Conference calls are boring. Even for investors, and even on earnings day, it can feel frightfully dull to sit still and listen through an hour-long post-earnings conference call with stock market analysts.
Even reading transcripts of these things can be a chore -- wading through reams of boilerplate and restatements of what a company already told you in its earnings release, searching for nuggets of new information.
Fortunately, you don't have to do any of that because we're happy to do the heavy lifting. Here are five key items that jumped out when military drone-builder Kratos Defense & Security Solutions (NASDAQ: KTOS) spoke with investors in last week's conference call.
Kratos's drones business is flying toward a brighter tomorrow. Image source: Getty Images.
Drones fly straight
Kratos' Unmanned Systems business's revenue [will] double from 2016 to 2018, excluding any potential upside from our tactical unmanned aerial drone business, of which, we have multiple development programs either under contract or in contract discussions. [Emphasis added.] -- Kratos CEO Eric M. DeMarco
Kratos has said similar things before, but this bears repeating. Drones, primarily built for target practice, remain the smallest business out of Kratos's three main business units. (The other two are Government Solutions and Public Safety, according to S&P Global Market Intelligence data.)
Last year, though, Kratos's drones business grew faster than any of its other businesses -- and if DeMarco is right in his prediction, by this time next year drones could graduate to become Kratos's second-biggest business for the first time ever. What's more, if the company succeeds in creating a new combat drone business, as it has been trying to do, revenues could more than double.
Loose lips sink drones
In the unmanned area, as a result of competitive, national security-related and other factors, we are unable to discuss specifics on certain programs that we're involved in, and ... we will be letting the financial performance of our Unmanned business reflect the progress that we're making. -- DeMarco
As the recipient of the occasional call an from investor relations professional whose company I have criticized (though not Kratos), I love it when CEOs talk like this. If I'm wrong in predicting a company's demise, don't call me up to yell at me about it -- prove me wrong. "Show me the money," and show your shareholders the money, too.
Kratos is promising to shut up and put up.
Did someone really ask "show me the money?"
Kratos' Unmanned business Q3 2017 revenues grew organically 127% over Q3 last year and they grew 87% sequentially over Q2 of this year, with our Unmanned Systems business generating a Q3 2017 book-to-bill ratio of 1.4:1. -- DeMarco
See what they did there? DeMarco first promised to let his results speak for themselves -- then he immediately reminded us what the results are saying. He told us that Unmanned Systems is on track to double its revenues, and that's just what the division did in Q3, largely through sales of Kratos's MQM-178 Firejet, BQM-177 SSAT and BQM-167 AFSAT unmanned target drones.
Kratos's rising book-to-bill ratio suggests that more such "doubling" should be forthcoming in future quarters.
What about Mako?
We expect a significant increase in funding for purchases of [UTAP-22 Mako drones] in 2018. Kratos' LCASD program remains on budget and on schedule for completion of development and initial flights in the middle of 2018. ... Kratos' Gremlins program, on which we are teamed with Dynetics and where Kratos is responsible for design and production of the UAS, remains on schedule and on budget with the down select of the final Phase III winner expected in Q1 of 2018 .... We are also hopeful of receiving a contract by the end of this year, or early next year for up to approximately 100 unmanned aerial drone systems from a certain customer. -- DeMarco
No Kratos conference call would be complete without an update on the combat drones program, into which Kratos has been pouring millions of dollars of R&D these past few years. If accelerated sales of target drones alone are expected to move the needle on Kratos' drones division, then successful sales of armed, jet-powered combat drones to the U.S. military could totally "tilt" this pinball machine.
Kratos has publicly revealed that at least some of the combat drones it's developing should sell for as much as $2 million or $3 million each. A sale of 100 such drones could as much as quadruple the annual sales of Kratos's drones division, on top of the doubling from sales of target drones. Additional sales of Mako, Gremlins, and LCASD drones (and others) could totally transform Kratos's business.
All that being said, there is one note of caution that deserves to be highlighted:
Curb your enthusiasm
We are updating our free cash flow guidance for '17 to a use of $51 million to $58 million ... We expect that these cash investments for our unmanned tactical initiatives will be substantially complete in the first half of '18 and that we will return to free cash flow generation in fiscal 2018. -- CFO Deanna Hom Lund
This is new -- and not good -- news. In quarters past, Lund has repeatedly assured investors that "investments for our unmanned tactical initiative will be substantially complete in 2017 and that we will return to free cash flow generation in 2018." As that deadline approaches, however, Kratos is starting to waffle.
Now it seems that, instead of turning FCF-positive from the get-go next year, Kratos will continue to burn cash, perhaps through the entire first six months of 2018. It's pushing its FCF-positive promise into the back half of the year, and now only firmly promising FCF positive for the year as a whole.
Given the company's history of overpromising on profitability only to underdeliver when earnings arrived, such caution is perhaps to be commended rather than criticized. Still, investors have to be disappointed at the prospect of watching Kratos continue burning cash -- perhaps for another nine long months -- before finally seeing a return on its investment in drones.
Here's hoping though that, come H2 2018, investors' patience will finally be rewarded.
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