

We've recently updated these for everybody to see. We've hit some significant milestones in Neutron production, and testing in this quarter, including completion of the second stage qualification tank and test stand in preparation for the cryogenic test campaign in the third quarter. This work is progressing at pace, thanks to our extensive experience with carbon composites throughout the Electron program, we have a strong head start on structures. In parallel, Earthworks at Launch Complex three in Wallops, Virginia, have commenced enabling pad construction to commence in Q3. Once complete, Neutron should enjoy all the benefits that come with launching from a pad that benefits from a clear line of sight to future launches, has significantly less congestion relative to the Cape, and close proximity to key government customers.

The propulsion team is also on schedule to deliver the first full-scale print of Archimedes, the Archimedes thrust chamber, and we're running a successful campaign of preburner tests at Purdue University. These milestones keep us on track for delivering the first complete qualification engine by the end of this year. In parallel, we're building avionics hardware and successfully testing it in hardware-in-the-loop simulations. All of these achievements puts us in a good position to meet some key milestones by the second half of this year, including completion of the second stage qualification test campaign. We're also targeting the completion of the first stage qualification tank and test stand, as well as the first Archimedes development engine and test campaign at our propulsion complex within NASA Stennis.

We're still working towards getting something on the pad by 2024, and we'll continue to provide updates as we progress through the year and, and the next. Our space systems team also recently delivered a really significant milestone in the second quarter in the form of successfully operating the latest Rocket Lab designed and built spacecraft on orbit. This is one of our newest spacecraft platforms, a high power, high payload volume spacecraft designed for short to mid duration missions in low Earth orbit. This was the first of 4 spacecraft that we're on contract to build and operate for Varda Space to enable in-space manufacturing. A highly bespoke and complex spacecraft designed for re-entry, which is a rare capability and something we're really proud to bring to market.

The spacecraft hosts a mini pharmaceutical lab that successfully grew crystals commonly used in drug treatments for HIV. With the in-space manufacturing now complete, the capsule is anticipated to return to Earth in the coming weeks. Meanwhile, the next two spacecraft for Varda are in advanced production and test, ready for the follow-up mission soon. All of these spacecraft feature components and software from across our space systems businesses, including solar panels, star trackers, radios, enabling us to produce them affordably at pace. It's also a demonstration of our business model as an end-to-end space company to both build and operate satellites on orbit. Finally, development is progressing well for our twin spacecraft mission to Mars for NASA.

For the ESCAPADE mission, we're developing two bespoke spacecraft to study Mars's magnetosphere next year. This quarter, we completed the qualification spacecraft ahead of an extensive test and qualification campaign. We now want to take the time to highlight some of our accomplishments so far in Q3. Successful launch for NASA, Telesat, and Spire. We've started the quarter strong with a successful rideshare mission from Launch Complex One, deploying satellites for NASA, Spire, and Telesat. We're on the brink now of our 40th Electron launch. On track to complete 3 more this quarter and 15 overall this year. Regarding our Capella launch, We Love The Nightlife. We continue to take an abundance, abundance of caution as we continue to track, continue our track record of the most reliable small rocket.

At present, the team is working through some unusual data from one of the engine sensors for that mission. Of course, these things happen with launch vehicles from time to time. We have a very straightforward path to resolution, and we'll, we'll reschedule the launch later this month. No big deal there. One of those missions, of course, was a recovery mission. This launch was an important one, as we used it to prove out our new waterproofing technologies and a new marine retrieval system for extracting Electron from the ocean. I'm pleased to report that the new system worked exceptionally well, and Electron splashed down in the best condition we've seen it yet.

We continue to operationalize Electron reusability with the first reflight of a recovered engine scheduled for the second half of this year, from where we'll schedule the first reflight of a full stage booster. Signed two new, sorry, sorry, signed 10 new Electron launches. Electron continues to be the preferred dedicated small launch option, demonstrated by continued and growing demand for launches. Since we reported earnings in May, we've signed deals for a total of 10 new dedicated launches, including block buys from return government and commercial customers. This really is a testament to Electron's reliability, frequent launch cadence, and in particular, the high degree of control over orbit that we can give to constellation operators, which is something they just cannot get on a large rideshare mission.With that, I'd like to turn the call over to our Chief Financial Officer, Adam Spice. Adam?

Adam Spice (CFO)

Thanks, Pete. Second quarter of 2023 revenue was $62 million, which was above the midpoint of our prior guidance of $60 million-$63 million. Second quarter of 2023 revenue reflects sequential growth of 13% and the result of three successful launches and a return to growth for our space systems business. Our launch services segment delivered revenue of $22.5 million in the quarter from three launches, which was consistent with our prior guidance of $23 million. The resulting average revenue per launch stepped up nearly $1 million to $7.5 million, consistent with our target average selling price for 2023.

Our Space Systems segment delivered $39.6 million in the quarter, which was up 12% sequentially and near the high end of our prior guidance range of $37 million-$40 million, driven by healthy growth in our satellite bus, solar, and separation systems businesses. Our backlog increased by $40.1 million to $534.3 million in the second quarter. We continue to see strength in our launch business, driven by returning launch customers with multi-launch requirements, HASTE-related missions, remanifesting launches from other failed or struggling launch providers. Our space systems backlog increased with the addition of a new satellite design and build program and strong component bookings, particularly for our software and solar businesses. Turning to gross margin.

GAAP gross margin for the first quarter was 23.5%, above the high end of our guidance range of 14%-16%. Non-GAAP gross margin for the second quarter was 31.8%, which was also well above our guidance range of 22%-24%. GAAP and non-GAAP gross margin improvements relative to our Q1 2023 results and Q2 2023 guidance reflect the release of a $4.1 million loss reserve associated with the expiration of a legacy launch contract, an increase in average launch selling price, and favorable mix within our solar and software businesses. Adjusting for this, non-GAAP gross margin would have been 25.2%, modestly above the high end of our previous guidance range. We ended Q2 with production-related headcount of 767, or up 10 from the prior quarter. Turning to operating expenses.

GAAP operating expenses for the second quarter of 2023 were $59.8 million, above the high end of our guidance range of $55 million-$57 million. Non-GAAP operating expenses for the second quarter were $43.4 million, which was modestly above our guidance range of $41 million-$43 million. The increases in both GAAP and non-GAAP operating expenses versus the first quarter of 2023 were primarily driven by higher staff costs related to new hires and our annual merit review and related compensation step-ups, material purchases supporting Neutron and Space Systems developments, and facilities and other ongoing expenses related to the Virgin Orbit asset acquisition.

In R&D specifically, GAAP expenses were up $7.1 million quarter-on-quarter as we continued to aggressively ramp our Neutron development efforts through new hires, large materials purchases, and outside professional services related to our Space Systems development programs. In addition to these areas contributing to the sequential increases, we also recognized increases in stock-based compensation and were impacted by the absence of ERC tax credits that were recognized in the prior quarter. Non-GAAP expenses were up $4.9 million quarter-on-quarter, driven similarly as GAAP expenses by staff costs, outside professional services, and materials-related purchases. Q2 ending R&D headcount was 518, representing an increase of 62 from 456 heads from the prior quarter.

In SG&A, GAAP expenses increased slightly by $200,000 quarter-on-quarter due to changes in contingent consideration related to our PSC acquisition, attributable to a higher average stock price in the quarter, higher M&A costs associated with the Virgin Orbit asset acquisition, and non-recurring ERC tax credits that were recorded in Q1, all of which were partially offset by a reduction in outside service expenses associated with year-end audit and compliance work. Non-GAAP SG&A expenses decreased by $1.7 million, owing primarily to the decrease in audit and compliance-related expenses. Q2 ending SG&A headcount was 228, representing an increase of nine from the prior quarter. In summary, total second quarter ending headcount was 1,513, up 81 heads from the prior quarter.

Cash consumed from operations was $6.1 million in the second quarter of 2023, compared to $25.4 million in the first quarter of 2023. The sequential improvement of $19.3 million was driven primarily by strength in cash collections. Purchases of property, equipment, and capitalized software licenses decreased from $12.7 million in Q1 of 2023 to $10.6 million in Q2 of 2023. The sequential decline was due to the timing of receipts for Neutron and Photon capital purchases. Overall, non-GAAP free cash flow, defined as GAAP operating cash flow, reduced by purchases of property, equipment, and capitalized software in the second quarter of 2023, was a use of $16.6 million, compared to $38.1 million in the first quarter of 2023.

When including our $16.1 million acquisition of select Virgin Orbit assets, which were primarily PP&E, non-GAAP free cash flow was a use of $37.8 million. The ending balance of cash, cash equivalents, restricted cash, and marketable securities was $419 million at the end of the second quarter of 2023. With that, let's turn to our guidance for the third quarter of 2023.

We expect revenue in the third quarter to range between $73 million and $77 million, which reflects $43 million-$47 million of contribution from Space Systems and $30 million from launch services, which assumes 4 launches. As referenced earlier, based on our manifested launch backlog, we continue to expect 15 launches in 2023, and our average selling price to support our current target pricing as we progress through the remainder of 2023. We expect third quarter GAAP gross margin to range between 21%-23% and non-GAAP gross margin to range between 28%-30%. These forecasted GAAP and non-GAAP gross margin improvements reflect continued efficiency improvements and greater fixed cost absorption and average launch selling price improvements.

We expect third quarter GAAP operating expenses to range between $51 million and $53 million, and non-GAAP operating expenses to range between $38 million and $40 million. The quarter-on-quarter decreases are driven primarily by the expected realization of a final $14 million contra R&D credit related to our Neutron upper stage development agreement with the U.S. Space Force, partially offset by continued step up of staff costs, prototyping, and material spend supporting Neutron and Photon development programs. We expect third quarter GAAP and non-GAAP net interest expense to be $500,000. We expect third quarter adjusted EBITDA loss to range between $10 million and $14 million, and basic shares outstanding to be approximately 484 million shares. With that, we'll hand the call over to the operator for questions.

Operator (participant)

At this time, I'd like to remind everyone, in order to ask a question, press star, then the 1 on your telephone keypad. Your first question comes from the line of Erik Rasmussen with Stifel. Your line is open.

Erik Rasmussen (VP of Data Centers and Hosting)

Yeah, thanks for taking the questions and nice job on the margins. I just wanted to dig into the guidance a little bit. You, you got into $73 million-$77 million. Launch seems to be in line. You got 4 launches there. Space systems, at $43 million-$47 million, seems a little bit light versus what we were expecting. I think, you know, sort of what we were expecting out of the second half. Yeah, could you maybe just break down where the sort of the disconnect is? You know, how should we be thinking about the second half overall versus the first half, and is this related to the MDA, you know, ramping maybe slower than expected?

Adam Spice (CFO)

Yeah, I'll take, I'll take a shot at that, and then, Pete, you can weigh in if you want to. Eric, yeah, like you, like you point out, launch is pretty much on, on target. With regards to contribution from space systems, there is a bit of a timing issue with regards to, you know, being able to recognize revenue over certain, you know, programs on the, on, on the satellite manufacturer side of the, of the house. I don't think it's all that unusual, given the early stage of, of these contracts that we're executing on. You know, we have a very stringent process for how we are able to recognize revenue over the period of the contracts.

There's nothing that's changed as far as the magnitude of the size of the opportunity or really that much of a time shift. You know, it's probably about kind of a, a half quarter light of what we were expecting in as far as contribution from those programs that we're ramping. We expect to make up a lot of that ground in the fourth quarter.

Erik Rasmussen (VP of Data Centers and Hosting)

Okay, you, you feel sort of pretty comfortable, a little bit a steeper ramp, even, even further in Q4 versus Q3 in terms of the space systems business?

Adam Spice (CFO)

Yeah, you know, absolutely.

Erik Rasmussen (VP of Data Centers and Hosting)

Great. I saw some of the new, some of the announcements after the close, the HASTE. Maybe just digging into that. You signed a new deal to launch a mission that starts, I guess, for sometime in 2024. Do you have, though, a specific award or contract behind this, or are these gonna these deals gonna sort of be, you know, one-offs?

Peter Beck (Founder and CEO)

Yeah, Erik, so we, we have we, we kind of have a multiple kind of relationships with multiple customers on this front. You know, the way the way these contracts are sort of developed, it's you know, it's fairly classified kind of work. It's difficult to give too much kind of insight into in into some of those. Suffice to say, we see a healthy pipeline of of these kind of missions sitting there.

Erik Rasmussen (VP of Data Centers and Hosting)

Right. Maybe.

Operator (participant)

Your next question comes from the line of Sujit DeSilva with Roth MKM. Your line is open.

Suji DeSilva (Managing Director and Senior Research Analyst)

Hi, Peter. Hi, Adam. Just to understand how the recovery effort is going. I know you're going to do some more milestones, and I read, I think, launches 41 to 45. Can you just describe the next steps and when this can become operational in terms of helping with the cost structure for the launches?

Peter Beck (Founder and CEO)

Yes, sure. Hey, Sujit. What, what we're balancing here is incrementally kind of adding learnings, but not interrupting production. Instead of doing, like, 1 big block change, as, as vehicles, as you pointed out, 41 and, and 45 come, come, come down the line, you know, each of them have the kind of the learnings and, and changes incorporated into them. I, I would say that, you know, the, the last vehicle we brought down, we, we added a whole bunch of waterproofing technologies. The next vehicle-... goes, goes the next step. Down at the power pack, we've, we've changed, changed a whole bunch of things like, you know, umbilical hatches and things like that. You know, we learned a lot from, from this last mission.

I would say we probably validated more than we learned. You know, it's rolling into a fairly operational sense, I would say, right now. If you look on our production line, about every 3rd rocket is a silver one with a red stripe for recovery. It's pretty much been operationalized from a production standpoint. I'd say there's still some more to go from the marine recovery, you know, that last mission, we splashed it down within 400 meters of, you know, the target. You know, the guys had it within sort of 15-20 minutes. They had it by the boat, that kind of worked well. Yeah, look, but I think, I think the last kind of major upgrade is on 45, and then hopefully at that point, it is, is just, you know, business as usual.

Adam Spice (CFO)

Suji, when it comes to your question with regards to what that's doing for our, our cost, I mean, we've definitely taken an incremental view of, you know, let's validate our, our, our, our assumptions each step of the way with these, with these recovery tests. As, you know, as we mentioned before, you know, we'll, we'll do a reflown engine, and then we'll do more reflown engines. We'll look to, to eventually obviously refly an entire booster. When we get to that point, then, you know, we believe the savings that we can articulate it, even if you've got to go back to our, our investor day, which is now almost 2 years ago, we think are still very valid as far as what we can bring as far as cost reduction and margin improvement for this Electron program.

Suji DeSilva (Managing Director and Senior Research Analyst)

All right. Thanks, guys. Then my other question is on a Neutron. It sounds like you're making good progress toward 2024 here, obviously, the Virgin Orbit acquisition. Can you talk about the OpEx and the shape of it in support of Neutron? Is there sort of a, kind of a peak quarter? Is it, you know, are we getting close to it, or is that gonna be a continued kind of steady spend to bring Neutron up? Just curious how that shapes out. Thanks.

Adam Spice (CFO)

Yeah, it's, it's, you know, any, like anything with a, with a rocket development program, it's, it's very hard to be too precise with when certain expenses are gonna hit and certain milestones are gonna be achieved. As you said, you know, we, we definitely are making, you know, steady progress against, you know, an anticipated launch at the end of 2024. I would say that, you know, we, we will continue to see a kind of a march up in expenses related to, to Neutron, with the exception of the Q3, which we talked about in our guide, where we have this $14 million, you know, contra R&D credit. That's certainly helping the PNL.

Once you get through Q3, there'll be a, you know, again, a significant step up that will start to look like more of a sequential kind of increasing trend on spend for Neutron. We don't see the spend peaking on Neutron till probably, you know, either I'd say as we certainly get much, much closer to the inaugural launch. Think about kind of the Q3 time frame of next year, where you'll probably see spending peak. Of course, there's gonna be a difference between, yeah, kind of what hits your PNL versus your CapEx, because, you know, those are all things that kind of move at different times. I think you'll just see, you know, a continued progression of investment in Neutron.

That shouldn't, you know, shouldn't be too out of school, but I think it's, it's hard to say that, you know, try to pick which quarter that spend is gonna peak at from both a PNL spend and also from a CapEx perspective.

Suji DeSilva (Managing Director and Senior Research Analyst)

Okay. All right. Thanks, Adam. Thanks, Peter.

Operator (participant)

Your next question comes from the line of Kristine Liwag with Morgan Stanley. Your line is open.

Kristine T. Liwag (Executive Director)

Hey, good afternoon, everyone. Maybe talk, talking about our pricing. You know, in the past few years, we've seen so many aspirational space companies, try their hand at launch, and, you know, a few of them have closed doors already. With the environment still pretty tight regarding launch capacity, can you talk about, like, the pricing difference for these bookings that you have for 2024 with the new BlackSky contract that you announced and how that compares to previous launch costs? When you put that together and as launch costs are coming down, as you get economies of scale, like, when should we expect to see gross margin break even at launch? It seems like that should be coming up pretty soon.

Adam Spice (CFO)

Pete, do you want to speak to the overall pricing environment, and I can talk to the margin question?

Peter Beck (Founder and CEO)

Yeah, sure, sure. Yeah. Thanks, Christine. Yeah, look, I mean, it, you know, you've read the tea leaves exactly right. I mean, as, as many launch companies kind of, aspirationally, you know, don't achieve, it's certainly created a tightness in the market. I will say that we, we've been pretty consistent with our pricing, all the time. We've, we've never done kind of unnatural things, where we, we just drop the pricing to take the oxygen out of the room. We've seen, you know, a number of providers try that approach, and of course, you can't build a successful business. You know, our pricing has been fairly steady, with respect, to that.

You know, we feel it represents really wonderful value for what you get. People always compare us to a rideshare mission, but really, the only accurate comparison is to a small, dedicated launch. Currently, the only, you know, other small dedicated launcher that's available is probably a Minotaur at some $30 million-$40 million. An Electron at, at $7.5 million is, it represents good value. You know, we've never needed to erode, you know, our pricing on that, on that product and still maintain really good sales traction.

Adam Spice (CFO)

Hey, Christine, when it comes to your questions on, on the profitability kind of benchmark for, for Electron, we've been pretty consistent in when we see 2 launches per month, that's where we really get to the economies of scale and the fixed cost absorption that we need to kind of increment our way, you know, towards our target of a 50%, you know, non-GAAP gross margin for Electron. It requires a few things to happen. Of course, you need the cadence that I mentioned, so 2 launches per month. We need our annual cost reductions on BOM and pro- production efficiency. We need also the, the savings from the recovery program that we were talking about earlier. All of those kind of, you know, kind of things are still very much in focus. Nothing has really shifted from that.

I would say the one thing is we, you know, we've already turned, you know, GAAP gross margin positive on, on the Electron launch platform. We don't really, we don't report below the gross margin line, so it's, it's hard to give a, you know, a lot of clarity on, for example, what the contribution margin looks like now that we're in positive gross margin territory on Electron. Needless to say, everything seems to be, you know, progressing in, in a way that is very much consistent with what we thought profitability should look like for this platform. We really are starting to see a lot of efficiencies in the business. I think probably the most encouraging is the way that we've been able to pivot a lot of the previously dedicated production resources over to support, you know, Neutron and Space Systems.

Again, I think the learning curve is definitely one that we've got well in hand. I think really the next big step for the margin enhancement really remains to be the, the recovery program, which, as Pete mentioned earlier, is well in hand as well. Hopefully that answers your question on margin.

Kristine Liwag (Executive Director, Head of Aerospace and Defense Equity Research)

Thanks, thanks, Peter, and thanks, Adam. Maybe I could ask a technology question. You know, late last month, NASA and DARPA announced an award to Lockheed and BWXT to test nuclear propulsion in space. I mean, Peter, you know, maybe it, it's still very early stage, but I was curious to get your thoughts on how much of a game changer nuclear propulsion could be in terms of increased speed, efficiency, and how viable is that to the Rocket Lab story? Where do you see its role for the company, if any?

Peter Beck (Founder and CEO)

Yeah, look, I'm a great fan of nuclear propulsion, in-space nuclear propulsion, because, you know, it's really, if you, if you think about it historically, chemical propulsion, we haven't really improved a whole lot since, since the, the early sixties. We, we reached chemical excuse me. We reached kind of chemical eq- equili- equilibrium some, quite some time ago. There needs to be a major advancement if we truly want to, to, to kind of be citizens of the solar system. I think nuclear propulsion is, is, is one of those things that can, can really trans-transform that. I'm very bullish on it. Now, it's deeply complex, and of course, the, the most challenging bit is, is getting, getting it to orbit in the first place.

There's sig-significant challenge with that. Once on orbit it's a, it's a really great technique. We, we're not. You know, we don't have any active programs internally, developing any of that technology, but I do think it's a technology to watch, and we'll certainly be watching it.

Kristine Liwag (Executive Director, Head of Aerospace and Defense Equity Research)

Great. Thank you for the color. Thanks, guys.

Operator (participant)

Your next question comes from the line of Cai von Rumohr with Cowen. Your line is open.

Cai von Rumohr (Managing Director)

Yes, thanks so much. You know, you talk of cost cuts to the BOM, but basically, we're in an inflationary environment. Folks are seeing supply chain disruptions. Talk to us a little bit about, you know, what are you seeing in terms of inflation? Regarding pricing, I mean, it looks like the pricing, average price of your launch in the third quarter is gonna be pretty much the same as the second. Are you in a period of stability, or is that just a mix-related issue?

Adam Spice (CFO)

Yeah, I can take that.

Peter Beck (Founder and CEO)

Yeah, thanks, Cai.

Adam Spice (CFO)

Okay, go ahead, Pete.

Peter Beck (Founder and CEO)

No, you go, Adam.

Adam Spice (CFO)

I would say, Cai, you know, on the inflation side of things and, and pricing, you know, the pricing that you're seeing in 2023 is a function of, you know, agreements that were put in place, you know, one year, for the most part, one year or even greater than that, in the rearview mirror. You know, we've been pretty consistent about where we see our pricing in 2023, and kind of we have an annual escalation in our pricing assumptions going forward. You know, obviously, we weren't able to predict inflation, you know, two years ago when some of these contracts were being entered into, or even one year ago. But, you know, fortunately, you know, for us, we've been able to get a lot of efficiencies on the production side of things.

You know, on the supply chain side, you know, we're very vertically integrated, so we're not as exposed as maybe some other companies, where they buy so much of their vehicle and subsystems from, from other providers. When I say vehicle, obviously, it applies to our, our space systems business as well. Particularly when you look at our Photon platforms and you, and you look at how much of the content is internally sourced, I think we've been pretty, I would say, well-insulated compared to others from supply chain shock and inflation-related events. Not to say we're completely immune from it. We certainly see it on the labor side of things. We see it on other kind of things that we purchase from third parties, you know, with regards to, like, rent and utilities and everything else that goes along, gases and so forth.

For the most part, just the nature of our, our kind of vertically integrated business, kind of insulates us a bit from that. Going forward on pricing, again, knowing now where, where inflation is and where kind of it's, it's expected to be, we're certainly taking that in consideration on pricing our, our launch contracts going forward. Yeah, I think we're, we covered the bases there as well. I'll let, you know, Pete comment as, as he sees.

Peter Beck (Founder and CEO)

No, you said exactly what I was gonna say, Adam. The way, the way we've kind of typically done stuff in the past, Cai, is, you know, we'll take a product and we'll put it into production, and we'll spend kind of the minimum required to put that in production. You know, we don't, we don't go out and build a giant factory and fill it full of gear and then, then, then go and build a product. What we'll generally do is build a product and then kind of iteratively, phase in automation and, and, and those kind of production gains.

You know, a LOX valve, for example, you know, would have been the very first, are entirely built by hand, and then we'll add a little bit more automation until, you know, we get to where we are today, where, you know, a lot of that process is entirely automated. That's where we can kind of realize some of these BOM savings, even in this kind of hideously inflationary environment.

Cai von Rumohr (Managing Director)

If your realized prices are basically what you priced a year ago, what should we look for for next year? Because it looks like you've done a pretty good job in offsetting whatever cost hikes there have been.

Adam Spice (CFO)

Yeah, I can take that. Cai, I would say that when we, you know, obviously, at this point, we've, we've got quite a bit of our 2024, significant portions of 2025, and even some cases beyond that, kind of already in backlog, right? We've done some anticipatory pricing, again, with what views of inflation were at the time that we entered those agreements, also where we thought our costs were gonna trend. You know, our focus is really on getting to our long-term gross margin targets, and we've been, we've not been shy about that for either our launch business or our space systems businesses. You know, I would say that, you know, we've what we've seen historically, though, is a continual upward march in our price.

If you go back even, you know, say, three or four years ago, we were, you know, we had a sticker price of a little under $5 million per launch. Now you can see what we've, what we've printed for Q2 and where we see the rest of the year folding out. Again, I think we see that, that trend increase. I think also, as maybe Kristine mentioned earlier on the call, there's been a lot of dropouts from aspirational launch providers, and that just kind of really. You know, if you also think about the pricing that you're seeing now coming through, probably didn't reflect the reality of today, where there are fewer people delivering the service than was kind of anticipated. A lot of people were selling on slideware and so forth back when some of these contracts were being negotiated.

As you get a more, I would say, a smaller group of people who've actually been able to deliver, you know, frequent, reliable access to space, you know, we believe that's supportive of firming up pricing. I think hopefully we see that trend continuing going forward, based on execution alone.

Cai von Rumohr (Managing Director)

The last one is, what's the split between adjusted gross profit between launch and space systems in the third quarter?

Adam Spice (CFO)

I don't believe we provide that in our, in our guide. We're, we're not getting down to that level of detail information at this time, Cai.

Cai von Rumohr (Managing Director)

Okay, great. Thanks so much.

Adam Spice (CFO)

Thank you.

Operator (participant)

Your next question comes from the line of Jason Gursky with Citi. Your line is open.

Jason Gursky (Equity Research Analyst)

Hey, good afternoon, everybody. I'm gonna start with a question on space systems and the Globalstar project and some of the rev rec that you talked about there. Adam, can you talk kind of what the status of that program is from a milestone perspective, CDR or, you know, preliminary design review? Just kind of where you are in that process so we can get a sense of, you know, what the shape of the curve looks like in the ramp for revenue and space systems over the next few quarters.

Adam Spice (CFO)

Yeah, I'll let Pete talk to the status of the, the engineering program.

Peter Beck (Founder and CEO)

Yeah, sure. Hey, Jason. So look, we, we remain solidly on track for that program. We've, we've obviously gone, gone, gone through PDR and CDR. You know, that program is marching, you know, on track and, yeah, it's as intended.

Jason Gursky (Equity Research Analyst)

Mm-hmm. That's on your side. Is your customer as well, they're kind of staying on track?

Peter Beck (Founder and CEO)

I mean, it's a joint project, so we all kind of rely on each other. You know, obviously there's, there's, there's the NDA piece, and our, our piece as well as Globalstar's piece. By, by kind of definition, for us to successfully deliver their our milestones, the other partners have to be as well.

Jason Gursky (Equity Research Analyst)

This, this, this quarter of revenue, that you're not gonna get this quarter, is it tied to any particular milestones ahead of us that we know we might see some announcements on in the future?

Adam Spice (CFO)

Yeah, I can jump in there, Pete. Jason, I think one of the challenges with the rev rec under ASC 606, with these programs, there's a lot of different, a lot of different hurdles that you've got to get over and satisfy. You know, we're, as a company, we're, you know, we're just as conservative on our, our accounting as we are on making sure that the launch vehicle is ready to go off. You know, we've recognized very little revenue historically under the contract with, with MDA, even not, you know, the little bit that's, that's embedded in our Q3. It's a function of, you know, certain parts of the program basically get allocated to R&D, and then other elements get allocated to, obviously, the, the cost of producing the, the, the spacecraft themselves.

We are still, up to this point, have been, you know, very much in the, in the R&D portion. The real heavy kind of phase, where you move into actually assembling spacecraft and pulling inventory and all those things that are required under that, which also tie into your rev rec, those have really kind of been a little always back-end loaded. To, I think, to Pete's point, I mean, I think all of the technical things are on, on track and on schedule. Now it's just a matter of really kind of, kind of getting to the point where we're, we're able to recognize the revenue, once we get the R&D portion largely behind us, which is kind of where, where we're at right now.

We're kind of right on that cusp as we, as we kind of start to convert from it kind of hitting the P&L on the, on the OpEx line versus now transitioning to rev rec and seeing the cost of sales come through as well.

Jason Gursky (Equity Research Analyst)

Mm-hmm. Okay, that's great. The second question is around capacity for Electron and Neutron. I'm just kind of curious if you've got a kind of an update on, you know, if the demand was there, you know, how many annual launches do you think you were capacitized to do on the Electron? Then, Pete, I think Maybe I heard this wrong, but I thought I heard you mention-

Peter Beck (Founder and CEO)

Mm-hmm

Jason Gursky (Equity Research Analyst)

That some of the, the, the inventory and equipment that you picked up from, from Virgin Orbit might accelerate the capacitization, for lack of a better word, on Neutron.

Peter Beck (Founder and CEO)

Mm-hmm.

Jason Gursky (Equity Research Analyst)

Be kind of curious, you know, you get that first launch done on Neutron, let's say everything goes swimmingly well, how much annual capacity would you have, on the, on the tail end of, you know, successfully certifying that, that launch vehicle?

Peter Beck (Founder and CEO)

Yeah, that's a great question. On, on Electron, look, we've facilitized a factory to be able to ultimately produce 1 Electron a week. The, you know, the factory's kind of capacity is stated at that. Now, in order for us to increase the capacity over today, there's no major piece of CapEx that we need to produce something. We have three pads operational, and it's really, it's really a headcount adjustment on that sense.

There's plenty of, plenty of capacity there for Electron growth, and we, we just kind of manage that capacity, and, you know, with, with, you know, the launches we have scheduled during the year, just so that we, we don't over, overkind of capacitize ourself on that, that sense. You know, with Neutron, we'll be following a pretty, pretty consistent path that, that's proven to work well with Neutron, as we did with Electron, where, you know, we start off with one vehicle. And it, and it's not, you know, it's not produced in a full production sense.

As we produce more, we add, we kind of bootstrap and add more facilities and more automation as we go through. The, obviously, being a reusable launch vehicle, the only thing that we have to really produce in volume is a second stage, which is a much smaller and remarkably simple, comparatively speaking to the first stage, device. The, the, the cadence for that can move up pretty quickly. The, the, the Virgin Orbit acquisition was, is, is really, is really a scaling enabler. Knowing that the way we kind of work here at Rocket Lab is we don't go out and just build giant factories and fill them full of gear and then start, start building one rocket.

We kind of build one rocket and then iteratively add those, those things along the way. We found that to be the most capital-efficient way of doing it. The, the beauty with the Virgin Orbit facility is that, you know, we walked in there, and, and it's just, you know, capitalized to the roof, with equipment. Where that really, really is gonna help us, especially from an engine development perspective or engine production perspective, is that a lot of the long lead, really expensive capital equipment, like, very bespoke CNC machines and, and measuring systems and whatnot, we just all picked up for $16.1 million.

Where, where Virgin Orbit for us is really, really gonna shine is on the backside of the project, where we need to start producing larger volumes of engines and even composite components and such.

Jason Gursky (Equity Research Analyst)

Right. Thank you. Adam, one last one, if you don't mind. The balance sheet, can you talk a little bit about the debt, and the plan for that?

Adam Spice (CFO)

Yeah. The debt on the balance sheet is from the $100 million Hercules Capital loan that we took out before going through our de-SPAC transaction, to really, again, de-risk that, that transaction itself. You know, we've been pretty active in, in looking at, at ways to access, you know, I would say, more cost-effective forms of capital. I think the capital that we have in the form of that loan has been incredibly flexible. They've been a great partner to us. You know, that was also taken at a time when the company was in a very different stage of its development versus where we are now, which we think opens up other options for us.

That said, you know, when we came public, we raised the amount of capital that we thought we would need to execute our, our vision on the space system side of the house, plus get Neutron to the pad. We still feel very comfortable that we're in that position. You know, we can always choose to go faster or go slower, depending on kind of where our capital resources, kind of what they look like. Right now, again, like we have a long-term roadmap that, that we can execute with the capital that we have. You know, we. Again, I think there will be opportunities to put more, replace that, that piece of capital with more efficient capital, because now we're much more mature and established.

It has gone current. The loan is payable within 12 months now. I think it comes due on June 1st, I believe, of 2024. Obviously, we've got some time, but we're very comfortable with where we're at from a liquidity perspective, and we have a lot more options now at our disposal than we had, you know, again, two, three years ago when that was taken out.

Peter Beck (Founder and CEO)

Okay, great. Thanks, everybody.

Adam Spice (CFO)

Mm-hmm.

Operator (participant)

Your next question comes from the line of Andre Madrid with Bank of America Securities. Your line is open.

Andre Madrid (Research Associate)

Yeah. Hey, guys. How are you? wanted to follow up on Susie's question, actually. would you guys be able to maybe provide a percent cost reduction that you're targeting through Neutron, Electron recovery, and maybe talk a bit more about how this can drive margins on the platform moving forward?

Adam Spice (CFO)

Yeah. If you look at the total cost of, of an Electron launch vehicle, about two-thirds of the costs are in the first stage, which is obviously where we're, we're focused on our recovery efforts. If you look at, you know, we've made some assumptions about how much rework will be required to the stage. You know, fortunately, you know, each one of these recovery missions that we've done have provided a lot of data for us to kind of confirm those, those assumptions. The fact that we're gonna be flying, you know, an engine, a reflown engine later this year, and a lot of other components have already gone kind of similar analysis, and even some of them have gone through flight, is very helpful.

If, if you look at the, the, the total cost that we've been targeting to get an Electron launch, including, you know, the, a reused booster on a certain percentage of our missions, which is also a factor that goes into the calculus. The second stage, where we look at BOM reductions, because that's not recoverable, and then the Kick Stage as well, you know, we've targeted getting the total cost of an Electron launch down into the, call it, you know, $3 million-$3.5 million per launch. And again, that's all, a lot of it's tied to, you know, launch cadence of at least two launches per month, getting our normal kind of realized BOM cost reductions realized, and then, of course, the benefits from, from recovering the first-stage boosters. Again, hopefully, that provides you a little bit more color and, and it addresses your question.

Andre Madrid (Research Associate)

Yeah. No, definitely, that is very helpful. Then maybe one more, if I may, on Neutron...

Adam Spice (CFO)

Sure

Andre Madrid (Research Associate)

Given that we just talked about Electron. I understand the platform is gonna expected to be reusable, land back on the pad, whatnot, but how should we be thinking about the cost structure there? Pete, do you want to take that one?

Peter Beck (Founder and CEO)

Pretty similar to. Sure, sure. Yep, yep, Andre. It's pretty similar to Electron in a reusable sense, really. I think the economics pretty much remain the same. There's just an extra zero, probably. But the actual, you know, fundamental economics of reuse pretty much pencil out the same. You know, the target margins are the same. You know, the added advantage, of course, with Neutron is that the more reuses we get out of the first stage, you know, the better those economics obviously look until you completely amortize the cost of that first stage over and over from the, you know, repeated uses.

Andre Madrid (Research Associate)

Great, great. That's, that's super help- super helpful. I'll, I'll leave it at that. Thanks, guys.

Adam Spice (CFO)

Thank you.

Peter Beck (Founder and CEO)

Thanks.

Operator (participant)

Your final question comes from the line of Edison Yu with Deutsche Bank. Your line is open.

Edison Yu (Director)

Hey, thanks, guys. A couple quick ones from, from me. I think we, we talked about 20 launches next year. Is this, is that still the right way to, to think about the, the manifest? Given all the activity, negative activity for the, the competition, do we think there's some maybe upside to that?

Peter Beck (Founder and CEO)

Yeah, I think, I think, that's certainly what we're planning for internally for production since Edison. You know, we're, we're kind of, you know, on, on, on target there. The thing is, with a lot of the, the kind of aspirational launch providers, you know, it, it wasn't always clear how many launches they actually had under contract. It, there's very few of them now left. Yeah, I mean, maybe there is, but I think most people have kind of realized who, who, you know, who, who's gonna be successful and who's not by now. I think the majority of the defection has, has probably, probably occurred.

Edison Yu (Director)

Understood. Then one on space systems. I know there were some difficulties, I think, initially with SolAero. What's the latest update on that business? Is that kind of recovering to the trajectory that you guys are expecting?

Peter Beck (Founder and CEO)

Yeah, I think, I think, I think we're very happy with where, where that, that, that, that business is going. I think, I think the team there have done a, a really great job, and I think, I think that is a, is a, is a, is a good example of, kind of a very traditional, historic space company coming under the wing of, of, of kind of, of Rocket Lab and, us kind of, you know, reculturalizing them. There are the, the, you know, the team also very much being up for that and enjoying that. I think, you know, that the, the, the result is, you know, Adam, you can say more, but, but personally, I'm, I'm very happy with the way that's tracking.

Adam Spice (CFO)

Yeah, I would say, Edison, that, you know, when we, when we closed that deal, it will be 2 years in, in January, we set a target for 30% gross margin, within that time frame, and, you know, on a non-GAAP basis. I would say that we're, we're absolutely still tracking towards that. I think if you'd asked me that question 6 months ago, I think I probably would have said that maybe there's some little bit of schedule risk. It might have taken maybe 2.5 years or 2 years to get there. But it feels like we're in the right place to kind of achieve that in the original time frame that we contemplated. As Pete said, we've been very, very excited. I mean, it's, it's a great team.

We love what that brings to the platform as far as the level of vertical integration for a very key and high percentage total cost of BOM to our platforms. Again, just gives us more control over delivering our solutions to our customers in a time frame and a cost and performance that we need to have. It's been a very big differentiator, and fortunately, the financials are following along with that.

Edison Yu (Director)

Great. Thanks.

Operator (participant)

I will now turn the call back over to Colin Canfield for closing remarks.

Colin Canfield (Investor Relations Manager)

Okay, thanks so much. Just a reminder for everyone on the call today, we actually were able to resolve the technical issue from our call provider to get the slides posted onto today's website. We also want to take the opportunity to flag that we'll be presenting at upcoming conferences for Bank of America, Jefferies, Citi, and Morgan Stanley during the upcoming months. Look forward to seeing you guys on the road, and thank you all for coming to today's call.

Operator (participant)

Ladies and gentlemen, that concludes today's call. Thank you for joining. You may now disconnect.