Kratos Defense & Security Solutions, Inc. — Q1 2024 Form 10-Q
Business context and reporting period
Kratos is a defense technology, products, systems and software company serving national security, defense and commercial markets. Its two reportable segments are Kratos Government Solutions (KGS) and Unmanned Systems (US). The unaudited quarter ended March 31, 2024 comprised 13 weeks; the comparable prior-year period ended March 26, 2023 and also comprised 13 weeks.
Financial performance and liquidity
| Metric | Q1 2024 | Comparable period | Change |
|---|---|---|---|
| Total revenue | $277.2 million | $231.8 million | Up 19.6% |
| Gross profit | $71.0 million | $59.4 million | Up $11.6 million |
| Gross margin | 25.6% | 25.6% | Flat |
| Operating income | $7.0 million | $0.5 million | Up $6.5 million |
| Net income attributable to Kratos | $1.3 million | $(7.0) million | Improved $8.3 million |
| Diluted EPS | $0.01 | $(0.05) | Improved |
| Cash flow from operations | $0.7 million | $(25.7) million | Improved $26.4 million |
| Capital expenditures | $16.6 million | $7.7 million | Up $8.9 million |
Service revenue increased 16.3% to $106.5 million, while product sales increased 21.8% to $170.7 million. KGS revenue rose 18.5% to $217.8 million, and US revenue rose 23.8% to $59.4 million. KGS operating income was $16.6 million, compared with $7.7 million; US reported an operating loss of $0.4 million, compared with $0.6 million; and corporate activities increased to $9.2 million from $6.6 million.
SG&A increased to $54.4 million from $47.8 million, but declined to 19.6% of revenue from 20.6%. R&D declined to $9.6 million from $10.2 million, or 3.5% of revenue versus 4.4%. Interest expense and other expense declined in aggregate to $3.0 million from $5.6 million. The $2.7 million tax provision produced a relatively high quarterly effective tax burden because the company used the discrete effective tax rate method.
Cash and cash equivalents were $338.9 million at March 31, 2024, versus $72.8 million at December 31, 2023. The increase primarily reflected $330.7 million of net proceeds from a February equity offering, partially offset by capital expenditures, debt repayment and working-capital needs. The company had $191.2 million of total debt, including $179.4 million of long-term debt net of issuance costs. No revolving credit borrowings were outstanding at quarter-end; $200.0 million of revolver capacity remained available, less approximately $10.3 million of letters of credit. The company was in compliance with its debt covenants.
Material changes and unusual items
- On February 27, 2024, Kratos issued 19.2 million shares at $18.00 per share, receiving approximately $331.2 million of net proceeds. Approximately $45 million was used to repay revolving credit borrowings.
- Shares outstanding increased to approximately 150.0 million at March 31, 2024 from 129.3 million at December 31, 2023, creating substantial dilution for existing holders.
- The company’s remaining minority-interest holders exercised their put right in KTT Core. The transaction is expected to close in Q2 2024 for approximately $22.5 million, payable 50% in cash and 50% in Kratos shares.
- The STS aerial target drone acquisition contributed to US segment growth. The acquisition consideration included issued and potentially issuable Kratos shares; the purchase-price allocation remains preliminary.
- Remaining performance obligations were approximately $1.27 billion, including $1.04 billion of funded backlog. Management expects approximately 52% of remaining performance obligations to convert to revenue in fiscal 2024, 27% in fiscal 2025 and the balance thereafter.
- Net contract assets increased to $111.4 million from $98.6 million, driven primarily by higher unbilled receivables. Approximately $3.3 million of billed and $1.5 million of unbilled receivables relate to a customer-terminated training program and remain subject to negotiation.
Guidance, outlook, commentary and risks
Management expects 2024 capital expenditures of approximately $28 million to $32 million, including approximately $18 million to $22 million for capital aerial targets and related support equipment. Management stated that cash on hand, available credit and expected operating cash flow should fund anticipated needs for at least the next 12 months.
Management expects continued defense demand in areas including space, unmanned systems, hypersonics, propulsion, C5ISR and microwave electronics. However, it cited significant uncertainty from continuing resolutions, defense-budget negotiations, possible government shutdowns or debt-ceiling issues, changes in federal priorities and the 2024 elections.
Additional operating pressures include supply-chain disruption, inflation, higher materials and subcontractor costs, shortages of qualified and security-cleared labor, higher interest rates, program delays, contract protests, customer cancellations, cybersecurity events and competition. U.S. Government revenue represented approximately 69% of total revenue in both periods, creating exposure to government funding and procurement decisions.
Government contract costs remain subject to DCAA audit. The company has not accrued a liability for potential claims where the loss range cannot reasonably be estimated. Ordinary-course litigation was described as immaterial, but unfavorable resolutions of contingencies could affect results or cash flows. Unrecognized tax benefits totaled $25.4 million at quarter-end, including $22.8 million that could affect the effective tax rate if recognized.
Important facts for investors to verify
- Whether revenue growth and improved operating income persist after the benefit of increased production activity and the STS acquisition.
- The conversion, timing and funding of the $1.27 billion backlog, including the risk that government contracts may be delayed, modified or terminated.
- The cash-flow impact of elevated inventory, vendor prepayments, capital expenditures and working-capital requirements.
- The extent of dilution from the February equity offering, employee equity awards and the anticipated KTT Core minority-interest payment.
- The timing and terms of the KTT Core put-right transaction expected in Q2 2024.
- Potential exposure from DCAA audits, contract-cost disputes, the terminated training program receivables and unrecognized tax benefits.
- Management’s projected 2024 capital expenditures of $28 million to $32 million and the associated production commitments for unmanned systems.