Kratos Defense & Security Solutions, Inc. (NASDAQ:KTOS) Q4 2023 Earnings Call Transcript
Kratos Defense & Security Solutions, Inc. (NASDAQ:KTOS) Q4 2023 Earnings Call Transcript February 13, 2024
Kratos Defense & Security Solutions, Inc. beats earnings expectations. Reported EPS is $0.12, expectations were $0.08. Kratos Defense & Security Solutions, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Thank you for standing by and welcome to Kratos Defense & Security Solutions Fourth Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions] I would now like to hand the call over to VP and General Counsel, Marie Mendoza. Please go ahead.
Marie Mendoza: Thank you. Good afternoon, everyone. Thank you for joining us for the Kratos Defense & Security Solutions fourth quarter and full year 2023 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, everybody. In 2023, Kratos achieved each of the goals we laid out at the beginning of the year, including 10% organic revenue growth, increased EBITDA, with positive cash flow generation, while also making significant internally funded investments, and potential transformational growth areas, for our company. Expected growth areas include high-performance jet drone systems, hypersonic rocket motors and systems, next-generation jet engines for drones, missiles, and loitering munitions, and OpenSpace software for virtualized satellites, C2 and TT&C. Kratos' product systems and software, which we envision, design, and engineer from the outset, to be produced in large quantities at a low cost, are a value-added differentiator for our customers and also, importantly, for our prime system integrator partners and teammates.
Kratos' relationships with the prime system integrators, including our being able, to rapidly provide relevant, low-cost, differentiated, and value-enhancing products, hardware, and systems is a key element of Kratos' strategy, and its core to our company's success. At Kratos, we believe that it's better to have a big part of something instead of all of nothing. And based on a program's requirements, including schedule, the potential size of a Kratos investment required, the technical development and financial risk to Kratos, and also expected customer preferences, we may team with one or more of our prime partners on certain program opportunities instead of Kratos priming ourselves. We believe this teaming or partnership approach has been very successful, including recently on a high-profile program.
On last quarter's conference call, I mentioned that we were expending significant effort, including bid, proposal, NRE, and other costs, in pursuit of certain large opportunities. As an update, we have successfully received potentially, the most important of these contracts in Kratos' unmanned systems business, with a prime partner. On a second opportunity, a different Kratos prime partner, was awarded a new missile defense system-related satellite constellation program, where Kratos is responsible for the ground system. Thirdly, we have been informed that a Kratos turbine technologies proposal, was accepted and we are now waiting for our customer to receive funding, hopefully in Q3. And finally, Kratos made the decision to pass on an opportunity as a prime, due to the size of the Kratos internal investment required, the financial risk to Kratos on this development program, and our assessment of an unacceptable probability of Kratos win.
There are several additional notable opportunities that Kratos is currently assessing, or in pursuit of, including where we are making significant investments, which hopefully we will be able to update you in the future. As we begin 2024, we are under contract on numerous programs of record, either as prime or partnered. These include new programs currently in development, programs transitioning, to low-rate initial production, programs that are in LRIP, and transitioning to full-rate production, and programs that are in full-rate production already where we expect increased future production quantities. Additionally, Kratos' opportunity pipeline is approximately $11 billion and our backlog is $1.2 billion, all providing us confidence in our 2024 financial forecast.
Additional recent Kratos achievements include a $579 million prime single award Space Force satellite communication system-related contract, which we were able to announce today. The Space Force contract covers the command and control consolidation system used for SATCOM telemetry, tracking, command, sustainment, and resiliency. The receipt of this award, which was Kratos' only large outstanding recompete, provides Kratos both future visibility, and an opportunity for growth, as reflected by the significant contract ceiling value increase, of approximately 50% over the previous contract vehicle, as the number of satellites in orbit has and is expected to continue to increase, contributing to the overall expected increase in this contract's scope.
It was reported that Kratos and Boeing have executed a memorandum of understanding for Kratos' TDI-J85 jet engines to be the propulsion provider for the Boeing Powered Joint Direct Attack Munition. It is anticipated that the Powered JDAM will provide air-launched, low-cost standoff capability against land and maritime threats. We received an approximate $23 million prime contract from the United States Marine Corps related to Kratos' Valkyrie tactical drone, and we received significant contract awards related to the Iron Dome and the Patriot air defense systems. It was also reported that Kratos' Terrier-Oriole two-stage rocket system was the propulsion system for the [V-MAX] hypersonic system launch. And it was reported that recent testing of a sophisticated AI software aboard an XQ-58A Valkyrie drone will influence how the U.S. Air Force develops and deploys autonomous technologies.
For 2024, expected Kratos growth areas, which are included in our base case financial forecast, include turbojet, turbofan, and rocket engines for unmanned aerial drones, loitering munitions, cruise missiles, hypersonic systems, supersonic platforms, space and other systems. Increased target drone sales, with target drones being used by the U.S. and our allies, to exercise radar, air defense, fighter aircraft, maritime, counter UAS, and other platforms and systems, all of which are in increasing demand globally. Hardware and product sale growth related to air defense, counter UAS, radar, and missile systems, including in Kratos' C5ISR and our microwave electronic products business. These include systems that are currently in theater in both Europe and the Middle East, and we expect the Sentinel Program with our prime partner Northrop to also be a 2024 organic growth driver.
We expect to see growth in Kratos' space, satellite, and training systems division, including particularly strong growth in virtual augmented reality and other training systems. In 2024, we expect Kratos' first-to-market virtualized software-based OpenSpace C2 and TT&C suite to continue to gain customer acceptance and designed in positions. Additionally, we are currently forecasting for 2025 to be an inflection point year for Kratos' satellite business, both in organic revenue growth and in profit generation, based on programs we have successfully received, those we expect to receive, and those we expect to either transition to, or begin production or deployment on. In the tactical drone area, we believe that Kratos remains well-positioned for this new large, and expected to be fast growing market area, both with Kratos drones and also with Kratos' family of turbojet and our turbofan engines.
Tactical drone initiatives, we are able to discuss publicly include, we are under a funded contract and have completed a successful series of mission system and related flights, including as related to Kratos' Mako tactical jet drone system. We are under a funded contract, and - integrating Kratos' jet engines into Kratos' drones. Kratos' Ghost Works is completing ground testing of a new drone-related system, at our Burns Flat Range location, which program we expect to transition in the future to a larger range for final system demonstration. We had hoped to transition this system to a larger range in Q4, but we were unable to do so. We are moving rapidly with Shield AI, integrating Shield's artificial intelligence into multiple Kratos jet drones, with flights being held at Kratos' Burns Flat Range facility.
We are completing production of the last of the initial 12 Valkyries, and we are in production on the second 12 Valkyries, which production rate we are calibrating now based on Kratos' internal resource allocation considerations, including as related to the new funded drone system program we have received. We are under a funded contract for a Valkyrie variant where mission, and other systems are being integrated. We are working with the government entity, on a separate Valkyrie variant, with funded first flights, expected in the fourth quarter of this year. And Kratos' Ghost Works is working on an additional Valkyrie variant, which new capability, performance, and low cost we believe will be another step function ahead, for Kratos' tactical drone family.
There are currently four Valkyrie variants that I can publicly confirm today, and a fifth that Kratos' Ghost Works is currently assessing. We expect to receive the largest Valkyrie-related contract award to-date in late 2024, and I am confident that all 24 Valkyries we have produced, or plan to complete production on will ultimately be sold, or delivered to funded customers. We are establishing an additional production line, for the new drone system program that we are under contract on with a partner. We believe that once we have the 2024 U.S. federal budget that Kratos' Thanatos, will receive a funded prime contract. Based on recent events, it is also possible that we will receive a funded prime contract for Kratos' Athena drone program system late this year, or early next year.
Initial derivatives of both Thanatos and Athena are flying today with customers. I expect Kratos' Valkyrie, Mako, Air Wolf, Thanatos, Athena, and other Kratos' tactical drones to be successful, and we continue to progress with multiple funded customers, entities, or partners, including for system missionization, concept of operations, payload integration, et cetera. However, we will remain conservative, and we have included no tactical drone production assumptions in Kratos' 2024 base case financial forecast, only S&T, RDT&E, and similar funded development initiatives, or programs. Major initiatives and opportunities Kratos currently plans, to invest in, or pursue in 2024, include we are establishing production facilities for Kratos' jet engines, including for missiles, drones, loitering, and powered munitions for several platforms, systems, and opportunities that we are currently under funded development contract on.
We are completing Kratos' Sentinel program ground transporter production facility, which will be one of the largest, and advanced technology secure production facilities in our company, which we are under a funded contract on. We are establishing the production line for the new system in Kratos' unmanned system division, I mentioned previously, which we are under a customer funded contract, and which is one of the most important programs in our company. We are completing the Zeus 1 and Zeus 2 engines, and preparing these systems for production and vehicle system integration, including as related to a customer funded hypersonic program we have and other customer initiatives. We are completing Kratos' Erinyes and Dark Fury hypersonic systems and beginning the build out of the related production integration facilities, also for which we have a funded customer contract.
We currently expect to receive in 2024, a customer funded contract, for approximately 25 Kratos' Oriole rocket systems, which we will need to prepare for, and execute on once received, all related to future launch missions. We are establishing a new space qualified microwave electronics development, and manufacturing facility in Israel, to support new funded space system program awards we have received. Others we expect to receive, and we are expanding our existing production, and manufacturing facility, to meet the increased capacity, and production requirements we're seeing. We will also complete enhancements to and expansion of our U.S. based microwave electronics manufacturing facility. We are establishing the facility and acquiring the machinery and equipment, including 3D and additive manufacturing equipment for Kratos' Materials Production Center of Excellence, where we are vertically integrating the production of Kratos' jet engines, space propulsion, and other programs and systems, most of which are already, or are expected to be underfunded government contracts.
We are also in discussions regarding new teaming, or partner agreements related, to significantly expanding Kratos' core business areas, including product, system, software, and technology, all of which have funded customer support, and this includes KTT, our turbine business, and our blade engine initiative. These examples are representative of the large number of opportunities Kratos has and expects to receive, and why 2024, is expected to be a significant internal investment, and capital expenditure year, as we prepare Kratos, to execute on recently received funded programs, and we position Kratos to successfully receive additional expected large new programs. We believe that the industry and Kratos, are in a once in a generation global buildup of defense and security, due to the geopolitical, and overall increased threat environment.
As a result of this strategic system buildup, the number and size of the potential opportunities that Kratos, has and continues to receive, has never been greater, and we expect Kratos' future opportunity set to continue to increase, including based on discussions with our customers, and also our prime system integrator partners. Accordingly, Kratos is focused on successful execution, of our existing programs and contracts, and making the required internally funded investments, in order to be qualified to successfully win, pursue and win these new opportunities. Accordingly, Kratos has no plans for any acquisitions of any size. Operational challenges include the obtaining, and retaining of qualified personnel, including those willing, and able to obtain a national security clearance, and the related high and increasing cost of these individuals, and of the supply chain, which is adversely impacting Kratos' margins, and also resource and capital allocation management, as we execute on existing programs that we pursue new opportunities.
For Kratos' 2024 financial plan, we are currently forecasting Q3, and in particular Q4, to be stronger for the first half of the year, which is directly related to the government contracting offices having to get funding under contract in a shortened time period as a result of the current CRA going through at least March 8, or four plus months into government fiscal 2024. If the CRA goes beyond March 8 of this year, we will take a look at the Kratos program portfolio, and the facts and circumstances at that time, and determine any adjustment to our forecast is required. Deanna.
Deanna Lund: Thank you, Eric. Good afternoon. As we have included a detailed summary of the fourth quarter and full year 2023 financial performance, as well as the initial first quarter and 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 fourth quarter were $273.8 million, exceeding our estimated range of $237 million to $257 million, which includes higher than expected performance, and delivery in our space and satellite, turbine technologies, C5ISR, and microwave products businesses, resulting in 17% organic growth in our KGS segment, for the fourth quarter of 2023, as compared to the fourth quarter of 2022. Adjusted EBITDA for the fourth quarter of 2023 was $29.1 million, exceeding our estimated range of $19 million to $23 million, reflecting the additional revenues, as well as a more favorable mix of revenues, including more, higher margin software and data related content, than forecasted in our space and satellite business.
Free cash flow generated from operations, of $48.1 million after funding CapEx of $19.3 million came in above our estimated range of breakeven free cash flow for the fourth quarter of 2023, reflecting the increased revenues and EBITDA, generated during the quarter, as well as favorable timing on accelerated customer milestone payments, collected in our turbine technologies, unmanned systems, and space and satellite businesses, which more than offset, our previous estimated shift in certain payment milestones, in our training solutions, and C5ISR businesses. Consolidated DSOs or day sales outstanding continued, to improve from 119 days in the third quarter to 109 days in the fourth quarter of 2023, with approximately $34 million in net cash generation, from customer receivables during the fourth quarter, which included certain favorable customer milestone payments.
In addition, advanced payments, or deferred revenues, increased $11 million during the fourth quarter. For full year 2023, revenues were $1.037 billion, or an organic growth rate of 12.6%, above FY '22 revenues, and above our estimated range, of $1 billion to $1.02 billion, including higher than expected performance, and delivery in our space and satellite, turbine technologies, and microwave products businesses. Full year adjusted EBITDA was $95.4 million, above our expected range of $85 million to $89 million, reflecting the increased revenues, and also a more favorable mix of revenues. Cash flow generated from operations for full year '23 was $65.2 million, and free cash flow generated from operations was $21.1 million after funding of capital expenditures of $52.4 million, less $8.3 million in receipts and proceeds for sales of Valkyries that were built as Kratos capital assets.
As mentioned earlier, cash flow was positively impacted by favorable customer payment milestone receipts, in our turbine technologies, unmanned systems, and space and satellite businesses, which more than offset the shift, in previously expected payment milestones, in our training solutions and C5ISR businesses. Our contract mix for the fourth quarter of '23 was 71% of revenues, generated from fixed price contracts, 24% of our revenues generated from cost plus type contracts, and 5% of revenues generated from time and material contracts. Revenues generated from contracts with the U.S. federal government during the fourth quarter of 2023, were approximately 69%, including revenues generated from contracts, with the DoD, non-DoD federal government agencies, and FMS contracts.
We generated 13% of revenues from commercial customers and 18% from foreign customers in the fourth quarter. We continue to make progress in our hiring and retention, of skilled technical labor across the company, with total headcount of 3,932 employees at the end of 2023, compared to 3,645 at the end of 2022. Now moving on to financial guidance. Our initial first quarter and full year 2024 financial guidance we provided today, includes our current forecasted business mix, and current delivery schedules, and our assumptions related to the expected impact, of the continued operating challenge related, to our obtaining and retaining qualified technical personnel, and the related increased cost for these employees, and across our entire labor base.
Our guidance also includes our assumptions related, to the continued impact of supply chain disruptions, inflation, and related expected costs, and price increases. Our first quarter and full year 2024 guidance, reflects the impact of certain performance, and deliveries in the fourth quarter of 2023, certain of which had been originally estimated to be executed, or delivered in the first quarter of 2024. As Eric mentioned earlier, we are forecasting that our unmanned systems business will be one of our leading growth drivers in 2024, which is currently forecasted to generate $260 million to $270 million in revenues, reflecting approximately 20% to 25% organic growth over 2023. Our 2024 cash flow estimates include investments in elevated capital expenditures, as Eric discussed earlier, on a base case estimated range of $70 million to $80 million, which includes a second production build for Valkyries of approximately $20 million, in anticipation of customer requirements, and demand, approximately $10 million to $13 million, to expand and build out, our microwave Israeli production facility, which includes expansion and improvements, related to being space qualified.
Approximately $10 million to $12 million, to establish Kratos' Material Production Center of Excellence and approximately $5 million to $7 million, to expand our global satellite sensor network in response, to specific customer contractual requirements, which specific expansion costs are expected, to be recovered under customer contracts. Importantly, a U.S. government budget was not passed by October 1, 2023, the beginning of federal fiscal year 2024, and as a result, Kratos and the industry, are operating under a continuing resolution authorization, which currently expires March 8, 2024, under which no new contracts, and no increases in increasing contracts, production, or funding, among other stipulations is permitted. Kratos' 2024 financial forecast and guidance provided today assumes that the current CRA, will be resolved and that a U.S. federal and DoD budget will be in place by March 8.
As a result, similar to Kratos' 2023 quarterly financial trajectory, which fiscal year also experienced a CRA, we are forecasting Kratos' third and fourth financial quarter results, of 2024 to be significantly greater, than the fiscal first and second quarter results, with the fourth quarter expected to be particularly strong in both revenue and EBITDA. If the current CRA goes beyond March 8, we will evaluate Kratos' 2024 financial forecast, at that time based on the existing facts, circumstances, and expectations.
Eric DeMarco: Yes, great. Thank you, Deanna. We'll turn it over to the moderator now for questions.
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