Kratos Defense & Security Solutions, Inc. — 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, hypersonic and missile-defense systems, rocket and turbine technologies, C5ISR, and training. The filing covers the 13-week quarter and 26-week year-to-date period ended June 26, 2022, compared with June 27, 2021. The company reports two segments: Kratos Government Solutions (KGS) and Unmanned Systems (US).
Key financial metrics
| Metric | Q2 2022 | Q2 2021 | Six months 2022 | Six months 2021 |
|---|---|---|---|---|
| Total revenue | $224.2 million | $205.1 million | $420.4 million | $399.3 million |
| Gross profit | $57.8 million | $52.0 million | $109.7 million | $103.0 million |
| Gross margin | 25.8% | 25.4% | 26.1% | 25.8% |
| Operating income (loss) | $(1.9) million | $3.3 million | $(3.1) million | $8.2 million |
| Net income (loss) attributable to Kratos | $(4.7) million | $1.1 million | $(20.6) million | $3.0 million |
| Diluted earnings (loss) per share | $(0.04) | $0.01 | $(0.16) | $0.02 |
| Cash flow from operating activities | Not separately provided | Not separately provided | $(29.5) million | $22.0 million |
Q2 service revenue increased 35.9% to $78.8 million, while product sales declined 1.2% to $145.4 million. Six-month service revenue increased 27.2% to $146.7 million, while product sales declined 3.6% to $273.7 million. SG&A was $44.5 million in Q2 and $87.8 million year to date; R&D was $9.2 million and $18.4 million, respectively.
At June 26, 2022, cash and cash equivalents were $142.4 million, down from $349.4 million at December 26, 2021. Current assets were $624.3 million and current liabilities were $227.8 million. Accounts receivable, unbilled receivables, and inventory were $100.6 million, $214.4 million, and $118.2 million, respectively.
Total debt principal was $300.0 million, consisting of a $200.0 million Term Loan A and $100.0 million drawn on a $200.0 million revolving facility. Approximately $100.0 million of revolver capacity remained, less $8.1 million of outstanding letters of credit. The company reported compliance with its debt covenants.
Material changes versus the prior comparable period
- Q2 revenue increased 9.3%, and six-month revenue increased 5.3%. KGS revenue increased 15.9% in Q2 and 10.0% year to date, while US revenue declined 6.5% and 6.2%, respectively.
- Revenue growth was supported by the Cosmic, CTT, and Southern Research Engineering acquisitions, which contributed approximately $21.5 million in Q2 and $36.2 million year to date.
- US revenue declined primarily because of timing and reduced activity in tactical drone programs. US segment operating income declined to a $5.0 million loss in Q2 and a $4.5 million loss year to date, partly reflecting an unfavorable product mix and a $5.5 million litigation settlement charge.
- Gross margin improved modestly, but operating results deteriorated because of higher SG&A, restructuring and other expenses, and acquisition-related costs.
- Six-month net loss included a $13.0 million loss on extinguishment of debt associated with refinancing the prior 6.5% Senior Secured Notes.
- Operating cash flow changed from $22.0 million of cash provided in the prior-year period to $29.5 million used, primarily because of higher receivables and a $25.8 million increase in inventory to support anticipated production and mitigate supply-chain disruption.
Guidance, outlook, risks, contingencies, and unusual items
The company did not provide a specific revenue or earnings forecast in the filing. Backlog was approximately $1,050.2 million at June 26, 2022, including $713.6 million of funded backlog, versus $865.6 million and $630.6 million, respectively, a year earlier. Management expects approximately 41% of remaining performance obligations to be recognized in fiscal 2022, 28% in fiscal 2023, and the balance thereafter.
Management expects fiscal 2022 capital expenditures of approximately $24 million to $27 million, including approximately $18 million to $20 million for capital aerial targets and related support equipment. Management stated that available cash, borrowing capacity, and expected operating cash flow should fund anticipated needs for at least the next 12 months.
- Supply-chain disruptions, inflation, higher labor costs, labor shortages, and difficulty hiring personnel with security clearances are adversely affecting costs, execution, margins, and forecasts.
- COVID-19 continued to affect suppliers, customers, access to facilities, demonstrations, exercises, and certain commercial programs; the ultimate financial impact remained uncertain.
- Defense-budget uncertainty, continuing resolutions, potential government shutdowns, debt-ceiling issues, funding delays, program cancellations, and changes in Department of Defense priorities could reduce or delay revenue.
- Most U.S. government contracts may be terminated for convenience. Backlog includes funded and unfunded amounts and may be affected by cancellations, scope changes, or delays.
- A $6.0 million settlement related to a previously terminated training program was collected in July 2022; approximately $4.8 million of unbilled receivables remained subject to negotiation.
- A dispute with an international customer was settled after quarter-end. The company recorded a $5.5 million litigation settlement charge and held $5.6 million of related inventory expected to be settled by year-end.
- DCAA audits and potential government cost claims remain unresolved; the company had not recorded a liability because a loss range could not reasonably be estimated.
- The remaining 9.95% minority interest in KTT Core remains subject to a future put right beginning in January 2024 and a company purchase right beginning in January 2025. The company paid $2.7 million in stock during the period, with additional stock consideration expected in March 2023.
Important facts for investors to verify
- Whether KGS growth and the acquired businesses offset continued weakness, execution issues, and margin pressure in Unmanned Systems.
- Conversion of the $1,050.2 million backlog, particularly the $713.6 million funded portion, into revenue and operating cash flow.
- Working-capital requirements, including $214.4 million of unbilled receivables and $118.2 million of inventory, and the recovery of operating cash flow.
- Liquidity after the decline in cash to $142.4 million, remaining revolver availability, mandatory debt amortization, and exposure to SOFR-based interest rates.
- Progress toward resolving the remaining $4.8 million training-program receivable and settling the $5.6 million of inventory related to the international customer dispute.
- Effects of supply-chain inflation, labor constraints, government funding uncertainty, and COVID-19 on production schedules and margins.
- Final purchase-price allocations and integration results for Cosmic, CTT, and Southern Research Engineering, as the filing states that certain acquisition accounting remains preliminary.