Kratos Defense & Security Solutions, Inc. — Q1 2023 Form 10-Q Summary
Business context and reporting period
Kratos develops defense and national-security technology, products and systems, with operations in Kratos Government Solutions (KGS) and Unmanned Systems (US). The filing covers the unaudited 13-week quarter ended March 26, 2023, compared with the quarter ended March 27, 2022.
Key financial metrics
| Metric | Q1 2023 | Q1 2022 | Change |
|---|---|---|---|
| Total revenue | $231.8 million | $196.2 million | 18.1% increase |
| Service revenue | $91.6 million | $67.9 million | 34.9% increase |
| Product sales | $140.2 million | $128.3 million | 9.3% increase |
| Gross profit | $59.4 million | $51.9 million | 14.5% increase |
| Gross margin | 25.6% | 26.5% | Down 0.9 percentage points |
| Operating income (loss) | $0.5 million | $(1.2) million | Improved |
| Net loss attributable to Kratos | $(7.0) million | $(15.9) million | Improved by $8.9 million |
| Diluted loss per share | $(0.05) | $(0.12) | Improved |
| Cash flow from operating activities | $(25.7) million | $(7.9) million | Greater use of cash |
| Capital expenditures | $7.7 million | $10.8 million | Decreased |
KGS revenue increased 28.0% to $183.8 million, including $12.0 million from the acquired Southern Research Engineering Division. US revenue decreased 8.7% to $48.0 million, primarily because of the timing of tactical drone program awards. KGS operating income was $7.7 million, compared with $5.6 million in the prior-year quarter; US operating loss was $0.6 million, compared with operating income of $0.5 million.
SG&A increased to $47.8 million from $43.3 million, but declined to 20.6% of revenue from 22.1%. Research and development expense increased to $10.2 million from $9.2 million. Interest expense was $5.3 million, compared with $5.9 million. The prior-year period included a $13.0 million loss on extinguishment of debt, which did not recur.
Balance sheet, debt and liquidity
- Cash and cash equivalents were $46.7 million at March 26, 2023, down from $81.3 million at December 25, 2022.
- Accounts receivable increased to $143.9 million from $105.7 million, while unbilled receivables decreased to $209.9 million from $222.8 million.
- Net contract assets were $144.7 million, compared with $160.7 million at year-end. Days sales outstanding increased to 139 days from 134 days.
- Principal debt totaled $256.2 million, consisting of $196.2 million under Term Loan A and $60.0 million under the revolving credit facility. The balance sheet reported $250.3 million of long-term debt net of debt issuance costs.
- Approximately $140.0 million of revolving capacity remained, before consideration of approximately $10.1 million of outstanding letters of credit. The current interest rate was 7.0%.
- The company was in compliance with its credit facility covenants at March 26, 2023 and stated that cash on hand, available credit and expected operating cash flow should fund anticipated needs for at least the next 12 months.
Material changes versus the prior comparable period
- Revenue growth was led by KGS, particularly space and satellite communications, C5ISR, turbine technologies, microwave electronics, defense and rocket support, and the SRE acquisition.
- US revenue declined because of reduced tactical drone activity and program-award timing.
- Gross margin declined because of less favorable segment and product mix; management also cited inflation, labor costs and supply-chain pressures.
- Operating results improved largely because the prior-year period included the $13.0 million debt-extinguishment loss.
- Operating cash usage increased to $25.7 million, primarily due to revenue-related accounts receivable growth and $8.3 million of inventory purchases.
- Total backlog increased to approximately $1.132 billion from $982.1 million, including $789.0 million of funded backlog versus $685.7 million a year earlier.
Guidance, outlook, commentary and risks
The company did not provide a clear quantitative revenue or earnings forecast in the filing. It expects to recognize approximately 48% of remaining performance obligations in fiscal 2023, 23% in fiscal 2024 and the balance thereafter. Management expects fiscal 2023 capital expenditures to be approximately $20 million to $25 million for the US business, including approximately $10 million to $15 million for first and second production runs of Valkyries ahead of government contract awards.
Management identified continued risks from federal budget uncertainty, continuing resolutions, debt-ceiling and shutdown issues, potential defense-program delays or cancellations, inflation, supply-chain disruptions, labor shortages, higher interest rates, cybersecurity threats, contract execution, subcontractor performance, competition and geopolitical developments including the conflict in Ukraine.
Approximately 69% of quarterly revenue came from the U.S. Government. Government contracts may be terminated for convenience, and portions of backlog are unfunded. The company also has approximately $4.8 million of unbilled receivables related to a terminated training program that remains subject to negotiation and settlement. DCAA audits may result in disputed or disallowed costs, although no liability was recorded for matters where the potential loss could not be reasonably estimated.
In April 2023, Kratos entered into a $195.0 million interest-rate swap effective May 1, 2023 through May 1, 2026, with a fixed rate of 3.721%, to manage interest-rate exposure on Term Loan A. The company also issued 828,128 common shares in April 2023 to settle the remaining purchase price for the KTT Core minority interest.
Important facts for investors to verify
- Whether revenue growth and backlog conversion continue, particularly in KGS and space-related programs.
- Whether US segment margins recover as tactical drone program awards are received.
- Cash conversion, accounts receivable collection, DSO and inventory requirements, given the quarter’s $25.7 million operating cash use.
- The effect of inflation, labor shortages, supply-chain constraints and higher interest rates on gross margins and cash flow.
- Availability of revolving credit after letters of credit and compliance with financial covenants.
- Timing and funding of the planned $20 million to $25 million US capital program and Valkyrie production investment.
- Resolution of the $4.8 million terminated-program receivable and outcomes of DCAA audits or other contingencies.
- Execution and accounting effects of the new interest-rate swap and remaining KTT Core minority-interest obligations.