Investors in Kratos Defense & Security (NASDAQ:KTOS) stock have been hard-pressed to find good news to cheer about lately. Last month's earnings report, featuring primarily revenue declines and per-share losses, certainly didn't qualify.

But already this month, things are starting to look a little different.

Drones are where the action is at Kratos -- but for profits, one must look elsewhere. Image source: Kratos Defense.

The very merry month of... June

Over the first half of the month of June, Kratos has reported a total of five new contract wins totaling $45.1 million in value. Annualized, that works out to new contracts coming in at roughly twice the rate at which Kratos collected revenue for contracts already booked over the past year. And while that's a pace that will probably be difficult to maintain, it does at least suggest that the company's decline in revenue last quarter may reverse and turn into growing revenue in the quarters to come.

But what about the profits?

According to data from S&P Global Market Intelligence, Kratos is currently just getting by in terms of the profitability of its revenues. Operating profit margins over the past 12 months amounted to a bare 0.8% profit on revenues (although when you add tax benefits to the mix, the company's net profit margin was actually 2.1%).

But what can we tell from the new contracts Kratos has been winning? Will they tend to boost the company's profit margin, or drag it down even further? Let's find out.

Five contracts, three winners

So far, Kratos has announced five contract wins this month:

  • $6.6 million to provide "specialized product and hardware" to directed energy and command, control, communications, computers, combat systems, intelligence, and surveillance and reconnaissance programs.
  • $2.6 million to supply product and hardware to a chemical, biological, radiological, nuclear, and high explosives program.
  • $22.3 million to support the "theater medical information program -- joint" within the Defense Department's medical records system.
  • $3.6 millionto design, engineer, deploy and integrate "specialized security systems" for "two major mass transportation customers in the United States."
  • $10 million to support "a certain airborne communication system program," probably within the company's unmanned systems division.

Kratos doesn't always make it obvious which of its contracts fall under which of its three major business divisions. Near as I can tell, however, the first three contracts described above appear to fall within the ambit of the company's Kratos Government Solutions (KGS) division, while the fourth is a "public safety and security" contract, and the fifth will be performed by the company's unmanned systems unit.

Why is this important? In a word: margins.

Kratos by the numbers

S&P Global data show that unmanned systems, while clearly the division for which Kratos has the highest hopes, is currently the least profitable of its business units, actually losing money over the past 12 months. Public safety is just barely profitable, producing operating profit margins of 1.8%.

In contrast, KGS is both Kratos' biggest division by revenue and its most profitable at 3.6% operating margins. And the fact that $31.5 million of the $45.1 million in new-won contracts -- 70% of them -- will be running through the company's most profitable division suggests this could be above-average profit-margin revenue for Kratos.

The upshot for investors

Critics of Kratos stock may point out (rightly) that a 3.6% profit margin still isn't very much. But at this point, beggars can't be choosers -- and 3.6% is at least better than the 0.8% overall operating profit margin Kratos has been managing thus far. Maybe, if Kratos can keep on winning more contracts of these sizes, and this caliber, there's at least a faint hope that in the not-too-distant future, the company will be able to earn consistent profits, without depending on tax benefits to provide them.


This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.