Kratos Defense & Security Solutions, Inc. — Q1 2022 Form 10-Q Summary
Business context and reporting period
Kratos is a defense technology and government contractor focused on unmanned systems, space and satellite communications, microwave electronics, cybersecurity, rocket and hypersonic systems, missile defense, turbine technologies, C5ISR, and training systems. The filing covers the unaudited 13-week quarter ended March 27, 2022, compared with the 13-week quarter ended March 28, 2021.
The company operates through Kratos Government Solutions (KGS) and Unmanned Systems (US). U.S. Government revenue represented approximately 71% of total revenue, compared with 73% in the prior-year quarter.
Financial performance and liquidity
| Metric | Q1 2022 | Q1 2021 | Change |
|---|---|---|---|
| Total revenue | $196.2 million | $194.2 million | 1.0% |
| Service revenue | $67.9 million | $57.3 million | 18.5% |
| Product sales | $128.3 million | $136.9 million | (6.3%) |
| Gross profit | $51.9 million | $51.0 million | 1.8% |
| Gross margin | 26.5% | 26.3% | 20 basis points |
| Operating income (loss) | $(1.2) million | $4.9 million | $(6.1) million |
| Net income (loss) | $(15.9) million | $1.9 million | $(17.8) million |
| Net loss per diluted share | $(0.12) | $0.01 | $(0.13) |
| Cash flow from continuing operations | $(7.9) million | $22.7 million | $(30.6) million |
Gross margin was approximately 26.5%; operating margin was approximately negative 0.6%; and net margin was approximately negative 8.1%. SG&A increased to $43.3 million from $37.9 million, while R&D increased to $9.2 million from $8.0 million. The company recorded a $13.0 million loss on extinguishment of debt, consisting primarily of a redemption premium and the write-off of deferred financing costs.
Cash and cash equivalents were $254.4 million at March 27, 2022, down from $349.4 million at December 26, 2021. Operating cash flow was affected by a $15.3 million inventory increase, a $19.8 million increase in unbilled receivables, and other working-capital uses. Investing cash flow included $58.5 million for acquisitions and $10.8 million of capital expenditures. Management expects 2022 capital expenditures of approximately $30 million to $33 million, including approximately $20 million for capital aerial targets and related equipment.
Total debt was approximately $300.0 million in principal, consisting of a $200.0 million Term Loan A and $100.0 million drawn under a new revolving credit facility. The company had approximately $100.0 million of remaining revolver capacity, reduced by approximately $13.2 million of outstanding letters of credit. The company stated that it was in compliance with its credit agreement covenants and believed available cash, borrowing capacity, and operating cash flow would fund needs for at least the next 12 months.
Material changes versus the prior comparable period
- KGS revenue increased 3.8% to $143.6 million, including $14.7 million from the Cosmic and CTT acquisitions. US revenue decreased 5.9% to $52.6 million, primarily due to production and build-cycle timing on the SSAT 177 program.
- Service revenue increased substantially, while product sales declined; product sales fell to 65.4% of total revenue from 70.5%.
- Gross margin improved modestly, but higher SG&A, R&D, restructuring, and acquisition-related costs drove operating income into a loss.
- Unmanned Systems operating income declined to $0.5 million from $4.2 million. KGS operating income declined to $5.6 million from $7.1 million, while corporate activities increased to a $7.3 million loss from $6.4 million.
- The company refinanced its prior $300.0 million of 6.5% Senior Secured Notes and former $90.0 million revolving facility with a five-year $200.0 million Term Loan A and a five-year $200.0 million revolver. The prior notes were redeemed on March 14, 2022.
- Backlog increased to approximately $982.1 million from $892.9 million at March 28, 2021. Funded backlog was $685.7 million versus $620.7 million.
Guidance, outlook, risks, contingencies, and unusual items
The company expects to recognize approximately 50% of its $982.1 million remaining performance obligations in fiscal 2022, 20% in fiscal 2023, and the balance thereafter. The filing does not provide formal revenue or earnings guidance.
On March 9, 2022, Kratos agreed to acquire Southern Research Institute’s Engineering Division for approximately $80.0 million, consisting of $75.0 million in cash and $5.0 million in common stock. Closing was expected during the second quarter of 2022, subject to conditions.
Approximately $10.8 million of unbilled receivables remained related to a training program terminated for convenience. A $6.0 million settlement was reached for a portion of that balance, expected to be collected in the third quarter of 2022; the remaining $4.8 million remained subject to negotiation. Kratos also reported a dispute with an international customer involving approximately $10.0 million of unbilled receivables and counterclaims for liquidated damages. Management recorded no adjustment to the related revenue or receivables.
Key risks include changes or delays in U.S. defense appropriations, continuing resolutions or government shutdowns, contract cancellations and bid protests, supply-chain disruption, customer and subcontractor performance, acquisition integration, cybersecurity and CMMC requirements, product defects, competition, debt leverage, litigation, DCAA audits, and COVID-19-related operational impacts. The filing states that no material changes occurred in previously disclosed risk factors.
The company reported a $0.2 million loss from discontinued operations, primarily related to settlement costs associated with the former Public Safety & Security Solutions business. Management concluded that disclosure controls were effective as of March 27, 2022, with no material changes in internal control over financial reporting.
Important facts for investors to verify
- Reconcile the deterioration from Q1 2021 net income to Q1 2022 net loss, including the $13.0 million debt-extinguishment charge and higher operating expenses.
- Monitor cash conversion, unbilled receivables, inventory growth, and days sales outstanding, which increased to 130 days from 128 days.
- Assess the cost and integration effects of Cosmic and CTT and the expected closing and financing of the Southern Research Engineering Division acquisition.
- Review the new credit facility’s interest-rate exposure, mandatory amortization, leverage-related pricing, covenant requirements, and available revolver capacity.
- Track the $6.0 million training-program settlement, the remaining $4.8 million receivable, and the approximately $10.0 million international customer dispute.
- Evaluate the quality and timing of the $982.1 million backlog, including the $685.7 million funded portion, since government contracts may be terminated or subject to funding and schedule changes.