Kratos Defense & Security Solutions, Inc. (NASDAQ:KTOS) Q1 2024 Earnings Call Transcript

Kratos Defense & Security Solutions, Inc. (NASDAQ:KTOS) Q1 2024 Earnings Call Transcript May 7, 2024

Kratos Defense & Security Solutions, Inc. misses on earnings expectations. Reported EPS is $0.00919 EPS, expectations were $0.05. KTOS isn't one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day. Thank you for standing by. Welcome to Kratos Defense & Security Solutions First Quarter 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] I would now hand the call over to your host, Marie Mendoza, Senior Vice President and General Counsel. Please go ahead.

Marie Mendoza: Thank you. Good afternoon, everyone. Thank you for joining us for the Kratos Defense & Security Solutions first quarter 2024 conference call. With me today is Eric DeMarco, Kratos' President and Chief Executive Officer; and Deanna Lund, Kratos' Executive Vice President and Chief Financial Officer. Before we begin the substance of today's call, I'd like everyone to please take note of a Safe Harbor paragraph that is included at the end of today's press release. This paragraph emphasizes the major uncertainties and risks inherent in the forward-looking statements we will make this afternoon. Please keep these uncertainties and risks in mind, as we discuss future strategic initiatives, potential market opportunities, operational outlook, financial guidance and other forward-looking statements during today's call.

Today's call will also include a discussion of non-GAAP financial measures, as that term is defined in Regulation G. Non-GAAP financial measures should not be considered in isolation from or as a substitute for financial information presented in compliance with GAAP. Accordingly, at the end of today's press release, we have provided a reconciliation of these non-GAAP financial measures to the company's financial results prepared in accordance with GAAP. With that, I will now turn the call over to Eric DeMarco.

Eric DeMarco: Thank you, Marie. Good afternoon. Kratos is positioning as a leading defense technology products and software company, focused on obtaining and supporting programs of record organic growth and execution was reflected in our Q1 results. As a public company that reports every three months, Kratos' team's execution is visible to all of our stakeholders and includes industry leading organic growth, LTM annual positive operating cash flow generation, increased profitability, while also making significant internally funded investments in large and growing market areas, where Kratos is the industry leader. Accelerating organic growth areas for Kratos include our unmanned jet drone systems, jet engines for drones, missiles, loitering munitions and high performance systems and microwave electronics for air defense, missile radar and satellite systems.

Kratos' strategy of partnering with large traditional system integrators with Kratos bringing differentiating value including existing capabilities and a lower cost is also accelerating, including in the drone, hypersonic, propulsion system, solid rocket motor and the C5ISR areas. For the first quarter, every Kratos business unit exceeded its revenue or profit forecaster bolt. We ended Q1 with a backlog of over $1.2 billion, an opportunity pipeline of approximately $11 billion and with the 2024 U.S. Defense Budget and The Supplemental Bill now approved, we have increased confidence in our 2024 financial forecast, which we affirm today and also as we now look towards 2025. Of particular note, Kratos' unmanned systems business Q1 organic growth was 21.8% with bookings of $81 million for a book-to-bill ratio of 1.41.

We are forecasting approximate 20% growth for unmanned systems this year, driven by the current geopolitical threat environment. Kratos' unmanned systems Q1 book-to-bill ratio of 1.4 on top of an approximate Q1 22% growth rate is reflective of the demand we are seeing for Kratos' affordable high performance jet drone aircraft systems, including certain programs and customers we are unable to publicly disclose, but which performance is reflected in our financials. There is a generational recapitalization of strategic weapon systems occurring as a result of the increasing global threat environment, including China, Russia, Iran and its proxies and also North Korea. We believe that Kratos is uniquely positioned to address the related demand, including with our ready-to-go now in production systems across the portfolio.

Priority areas of this recapitalization for the U.S. and its allies, which priorities are routinely reported on in the press, include air defense systems, drones, loitering munitions, missiles and engines for these systems, radar, counter UAS space and satellite systems, strategic deterrence, rocket hypersonic, missile defense target and training systems. Recent notable items for Kratos include the successful static fire test of Kratos' Zeus 2 solid rocket motor or SRM. With the previous successful static fire test of the Kratos Zeus 1 SRM, we have placed the initial order for nine combined Zeus 1 and Zeus 2 SRMs with our partner Aerojet to address expected initial customer demand for these affordable systems, with the first Zeus customer funded mission now scheduled for later this year.

Additionally, Kratos' Erinyes hypersonic flyer is now complete with the first customer funded flight now also scheduled for later this year, which system will include a Kratos integrated multistage solid rocket stack. Kratos is one of the very few entities that has a substantially vertically-integrated hypersonic system and BMD target mission system, including the rocket motors through the front end payload or the flyer. Kratos' Zeus SRMs and our Erinyes and Dark Fury Hypersonic Flyers a recent example of Kratos delivering actual systems not hoped for someday products or PowerPoints and with Kratos being first to market with relevant systems that the customer wants. Related to Kratos' hypersonic and ballistic missile defense business, we are planning to make significant investments in facilities, machinery, equipment, integration assets, rocket and other systems and assets, as we position for execution of existing and expecting demand for Kratos' rocket, BMD, SRM and hypersonic systems.

We expect Kratos' rocket systems business including Kratos' Zeus, Oriole, ARAB, Erinyes, Dark Fury and our other systems to be a key future year growth contributor for Kratos. In our Israeli-based Microwave Electronics business, which significantly outperformed in Q1 and which business is also accelerating, we have received new and increased follow-on orders to existing programs and contracts, including as related to missile, radar and air defense systems, including Iron Dome, Iron Sting, Lightning, Aero, Barak and others. Kratos' Microwave Electronics business is also supporting satellite, space system and C5ISR programs, including Kratos just recently receiving the initial design order from a new space company for Kratos' products on their satellites.

In Kratos' Microwave Electronics business, we are making investments in both new and existing facilities, including space qualified facilities, plant and equipment in order to successfully execute on the many new and expanded programs we have already received and additional programs we expect to receive. Kratos Turbine Technologies and our Engine business has also been accelerating and significantly outperformed in Q1, with programs and initiatives including small jet engines for drones, missiles and loitering munitions, engines for hypersonic and supersonic systems and engine and propulsion systems for space and certain classified aerial systems. KTT's Spartan Development Group is under customer funded contract for a new propulsion system for a classified aircraft and also a separate new Spartan Group propulsion system has now been integrated into a customer's classified drone system and is preparing for initial flight.

Both of these new system programs are important contributors to KTT and are expected to grow as these new program systems evolve. We will be making investments in our engine businesses including for a low cost manufacturing facility, infrastructure, systems and assets, including as related to loitering munition and missile system production contracts, where we are designed in, certain of which we expect to receive this year now that the funding bills have been approved. We also continue to be on schedule and on budget under a customer-funded contract where we are integrating Kratos' jet engines into certain Kratos high performance jet drones. Kratos' C5ISR business is also positioned for future growth with programs of record and contracts including Sentinel, Patriot, IBCS, IFPIC enduring shield, SHORAD and other missile radar air defense and counter UAS programs of record.

The global demand for air defense, radar and strategic systems is providing a catalyst for C5ISR growth, and I encourage you to take a look at the size, opportunity and quantities related to certain of these programs Kratos supports. Kratos' unique, one of a kind owned and operated global space domain awareness or SDA system is an incredibly important Kratos asset with its data and information being of increasing value to our customers, including as a result of the significant number of additional spacecraft being deployed. Data sales to customers from Kratos' SDA, similar to Kratos' OpenSpace software and license sales, are certain of the highest margin in our company and can be contributors to Kratos exceeding our profit forecasts based on mix.

A technician in a laboratory carrying out research and development of microwave electronics.

Representative of the progress Kratos' OpenSpace virtualized ground system continues to make, Kratos recently demonstrated a fully virtualized SATCOM ground system for the United States Army Futures Command over SES's O3b MEO Constellation and we also successfully demonstrated fully virtualized SATCOM over LEO for the United States Army. We continue to make significant investments in our first-to-market OpenSpace virtual C2 and TT&C software product family and also at the expansion of our global SDA system. Kratos' Unmanned Systems business highlights we can discuss include: Kratos' Valkyrie flying with two F-35 aircraft, successfully demonstrating the ability to deliver an integrated electronic attack capability during a live fire test event at Eglin Air Force Base with the United States Marine Corps as part of the Penetrating Affordable Autonomous Collaborative Killer Portfolio or PAACK-P program.

During the PAACK-P program mission, Kratos' Valkyrie advanced EA payload autonomously detected, identified and geo-located multiple tactically relevant targets of interest, transmitted emitter target track coordinates to collaborative assets and successfully presented non-kinetic electronic attack effects to multiple emitters. The recent M Prefects reported for the Marines' MQ-58A Valkyrie means multi mission in the U.S. Military Wide Aircraft Designation System with the use of M rather than X indicating a platform intended or in planning for operational use, transitioning from the X or experimental. Kratos' Ghost Works recently had successful ground tests on a new system Valkyrie variant, and we are planning on initial flights in the next few months pending availability of a specific range, asset and necessary clearances.

We are currently in customer discussions and we expect to receive our most important Valkyrie related contract award either late this year or early next year. As a result of the Valkyrie progress and the expectations we have, we are making the internal investment required to accelerate the completion of the current Valkyrie serial production, including multiple variants totaling 24 systems. We have now begun working with our in place qualified supply chain and vendor base on pricing out the next Valkyrie production lot beyond the current '24 as most of the '24 are now sold, customer committed, or which we believe we have clear customer opportunity line of sight. We have recently been informed that, we should be receiving a Kratos Athena drone system related contract award in the next few months.

And additionally, since our last report to you, Kratos' Apollo drone system had a successful customer-funded demonstration flight with a special payload. Recent world events have generated renewed customer interest in Kratos' Apollo, Athena and other Kratos tactical drone systems. As I have mentioned previously, for customer, competitive or security related reasons, we are unable to discuss certain programs, contracts or initiatives Kratos is involved with, and we will let the financial results provide the progress, as reflected in first quarter in our Unmanned Systems business. We are in the planning process to expand our tactical drone production at other facilities to address the increased and expected demand. Overall, we're focused on execution of our record backlog and $11 billion opportunity pipeline, including certain large new program awards, we expect to receive over the next few quarters that we are preparing for.

Accordingly, we have no significant acquisitions contemplated potentially only small Kratos business consistent tuck-ins. Virtually every opportunity or initiative we executed our recent equity raise for, has either successfully closed or progressed with continued progress expected over the coming months. As I have discussed today, Kratos will be investing in plants, facilities, equipment, systems, capital assets and other areas in order to successfully execute on programs we have now received or that we expect to receive. Additionally, we believe that the equity raise was instrumental in Kratos just recently being successfully down selected as the winner of large new opportunity which we are currently in negotiations in diligence internally called Prometheus.

Next several months, Kratos' base case forecasted growth areas include air defense, turbine technologies, engines, missile, radar and CUA systems, drones, C5ISR, Microwave Electronics and Training Systems. Potential future catalysts and potential upsides to Kratos' base case forecast include tactical drones, BMD Rocket and Hypersonic Systems and Jet Engines and Propulsion Systems. Deanna?

Deanna Lund: Thank you, Eric. Good afternoon. As we have included a detailed summary of the first quarter financial performance as well as the initial second quarter and affirmation of the full year 2024 financial guidance in the press release we published earlier today, I will focus on the highlights in my remarks today. Revenues for the first quarter were $277.2 million exceeding our estimated range of $240 million to $260 million which includes higher than expected performance and delivery across most of our businesses with notable strength in our Turbine Technologies and Microwave Products businesses. All business units generated organic revenue growth over last year's first quarter, resulting in a 19.5% consolidated organic revenue growth rate, including the impact of the Sierra Technical Services, or STS, acquisition on a pro form a basis as if acquired at the beginning of 2023.

Adjusted EBITDA for the first quarter of '24 was $26 million exceeding our estimated range of $16 million to $18 million reflecting the additional revenues as well as a more favorable mix of higher margin revenues with notable strength in our Turbine Technologies and Microwave Products businesses as well as higher margin software and data related content from our satellite business. Positive cash flow from operations generated was $700,000, which includes the impact of working capital requirements related to increases in inventory balances and prepaid assets related to supplier required deposits and prepayments for materials and equipment. Free cash flow used from operations was $15.9 million after funding capital expenditures of $16.6 million.

As we planned, we are making investments to expand and build out certain of our manufacturing and production facilities in our microwave products, rocket system and hypersonic businesses to meet anticipated customer orders and requirements and investing in related new machinery, equipment and systems. We are also continuing to manufacture the two production lots of Valkyries prior to contract award. We also utilized $45 million of the proceeds from the equity offering to pay down all amounts outstanding on our revolving line of credit. Consolidated DSOs or days sales outstanding continued to improve from 109 days in the fourth quarter of 2023 to 107 days in the first quarter of 2024, reflecting the timing of customer milestone payments. Our contract mix for the first quarter of '24 was 68% fixed price, 26% cost plus and 6% time and materials.

Revenues generated from contracts with the US Federal Government during the Q1 of '24 were approximately 69%, which includes revenues generated from contracts with the DoD, non-DoD federal government agencies and FMS contracts. In the first quarter of '24, we generated 12% of revenues from commercial customers and 19% from foreign customers. An operational priority remains the hiring and retention of skilled technical labor across the company, with total Kratos headcount of 3,986 at the end of the first quarter of '24 as compared to 3,932 employees at the end of '23. Now moving on to financial guidance. Our initial second quarter '24 financial guidance we provided today includes our current forecasted business mix and expected delivery schedules and our assumptions related to the potential impact of the continued operating challenge related to our obtaining and retaining qualified technical personnel, and the related increased cost for those employees across our entire labor base.

Our guidance also includes our assumptions related to the continued impact of supply chain disruptions, inflation and related expected cost and price increases. Our second quarter and full year 2024 guidance reflects the impact of certain performance and deliveries made in the first quarter of '24, certain of which had originally been estimated to be executed or delivered in the second quarter of '24. Eric?

Eric DeMarco: Thank you, Deanna. We'll turn it over now to the moderator for questions.

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