It's earnings season for defense contractors on Wall Street. Today, we take a look at Kratos Defense, an up-and-comer in the drone space. Image source: Getty Images.
Tiny defense contractor Kratos Defense & Security (KTOS 0.58%) stock exploded 22% higher after reporting earnings on Thursday last week -- and it hasn't looked back. In the two days since earnings came out, the stock has continued to climb, recently topping $5.65 a share and closing in on $6 -- a gain that, if reached, will put the stock up more than 30% since minutes before its earnings came out.
So how did that happen?
Q2 by the numbers
Let's start with the high-level numbers. In Q2 2016, Kratos reported:
- Quarterly sales of $168.2 million, up 5% from last year's Q2 result.
- $0.17 per share in net losses, about 31% less than a year ago.
- A surprise "pro forma" profit of one shiny penny per share.
It was probably that last result that really got investors excited last week. Analysts, after all, had been forecasting a $0.07-per-share diluted loss for the quarter. And that wasn't all the good news that management had to share.
Dig deeper and looking higher
For example, in Q2, Kratos says its satellite, technology, and training division (STT) was the company's bright shining star, growing revenues more than 21% year over year to $70.3 million, and accounting for nearly $0.42 out of every $1 that Kratos as a whole brought in during the quarter. As Kratos observes, STT is both the company's best free cash flow producer and a strong grower. In Q2, the division boasted a book-to-bill ratio of 1.1 -- 10% more new orders brought in than the value of old orders that were fulfilled and converted to revenue in the quarter.
Business wasn't half bad in the company's high-profile Unmanned Systems division, either. Kratos' drones business grew 25% sequentially. And in a most welcome development, management confirmed that it has now won all three of the three big drone contracts it had targeted for winning earlier this year: the DARPA Gremlins competition, a second contract to build a "Tactical UAS,"and finally the Low-Cost Attritable Strike (LCASD) Unmanned Aerial System Demonstration contract, a $7.3 million award issued by the Air Force last month, that could eventually yield as much as "approximately $100 million" in additional revenue.
Not all rainbows and unicorns
Not all of Kratos' news was good, however. For example, while STT boasted a book-to-bill ratio of 1.1, the ratio for Kratos as a whole was only 0.8. What that means is that the company as a whole booked a whole lot more revenue in the quarter than it brought in as new business -- and this may foreshadow a decline in sales going forward. As further evidence, Kratos boasted that as of the end of Q2, the company now has $875 million of work to be done in its backlog. What the company was less eager to point out is that one year ago, at the end of Q2 2015, its backlog was 9% higher -- $954 million.
Contrary to the impression of a booming business that management sought to give, it appears that business may actually be drying up at Kratos.
The upshot for investors
Put it all together, and what have we got? Kratos was sort of profitable in Q2, but only pro forma. It grew its revenues nicely, but backlogs of future revenues are drying up. And while Kratos has won all of the drone contracts it set out to win, the dollar amounts involved are all still pretty small.
I have to say that while on the surface, a lot of the news at Kratos looks pretty good, once you take the caveats into account, these developments appear somewhat less than wonderful. Still, going forward, Kratos management says it's still targeting contract wins worth as much as $6.2 billion in new business. Investors can only hope that these opportunities will prove more lucrative than those that have come before.
