Kratos Defense & Security Solutions, Inc. — Q1 2021 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, rocket systems, turbine technologies, C5ISR and training. The filing covers the 13-week quarter ended March 28, 2021, compared with the 13-week quarter ended March 29, 2020. The company operates through Kratos Government Solutions (KGS) and Unmanned Systems (US).
Key Financial Metrics
| Metric | Q1 2021 | Q1 2020 |
|---|---|---|
| Total revenue | $194.2 million | $168.9 million |
| Service revenue | $57.3 million | $63.6 million |
| Product sales | $136.9 million | $105.3 million |
| Gross profit | $51.0 million | $45.8 million |
| Gross margin | 26.3% | 27.1% |
| Operating income | $4.9 million | $4.7 million |
| Income from continuing operations | $1.9 million | $0.2 million |
| Net income attributable to Kratos | $1.9 million | $(0.2) million |
| Diluted earnings per share | $0.01 | Not meaningful due to reported near-zero amount |
| Operating cash flow from continuing operations | $22.7 million | $4.0 million |
SG&A was $37.9 million, or 19.5% of revenue, versus $34.9 million, or 20.7%, in the prior-year quarter. Research and development expense increased to $8.0 million, or 4.1% of revenue, from $5.7 million, or 3.4%. Net interest expense was $5.9 million.
At March 28, 2021, cash and cash equivalents were $383.6 million, compared with $380.8 million at December 27, 2020. Total assets were $1.565 billion and total stockholders’ equity was $929.0 million. Principal long-term debt was $305.5 million, including $300.0 million of 6.5% senior secured notes due 2025; carrying value was $301.6 million. The company had no revolver borrowings, $5.9 million of outstanding letters of credit and $68.6 million of net borrowing-base availability. Management stated that liquidity is sufficient for anticipated needs for at least the next 12 months.
Material Changes Versus the Prior Comparable Period
- Revenue increased $25.3 million, or 15.0%, primarily from higher product sales and contributions from acquisitions.
- KGS revenue increased 9.0% to $138.3 million, including approximately $8.6 million from ASC Signal and organic growth in several businesses. KGS service revenue declined because of lower turbine technology services and reduced scope in certain international training contracts.
- US revenue increased 33.1% to $55.9 million, driven by SSAT 177 and Valkyrie programs and approximately $1.7 million from the TDI and 5-D Systems acquisitions.
- Product sales rose 30.0% and represented 70.5% of revenue, versus 62.3% in the prior-year quarter. Service revenue declined 9.9%.
- Gross margin decreased 80 basis points to 26.3%. Service margins fell to 25.8% from 28.9%, while product margins increased to 26.4% from 26.0%.
- US segment operating income increased to $4.2 million from $0.5 million; KGS operating income decreased to $7.1 million from $9.3 million. Corporate activities increased to a $6.4 million expense from $5.1 million.
- Operating cash flow improved by $18.7 million, mainly from working-capital improvements and lower days sales outstanding, which declined to 124 days from 133 days at year-end.
- Backlog increased to approximately $892.9 million from $646.8 million at March 29, 2020; funded backlog was $620.7 million versus $549.8 million.
Guidance, Outlook, Risks and Unusual Items
The filing does not provide formal quarterly or annual revenue or earnings guidance. Management expects approximately 49% of remaining backlog to be recognized as revenue in 2021, 18% in 2022 and the balance thereafter. Planned 2021 capital expenditures are approximately $30 million to $33 million, including approximately $20 million to $25 million for capital aerial targets and related support equipment.
Management cited the proposed fiscal 2022 national security budget of $753 billion, including $715 billion for the Department of Defense, and a policy focus on research, development, innovation and next-generation defense capabilities. However, budget uncertainty, continuing resolutions, potential government shutdowns, funding reductions, program delays or cancellations and debt-ceiling or appropriations disputes could adversely affect the business.
- COVID-19 continued to affect supply chains, supplier deliveries, customer access, travel, demonstrations, exercises and certain commercial demand. The ultimate financial impact remained uncertain.
- Approximately $11.5 million of unbilled receivables related to a training program terminated for convenience remained outstanding pending settlement.
- The company was disputing approximately $10.0 million of unbilled receivables with an international US-segment customer. Management recorded no adjustment to revenue or the receivable.
- The company remained in an approximately $8.0 million dispute regarding the closing working-capital adjustment from the sale of its former Public Safety & Security Solutions business.
- DCAA audits may result in claims concerning potentially disallowed, overstated or disputed costs. The company had not recorded a liability because the potential loss could not reasonably be estimated.
- Contract profitability depends on estimates of costs, schedules, technical performance, funding, subcontractor execution and variable consideration. The filing states that no individual or aggregate cumulative catch-up adjustment was material during the quarter.
- The company was in compliance with the covenants governing its senior secured notes and credit agreement. The notes and related guarantees are secured and contain restrictions on additional debt, asset sales, liens, investments and other corporate actions.
- A $2.4 million tax benefit from stock-based compensation contributed materially to the quarterly income tax benefit of $2.7 million.
Investor Verification Checklist
- Verify the sustainability of revenue growth, particularly the increased mix of product sales and the contribution from ASC Signal and other acquisitions.
- Monitor gross-margin performance, developmental-program mix and the widening difference between KGS and US segment margins.
- Reconcile reported backlog with funded backlog and assess the timing, funding and cancellation risk of government contracts.
- Track collection and resolution of the $11.5 million training-program receivable and the approximately $10.0 million international customer dispute.
- Assess planned capital expenditures and their effect on free cash flow, especially investment in aerial targets and US-segment programs.
- Review the 2025 maturity and 6.5% interest cost of the senior secured notes, revolver availability and covenant compliance.
- Evaluate the potential effects of defense-budget decisions, continuing resolutions, government shutdowns, COVID-19 disruptions, DCAA audits and litigation contingencies.
- Determine whether future earnings remain dependent on tax benefits, stock-based compensation effects and favorable contract-estimate revisions.