Kratos Defense & Security Solutions, Inc. — FY2021 Form 10-K 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, missile defense, hypersonics, turbine technologies, C5ISR, and training systems. The filing covers the 52-week fiscal year ended December 26, 2021; it is an annual report rather than a standalone fourth-quarter filing. Reportable segments were Kratos Government Solutions (KGS) and Unmanned Systems (US).
Key financial metrics
| Metric | FY2021 | FY2020 | Change |
|---|---|---|---|
| Revenue | $811.5 million | $747.7 million | +8.5% |
| Gross profit | $225.1 million | $203.2 million | +10.8% |
| Gross margin | 27.7% | 27.2% | +50 bps |
| Operating income | $27.9 million | $29.3 million | -4.8% |
| Operating margin | 3.4% | 3.9% | Down approximately 50 bps |
| Income from continuing operations | $0.5 million | $80.3 million | Down materially |
| Net income attributable to Kratos | $(2.0) million | $79.6 million | Turned to loss |
| Diluted EPS attributable to Kratos | $(0.02) | $0.67 | Down materially |
| Operating cash flow from continuing operations | $35.3 million | $44.7 million | -21.0% |
| Capital expenditures | $46.5 million | $35.9 million | +$10.6 million |
| Cash and cash equivalents | $349.4 million | $380.8 million | Down $31.4 million |
| Long-term debt, net | $296.7 million | $301.0 million | Down $4.3 million |
- KGS revenue increased 3.4% to $579.6 million, while US revenue increased 24.0% to $231.9 million.
- Product sales rose 18.7% to $592.1 million and represented 73.0% of revenue; service revenue declined 11.8% to $219.4 million.
- KGS operating income was $42.3 million, US operating income was $13.2 million, and corporate activities reduced operating income by $27.6 million.
- SG&A increased to $160.2 million, including $25.8 million of stock-based compensation and higher infrastructure and CMMC compliance costs. R&D increased to $35.2 million from $27.0 million.
- Approximately 70% of revenue came from the U.S. Government, including foreign military sales. The U.S. Air Force represented 26.7% of revenue and the U.S. Navy 13.9%.
Material changes versus the prior comparable period
- Revenue growth was led by increased production on SSAT 177, AFSAT 167, and Valkyrie programs, the full-year contribution from 5-D Systems, and growth in space, satellite, cyber, microwave, turbine, and ASC Signal activities.
- Service revenue declined because of lower turbine technology and training revenue, the loss of an international training contract, and COVID-19-related delays and disruptions.
- Gross margin improved modestly, but operating income declined as SG&A, stock compensation, R&D, corporate infrastructure, and compliance costs increased.
- FY2020 earnings benefited from an $80.1 million non-cash income tax benefit from releasing a deferred-tax-asset valuation allowance. FY2021 instead included a $3.9 million tax provision, making the year-over-year net income comparison unfavorable.
- Discontinued operations produced a $2.1 million loss in FY2021, primarily from the final working-capital settlement and related legal expenses associated with the previously divested Public Safety & Security business.
- Backlog increased to $953.9 million from $922.2 million, with $653.7 million funded. Management expects approximately 51% of backlog to convert to revenue in 2022 and an additional 19% in 2023.
Liquidity, debt, outlook, risks, and unusual items
- Cash flow from continuing operations was $35.3 million. Investing cash use was $52.1 million, including $46.5 million of capital expenditures and $12.3 million of acquisition-related payments. Financing cash use was $9.3 million.
- The company had no borrowings under its $90.0 million revolving credit facility, $6.5 million of outstanding letters of credit, and reported $66.6 million of net borrowing-base availability at year-end. It was in compliance with debt covenants.
- The principal amount of the 6.5% Senior Secured Notes was $300.0 million, due November 2025. Total contractual cash obligations and commitments were $680.8 million, including debt, interest, purchase orders, and lease obligations.
- After year-end, on February 18, 2022, Kratos refinanced the notes and revolving facility with a new $200 million revolving facility and $200 million Term Loan A. It drew approximately $200 million under the term loan and $100 million on the revolver, and expected annual cash-interest savings of approximately $10 million to $13 million. Redemption of the 6.5% notes was expected to close March 14, 2022 at 103.25% of principal plus accrued interest.
- Management stated that cash on hand, operating cash flow, and available credit were expected to fund near-term liquidity needs, but additional capital could be required to support large tactical-drone production awards.
- Management’s strategy emphasizes internally funded R&D, proprietary technology, unmanned systems, space-related capabilities, production growth, and improved operating margins through scale and operating efficiencies. No formal revenue or earnings guidance is provided in the filing.
- COVID-19 continued to affect employee availability, supply chains, transportation, customer access, demonstrations, testing, and certain commercial and international programs. Semiconductor, aluminum, and milling shortages created additional delivery and cost risks.
- Key risks include dependence on U.S. Government appropriations, continuing resolutions and shutdowns; contract cancellations and protests; fixed-price cost overruns; customer and program concentration; cybersecurity and CMMC compliance; supplier constraints; classified-program opacity; competition; goodwill impairment; DCAA audits and potential cost adjustments; and substantial leverage.
- The filing identifies approximately $8.2 million of unbilled receivables related to a terminated training program and approximately $10.0 million disputed with an international customer. Management recorded no adjustment to the related revenue or receivables at year-end.
- A $6.9 million favorable estimate-at-completion adjustment was recorded on one long-term government contract. The filing states that no other individual cumulative catch-up adjustment was material.
Most important facts for investors to verify
- Whether the $953.9 million backlog, particularly the unfunded portion, converts to revenue on the stated timing and at expected margins.
- Progress toward production-scale awards and programs of record for Valkyrie, Skyborg, SSAT, AFSAT, and other unmanned systems.
- Cash conversion, unbilled receivables, inventory growth, and resolution of the $8.2 million and $10.0 million receivable matters.
- The terms, borrowing levels, covenant headroom, mandatory amortization, and interest savings under the February 2022 refinancing.
- Exposure to U.S. defense appropriations, continuing resolutions, government shutdowns, bid protests, and changes in program priorities.
- Impact of supply-chain shortages, COVID-19 effects, labor availability, cybersecurity requirements, and CMMC compliance costs on delivery schedules and margins.
- Assumptions supporting the $493.9 million goodwill balance and the risk of future impairment if unmanned-systems growth or government funding falls short.
- Results of DCAA audits and any resulting cost disallowances, refunds, penalties, or restrictions on future contracting.