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EX-32.2 - EXHIBIT 32.2 - KRATOS DEFENSE & SECURITY SOLUTIONS, INC.ktos20171001ex-322.htm
EX-32.1 - EXHIBIT 32.1 - KRATOS DEFENSE & SECURITY SOLUTIONS, INC.ktos20171001ex-321.htm
EX-31.2 - EXHIBIT 31.2 - KRATOS DEFENSE & SECURITY SOLUTIONS, INC.ktos20171001ex-312.htm
EX-31.1 - EXHIBIT 31.1 - KRATOS DEFENSE & SECURITY SOLUTIONS, INC.ktos20171001ex-311.htm

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 

FORM 10-Q
 
ý      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the Quarterly Period Ended October 1, 2017
 
¨        TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934
 
Commission file number 001-34460
 
 
KRATOS DEFENSE & SECURITY SOLUTIONS, INC.
(Exact name of Registrant as specified in its charter)
Delaware
13-3818604
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer Identification No.)
4820 Eastgate Mall, Suite 200
San Diego, CA 92121
(858) 812-7300
(Address, including zip code, and telephone number, including
area code, of Registrant’s principal executive offices)
 
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes ý  No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes ý  No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act:
Large accelerated filer o
Accelerated filer ý
 
 
Non-accelerated filer o
Smaller reporting company o
 
 
(Do not check if a smaller reporting company)
Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.   Yes o  No o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes o  No ý
As of October 27, 2017, 103,297,525 shares of the registrant’s common stock were outstanding.
 



KRATOS DEFENSE & SECURITY SOLUTIONS, INC.
 
FORM 10-Q
 
FOR THE QUARTERLY PERIOD ENDED OCTOBER 1, 2017
 
INDEX
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2


PART I. FINANCIAL INFORMATION

Item 1.  Financial Statements.
KRATOS DEFENSE & SECURITY SOLUTIONS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
 (in millions, except par value and number of shares)
 (Unaudited)
 
October 1, 2017
 
December 25, 2016
Assets
 

 
 

Current assets:
 

 
 

Cash and cash equivalents
$
239.2

 
$
69.1

Restricted cash
0.2

 
0.5

Accounts receivable, net
244.2

 
229.4

Inventoried costs
62.8

 
55.4

Prepaid expenses
11.6

 
8.9

Other current assets
9.8

 
9.8

Total current assets
567.8

 
373.1

Property, plant and equipment, net
56.7

 
49.8

Goodwill
485.3

 
485.4

Intangible assets, net
24.5

 
32.6

Other assets
8.4

 
7.7

Total assets
$
1,142.7

 
$
948.6

Liabilities and Stockholders Equity
 

 
 

Current liabilities:
 

 
 

Accounts payable
$
50.6

 
$
52.7

Accrued expenses
41.8

 
50.0

Accrued compensation
33.7

 
39.1

Accrued interest
10.0

 
3.6

Billings in excess of costs and earnings on uncompleted contracts
51.1

 
41.8

Other current liabilities
10.5

 
7.7

Current liabilities of discontinued operations
1.1

 
1.6

Total current liabilities
198.8

 
196.5

Long-term debt, net of current portion
369.7

 
431.0

Other long-term liabilities
38.5

 
41.0

Non-current liabilities of discontinued operations
3.8

 
3.7

Total liabilities
610.8

 
672.2

Commitments and contingencies


 


Stockholders equity:
 

 
 

Preferred stock, $0.001 par value, 5,000,000 shares authorized, 0 shares outstanding at October 1, 2017 and December 25, 2016

 

Common stock, $0.001 par value, 195,000,000 shares authorized; 103,295,733 and 73,945,533 shares issued and outstanding at October 1, 2017 and December 25, 2016, respectively

 

Additional paid-in capital
1,232.2

 
956.2

Accumulated other comprehensive loss
(1.8
)
 
(1.7
)
Accumulated deficit
(698.5
)
 
(678.1
)
Total stockholders equity
531.9

 
276.4

Total liabilities and stockholders equity
$
1,142.7

 
$
948.6

 
The accompanying notes are an integral part of these condensed consolidated financial statements.

3


KRATOS DEFENSE & SECURITY SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(in millions, except per share amounts)
 (Unaudited)
 
Three Months Ended
 
Nine Months Ended
 
October 1, 2017
 
September 25, 2016
 
October 1, 2017
 
September 25, 2016
Service revenues
$
86.7

 
$
87.2

 
$
263.3

 
$
258.0

Product sales
109.5

 
78.2

 
286.4

 
228.6

Total revenues
196.2

 
165.4

 
549.7

 
486.6

Cost of service revenues
60.8

 
64.7

 
189.6

 
189.4

Cost of product sales
87.3

 
74.8

 
219.5

 
190.2

Total costs
148.1

 
139.5

 
409.1

 
379.6

Gross profit
48.1

 
25.9

 
140.6

 
107.0

Selling, general and administrative expenses
40.7

 
35.5

 
120.0

 
109.6

Research and development expenses
4.2

 
3.2

 
12.7

 
10.1

Unused office space, restructuring expenses, and other
0.1

 
0.2

 
0.5

 
10.5

Operating income (loss) from continuing operations
3.1

 
(13.0
)
 
7.4

 
(23.2
)
Other income (expense):
 

 
 

 
 
 
 
Interest expense, net
(7.7
)
 
(8.7
)
 
(23.1
)
 
(26.1
)
Loss on extinguishment of debt

 

 
(2.1
)
 

Other income, net
0.6

 
0.1

 
1.0

 
0.6

Total other expense, net
(7.1
)
 
(8.6
)
 
(24.2
)
 
(25.5
)
Loss from continuing operations before income taxes
(4.0
)
 
(21.6
)
 
(16.8
)
 
(48.7
)
Provision for income taxes from continuing operations
0.2

 
1.9

 
3.5

 
7.3

Loss from continuing operations
(4.2
)
 
(23.5
)
 
(20.3
)
 
(56.0
)
Discontinued operations
 
 
 
 
 
 
 
Loss from operations of discontinued component

 
(0.1
)
 
(0.1
)
 
(0.1
)
Income tax expense
(0.1
)
 

 
(0.1
)
 
(0.1
)
Loss from discontinued operations
(0.1
)
 
(0.1
)
 
(0.2
)
 
(0.2
)
Net loss
$
(4.3
)
 
$
(23.6
)
 
$
(20.5
)
 
$
(56.2
)
Basic and diluted loss per common share:
 

 
 

 
 
 
 
Loss from continuing operations
$
(0.05
)
 
$
(0.39
)
 
$
(0.24
)
 
$
(0.93
)
Loss from discontinued operations

 

 

 
(0.01
)
Net loss per common share
$
(0.05
)
 
$
(0.39
)
 
$
(0.24
)
 
$
(0.94
)
 
 
 
 
 
 
 
 
Basic and diluted weighted average common shares outstanding
90.5

 
60.5

 
85.0

 
60.0

Comprehensive Loss
 
 
 
 
 
 
 
Net loss (from above)
$
(4.3
)
 
$
(23.6
)
 
$
(20.5
)
 
$
(56.2
)
Change in cumulative translation adjustment
(0.2
)
 
(0.1
)
 
(0.1
)
 
(0.2
)
Comprehensive loss
$
(4.5
)
 
$
(23.7
)
 
$
(20.6
)
 
$
(56.4
)
 
The accompanying notes are an integral part of these condensed consolidated financial statements.


4


KRATOS DEFENSE & SECURITY SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions)
(Unaudited)
 
Nine Months Ended
 
October 1, 2017
 
September 25, 2016
Operating activities:
 

 
 
Net loss
$
(20.5
)
 
$
(56.2
)
Loss from discontinued operations
0.2

 
0.2

Loss from continuing operations
(20.3
)
 
(56.0
)
Adjustments to reconcile loss from continuing operations to net cash used in operating activities from continuing operations:
 

 
 

Depreciation and amortization
17.0

 
17.3

Stock-based compensation
6.8

 
4.2

Deferred income taxes
1.9

 
3.2

Amortization of deferred financing costs
1.0

 
1.2

Amortization of discount on Senior Secured Notes
0.6

 
0.7

Loss on extinguishment of debt
2.1

 

Provision for doubtful accounts
0.1

 
0.3

Litigation related charges

 
1.7

Provision for non-cash restructuring charges

 
7.7

Changes in assets and liabilities, net of acquisitions:
 

 
 

Accounts receivable
(14.9
)
 
(3.3
)
Inventoried costs
(4.9
)
 
(8.5
)
Prepaid expenses and other assets
(6.2
)
 
2.0

Accounts payable
(1.6
)
 
(1.4
)
Accrued expenses
(8.7
)
 
11.9

Accrued compensation
(5.5
)
 
(3.9
)
Advance payments received on contracts
(0.5
)
 
2.7

Accrued interest
6.5

 
7.8

Billings in excess of costs and earnings on uncompleted contracts
9.2

 
0.3

Income tax receivable and payable
1.3

 
0.8

Other liabilities
(0.6
)
 
2.6

Net cash used in operating activities from continuing operations
(16.7
)
 
(8.7
)
Investing activities:
 

 
 

Cash paid for acquisitions, net of cash acquired
0.2

 

Change in restricted cash
0.2

 
0.1

Capital expenditures
(19.0
)
 
(5.1
)
Proceeds from sale of assets
0.7

 

Net cash used in investing activities from continuing operations
(17.9
)
 
(5.0
)
Financing activities:
 
 
 

Extinguishment of long-term debt
(64.0
)
 

Proceeds from the issuance of common stock
268.0

 

Repayment of debt
(0.8
)
 
(0.8
)
Proceeds from exercise of restricted stock units, employee stock options, and employee stock purchase plan
1.5

 
2.1

Net cash provided by financing activities from continuing operations
204.7

 
1.3

Net cash flows of continuing operations
170.1

 
(12.4
)
Net operating cash flows of discontinued operations
(0.1
)
 
0.1

Net investing cash flows of discontinued operations
(0.5
)
 
4.3

Effect of exchange rate changes on cash and cash equivalents
0.6

 

Net increase (decrease) in cash and cash equivalents
170.1

 
(8.0
)
Cash and cash equivalents at beginning of period
69.1

 
28.5

Cash and cash equivalents at end of period
$
239.2

 
$
20.5


The accompanying notes are an integral part of these condensed consolidated financial statements.

5


KRATOS DEFENSE & SECURITY SOLUTIONS, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
(Unaudited)
 
Note 1. Summary of Significant Accounting Policies
 
All references to the “Company” and “Kratos” refer to Kratos Defense & Security Solutions, Inc., a Delaware corporation, and its subsidiaries.
 
(a)
Basis of Presentation

 The information as of October 1, 2017 and for the three and nine months ended October 1, 2017 and September 25, 2016 is unaudited. The condensed consolidated balance sheet as of December 25, 2016 was derived from the Company’s audited consolidated financial statements at that date. In the opinion of management, these unaudited condensed consolidated financial statements include all adjustments, consisting of normal recurring adjustments necessary for a fair presentation of the Company’s financial position, results of operations and cash flows for the interim periods presented. The results have been prepared in accordance with the instructions to Form 10-Q and do not necessarily include all information and footnotes necessary for presentation in accordance with accounting principles generally accepted in the U.S. (“GAAP”). These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the related notes included in the Company’s audited annual consolidated financial statements for the fiscal year ended December 25, 2016, included in the Company’s Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission on February 27, 2017 (the “Form 10-K”). Interim operating results are not necessarily indicative of operating results expected in subsequent periods or for the year as a whole.

 
(b)
Principles of Consolidation
 
The condensed consolidated financial statements include the accounts of the Company and its 100% owned subsidiaries for which all inter-company transactions have been eliminated in consolidation.
 
(c)
Fiscal Year
 
The Company has a 52/53 week fiscal year ending on the last Sunday of the calendar year, with interim fiscal periods ending on the last Sunday of each calendar quarter. The three and nine month periods ended October 1, 2017 and September 25, 2016 consisted of 14-week and 13-week periods and 40-week and 39-week periods, respectively. There are 53 calendar weeks in the fiscal year ending on December 31, 2017 and 52 calendar weeks in the fiscal year ended on December 25, 2016.
 
(d)    Accounting Estimates

There have been no significant changes in the Company’s accounting estimates for the three and nine months ended October 1, 2017 as compared to the accounting estimates described in the Form 10-K.

(e)    Accounting Standards Updates

In May 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2017-09 (“ASU 2017-09”), Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting. ASU 2017-09 was issued to provide guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. The amendments in this ASU are effective for annual periods beginning after December 15, 2017. The Company does not expect that the standard will have a material effect on its consolidated financial statements and will apply this guidance to applicable transactions after the adoption date.

In January 2017, the FASB issued ASU 2017-04 (“ASU 2017-04”), Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. ASU 2017-04 amends the guidance to simplify the subsequent measurement of goodwill by removing Step 2 of the goodwill impairment test. Instead, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value. ASU 2017-04 is effective for annual reporting periods beginning after December 15, 2019, with early adoption permitted. The Company is

6


currently evaluating the impact of the new guidance and timing of adoption, but does not expect that the standard will have a material impact on its consolidated financial statements.
    
In October 2016, the FASB issued ASU 2016-16 (“ASU 2016-16”), Income Taxes (Topic 740), Intra-Entity Transfers of Assets Other Than Inventory. ASU 2016-16 requires that entities recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs, rather than when the asset is sold to an outside party. ASU 2016-16 is effective for annual reporting periods beginning after December 15, 2017, including interim periods within those annual reporting periods. Early adoption is permitted as of the beginning of an annual reporting period (as of the first interim period if an entity issues interim financial statements). ASU 2016-16 requires adoption on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. The Company early adopted this standard on December 26, 2016. The adoption of this guidance did not have a material impact on the Company’s consolidated financial statements.
    
In August 2016, the FASB issued ASU 2016-15 (“ASU 2016-15”), Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. The objective of ASU 2016-15 is to reduce existing diversity in practice by addressing eight specific cash flow issues related to how certain cash receipts and cash payments are presented and classified in the statement of cash flows. ASU 2016-15 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted. If early adopted, an entity must adopt all of the amendments in the same period. The Company does not believe that the adoption of this guidance will have a material impact on its consolidated financial statements.

In February 2016, the FASB issued ASU 2016-02 (“ASU 2016-02”), Leases. ASU 2016-02 requires that lessees recognize assets and liabilities for the rights and obligations underlying leases with a lease term of more than one year. The amendments in this ASU are effective for annual periods beginning after December 15, 2018. Early adoption is permitted. The Company is currently evaluating the impact of the adoption of ASU 2016-02 on its consolidated financial statements.

In May 2014, the FASB issued ASU 2014-09 (“ASU 2014-09”), Revenue from Contracts with Customers. ASU 2014-09 establishes a broad principle that would require an entity to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The FASB has also issued several updates to ASU 2014-09. The new standard supersedes GAAP guidance on revenue recognition and requires the use of more estimates and judgments than the present standards. It also requires additional disclosures. ASU 2014-09 may be applied either retrospectively or through the use of a modified-retrospective method. The full retrospective method requires companies to recast each prior reporting period presented as if the new guidance had always existed. Under the modified retrospective method, companies would recognize the cumulative effect of initially applying the standard as an adjustment to the opening balance of retained earnings at the date of initial application. The Company plans to adopt the new revenue standard effective January 1, 2018, through the use of the modified-retrospective method.

The Company commenced a detailed analysis of the impact of ASU 2014-09 in 2016, by evaluating its impact on selected contracts at each of the Company’s business segments. With this baseline understanding, the Company developed a project plan to evaluate the contracts across all the business segments, spent significant effort in education of both management and other employees on the effects of the new guidance and assessed the internal control structure in order to adopt the ASU on January 1, 2018. ASU 2014-09 also requires expanded disclosure regarding the nature, timing, and uncertainty of revenue, cash flow and customer contract balances, including how and when performance obligations are satisfied and the relationship between revenue recognized and changes in contract balances during a reporting period. The Company has evaluated these disclosure requirements and is incorporating the collection of relevant data into its quarterly processes. The Company also designed and implemented specific controls based on the evaluation of the impact of ASU 2014-09, including the calculation of the cumulative effect of adopting ASU 2014-09. Although the Company does not expect significant changes to its accounting systems or controls upon adoption of ASU 2014-09, it has modified certain of its current controls to incorporate the revisions that it has made to its accounting policies and practices. The Company’s management has periodically briefed the Audit Committee on progress made towards adoption.

Based upon an assessment of material active contracts, the Company does not expect the impact on the results of operations or cash flows upon adoption or in the periods after adoption to be material. Under ASU 2014-09, revenue is recognized as control transfers to the customer. As such, revenue for the Company’s contracts will generally be recognized over time using the cost-to-cost method, which is consistent with the revenue recognition model currently in use for the majority of contracts. For those contracts where revenue is currently recognized as units are delivered, in most cases the accounting for those contracts will change under ASU 2014-09 such that revenue will be recognized as costs are incurred. This change will generally result in an acceleration of revenue as compared with the current revenue recognition method for those contracts.

7



The Company expects the cumulative effect of adopting ASU 2014-09 to result in an increase in revenue of less than $3 million and an increase in operating income of less than $2 million. These changes principally reflect the impact of converting contracts currently applying the units-of-delivery method to the cost-to-cost method of accounting. The Company will adopt the new revenue guidance effective January 1, 2018, by recognizing the cumulative effect of adoption as an increase in unbilled accounts receivable, a reduction in inventoried costs, an increase in advance payments and amounts in excess of costs incurred and a net decrease in accumulated deficit as of January 1, 2018. The Company will continue the evaluation of ASU 2014-09 (including how it may impact new contracts received as well as new or emerging interpretations of the standard) through the date of adoption.

(f)
Fair Value of Financial Instruments
 
The carrying amounts and the related estimated fair values of the Company’s long-term debt financial instruments not measured at fair value on a recurring basis at October 1, 2017 and December 25, 2016 are presented in Note 7. The carrying value of all other financial instruments, including cash equivalents, accounts receivable, accounts payable, accrued expenses, billings in excess of cost and earnings on uncompleted contracts, income taxes payable and short-term debt, approximated their estimated fair values at October 1, 2017 and December 25, 2016 due to the short-term nature of these instruments.


Note 2. Goodwill and Intangible Assets
 
(a)
Goodwill
 
The carrying amounts of goodwill as of October 1, 2017 and December 25, 2016 by reportable segment are as follows (in millions):
 
As of October 1, 2017
 
Kratos Government Solutions
 
Public Safety & Security
 
Unmanned Systems
 
Total
Gross value
$
567.7

 
$
53.9

 
$
111.1

 
$
732.7

Less accumulated impairment
215.3

 
18.3

 
13.8

 
247.4

Net
$
352.4

 
$
35.6

 
$
97.3

 
$
485.3



 
As of December 25, 2016
 
Kratos Government Solutions
 
Public Safety & Security
 
Unmanned Systems
 
Total
Gross value
567.8

 
53.9

 
111.1

 
732.8

Less accumulated impairment
215.3

 
18.3

 
13.8

 
247.4

Net
$
352.5

 
35.6

 
97.3

 
485.4




8


(b)    Purchased Intangible Assets
 
The following table sets forth information for finite-lived and indefinite-lived intangible assets (in millions):
 
 
As of October 1, 2017
 
As of December 25, 2016
 
Gross
Value
 
Accumulated
Amortization
 
Net
Value
 
Gross
Value
 
Accumulated
Amortization
 
Net
Value
Acquired finite-lived intangible assets:
 

 
 

 
 
 
 

 
 

 
 
Customer relationships
$
53.7

 
$
(48.9
)
 
$
4.8

 
$
53.7

 
$
(44.9
)
 
$
8.8

Contracts and backlog
30.8

 
(25.2
)
 
5.6

 
30.8

 
(23.7
)
 
7.1

Developed technology and technical know-how
25.0

 
(17.9
)
 
7.1

 
25.2

 
(15.7
)
 
9.5

Trade names
1.4

 
(1.3
)
 
0.1

 
1.4

 
(1.1
)
 
0.3

Total finite-lived intangible assets
110.9

 
(93.3
)
 
17.6

 
111.1

 
(85.4
)
 
25.7

Indefinite-lived trade names
6.9

 

 
6.9

 
6.9

 

 
6.9

Total intangible assets
$
117.8

 
$
(93.3
)
 
$
24.5

 
$
118.0

 
$
(85.4
)
 
$
32.6


Consolidated amortization expense related to intangible assets subject to amortization was $7.9 million and $7.9 million for the nine months ended October 1, 2017 and September 25, 2016, respectively.

Note 3. Inventoried Costs
 
Inventoried costs consisted of the following components (in millions):
 
 
October 1,
2017
 
December 25,
2016
Raw materials
$
33.0

 
$
31.9

Work in process
26.9

 
22.1

Finished goods
2.2

 
1.4

Supplies and other
2.0

 
1.8

Subtotal inventoried costs
64.1

 
57.2

Less: Customer advances and progress payments
(1.3
)
 
(1.8
)
Total inventoried costs
$
62.8

 
$
55.4

 


9


Note 4. Stockholders’ Equity
 
A summary of the changes in stockholders’ equity is provided below (in millions):
 
 
For the Nine Months Ended
 
October 1, 2017
 
September 25, 2016
Stockholders’ equity at beginning of period
$
276.4

 
$
254.2

Comprehensive loss:
 

 
 

Net loss
(20.5
)
 
(56.2
)
Change in cumulative translation adjustment
(0.1
)
 
(0.2
)
Total comprehensive loss
(20.6
)
 
(56.4
)
Exercise of stock options and warrants
0.4

 

Stock-based compensation
6.8

 
4.2

Issuance of common stock for cash
267.8

 

Issuance of common stock for employee stock purchase plan
3.1

 
2.6

Restricted stock units traded for taxes
(2.0
)
 
(0.5
)
Stockholders’ equity at end of period
$
531.9

 
$
204.1


The components of accumulated other comprehensive loss are as follows (in millions):

 
October 1, 2017
 
September 25, 2016
Cumulative translation adjustment
$
(1.2
)
 
$
(0.8
)
Post-retirement benefit reserve adjustment net of tax expense
(0.6
)
 
(0.8
)
Total accumulated other comprehensive loss
$
(1.8
)
 
$
(1.6
)

There were no reclassifications from accumulated other comprehensive loss to net loss for the nine months ended October 1, 2017 and September 25, 2016.

Common stock issued by the Company for the nine months ended October 1, 2017 and September 25, 2016 was as follows (in millions):
 
 
For the Nine Months Ended
 
October 1, 2017
 
September 25, 2016
Shares outstanding at beginning of the period
73.9

 
59.1

Stock issued for cash
28.0

 

Stock issued for employee stock purchase plan, stock options and restricted stock units exercised
1.4

 
1.4

Shares outstanding at end of the period
103.3

 
60.5

 
Note 5. Net Loss Per Common Share
 
The Company calculates net loss per share in accordance with FASB Accounting Standards Codification Topic 260, Earnings per Share (“Topic 260”). Under Topic 260, basic net loss per common share is calculated by dividing net loss by the weighted-average number of common shares outstanding during the reporting period. Diluted net loss per common share reflects the effects of potentially dilutive securities.

Shares from stock options and awards, excluded from the calculation of diluted net loss per share because their inclusion would have been anti-dilutive, were 0.1 million and 0.2 million for the three and nine months ended October 1, 2017, respectively, and 1.2 million and 1.4 million for the three and nine months ended September 25, 2016, respectively.
 

10



Note 6. Income Taxes
 
The reconciliation of the income tax benefit from continuing operations computed by applying the statutory federal income tax rate of 35% to loss from continuing operations before income taxes to the income tax provision for the three and nine months ended October 1, 2017 and September 25, 2016 was as follows (in millions):
 
 
For the Three Months Ended
 
For the Nine Months Ended
 
October 1,
2017
 
September 25,
2016
 
October 1,
2017
 
September 25,
2016
Income tax benefit at federal statutory rate
$
(1.4
)
 
$
(7.5
)
 
$
(5.9
)
 
$
(17.0
)
State and foreign taxes, net of federal tax benefit and valuation allowance
0.2

 
0.5

 
0.6

 
1.9

Nondeductible expenses and other
(0.5
)
 
0.1

 
0.5

 
0.8

Impact of deferred tax liabilities for indefinite-lived assets
(0.6
)
 
1.2

 
2.2

 
3.5

Increase in reserves for uncertain tax positions
0.6

 
0.2

 
0.7

 
1.9

Increase in federal valuation allowance
1.9

 
7.4

 
5.4

 
16.2

Total income tax provision
$
0.2

 
$
1.9

 
$
3.5

 
$
7.3


In assessing the Company’s ability to realize deferred tax assets, management considers, on a periodic basis, whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. As such, management has determined that it is appropriate to maintain a full valuation allowance against the Company’s U.S. federal, combined state and certain foreign deferred tax assets, with the exception of an amount equal to its deferred tax liabilities, which can be expected to reverse over a definite life.
Federal and state income tax laws impose restrictions on the utilization of net operating losses (“NOLs”) and tax credit carryforwards in the event that an “ownership change” occurs for tax purposes, as defined by Section 382 of the Internal Revenue Code of 1986, as amended (“Section 382”). In general, an ownership change occurs when shareholders owning 5% or more of a “loss corporation” (a corporation entitled to use NOLs or other loss carryovers) have increased their ownership of stock in such corporation by more than 50 percentage points during any three-year period. The annual base Section 382 limitation is calculated by multiplying the loss corporation’s value at the time of the ownership change by the greater of the long-term tax-exempt rate determined by the Internal Revenue Service in the month of the ownership change or the two preceding months. This base limitation is subject to adjustments, including an increase for built-in gains recognized in the five-year period after the ownership change.
In March 2010, an “ownership change” occurred that will limit the utilization of NOL carryforwards. In July 2011, another “ownership change” occurred. The March 2010 ownership change limitation is more restrictive. In prior years, the Company acquired corporations with NOL carryforwards at the date of acquisition (“Acquired NOLs”). The Acquired NOLs are subject to separate limitations that may further restrict the use of Acquired NOLs. As a result, the Company’s federal annual utilization of NOL carryforwards was limited to $27.0 million a year for the five years succeeding the March 2010 ownership change and $11.6 million for each year thereafter subject to separate limitations for Acquired NOLs. If the entire limitation amount is not utilized in a year, the excess can be carried forward and utilized in future years.
For the nine months ended October 1, 2017, such limitations did not impact the income tax provision, since the amount of taxable income did not exceed the annual limitation amount. However, future equity offerings or acquisitions that have equity as a component of the purchase price could also cause an “ownership change.” If and when any other “ownership change” occurs, utilization of the NOLs or other tax attributes may be further limited.
As discussed elsewhere, deferred tax assets relating to the NOLs and credit carryforwards are offset by a full valuation allowance. In addition, utilization of state tax loss carryforwards is dependent upon sufficient taxable income apportioned to the states.
The Company is subject to taxation in the U.S. and various state and foreign tax jurisdictions. The Company’s tax years for 2000 and later are subject to examination by the U.S. and state tax authorities due to the existence of the NOL carryforwards. Generally, the Company’s tax years for 2002 and later are subject to examination by various foreign tax authorities as well.

11


As of December 25, 2016, the Company had $18.6 million of unrecognized tax benefits that, if recognized, would impact the effective income tax rate, subject to possible offset by an increase in the deferred tax asset valuation allowance. During the nine months ended October 1, 2017, unrecognized tax benefits increased by $0.2 million relating to various current year and prior positions.

The Company recognizes interest and penalties related to unrecognized tax benefits in its provision for income taxes. For the nine months ended October 1, 2017 and September 25, 2016, a $0.4 million expense and $0.8 million expense, respectively, were recorded related to interest and penalties related to unrecognized tax benefits. For the nine months ended October 1, 2017 and September 25, 2016, there was no material benefit recorded related to the removal of interest and penalties. The Company believes that it is reasonably possible that as much as $1.0 million of the liabilities for uncertain tax positions will expire within twelve months of October 1, 2017 due to the expiration of various applicable statutes of limitation.

Note 7. Debt
 
(a)
Issuance of 7.00% Senior Secured Notes due 2019
 
In May 2014, the Company refinanced its $625.0 million of 10% Senior Secured Notes due in 2017 (the “10% Notes”) with $625.0 million of newly issued 7.00% Senior Secured Notes due in 2019 (the “7% Notes”). The net proceeds from the issuance of the 7% Notes was $618.5 million after an original issue discount of $6.5 million. The Company incurred debt issuance costs of $8.8 million associated with the 7% Notes. The Company utilized the net proceeds from the issuance of the 7% Notes, a $41.0 million draw on its Credit Agreement (as defined below), as well as cash from operations to extinguish the 10% Notes. The Company completed the offering of the 7% Notes in a private placement conducted pursuant to Rule 144A and Regulation S under the Securities Act of 1933, as amended (the “Act”). On October 16, 2014, the Company exchanged the outstanding 7% Notes for an equal amount of new 7.00% Senior Secured Notes due in 2019 (the “Notes”) that had been registered under the Act. The terms of the Notes issued in the exchange offer were identical in all material respects to the terms of the 7% Notes, except the Notes issued in the exchange offer had been registered under the Act.

The Notes are governed by an Indenture, dated May 14, 2014 (the “Indenture”), among the Company, certain of the Company’s subsidiaries (each, a “Subsidiary Guarantor” and together, the “Subsidiary Guarantors”) and Wilmington Trust, National Association, as Trustee and Collateral Agent. A Subsidiary Guarantor can be released from its Guarantee (as defined in the Indenture) (a) if all of the capital stock issued by such Subsidiary Guarantor or all or substantially all of the assets of such Subsidiary Guarantor are sold or otherwise disposed of; (b) if the Company designates such Subsidiary Guarantor as an Unrestricted Subsidiary (as defined in the Indenture); (c) if the Company exercises its legal defeasance option or its covenant defeasance option; or (d) upon satisfaction and discharge of the Indenture or payment in full in cash of the principal of, premium, if any, and accrued and unpaid interest on the Notes.

The holders of the Notes have a first priority lien on substantially all of the Company’s assets and the assets of the Subsidiary Guarantors, except with respect to accounts receivable, inventory, deposit accounts, securities accounts, cash, securities and general intangibles (other than intellectual property), on which the holders of the Notes have a second priority lien to the $110.0 million Credit Agreement.

The Company pays interest on the Notes semi-annually, in arrears, on May 15 and November 15 of each year.

The Notes include customary covenants and events of default as well as a consolidated fixed charge ratio of 2.0:1 for the incurrence of additional indebtedness. Negative covenants include, among other things, limitations on additional debt, liens, negative pledges, investments, dividends, stock repurchases, asset sales and affiliate transactions. Events of default include, among other events, non-performance of covenants, breach of representations, cross-default to other material debt, bankruptcy, insolvency, material judgments and changes in control. As of October 1, 2017, the Company was in compliance with the covenants contained in the Indenture governing the Notes.

The Company may redeem some or all of the Notes at 102.625% of the aggregate principal amount of such Notes if redeemed on or before May 15, 2018 and 100% of the aggregate principal amount of such Notes if redeemed on or after May 16, 2018, plus accrued and unpaid interest to the date of redemption.

The terms of the Indenture require that the net cash proceeds from asset dispositions be utilized to (i) repay or prepay amounts outstanding under the Credit Agreement unless such amounts are reinvested in similar collateral, (ii) make an investment in assets that replace the collateral of the Notes or (iii) a combination of both clauses (i) and (ii). To the extent there

12


are any remaining net proceeds from the asset disposition after application of clauses (i) and (ii), such amounts are required to be utilized to repurchase Notes at par after 360 days following the asset disposition.

Following the sale of its U.S. and U.K. Electronic Products Divisions (the “Herley Entities”) the Company paid down $41.0 million outstanding under the Credit Agreement and repurchased $175.0 million of the Notes at par, in accordance with the terms of the Indenture. The total reacquisition price of the Notes was $178.4 million including the write off of $1.8 million of unamortized issue costs, $1.4 million of unamortized discount, along with $0.2 million of legal fees, which resulted in a loss on extinguishment of debt of $3.4 million.

The Company reinvested all net proceeds remaining after the repurchase of the $175.0 million of Notes in replacement collateral in accordance with the terms of the Indenture within 360 days following the asset disposition, in accordance with the terms of the Indenture.

During the quarter ended December 25, 2016, the Company repurchased and extinguished $14.5 million of the outstanding Notes, which resulted in a gain of $0.4 million offset by $0.1 million of unamortized issuance cost and $0.1 million of unamortized discount resulting in a gain on extinguishment of debt of $0.2 million.

During the quarter ended March 26, 2017, the Company repurchased and extinguished $62.7 million of the outstanding Notes, which resulted in a loss of $1.4 million and the realization of $0.4 million of unamortized issuance cost and $0.3 million of unamortized discount resulting in a loss on extinguishment of debt of $2.1 million.

As of October 1, 2017, there was $372.8 million in Notes outstanding.

(b)    Other Indebtedness
 
$110.0 Million Credit Agreement

On May 14, 2014, the Company entered into a $110.0 million Credit and Security Agreement, dated May 14, 2014 (the “Credit Agreement”), with the lenders from time to time party thereto, SunTrust Bank, as Agent (the “Agent”), PNC Bank, National Association, as Joint Lead Arranger and Documentation Agent, and SunTrust Robinson Humphrey, Inc., as Joint Lead Arranger and Sole Book Runner. The Credit Agreement established a five-year senior secured revolving credit facility in the maximum amount of $110.0 million (subject to a potential increase of the maximum principal amount to $135.0 million, subject to the Agent’s and applicable lenders’ approval as described therein), consisting of a subline for letters of credit in an amount not to exceed $50.0 million, as well as a swingline loan in an aggregate principal amount at any time outstanding not to exceed $10.0 million. The obligations under the Credit Agreement are secured by (i) a first priority lien on the Company’s accounts receivable, inventory, deposit accounts, securities accounts, cash, securities and general intangibles (other than intellectual property) and (ii) a second priority lien, junior to the lien securing the Notes, on all of the Company’s other assets.

The Credit Agreement contains certain covenants, which include, but are not limited to, restrictions on indebtedness, liens, and investments, and limits on other various payments, as well as a financial covenant relating to a minimum fixed charge coverage ratio of 1.15:1 (as modified per the Third Amendment and the Fourth Amendment, as defined and discussed below). Events of default under the terms of the Credit Agreement include, but are not limited to: failure of the Company to pay any principal of any loans in full when due and payable; failure of the Company to pay any interest on any loan or any fee or other amount payable under the Credit Agreement within three business days after the date when due and payable; failure of the Company or any of its subsidiaries to comply with certain covenants and agreements, subject to applicable grace periods and/or notice requirements; any representation, warranty or statement made in or pursuant to the Credit Agreement or any related writing or any other material information furnished by the Company or any of its subsidiaries to the Agent or the lenders proving to be false or erroneous; and the occurrence of an event or condition having or reasonably likely to have a material adverse effect, which includes a material adverse effect on the business, operations, condition (financial or otherwise) or prospects of the Company or the ability of the Company to repay its obligations. Where an event of default arises from certain bankruptcy events, the commitments will automatically and immediately terminate and the principal of, and interest then outstanding on, all of the loans will become immediately due and payable. Subject to certain notice requirements and other conditions, upon the occurrence of an event of default, including the occurrence of a condition having or reasonably likely to have a material adverse effect, commitments may be terminated and the principal of, and interest then outstanding on, all of the loans may become immediately due and payable. At October 1, 2017, no event of default had occurred and the Company believes that events or conditions having a material adverse effect, giving rise to an acceleration of any amounts outstanding under the Credit Agreement, have not occurred and the likelihood of such events or conditions occurring is remote.

Borrowings under the Credit Agreement may take the form of a base rate revolving loan, Eurodollar revolving loan or

13


swingline loan. Base rate revolving loans and swingline loans will bear interest at a rate per annum equal to the sum of the applicable margin from time to time in effect plus the highest of (i) the Agent’s prime lending rate, as in effect at such time, (ii) the federal funds rate, as in effect at such time, plus 0.50% per annum, and (iii) the adjusted London Interbank Offered Rate (“LIBOR”) determined at such time for an interest period of one month, plus 1.00% per annum. Eurodollar revolving loans will bear interest at a rate per annum equal to the sum of the applicable margin from time to time in effect plus the adjusted LIBOR. The applicable margin varies between 1.50% and 2.00% for base rate revolving loans and swingline loans and 2.50% and 3.00% for Eurodollar loans, and is based on several factors including the Company’s then-existing borrowing base and the lender’s total commitment amount and revolving credit exposure. The calculation of the Company’s borrowing base takes into account several items relating to the Company and its subsidiaries, including, without limitation, amounts due and owing under billed and unbilled accounts receivables, then-held eligible raw materials inventory, work-in-process inventory, and applicable reserves.

On May 31, 2015, the Company entered into a third amendment (the “Third Amendment”) to the Credit Agreement. Under the terms of the Third Amendment, the definitions of certain terms of the Credit Agreement were modified, the disposition of the Herley Entities was approved by the lenders, a minimum $175.0 million repurchase of the Notes by the Company was required, and the payment in full of the outstanding balance of the Credit Agreement was required. Additionally, the measurement of the fixed charge coverage ratio of 1.15:1 was modified as follows: (i) the fixed charge coverage ratio will not be measured as of the end of any quarterly reporting period ending after June 30, 2015, if on such date (a) there are no outstanding revolving loans or swingline loans and (b) the aggregate amount outstanding under letters of credit is less than or equal to $17.0 million, and (ii) as to any subsequent quarterly reporting period ending after June 30, 2015, and not covered by clause (i) above, a fixed charge coverage ratio of at least 1.05:1 must be maintained if the percentage of (a) outstanding revolving loans plus the sum of the outstanding swingline loans and outstanding letters of credit that are in excess of $17.0 million, to (b) the revolving credit commitment, minus the Herley Disposition Proceeds Reinvestment Reserve (as defined below) is greater than 0.00% but less than 15.00% or a fixed charge coverage ratio of at least 1.10:1 must be maintained if the aforementioned percentage is equal to or greater than 15.00% but less than 25.00%. In all other instances, a fixed charge coverage ratio of at least 1.15:1 must be maintained. For purposes of computing the fixed charge coverage ratio, the associated reduction in consolidated interest expense in connection with the repurchase of Notes with proceeds from the sale of the Herley Entities shall be deemed to have occurred on the first day of the most recently completed four quarterly reporting periods prior to the sale.

The terms of the Third Amendment also included the establishment of a reserve (the “Herley Disposition Proceeds Reinvestment Reserve”) that reduced the maximum $110.0 million total borrowing base on the Credit Agreement. With the sale of the Herley Entities, a $50.8 million reserve was established based upon the collateral carrying value under the Credit Agreement of the Herley Entities disposed. The reserve and therefore the maximum borrowing base were adjusted monthly for the subsequent cumulative reinvestment in similar collateral assets over a period not to have exceeded 360 days from the date of sale of the Herley Entities. As of October 1, 2017, there was no reserve on the maximum borrowings, resulting from a cumulative reinvestment in similar collateral assets since the sale of the Herley Entities in excess of the $50.8 million reserve established at the date of the sale of the Herley Entities. The Company made investments in assets that replaced the collateral, which reinstated the maximum facility to the full $110.0 million as of the end of the first quarter of 2016.

On August 20, 2015, the Company entered into a fourth amendment (the “Fourth Amendment”) to the Credit Agreement. Among other things, the Fourth Amendment provides for a modification of the Third Amendment as it relates to when the minimum fixed charge coverage ratio will be measured based upon the Company’s outstanding borrowings. Outstanding borrowings for purposes of computing the applicable minimum fixed charge coverage ratio exclude any letter of credit exposure outstanding of $17.0 million plus the amount of letters of credit outstanding for the divested Herley Entities for which a cash deposit has been placed in escrow by the buyer to cover the amount of such outstanding letters of credit, should the letters of credit be pulled.

As of October 1, 2017, there were no borrowings outstanding on the Credit Agreement and $9.2 million outstanding on letters of credit, resulting in net borrowing base availability of $68.7 million. The Company was in compliance with the financial covenants of the Credit Agreement and its amendments as of October 1, 2017.

Debt Acquired in Acquisition
 
The Company has a $10.0 million ten-year term loan with a bank in Israel entered into on September 16, 2008 in connection with the acquisition of one of its wholly owned subsidiaries. The balance under the term loan as of October 1, 2017 was $1.0 million, and the loan is payable in quarterly installments of $0.3 million plus interest at LIBOR plus a margin of 1.5%. The loan agreement governing the term loan contains various covenants, including a minimum net equity covenant as defined in the loan agreement. The Company was in compliance with all covenants contained in this loan agreement as of October 1, 2017.

14



Fair Value of Long-term Debt
 
Carrying amounts and the related estimated fair values of the Company’s long-term debt financial instruments not measured at fair value on a recurring basis at October 1, 2017 and December 25, 2016 are presented in the following table:
 
 
 
As of October 1, 2017
 
As of December 25, 2016
$ in millions
 
Principal
 
Carrying
Amount
 
Fair Value
 
Principal
 
Carrying
Amount
 
Fair Value
Total long-term debt including current portion
 
$
373.8

 
$
370.7

 
$
383.1

 
$
437.3

 
$
432.0

 
$
423.6

 
The fair value of the Company’s long-term debt was based upon actual trading activity (Level 1, Observable inputs -quoted prices in active markets).

 As of October 1, 2017, the difference between the carrying amount of $370.7 million and the principal amount of $373.8 million presented in the table above is the net unamortized original issue discount of $1.4 million and the unamortized debt issuance costs of $1.7 million, which are being accreted to interest expense over the term of the related debt. As of December 25, 2016, the difference between the carrying amount of $432.0 million and the principal amount of $437.3 million presented in the previous table is the net unamortized original issue discount of $2.4 million and the unamortized debt issuance costs of $2.9 million, which are being accreted to interest expense over the term of the related debt.

Note 8. Segment Information
 
The Company operates in three reportable segments. The Kratos Government Solutions (“KGS”) reportable segment is comprised of an aggregation of KGS operating segments, including the microwave electronic products, satellite communications, modular systems and defense and rocket support operating segments. The Unmanned Systems (“US”) reportable segment consists of its unmanned aerial system and unmanned ground and seaborne system businesses. The KGS and US reportable segments provide products, solutions and services for mission critical national security programs. KGS and US customers primarily include national security related agencies, the U.S. Department of Defense (the “DoD”), intelligence agencies and classified agencies, and to a lesser degree, international government agencies and domestic and international commercial customers. The Public Safety & Security (“PSS”) reportable segment provides independent integrated solutions for advanced homeland security, public safety, critical infrastructure, and security and surveillance systems for government and commercial applications. PSS customers include those in the critical infrastructure, power generation, power transport, nuclear energy, financial, IT, healthcare, education, transportation and petro-chemical industries, as well as certain government customers.

The Company organizes its reportable segments based on the nature of the products, solutions and services offered. Transactions between segments are generally negotiated and accounted for under terms and conditions similar to other government and commercial contracts. This presentation is consistent with the Company’s operating structure. In the following table, total operating income (loss) from continuing operations of the reportable business segments is reconciled to the corresponding consolidated amount. The reconciling item “unallocated corporate expense, net” includes costs for certain stock-based compensation programs (including stock-based compensation costs for stock options, employee stock purchase plan and restricted stock units), the effects of items not considered part of management’s evaluation of segment operating performance, merger and acquisition expenses, corporate costs not allocated to the segments, and other miscellaneous corporate activities.

During the nine months ended September 25, 2016, the PSS reportable segment recorded a $1.9 million charge related to a litigation settlement of a contract dispute and the KGS reportable segment recorded a $7.8 million charge as a result of the decision to close one of its manufacturing facilities and exit certain lower margin product business lines. The operating loss for the US segment for the three and nine months ended September 25, 2016 includes an $18.7 million loss accrual recorded on the Low Cost Attritable Unmanned Aerial System Demonstration cost share contract awarded in July 2016.


15


 Revenues, depreciation and amortization, and operating income (loss) generated by the Company’s reportable segments for the three and nine month periods ended October 1, 2017 and September 25, 2016 are as follows (in millions):
 
 
Three Months Ended
 
Nine Months Ended
 
October 1, 2017
 
September 25, 2016
 
October 1, 2017
 
September 25, 2016
Revenues:
 

 
 
 
 
 
 
Kratos Government Solutions
 
 
 
 
 
 
 
Service revenues
$
47.5

 
$
52.9

 
$
149.4

 
$
163.1

Product sales
67.9

 
59.9

 
207.0

 
178.3

Total Kratos Government Solutions
115.4

 
112.8

 
356.4

 
341.4

Public Safety & Security
 
 
 
 
 
 
 
Service revenues
39.2

 
34.3

 
113.9

 
94.9

Product sales

 

 

 

Total Public Safety & Security
39.2

 
34.3

 
113.9

 
94.9

Unmanned Systems
 
 
 
 
 
 
 
Service revenues

 

 

 

Product sales
41.6

 
18.3

 
79.4

 
50.3

Total Unmanned Systems
41.6

 
18.3

 
79.4

 
50.3

Total revenues
$
196.2

 
$
165.4

 
$
549.7

 
$
486.6

Depreciation & amortization:
 
 
 
 
 
 
 
Kratos Government Solutions
$
3.5

 
$
3.6

 
$
10.7

 
$
11.3

Public Safety & Security
0.1

 
0.1

 
0.3

 
0.4

Unmanned Systems
2.4

 
1.9

 
6.0

 
5.6

Total depreciation and amortization
$
6.0

 
$
5.6

 
$
17.0

 
$
17.3

Operating income (loss) from continuing operations:
 

 
 

 
 
 
 
Kratos Government Solutions
$
1.7

 
$
7.7

 
$
17.0

 
$
10.4

Public Safety & Security
2.5

 
0.8

 
2.8

 
(1.7
)
Unmanned Systems
1.7

 
(20.4
)
 
(5.1
)
 
(27.6
)
Unallocated corporate expense, net
(2.8
)
 
(1.1
)
 
(7.3
)
 
(4.3
)
Total operating income (loss) from continuing operations
$
3.1

 
$
(13.0
)
 
$
7.4

 
$
(23.2
)


16


Note 9. Significant Customers
 
Revenue from the U.S. Government, which includes foreign military sales, includes revenue from contracts for which the Company is the prime contractor as well as those for which the Company is a subcontractor and the ultimate customer is the U.S. Government. The KGS and US segments have substantial revenue from the U.S. Government. Sales to the U.S. Government amounted to approximately $118.2 million and $95.4 million, or 60% and 58% of total revenue, for the three months ended October 1, 2017 and September 25, 2016, respectively, and $325.9 million and $293.6 million, or 59% and 60% of total revenue, for the nine months ended October 1, 2017 and September 25, 2016, respectively.
 
Note 10. Commitments and Contingencies
 
In addition to commitments and obligations in the ordinary course of business, the Company is subject to various claims, pending and potential legal actions for damages, investigations relating to governmental laws and regulations and other matters arising out of the normal conduct of the Company’s business. The Company assesses contingencies to determine the degree of probability and range of possible loss for potential accrual in its condensed consolidated financial statements. An estimated loss contingency is accrued in the Company’s condensed consolidated financial statements if it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Because litigation is inherently unpredictable and unfavorable resolutions could occur, assessing litigation contingencies is highly subjective and requires judgments about future events. When evaluating contingencies, the Company may be unable to provide a meaningful estimate due to a number of factors, including but not limited to the procedural status of the matter in question, the presence of complex or novel legal theories, and the ongoing discovery and development of information important to the matters. In addition, damage amounts claimed in litigation against it may be unsupported, exaggerated or unrelated to possible outcomes and, as such, are not meaningful indicators of its potential liability. The Company regularly reviews contingencies to determine the adequacy of its accruals and related disclosures. The amount of ultimate loss may differ from these estimates. It is possible that cash flows or results of operations could be materially affected in any particular period by the unfavorable resolution of one or more of these contingencies. Whether any losses finally determined in any claim, action, investigation or proceeding could reasonably have a material effect on the Company’s business, financial condition, results of operations or cash flows will depend on a number of variables, including the timing and amount of such losses; the structure and type of any remedies; the monetary significance any such losses, damages or remedies may have on the Company’s condensed consolidated financial statements; and the unique facts and circumstances of the particular matter that may give rise to additional factors.

Legal and Regulatory Matters
U.S. Government Cost Claims.

The Company’s contracts with the DoD are subject to audit by the Defense Contract Audit Agency (“DCAA”). As a result of these audits, from time to time the Company is advised of claims concerning potential disallowed, overstated or disputed costs. For example, during the course of recent audits of the Company’s contracts, the DCAA is closely examining and questioning certain of the established and disclosed practices that it had previously audited and accepted. The Company’s personnel regularly scrutinizes costs incurred and allocated to contracts with the U.S. Government for compliance with regulatory standards. On July 28, 2015, the Company received a determination letter from the Defense Contract Management Agency (“DCMA”) regarding what the DCMA believed were certain unallowable costs for one of the Company’s subsidiaries with respect to fiscal year 2007. In April 2016, the Company reached an agreement with the DCAA to settle matters related to unallowable costs for this subsidiary for fiscal years 2007 and 2008 for approximately $0.2 million. For those Company subsidiaries and fiscal years which have not yet been audited by the DCAA or for those audits which are in process which have not been completed by the DCAA, the Company cannot reasonably estimate the range of loss, if any, that may result from audits and reviews in which it is currently involved given the inherent difficulty in predicting regulatory action, fines and penalties, if any, and the various remedies and levels of judicial review available to the Company in the event of an adverse finding. As a result, the Company has not recorded any liability related to these matters.

Other Litigation Matters.

The Company is subject to normal and routine litigation arising from the ordinary course and conduct of business and, at times, as a result of acquisitions and dispositions. Such disputes include, for example, commercial, employment, intellectual property, environmental and securities matters. The aggregate amounts accrued related to these matters are not material to the total liabilities of the Company. The Company intends to defend itself in any such matters and does not currently believe that the outcome of any such matters will have a material adverse impact on the Company’s financial condition, results of

17


operations or cash flows. During the nine months ended September 25, 2016, the Company recorded a charge of $1.9 million related to a litigation settlement of a contract dispute in the PSS segment.

Note 11. Condensed Consolidating Financial Statements

The Company has $372.8 million in outstanding Notes (see Note 7). The Notes are guaranteed by the Subsidiary Guarantors and are collateralized by the assets of all of the Company’s 100% owned subsidiaries. The Notes are fully and unconditionally guaranteed on a joint and several basis by each Subsidiary Guarantor and the Company. There are no contractual restrictions with respect to the Notes limiting cash transfers from Subsidiary Guarantors by dividends, loans or advances to the Company. The Notes are not guaranteed by the Company’s foreign subsidiaries (the “Non-Guarantor Subsidiaries”).

The following tables present condensed consolidating financial statements for the parent company, the Subsidiary Guarantors and the Non-Guarantor Subsidiaries, respectively. The condensed consolidating financial information below follows the same accounting policies as described in the condensed consolidated financial statements, except for the use of the equity method of accounting to reflect ownership interests in 100% owned subsidiaries, which are eliminated upon consolidation.


18



Condensed Consolidating Balance Sheet
October 1, 2017
(Unaudited)
(in millions)
 
Parent Company
 
Subsidiary Guarantors on a Combined Basis
 
Non-Guarantors on a Combined Basis
 
Eliminations
 
Consolidated
Assets
 
 
 
 
 
 
 
 
 
Current Assets:
 
 
 
 
 
 
 
 
 
  Cash and cash equivalents
$
233.0

 
$
(2.2
)
 
$
8.4

 
$

 
$
239.2

  Accounts receivable, net

 
220.4

 
23.8

 

 
244.2

  Amounts due from affiliated companies
227.6

 

 

 
(227.6
)
 

  Inventoried costs

 
42.6

 
20.2

 

 
62.8

  Other current assets
3.6

 
14.3

 
3.7

 

 
21.6

    Total current assets
464.2

 
275.1

 
56.1

 
(227.6
)
 
567.8

Property, plant and equipment, net
1.9

 
47.9

 
6.9

 

 
56.7

Goodwill

 
442.6

 
42.7

 

 
485.3

Intangible assets, net

 
17.9

 
6.6

 

 
24.5

Investment in subsidiaries
469.2

 
67.9

 

 
(537.1
)
 

Other assets
0.4

 
8.0

 

 

 
8.4

    Total assets
$
935.7

 
$
859.4

 
$
112.3

 
$
(764.7
)
 
$
1,142.7

Liabilities and Stockholders Equity
 
 
 
 
 
 
 
 
 
Current liabilities:
 
 
 
 
 
 
 
 
 
Accounts payable
$
1.9

 
$
43.0

 
$
5.7

 
$

 
$
50.6

Accrued expenses
12.3

 
36.9

 
2.6

 

 
51.8

Accrued compensation
3.5

 
27.1

 
3.1

 

 
33.7

Billings in excess of costs and earnings on uncompleted contracts

 
47.5

 
3.6

 

 
51.1

Amounts due to affiliated companies

 
198.5

 
29.1

 
(227.6
)
 

Other current liabilities
0.6

 
5.2

 
4.7

 

 
10.5

Current liabilities of discontinued operations
1.0

 

 
0.1

 

 
1.1

    Total current liabilities
19.3

 
358.2

 
48.9

 
(227.6
)
 
198.8

Long-term debt, net of current portion
369.7

 

 

 

 
369.7

Other long-term liabilities
11.0

 
20.0

 
7.5

 

 
38.5

Non-current liabilities of discontinued operations
3.8

 

 

 

 
3.8

    Total liabilities
403.8

 
378.2

 
56.4

 
(227.6
)
 
610.8

Total stockholders equity
531.9

 
481.2

 
55.9

 
(537.1
)
 
531.9

    Total liabilities and stockholders equity
$
935.7

 
$
859.4

 
$
112.3

 
$
(764.7
)
 
$
1,142.7


19



Condensed Consolidating Balance Sheet
December 25, 2016
(Unaudited)
(in millions)

 
Parent Company
 
Subsidiary Guarantors on a Combined Basis
 
Non-Guarantors on a Combined Basis
 
Eliminations
 
Consolidated
Assets
 
 
 
 
 
 
 
 
 
Current Assets:
 
 
 
 
 
 
 
 
 
  Cash and cash equivalents
$
67.2

 
$
(3.3
)
 
$
5.2

 
$

 
$
69.1

  Accounts receivable, net

 
197.9

 
31.5

 

 
229.4

  Amounts due from affiliated companies
204.6

 

 

 
(204.6
)
 

  Inventoried costs

 
37.2

 
18.2

 

 
55.4

  Other current assets
6.3

 
11.6

 
1.3

 

 
19.2

    Total current assets
278.1

 
243.4

 
56.2

 
(204.6
)
 
373.1

Property, plant and equipment, net
1.6

 
41.7

 
6.5

 

 
49.8

Goodwill

 
442.5

 
42.9

 

 
485.4

Intangible assets, net

 
24.5

 
8.1

 

 
32.6

Investment in subsidiaries
458.0

 
67.5

 

 
(525.5
)
 

Other assets
0.4

 
7.3

 

 

 
7.7

    Total assets
$
738.1

 
$
826.9

 
$
113.7

 
$
(730.1
)
 
$
948.6

Liabilities and Stockholders Equity
 
 
 
 
 
 
 
 
 
Current liabilities:
 
 
 
 
 
 
 
 
 
  Accounts payable
$
4.5

 
$
43.7

 
$
4.5

 
$

 
$
52.7

  Accrued expenses
5.6

 
44.5

 
3.5

 

 
53.6

  Accrued compensation
4.0

 
31.2

 
3.9

 

 
39.1

Billings in excess of costs and earnings on uncompleted contracts

 
38.9

 
2.9

 

 
41.8

  Amounts due to affiliated companies

 
174.6

 
30.0

 
(204.6
)
 

  Other current liabilities
1.4

 
4.1

 
2.2

 

 
7.7

Current liabilities of discontinued operations
1.5

 

 
0.1

 

 
1.6

    Total current liabilities
17.0

 
337.0

 
47.1

 
(204.6
)
 
196.5

Long-term debt, net of current portion
430.2

 

 
0.8

 

 
431.0

Other long-term liabilities
10.8

 
19.9

 
10.3

 

 
41.0

Non-current liabilities of discontinued operations
3.7

 

 

 

 
3.7

    Total liabilities
461.7

 
356.9

 
58.2

 
(204.6
)
 
672.2

 Total stockholders equity
276.4

 
470.0

 
55.5

 
(525.5
)
 
276.4

    Total liabilities and stockholders equity
$
738.1

 
$
826.9

 
$
113.7

 
$
(730.1
)
 
$
948.6



20



Condensed Consolidating Statement of Operations and Comprehensive Income (Loss)
Three Months Ended October 1, 2017
(Unaudited)
(in millions)
 
Parent Company
 
Subsidiary Guarantors on a Combined Basis
 
Non-Guarantors on a Combined Basis
 
Eliminations
 
Consolidated
Service revenues
$

 
$
84.8

 
$
1.9

 
$

 
$
86.7

Product sales

 
99.3

 
15.0

 
(4.8
)
 
109.5

  Total revenues

 
184.1

 
16.9

 
(4.8
)
 
196.2

Cost of service revenues

 
59.7

 
1.1

 

 
60.8

Cost of product sales

 
80.2

 
11.9

 
(4.8
)
 
87.3

  Total costs

 
139.9

 
13.0

 
(4.8
)
 
148.1

  Gross profit

 
44.2

 
3.9

 

 
48.1

Selling, general and administrative expenses
2.3

 
35.3

 
3.2

 

 
40.8

Research and development expenses

 
4.2

 

 

 
4.2

  Operating income (loss) from continuing operations
(2.3
)
 
4.7

 
0.7

 

 
3.1

Other income (expense):
 
 
 
 
 
 
 
 
 
  Interest income (expense), net
(7.7
)
 

 

 

 
(7.7
)
  Other income (expense), net

 
0.1

 
0.5

 

 
0.6

  Total other income (expense), net
(7.7
)
 
0.1

 
0.5

 

 
(7.1
)
Income (loss) from continuing operations before income taxes
(10.0
)
 
4.8

 
1.2

 

 
(4.0
)
Provision (benefit) for income taxes from continuing operations
0.3

 
(0.1
)
 

 

 
0.2

Income (loss) from continuing operations
(10.3
)
 
4.9

 
1.2

 

 
(4.2
)
Loss from discontinued operations
(0.1
)
 

 

 

 
(0.1
)
Equity in net income (loss) of subsidiaries
6.1

 
1.2

 

 
(7.3
)
 

Net income (loss)
$
(4.3
)
 
$
6.1

 
$
1.2

 
$
(7.3
)
 
$
(4.3
)
Comprehensive income (loss)
$
(4.5
)
 
$
6.1

 
$
1.0

 
$
(7.1
)
 
$
(4.5
)


21



Condensed Consolidating Statement of Operations and Comprehensive Income (Loss)
Three Months Ended September 25, 2016
(Unaudited)
(in millions)
 
Parent Company
 
Subsidiary Guarantors on a Combined Basis
 
Non-Guarantors on a Combined Basis
 
Eliminations
 
Consolidated
Service revenues
$

 
$
84.3

 
$
2.9

 
$

 
$
87.2

Product sales

 
67.8

 
12.4

 
(2.0
)
 
78.2

  Total revenues

 
152.1

 
15.3

 
(2.0
)
 
165.4

Cost of service revenues

 
62.9

 
1.8

 

 
64.7

Cost of product sales

 
67.7

 
9.1

 
(2.0
)
 
74.8

  Total costs

 
130.6

 
10.9

 
(2.0
)
 
139.5

  Gross profit

 
21.5

 
4.4

 

 
25.9

Selling, general and administrative expenses
0.2

 
33.3

 
2.2

 

 
35.7

Research and development expenses

 
3.1

 
0.1

 

 
3.2

  Operating income (loss) from continuing operations
(0.2
)
 
(14.9
)
 
2.1

 

 
(13.0
)
Other income (expense):
 
 
 
 
 
 
 
 
 
  Interest expense, net
(8.7
)
 

 

 

 
(8.7
)
  Other income (expense), net

 
0.1

 

 

 
0.1

  Total other income (expense), net
(8.7
)
 
0.1

 

 

 
(8.6
)
Income (loss) from continuing operations before income taxes
(8.9
)
 
(14.8
)
 
2.1

 

 
(21.6
)
Provision for income taxes from continuing operations
0.1

 
1.7

 
0.1

 

 
1.9

Income (loss) from continuing operations
(9.0
)
 
(16.5
)
 
2.0

 

 
(23.5
)
Loss from discontinued operations

 
(0.1
)
 

 

 
(0.1
)
Equity in net income (loss) of subsidiaries
(14.6
)
 
2.0

 

 
12.6

 

Net income (loss)
$
(23.6
)
 
$
(14.6
)
 
$
2.0

 
$
12.6

 
$
(23.6
)
Comprehensive income (loss)
$
(23.7
)
 
$
(14.6
)
 
$
1.9

 
$
12.7

 
$
(23.7
)


22


 
 
 
 
 
 
 
 
 
 
Condensed Consolidating Statement of Operations and Comprehensive Income (Loss)
Nine Months Ended October 1, 2017
(Unaudited)
(in millions)
 
Parent Company
 
Subsidiary Guarantors on a Combined Basis
 
Non-Guarantors on a Combined Basis
 
Eliminations
 
Consolidated
Service revenues
$

 
$
253.5

 
$
9.8

 
$

 
$
263.3

Product sales

 
256.6

 
40.8

 
(11.0
)
 
286.4

Total revenues

 
510.1

 
50.6

 
(11.0
)
 
549.7

Cost of service revenues

 
182.3

 
7.3

 

 
189.6

Cost of product sales

 
197.2

 
33.3

 
(11.0
)
 
219.5

Total costs

 
379.5

 
40.6

 
(11.0
)
 
409.1

Gross profit

 
130.6

 
10.0

 

 
140.6

Selling, general and administrative expenses
5.8

 
105.4

 
9.3

 

 
120.5

Research and development expenses

 
11.9

 
0.8

 

 
12.7

  Operating income (loss) from continuing operations
(5.8
)
 
13.3

 
(0.1