What happened

Shares of military drone maker Kratos Defense & Security Solutions (KTOS 2.14%) are falling today, down by 13.5% as of 1:11 p.m. EDT, after the defense specialist paired a solid earnings release last night with weak guidance.  

Analysts had estimated that Kratos would report $0.06 per share in profit for fiscal Q2 2021 -- and it did that. Moreover, analysts had forecast that sales would be only $199 million for the quarter, but Kratos posted more than $205 million in revenue.

Red down arrow on a black backdrop with columns of numbers.

Image source: Getty Images.

So what

So far, so good.

Sales for the quarter increased 20% in comparison to last year's Q2, of which 12% was organic growth not purchased through acquisitions. Sales growth in "unmanned systems" -- i.e., drones, Kratos' sexiest segment -- was particularly strong, rising 44%.

And Kratos reported a $0.01-per-share net profit for the quarter, when calculated according to generally accepted accounting principles (GAAP) -- not as good as the $0.06-per-share pro forma profit, admittedly, but a whole lot better than the $0.01-per-share GAAP loss the company posted a year ago.  

Now what

Now here's where the news turns bad: Despite the net profit, Kratos' free cash flow for the quarter was negative $11.6 million, albeit partially due to capital investments made to grow the drones business.

Of more concern is the fact that the company's book-to-bill ratio for the quarter was only 0.9 to 1, implying that new orders aren't coming in as fast as old orders were shipped and suggesting a future slowing in sales growth. Worse, the book-to-bill ratio of Kratos' drones segment plummeted to a disheartening 0.4 to 1, indicating an even steeper slowdown.

Reinforcing this view that business is slowing, Kratos updated its guidance to call for sales between $195 million and $205 million in Q3, which was short of the $216 million that Wall Street had been forecasting. Indeed, even if Kratos maxes out its prediction in the third quarter, the $11 million shortfall in sales will eclipse the $6 million sales surplus it bragged about in Q2 -- resulting in a net six-month-long sales miss for the company.

No wonder investors are a little upset.