2019 Annual Report
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Kratos Defense & Security Solutions
10680 Treena Street
Suite 600
San Diego, CA 92131
Phone: 858.812.7300
Fax: 858.812.7301
www.KratosDefense.com
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Turbine Technologies
Missile Defense
Unmanned Aerial Systems
Space Situational Awareness
Satellite C2
Officers
Eric DeMarco
Directors
Scott Anderson
Corporate Headquarters
Kratos Defense & Security Solutions, Inc.
President and Chief Executive Officer
President and Chief Executive Officer
10680 Treena Street, Suite 600
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Microwave Electronics
President, Technology & Training Solutions
Principal
President, Defense & Rocket Support
Senior Financial Executive (Ret.)
Corporate Communications/
Services
Titan Corporation
Investor Relations
Jane Judd
Corporate Contact Information
Unmanned Ground Systems
Directed Energy Systems
Kratos develops transformative, affordable technology
for the Department of Defense and is changing
the way breakthrough technologies are brought
to the defense industry.
NE Wireless Networks, LLC
Eric DeMarco
President and Chief Executive Officer
Kratos Defense & Security Solutions, Inc.
San Diego, CA 92131
Phone. 858.812.7300
Fax: 858.812.7301
William Hoglund
Chairman of the Kratos Board
Safeboats International, LLP
Scot Jarvis
Cedar Grove Partners, LLC
External Legal Counsel
Paul Hastings, LLP
4747 Executive Drive, 12th Floor
San Diego, CA 92121
Independent Accountants
Deloitte & Touche, LLP
655 W. Broadway, Suite 700
San Diego, CA 92101
Sam Liberatore
Senior Vice President (Ret.)
Madison Research Division
Amy Zegart
Kratos Defense & Security Solutions, Inc.
Corporate Headquarters
Toll Free: 877.934.4687
Corporate News Releases, SEC Forms
including 10-K and 10-Q, and other
Senior Fellow, The Hoover Institution
information may be found at:
Stanford University
www.KratosDefense.com
Registrar/Transfer Agent
EQ
1110 Center Pointe Curve, Suite 101
Mendota Heights, MN 55120
COPYRIGHT 2020. All rights reserved. Kratos is a
registered trademark of Kratos Defense & Security
Solutions, Inc. Certain other product names, brand
names and company names may be trademarks or
designations of their respective owners.
Deanna Lund
Executive Vice President and
Chief Financial Officer
Jonah Adelman
Senior Vice President
President, Microwave Electronics
Phil Carrai
Senior Vice President
Dave Carter
Senior Vice President
Steve Fendley
Senior Vice President
President, Unmanned Systems
Thomas Mills
Senior Vice President
President, C5ISR
Stacey Rock
Senior Vice President
Ben Goodwin
Senior Vice President
Corporate Development & Government
Affairs
Maria Cervantes de Burgreen
Vice President and Corporate Controller
Marie Mendoza
Vice President and General Counsel
President, Turbine Technologies
Shareowner Services
Kratos Defense & Security Solutions, Inc. is traded on the Nasdaq Global Select Market Exchange under the stock ticker: KTOS
10-K
Letter to the Stockholders
31MAR201623065051
To Kratos Stockholders,
Kratos completed 2019 accomplishing substantially all of the major objectives we set out to achieve at the beginning
of the year, including the first of now several successful flights of the XQ-58A Valkyrie Tactical UAV, the first
successful flight of the Gremlins Tactical UAV and the completion of our first major acquisition since 2012,
positioning Kratos in the next generation turbo jet/turbofan market for missiles and UAVs. The acquired business,
now Kratos Turbine Technologies or KTT, reflects Kratos’ strategy to focus on disruptive market opportunity areas
for affordable leading technology, where Kratos can achieve an industry leading first mover position. Kratos’ Space
and Satellite business, the industry leader in software based modem and Command and Control (C2) systems,
continued its successful transition to address the rapidly evolving satellite communications market, where Kratos’
new products will be required to support many of the thousands of Low Earth Orbit (LEO) and Mid Earth Orbit
(MEO) satellites expected to be launched. In 2019, Kratos’ C5ISR business demonstrated its industry leading
capabilities in support of Missile, Radar, Missile Defense and Combat Systems, and our Rocket Support business
continued to be an industry leader in Ballistic Missile Defense (BMD) targets and is well positioned for the new and
well-funded Hypersonic System area. Kratos’ Microwave Electronics business demonstrated its industry leading
products and capabilities in the electronic warfare, electronic attack, missile, radar and guided munitions areas, with
multiple new program related contract awards.
Kratos’ mission is to be a national security provider that is a leader in transforming the current lengthy Department
of Defense (DoD) procurement process with our affordable and rapidly developed systems and solutions,
significantly reducing the timeline to field systems to the warfighter in large quantities. We believe that
affordability is a technology all of its own, and being first to market with our affordable systems is a key Kratos
competitive differentiator. Representative of the continued successful execution of our mission, in 2019, Kratos’
XQ-58A Valkyrie was identified as the first drone for the new, expected-to-be multi-billion dollar Skyborg artificial
intelligence program. Additionally, the Valkyrie was announced to be the first drone of the also new and expected-
to-be multi-billion dollar Advanced Battle Management System (AMBS) Program, the DoD’s “internet of things”
where all elements of the battlefield are connected. And also importantly, in 2019 Valkyrie was also identified as
one of the USAF’s first Vanguard Programs, which are programs that could yield revolutionary future
capabilities. We believe that Kratos’ Valkyrie is just one of many industry leading transformative Kratos systems
which will be successful in the future, with others including the Gremlins UAS, Programs Thanatos and Air Wolf,
our next generation software defined C2 systems, next generation turbines and our Space Situational Awareness
System.
I thank our employees for the incredible work they perform for the national security mission and for our Country,
and I thank our investors and all other stakeholders for enabling the creation and success of our Company.
Sincerely,
Eric DeMarco
President & Chief Executive Officer
10-K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 29, 2019
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
(State or other jurisdiction of
incorporation or organization)
13-3818604
(I.R.S. Employer Identification No.)
10680 Treena St., Suite 600
San Diego, CA 92131
(858) 812-7300
(Address, including zip code, and telephone number, including
area code, of Registrant’s principal executive offices)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT
Title of each class
Trading Symbol(s)
Name of each exchange on which
registered
Common Stock, $0.001 par value
KTOS
The NASDAQ Global Select Market
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes
No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes
No
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
No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of
Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such
files). Yes
No
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
Non-accelerated filer
Accelerated filer
Smaller reporting company
Emerging growth company
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.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes
No
The aggregate market value of the registrant’s voting and non-voting common stock held by non-affiliates as of June 28, 2019, the last business day of the
registrant’s most recently completed second fiscal quarter, was approximately $2,061.5 billion, based on the closing sale price for shares of the registrant’s
common stock as reported by the NASDAQ Global Select Market on such date. This disclosure excludes shares of common stock held by executive officers,
directors and stockholders whose individual ownership exceeds 10% of the common stock outstanding on June 28, 2019 because such persons may be deemed
to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for any other purpose.
As of February 20, 2020, 106,941,556 shares of the registrant’s common stock were outstanding.
Documents Incorporated by Reference
Items 10, 11, 12, 13 and 14 of Part III of this annual report on Form 10-K incorporate information by reference from
the registrant’s definitive proxy statement to be filed pursuant to Regulation 14A in connection with the registrant’s 2020
Annual Meeting of Stockholders or an amendment to this annual report on Form 10-K to be filed with the Securities and
Exchange Commission within 120 days after the close of the fiscal year covered by this annual report on Form 10-K.
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KRATOS DEFENSE & SECURITY SOLUTIONS, INC.
FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 29, 2019
TABLE OF CONTENTS
PART I
Item 1.
Business
Item 1A.
Risk Factors
Item 1B.
Unresolved Staff Comments
Item 2.
Item 3.
Item 4.
PART II
Item 5.
Item 6.
Item 7.
Properties
Legal Proceedings
Mine Safety Disclosures
Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of
Equity Securities
Selected Financial Data
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
Item 8.
Item 9.
Financial Statements and Supplementary Data
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A.
Controls and Procedures
Item 9B.
Other Information
PART III
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
PART IV
Item 15.
Item 16.
Directors, Executive Officers and Corporate Governance
Executive Compensation
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters
Certain Relationships and Related Transactions, and Director Independence
Principal Accounting Fees and Services
Exhibits, Financial Statement Schedules
Form 10-K Summary
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All references to “us,” “we,” “our,” the “Company” and “Kratos” refer to Kratos Defense & Security Solutions, Inc., a
Delaware corporation, and its subsidiaries.
FORWARD LOOKING STATEMENTS
This Annual Report on Form 10-K (this “Annual Report”) contains “forward-looking statements” relating to our
future financial performance, the market for our services and our expansion plans and opportunities. In some cases, you can
identify forward-looking statements by terminology such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,”
“believe,” “estimate,” “predict,” “potential,” or “continue,” the negative of such terms or other comparable terminology.
These forward-looking statements reflect our current beliefs, expectations and projections, are based on assumptions, and are
subject to known and unknown risks and uncertainties that could cause our actual results or achievements to differ materially
from any future results or achievements expressed in or implied by our forward-looking statements. Many of these factors are
beyond our ability to control or predict. As a result, you should not place undue reliance on forward-looking statements. The
most important risks and uncertainties that could cause our actual results or achievements to differ materially from the results
or achievements expressed in or implied by our forward-looking statements, include, but are not limited to those specifically
addressed in Item 1A “Risk Factors” in this Annual Report, as well as those discussed elsewhere in this Annual Report. These
forward-looking statements reflect our views and assumptions only as of the date such forward-looking statements are made.
Except as required by law, we assume no responsibility for updating any forward-looking statements, whether as a result of new
information, future events or otherwise.
PART I.
Item 1. Business.
Overview
Kratos is a government contractor at the forefront of the U.S. Department of Defense’s (the “DoD”) recapitalization of
strategic weapon systems to address peer and near peer threats and its related Rapid Innovation Initiatives. Kratos is a leading
technology, intellectual property, proprietary product and system company focused on the U.S. and its allies’ national security.
Kratos is a recognized industry leader in the rapid development, demonstration and fielding of high technology systems and
products at an affordable cost. Kratos’ primary focus areas are unmanned systems, space and satellite communications,
microwave electronics, cyber security/warfare, training systems, missile defense, turbine technologies, and C5ISR (as defined
below). We believe that our technology, intellectual property, proprietary products and designed-in positions on our customers’
programs, platforms and systems, and our ability to rapidly develop, demonstrate and field affordable leading technology
systems gives us a competitive advantage and creates a high barrier to entry into our markets. Our workforce is primarily
engineering and technically oriented with a significant number of employees holding national security clearances. Much of our
work is performed at customer locations, or in a secure manufacturing facility. Our primary end customers are national security
related agencies. Our entire organization is focused on executing our strategy of becoming the leading technology and
intellectual property based product and system company in our industry.
Industry Update
On December 18, 2019, President Trump signed two 2020 spending bills totaling $1.4 trillion. The bills allocate $738
billion to the military and $632 billion to non-defense agencies, representing increases over FY 2019 of $22 billion for the
Pentagon and $27 billion for non-defense agencies. The National Defense Authorization Act (“NDAA”) grants a base budget of
approximately $666.5 billion (including the establishment of a new, sixth armed service for space) and an additional $71.5
billion for overseas contingency operations funding, a.k.a. the war budget. The federal budget and debt ceiling are expected to
continue to be the subject of considerable debate, which could have a significant impact on defense spending broadly and the
Company’s programs in particular. The U.S. Government’s fiscal year (“FY”) ends September 30.
The budget environment, including budget caps mandated by the Budget Control Act of 2011 (“BCA”) for fiscal years
2020 and 2021, and uncertainty surrounding the debt ceiling and the appropriations process, remain significant short and long-
term risks. Considerable uncertainty exists regarding how future budget and program decisions will unfold, including the
defense spending priorities of the Administration and Congress and what challenges budget reductions (required by the BCA
and otherwise) will present for the defense industry. If annual appropriations bills are not timely enacted for FY 2021 or
beyond, the U.S. Government may again operate under a continuing resolution, restricting new contract or program starts,
presenting resource allocation challenges and placing limitations on some planned program budgets, and we may face another
government shutdown of unknown duration. If a prolonged government shutdown of the DoD were to occur, it could result in
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program cancellations, disruptions and/or stop work orders and could limit the U.S. Government’s ability to effectively progress
programs and to make timely payments, and our ability to perform on our U.S. Government contracts and successfully compete
for new work.
Additionally, funding for certain programs in which we participate may be reduced, delayed or cancelled, and global
budget cuts could adversely affect the viability of our subcontractors, suppliers, and employee base. While we believe that our
business is well-positioned in areas that the DoD and other customers have indicated are areas of focus for future defense
spending, the long-term impact of the BCA, other defense spending cuts, challenges in the appropriations process, the debt
ceiling and the ongoing fiscal debates remain uncertain.
Significant delays or reductions in appropriations; long-term funding under a continuing resolution; an extended debt
ceiling breach or government shutdown; and/or future budget and program decisions, among other items, may negatively
impact our business and programs and could have a material adverse effect on our financial position, results of operations and/
or cash flows.
Current Reporting Segments
The Company currently operates in two reportable segments. The Kratos Government Solutions (“KGS”) reportable
segment is comprised of an aggregation of KGS operating segments, including our microwave electronic products, space,
training and cybersecurity, C5ISR/modular systems, turbine technologies, and defense and rocket support services operating
segments. The Unmanned Systems (“US”) reportable segment consists of our unmanned aerial system and unmanned ground
and seaborne system products.
We organize our operating segments based primarily on the nature of the products, solutions and services offered.
Transactions between segments are negotiated and accounted for under terms and conditions similar to other government and
commercial contracts, and these intercompany transactions are eliminated in consolidation. For additional information
regarding our reportable segments, see Note 14 of the Notes to Consolidated Financial Statements contained within this Annual
Report. From a customer and solutions perspective, we view our business as an integrated whole, leveraging skills and assets
wherever possible.
On February 27, 2019, the Company acquired 80.1% of the issued and outstanding shares of capital stock of Florida
Turbine Technologies Inc., a Florida corporation (“FTT Inc.”), and 80.1% of the membership interests in FTT CORE, LLC, a
Delaware limited liability company (“FTT Core” and, together with FTT Inc. and their respective subsidiaries, “FTT”), for an
aggregate purchase price of approximately $60 million. FTT is a leading turbomachinery design and manufacturing company
specializing in engineering, development, and testing of gas turbines, propulsion components, engine and other systems for
military and commercial applications. FTT is now the KTT Division, which is focused on the development and production of
small, affordable, high-performance jet engines for the next generation of tactical weapon systems and tactical jet Unmanned
Aerial Systems (“UAS”). The KTT Division is included in the KGS segment. For additional information regarding the
acquisition of FTT, see Note 2 of the Notes to Consolidated Financial Statements contained within this Annual Report.
Competitive Strengths
We believe that our intellectual property, proprietary products, and technology are strongly aligned with certain of the
highest priority spending areas of the DoD including the 2018 National Defense Strategy document, and the DoD’s focus on
leveraging technology to defeat or deter peer and near-peer adversaries. We also believe that our proven ability to rapidly
design, develop, demonstrate and field leading technology products and systems at an affordable cost differentiates us from our
competitors. We believe that our longstanding customer relationships, and the designed-in position of our systems, technology
and products into our customers’ platforms, programs and systems, provide a unique competitive advantage and position us
well for accelerated growth.
Specialized national security focus aligned with mission-critical national security priorities. Continued concerns
related to the threats posed by certain foreign nations, including nations with peer or near peer capabilities have caused the U.S.
Government to identify national security as an area of functional and spending priority. Budget pressures, particularly related to
DoD spending, have placed a premium on developing and fielding low-cost, high-technology solutions to assist in national
security missions. While recent budget pressures have at times caused delays in orders for our business, current budget
projections, including the recently enacted fiscal 2020 DoD budget, the Pentagon’s fiscal 2021 DoD budget request which was
released on February 10, 2020 and the Fiscal Year Defense Plan (“FYDP”), suggest defense spending will increase over the
next few years. The improving outlook for defense spending is primarily focused on enhanced power projection, warfighting
readiness, lethality, and recapitalization of key strategic defense systems to address peer and near peer threats. Our primary
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capabilities and areas of focus, listed below, are strongly aligned with the objectives of the U.S. Government as outlined in the
2018 National Defense Strategy document:
Satellite communications and radio frequency interference detection location and mitigation
• Unmanned aerial drone, unmanned ground and unmanned seaborne systems and artificial intelligence
•
• Microwave electronics supporting warfare, missile, radar and communication systems
• Electronic warfare, attack, missile, and radar systems
•
Intelligence, surveillance and reconnaissance
• Ballistic missile defense and hypersonic systems
• C5ISR systems
• Cyber security and information assurance
•
Specialized training systems and operational readiness
IP-centric defense company with proprietary products and technology which address critical current and emerging
threats faced by U.S. and allied militaries. As a technology-focused defense company at the forefront of the DoD’s strategy for
technology rich and affordable systems, our current and growing portfolio of proprietary systems, products, solutions, and
related intellectual property addresses some of the most critical needs of U.S. and allied militaries in the fields of unmanned
systems, space & satellite communications, microwave electronics, cyber security/warfare, missile defense, combat and training
systems. A key element of our customers’ strategy, and where we have invested significantly, is the development of capabilities
and intellectual property addressing the recent challenges faced by U.S. and allied militaries in Anti-Access and Aerial-Denial
(“A2/AD”) environments. This is evidenced by our significant investment in high-performance Unmanned Aerial Drone
System (“UADS”) platforms and technology, which has culminated in a series of Unmanned Combat Aerial System (“UCAS”)
contract wins. Additionally, with our space & satellite and terrestrial ground segment command, control, radio frequency
interference monitoring, geolocation and mitigation products and capabilities, we believe we are well-positioned to capitalize
on the 2020 DoD budget for space investments, a significant portion of which is for the development and protection of U.S.
national security space assets and infrastructure. Accordingly, our proprietary products, systems and technologies are developed
and refined with the goal of enabling our customers to maintain an advantage over the advanced and constantly evolving threats
of adversaries, at an affordable cost. In many instances, we are one of the few companies that produce the mission-critical
technology our customers require, or we outperformed our peers in a competitive bidding process. We maintain a strategy of
internally funding research and development and owning the intellectual property of many of these high-performance
capabilities and systems.
Technology-driven company aligned with and supporting our customers’ increased innovation, technology, and
strategic national security initiatives, with focus on speed and affordability. As the DoD works to increase or maintain its
technological advantage over adversaries, it has continued its efforts to create breakthrough technologies for national security,
accelerate innovation to the warfighter, and repurpose current capabilities to create cost-effective, disruptive technology
advances. With our focus on delivering proven leading edge systems, products and technologies that address the most critical
current and emerging threats, our customers include some of the most technologically advanced organizations of the defense
establishment, including the Defense Innovation Unit (“DIU”) (formerly the Defense Innovation Unit Experimental (“DIUx”)),
Defense Advanced Research Projects Agency (“DARPA”), Air Force Research Laboratory (“AFRL”), the Strategic Capabilities
Office (SCO), the Strategic Command (STRATCOM), the National Aeronautics and Space Administration, the U.S. intelligence
community, and other confidential customers. We believe our focus on constant innovation, capability improvements across our
product and solutions portfolio, speed of development, and production and affordability are key differentiators that align us
with and address our customers’ key initiatives.
In-depth understanding of customer missions. We have a reputation for successfully and rapidly designing, developing,
demonstrating and fielding mission-critical products, solutions and services to our customers, at an affordable cost. Our long-
term relationships with the U.S. Air Force, U.S. Army, U.S. Navy and other national security related customers and agencies
enable us to develop an in-depth understanding of their missions, problems and technical requirements. In addition, a
substantial number of our employees are located at our customer locations, or at secure manufacturing facilities, all of which
provides Kratos with valuable strategic insight into our customers’ ongoing missions and future program and mission
requirements. This understanding of our customers’ missions, requirements, and needs, in conjunction with the strategic
location of our employees, enables us to offer technical solutions tailored to our customers’ specific requirements and evolving
mission objectives. In addition, once our products are “designed in” and we are on-site with a customer and providing our
products and solutions, we have historically been successful in winning new and recompete business.
Kratos is an industry leader in high performance, jet powered, unmanned aerial target drone systems which are designed
to replicate state of the art adversarial fighter aircraft, missiles and other threats. Kratos is the sole source or primary unmanned
aerial target drone system provider to the U.S. Air Force, Navy, Army, and numerous allied foreign defense agencies.
5
Leveraging off of this technology, for which Kratos owns the intellectual property, we made a significant investment over the
past six years developing Kratos’ first UCAS, our Unmanned Tactical Aerial Platform (“UTAP-22”), now formally called
“Mako.” After successfully achieving the Mako’s first concept flights at the end of 2015, in 2016 we received a $12.6 million
single-award contract to demonstrate certain payload integration and loyal wingman teaming with manned aircraft in a major
military exercise. At the time, this contract was one of the largest awarded contracts by the DIUx. We are currently under
contract with several additional customers related to Kratos’ Mako.
A select sample of Kratos’ other key UAS products and contracts includes:
•
•
In 2017, we successfully advanced to Phase II of the Gremlins program, awarded by DARPA, the U.S.
Government’s leader in breakthrough technologies for national security, teamed with our partner company,
Dynetics. In 2018, as part of the Dynetics led team, we were selected for award on Phase III of the Gremlins
program to demonstrate safe and reliable launch and aerial recovery of multiple unmanned drone system
aircraft, capable of employing and recovering diverse distributed payloads in volley quantities. In January
2020, DARPA and Dynetics announced that the successful first flight of the X-61A Gremlins Air Vehicle was
completed on November 23, 2019.
In 2016, we were awarded the AFRL Low Cost Attritable Strike Demonstration (“LCASD”) UCAS single-
award cost share contract. The LCASD, or Valkyrie, is an approximately 30 foot by 22 foot unmanned strike
aerial drone system. During 2019, the Company announced that the Kratos/AFRL team successfully
completed three flights for the Valkyrie, or the XQ-58A. In January 2020, the Company completed its fourth
demonstration flight, including the successful deployment of its parachutes, and landed normally, validating
the design changes incorporated for the test flight airbag system following the third flight in 2019.
•
In 2019, the Kratos XQ-58A Valkyrie was awarded Aviation Week’s Laureate Award for Defense Technology
and Innovation.
• We have redeveloped our Air Force Subscale Aerial Target BQM-167 into what we believe to be the highest
performance unmanned aircraft in the world, the U.S. Navy Sub-Sonic Aerial Target (“SSAT”) Drone
BQM-177A, with low rate initial production awarded to Kratos in June 2017. In 2018, delivery of the first
production aerial targets was made to the U.S. Navy, and achievement of Initial Operational Capability (IOC)
was reported by the U.S. Navy in February 2019. In 2019, the Company was awarded a $25.4 million
contract for Lot 3 of low rate initial production for 34 BQM-177A aerial targets. To date, the Company has
been awarded production orders for 105 BQM-177A aerial targets. We expect the SSAT program to become
one of the largest and most important to Kratos in the near term.
•
•
•
In 2018, we received a single award $109 million maximum value three year production contract for Air
Force Subscale Aerial Target BQM-167A, with $27 million being initially obligated at the time of award for
30 Lot 14 BQM-167A aerial targets and production support, and an additional $31.9 million being obligated
for 35 Lot 15 BQM-167A targets in 2019.
In 2018, we received a ten-year, sole source, single award framework contract from QinetiQ UK for Kratos’
MQM-178 Firejet aerial targets, spares, ground support equipment, technical services, and training. In 2018,
we were awarded a prime contract for the Aerial Target Systems 2 (ATS-2), Multiple Award Indefinite
Delivery Indefinite Quantity (“IDIQ”) Contract with a ceiling value of $93.3 million, and a five year period
of performance.
In 2018, we received a sole source, single award multi-year IDIQ contract from the Swedish Defence
Materiel Administration for our MQM-178 Firejet aerial target aircraft and associated ground support
equipment, spares, payloads, components, expendables and support services. The first order under the three-
year IDIQ contract was received in the first half of 2019. Additionally, there are two three-year exercisable
option periods for a total potential contract performance term of nine years.
•
In 2019, the Company produced its first MQM-178 Firejet target drones at its new production facility in
Oklahoma City.
We believe that our internally developed and owned intellectual property allows us to provide more capable jet
powered, unmanned aircraft, designed to fly in A2/AD environments and with performance capabilities equal to or greater than
fourth generation manned jet fighter aircraft, at an affordable cost. Kratos’ tactical UAS provide force multiplication and
augmentation for manned high performance fighter aircraft. We believe that there are very few high-performance UAS that are
affordable and as advanced as our technologies addressing the A2/AD environment, which the DoD has identified as a U.S.
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capabilities gap. As such, consistent with the needs and requirements of the U.S. and allied militaries, we believe that our
leadership in these types of high performance unmanned aircraft provides us with a future market opportunity of these types of
low-cost, high-performance systems.
We are also an industry leader in ground-based command, control and communications systems for satellites, and a
leader in related radio frequency interference identification, geolocation and mitigation, or Space Situational Awareness (SSA).
Our primary customers include the U.S. Air Force, Space Command and other agencies. Our microwave electronics business
products have designed-in positions on critical combat system programs, including Barak, Gripen, Iron Dome, Sling of David,
F-15, F-16, Gripen, and Arrow. Our advanced capabilities in the training systems and solutions market, including for aircraft
and combat vehicles, have allowed us to successfully remain at the forefront of defense industry readiness initiatives. We
believe our strategy of internally funding the research and development of many of our systems, products, solutions and
capabilities will continue to solidify our position in high growth markets, such as high performance UADS, satellite
communications, microwave electronics and training systems, and allow us to grow, over the long-term, at a rate greater than
that of the industry.
Diverse base of key contracts with low concentration. Many of our contracts are single-award and/or sole source in
nature, where we are the only awardee by the customer. In many cases, our ability to obtain single award, sole source contracts
is due to our intellectual property, proprietary products, historical performance qualifications, relative experience and
affordability. Additionally, as a result of our business development focus on securing key contracts, we are also a preferred
contractor on numerous multi-year, government-wide acquisition contracts (“GWACs”) and multiple award contracts. Our
preferred contractor status provides us with the opportunity to bid on billions of dollars of business each year against a discrete
number of other pre-qualified companies.
We have a highly diverse base of customers and contracts with no contract representing more than 8% of 2019 revenue.
Our fixed-price contracts, the majority of which are production contracts, represent approximately 83% of our 2019 revenue.
Our cost-plus-fee contracts and time and materials contracts represent approximately 12% and 5%, respectively, of our 2019
revenue. We believe our diverse base of key contracts and low reliance on any one contract provides us with a stable, balanced
revenue stream. Our recent major contract awards, including a single award $223 million U.S. Navy contract for short and
medium range suborbital flight vehicles (for which Kratos has teamed with Corvid Technologies), a $31.8 million funding
award for production Lot 15 for the Air Force Subscale Aerial Target program, a $35.0 million IDIQ contract for Air Force
subscale aerial target peculiar spares, $32.0 million in additional task orders awarded on Foreign Military Sales (“FMS”) to
support the Royal Saudi Naval Forces, a prime contract award to deliver up to 33 Oriole Rocket motors to a U.S. Government
customer, a $17.6 million contract award for new tactical drone system research, development and initial production, a $24
million microwave electronic products contract in support of a missile system program, a C5ISR $50 million single award
production contract in support of a National Security Program, a $39 million contract for 24-hour space-based RF signal
communication (SSA) services, a $25.4 million contract for Lot 3 for BQM-177A aerial targets, and multiple space and satellite
communications awards have continued to allow us to grow the business while maintaining a diverse contract base.
Significant cash flow visibility driven by stable backlog. As of December 29, 2019 and December 30, 2018, our total
backlog (see Backlog below) was approximately $601.2 million and $620.7 million respectively, of which approximately
$501.3 million was funded in 2019 and $537.2 million was funded in 2018. The majority of our sales are from awards issued
under long-term contracts, typically three to five years in duration. Our contract backlog provides visibility into stable future
revenue and cash flow over a diverse set of contracts. Importantly, a number of our systems and products are designed-in on
and support long term, multi-year/multi-decade programs, which provides significant operational and financial visibility to our
Company.
Highly skilled employees and an experienced management team. We deliver our systems, products and services
through a skilled and primarily engineering and technically oriented workforce of approximately 3,000 employees. Our senior
managers have significant experience with U.S. Government agencies, the U.S. military and U.S. Government contractors. A
significant number of Kratos employees hold national security clearances. Members of our management team have experience
growing businesses both organically and through acquisitions and delivering significant value to stakeholders. We believe that
the cumulative experience and differentiated expertise of our personnel in our core focus areas, coupled with our sizable and
technically oriented employee base, allow us to qualify for and bid on larger programs and contracts in a prime contracting role.
Our Strategy
Our strategy is to focus on our core business areas, including unmanned systems, space and satellite communications,
cyber security, microwave electronics, missile defense and hypersonic systems, turbine technologies, training and C5ISR
systems, which are closely aligned with the DoD’s mission and funding priorities. We will continue to invest in differentiating
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systems, products, technology and intellectual property. We intend to be the leader in rapidly developing, demonstrating and
delivering to the warfighter proven leading technology systems, at an affordable cost.
Internal Growth
We are focused on generating internal growth by capitalizing on our ability to rapidly develop, demonstrate and field
leading technology systems and products at an affordable cost. We will make targeted discretionary investments in mission
critical DoD priority areas, including unmanned systems, space and satellite communications, cyber security, microwave
electronics, missile defense and training systems, which have the highest potential for growth based on recent DoD funding
requests, and in which we will retain the intellectual property rights.
Expand technology product, solution and service offerings provided to existing customers. We are focused on
expanding the technology, products, systems and solutions we provide to our current customers by leveraging our strong
relationships, technical capabilities, intellectual property and past performance qualifications as well as by offering a wider
range of comprehensive low-cost technology leading and proven products and solutions. In regard to areas of specialization, our
product and solution offerings include the manufacturing of specialized defense electronics; integrated technology solutions for
satellite command, control and communications; specialized high performance UADS and drone aircraft for tactical and threat
representation target purposes; and Unmanned Ground Systems (“UGS”) and Unmanned Seaborne Systems. We believe our
understanding of customer needs, missions, requirements and processes, and our ability to rapidly deliver low cost, technology
leading systems, products and solutions, position us well for success in the current national security environment.
Capitalize on current contract base. We are pursuing new program and contract opportunities and awards as we build
the business with our expanding technology base, intellectual property ownership, contract portfolio, and product, solution and
service offerings. We are also aggressively pursuing several national security priority areas, including high performance UADS,
satellite communications command, control, communication and signal monitoring products (SSA), microwave electronics for
missiles, radars, electronic warfare and communications, cyber security solutions, specialized training systems, autonomy and
artificial intelligence systems, robotics, directed energy systems, hypersonic systems, electromagnetic rail gun systems and next
generation ballistic missile targets. We are also assessing new tactical program areas and platforms to pursue that are consistent
with our core capabilities, technology and intellectual property.
Expand customer and contract base. We are focused on expanding our customer base into areas with significant
growth opportunities as indicated by the FY 2020 DoD budget, the 2021 DoD budget requests and FYDP, and the 2018
National Defense Strategy document, by leveraging our technology, intellectual property, proprietary products, capabilities,
industry reputation, long-term customer relationships and diverse contract base. We also believe that our ability to rapidly
develop, demonstrate and field high technology systems and products at an affordable cost is a clear competitive differentiator
for our Company. We anticipate that this overall expansion in our capabilities will enable us both to pursue larger program
opportunities, higher value work and to further diversify our revenue base across additional U.S. Government, international and
commercial customers.
Improve operating margins. We believe that we have opportunities to increase our operating margins and improve
profitability by capitalizing on our corporate infrastructure investments as our business grows, production of our products and
systems increases and related revenues increase. We are proactively focused on continuously improving efficiencies, reducing
costs, and concentrating our efforts on operational excellence.
Invest in strategic growth areas. Over the past several years, we have made significant internally funded investments
in strategic growth areas including unmanned tactical aircraft drone systems. Specifically, we have increased internally funded
research and development, capital expenditures and infrastructure investments, including executive management, bid, proposal
and new business capture, pursuit and related expenses. We have made these investments with the intention of developing,
demonstrating, fielding and bringing to production high performance jet powered unmanned aerial combat systems. These
investments also allow us to retain the intellectual property rights, design and data packages for these platforms and systems,
and to ultimately secure sole source production positions in these strategic growth areas. Specifically, since 2012, we have
invested over $120 million in our UAS through internally funded research, development and contract design retrofit costs for
new platforms under development and capital expenditures for aircraft and related equipment related to this strategic growth
area.
• We invested in internally funded research, development and capital expenditures to build our own UTAP-22
(Mako) UAS from 2012 to 2015, and demonstrated the capabilities of the UTAP-22 Mako in a flight
demonstration in the fall of 2015 where Kratos Mako drones flew as an unmanned wingman to manned tactical
fighter jet aircraft. As a result of these successful flights and capabilities demonstrations, we were awarded an
initial $12.6 million prime contract from the DIUx for sensor integration and flight demonstration of our UTAP-22
Mako unmanned aerial system the following year. Under this effort, we integrated certain sensors into our
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UTAP-22 Mako and participated in a large, complex flight exercise in 2017. As a result of our development and
demonstration of the Mako, we have been awarded several tactical and developmental awards, including an initial
$17.6 million contract award in October 2019 for jet drone research, development and initial production efforts,
with the scope of work and related funds under this program expected to increase as execution and performance
milestones are successfully achieved.
• We received a $40.8 million single award, cost-share contract from the AFRL for the LCASD. Under the LCASD
contract award, we are designing, developing, and will deliver, demonstrate and test a technical baseline for a
high-speed long-range, low-cost limited life-strike UAS. For our investment, we will retain hard (including two
LCASD aircraft) and other assets, and important intellectual property, software, data, platform and system rights,
which we believe will be critically important and valuable over the expected long-term life of this platform,
including with respect to future production opportunities. During 2019, the Company announced that the Kratos/
AFRL team successfully completed three flights for the Valkyrie, or the XQ-58A. In January 2020, the Company
completed its fourth demonstration flight, including the successful deployment of its parachutes, and landed
nominally, validating the design changes incorporated for the test flight airbag system following the third flight in
2019.
• We were awarded one of four prime contract awards from DARPA for the Gremlins program. Under the Gremlins
program, DARPA envisions a swarm of approximately 20 high performance unmanned aerial vehicles that are
deployed by an inflight aircraft, and are later recovered, inflight, by an aircraft. The approximate $3.9 million
Phase I contracts were awarded to four competing companies, with the intent to ultimately down select to one
finalist company over a period of approximately 36 months. In 2017, we successfully advanced to Phase II of the
Gremlin’s program, teamed with our partner company Dynetics. In 2018, as part of the Dynetics-led team, we
were selected for award on Phase III of the Gremlins program to demonstrate safe and reliable launch and aerial
recovery of multiple unmanned drone system aircraft, capable of employing and recovering diverse distributed
payloads in volley quantities. In January 2020, DARPA and Dynetics announced that the successful first flight of
the X-61A Gremlins Air Vehicle was completed on November 23, 2019. Kratos is a key subcontractor to Dynetics
on the Gremlins program.
Capitalize on corporate infrastructure investments. In recent periods, we have made significant investments in our
senior management and corporate infrastructure related to cyber security threats to our Company, increased and changing
regulations we are subject to, and the changing national security industry environment. These investments also included hiring
senior executives with significant experience in the national security industry, hiring firms to support us on Capitol Hill,
Congressionally and with our customers, strengthening our internal controls over financial reporting and accounting staff in
support of increasing public company reporting requirements, expanding our infrastructure in response to increases in cyber
security protection and related regulatory requirements, and expanding our backlog and bid and proposal pipeline. We expect to
be allocating additional resources in our pursuit of new, larger and highly technical prime contract opportunities. We believe our
management experience and corporate infrastructure can support a company with a much larger revenue base than ours.
Accordingly, we believe that, to the extent our revenue grows, we will be able to leverage this infrastructure base and increase
our operating margins.
Customers
A representative list of customers in our KGS and US segments during 2019 included the U.S. Air Force, U.S. Army,
U.S. Navy, U.S. Marines, Missile Defense Agency, Space Command, the National Aeronautics and Space Administration, FMS,
the U.S. Southern Command, STRATCOM, the Strategic Capabilities Office (SCO), DIU or DIUx, the Rapid Capabilities
Offices, the U.S. intelligence community and certain confidential customers.
Revenue from the U.S. Government (which includes FMS) includes revenue from contracts for which we are the
prime contractor as well as those for which we are a subcontractor and the ultimate customer is the U.S. Government. Revenues
from U.S. Government agency customers in aggregate accounted for approximately 71%, 72% and 75% of total revenues in
2019, 2018, and 2017, respectively.
Backlog
Effective January 1, 2018, we adopted the requirements of Accounting Standards Codification 606, Revenue from
Contracts with Customers (“ASC 606”), utilizing the modified retrospective method as discussed in Note 1 of the Notes to
Consolidated Financial Statements contained within this Annual Report. Since our adoption of ASC 606, revenues from
remaining performance obligations, also referred to as total backlog, are now calculated as the dollar value of our remaining
performance obligations on executed contracts. As of December 29, 2019 and December 30, 2018, our backlog was
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approximately $601.2 million and $620.7 million, respectively, of which $501.3 million was funded in 2019 and $537.2 million
was funded in 2018. We expect to recognize approximately 62.0% of the remaining total backlog as revenue in 2020, an
additional 21.0% in 2021 and the balance thereafter.
Total backlog is our estimate of the amount of revenue expected to be realized over the remaining life of awarded
contracts and task orders that we have in hand as of the measurement date. Total backlog can include award fees, incentive fees,
or other variable consideration estimated based on the most likely amount the Company is expected to be entitled to receive, to
the extent that it is probable that a significant reversal of cumulative revenue recognized will not occur. Total backlog can
include both funded and unfunded future revenue under government contracts. Total backlog does not include orders for which
neither party has performed and which each party has the unilateral right to terminate a wholly unperformed contract without
compensating the other party. As such, total backlog generally does not include options for additional performance obligations
which have not been executed unless they are considered a material right of the base contract. For IDIQ contracts, only awarded
or funded task orders are included for backlog purposes.
We define funded backlog as estimated future revenue under government contracts and task orders for which funding
has been appropriated by Congress and authorized for expenditure by the applicable agency, plus an estimate of the future
revenue expected to be realized from commercial contracts that are under firm orders. Funded backlog does not include the full
potential value of the Company’s contracts because Congress often appropriates funds to be used by an agency for a particular
program of a contract on a yearly or quarterly basis even though the contract may call for performance over a number of years.
As a result, contracts typically are only partially funded at any point during their term, and all or some of the work to be
performed under the contracts may remain unfunded unless and until Congress makes subsequent appropriation and the
procuring agency allocates funding to the contract.
Contracts undertaken by us may extend beyond one year. Accordingly, portions are carried forward from one year to
the next as part of backlog. Because many factors affect the scheduling of projects, no assurance can be given as to when
revenue will be realized on projects included in our backlog. Although funded backlog represents only business that is
considered to be firm, we cannot guarantee that cancellations or scope adjustments will not occur. The majority of funded
backlog represents contracts with terms that would entitle us to all or a portion of our costs incurred and potential fees upon
cancellation by the customer.
A significant number of the programs that Kratos’ systems, products and solutions support are multi-year/multi-decade
in nature. Accordingly, based on historical customer usage or operational tempo, the Company has reasonable expectations or
visibility of what ultimate orders for Kratos’ systems, products and solutions will be. The Company does not include these
expected amounts in its backlog until a related contract award is received.
Management believes that year-to-year comparisons of backlog are not necessarily indicative of future revenues. The
actual timing of receipt of revenues, if any, on projects included in backlog could change because many factors affect the
scheduling of projects. In addition, cancellations or adjustments to contracts may occur. Backlog is typically subject to large
variations from quarter to quarter as existing contracts are renewed or new contracts are awarded. Additionally, all U.S.
Government contracts included in backlog, whether or not funded, may be terminated at the convenience of the U.S.
Government.
Employees
As of December 29, 2019, we had a work force of approximately 3,000 full-time, part-time and on-call employees.
Competition
Our market is competitive and includes a number of companies in the U.S. defense and national security industries.
Most of the companies that we compete against have significantly greater financial, technical, marketing and other resources
and generate greater revenues than we do. Competition in the KGS and US segments include tier one, large U.S. Government
contractors and system integrators such as Northrop Grumman, Lockheed Martin, General Dynamics, Raytheon, BAE Systems,
L3Harris, General Atomics and Boeing. While we view other government contractors as competitors, we also team with these
same companies in joint proposals or in the delivery of our products, solutions and services for customers. Tier two competitors
include smaller government contractors such as Mercury Systems, Qinetiq, Cobham, Aerojet Rocketdyne and AAR Corp.
Intense competition and long operating cycles are key characteristics of our business within the defense industry. It is also
common in the defense industry for work on major programs to be shared among a number of companies. A company
competing to be a prime contractor or subcontractor on an award may, upon final award of the contract to another competitor,
become a subcontractor for the final prime contractor. It is not unusual to compete for a contract award with a peer company
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and simultaneously perform as a supplier to or be a customer of that same competitor on other contracts, or vice versa. The
nature of major defense programs, conducted under binding contracts, allows companies that perform well to benefit from a
level of program continuity not frequently found in other industries.
We believe that the principal competitive factors in our ability to win new business include our strategy of focusing on
priority DoD requirements and funding areas, our intellectual property, proprietary products, technology and our ability to
rapidly develop, demonstrate and deliver systems to the warfighter at an affordable cost. Also important is our past performance
qualifications, customer relationships, domain and technology expertise, the ability to obtain and replace contract vehicles, the
ability to deliver results within budget (time and cost), reputation, accountability, staffing flexibility, and project management
expertise. Additionally, our ability to deliver cost effective systems, products, solutions and services that meet our customers’
requirements is also a key differentiator.
In the U.S. defense, IT, and services markets, the U.S. Government has stressed competition and affordability or low
cost in connection with its future procurement of products and services. This has led to fewer sole source awards, as well as
more emphasis on cost competitiveness, with contract awards issued on a Low Price Technically Acceptable (“LPTA”) basis
rather than a best value basis, which has negatively impacted our Defense and Rocket Support Services (“DRSS”) business in
our KGS segment. In addition, competitor bid protests have become more prevalent in the current competitive environment,
resulting in further delay of contract procurement activity.
Research and Development
We believe that our future success depends upon our ability to continue to rapidly develop new products and services,
and enhancements to and applications for our existing products and services, to be delivered at an affordable cost. Our research
and development expenses were $18.0 million, $15.6 million and $17.8 million in 2019, 2018, and 2017, respectively. We
intend to continue our focus on research and development as a key strategy for growth, which will focus on investments in
those fields that we believe will offer the greatest opportunity for growth and profitability. Our current primary internal research
and development (“IR&D”) focus areas include satellite communications and signal monitoring, unmanned systems, electronic
products, and turbine technologies.
Intellectual Property
We believe that our continued success depends in large part on our proprietary technology, the intellectual skills of our
employees and the ability of our employees to continue to innovate. We rely on a combination of patent, copyright, trademark
and trade secret laws, as well as confidentiality agreements, to establish and protect our proprietary rights.
As of December 29, 2019, we held a number of U.S. and foreign patents. We do not consider our business to be
materially dependent upon any individual patent. We will continue to file and pursue patent applications when and where
appropriate to attempt to protect our rights in our proprietary technologies. We also encourage our employees to continue to
invent and develop new technologies so as to maintain our competitiveness in the marketplace.
We own or have rights to use certain trademarks, service marks and trade names that we use in conjunction with the
operation of our business. Certain of our trademarks have also been registered in selected foreign countries.
Government Regulation
We are subject to various government regulations, including various U.S. Government regulations as a contractor and
subcontractor to the agencies of the U.S. Government. Among the most significant U.S. Government regulations affecting our
business are:
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the Federal Acquisition Regulations and supplemental agency regulations, which comprehensively regulate
the formation, administration, and performance under government contracts;
the Truthful Cost or Pricing Data Statute (formerly the Truth in Negotiations Act), which requires certification
and disclosure of all cost and pricing data in connection with contract negotiations;
the Cost Accounting Standards, which impose accounting requirements that govern our right to
reimbursement under cost-based government contracts;
the Foreign Corrupt Practices Act, which prohibits U.S. companies from providing anything of value to a
foreign official to help obtain, retain or direct business, or obtain any unfair advantages;
the False Claims Act and the False Statements Act, which, respectively, impose penalties for payments made
on the basis of false facts provided to the government and impose penalties on the basis of false statements,
even if they do not result in a payment; and
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laws, regulations and executive orders restricting the use and dissemination of information classified for
national security purposes and the exportation of certain products and technical data.
We also need special security clearances to continue working on and advancing certain of our programs and contracts
with the U.S. Government. Classified programs generally will require that we comply with various Executive Orders, federal
laws and regulations and customer security requirements that may include restrictions on how we develop, store, protect and
share information, and may require our employees to obtain government clearances.
The nature of the work we do for the federal government may also limit the parties who may invest in or acquire us.
Export laws may keep us from providing potential foreign acquirers with a review of the technical data they would be
acquiring. In addition, there are special requirements for foreign parties who wish to buy or acquire control or influence over
companies that control technology or produce goods in the security interests of the U.S. There may need to be a review under
the Exon-Florio provisions of the Defense Production Act. Finally, the government may require a prospective foreign owner to
establish intermediaries to actually run that part of the company that does classified work, and establishing a subsidiary and its
separate operation may make such an acquisition less appealing to such potential acquirers.
In addition, the export from the U.S. of certain of our products may require the issuance of a license by the U.S.
Department of Commerce under the Export Administration Act, as amended, and its implementing regulations as kept in force
by the International Emergency Economic Powers Act of 1977, as amended. Some of our products may require the issuance of
a license by the U.S. Department of State under the Arms Export Control Act and its implementing regulations, which licenses
are generally harder to obtain and take longer to obtain than do Export Administration Act licenses.
Our business may require compliance with state or local laws designed to limit the uses of personal user information
gathered online or require online services to establish privacy policies.
Material Availability
We procure critical material, components, products and subsystems from both domestic and global supply partners.
These supply sources may be single sources for certain components and the material provided may have extended lead times.
To support our continuing customer needs, we have taken steps to mitigate sourcing risks. This includes working closely with
our suppliers to ensure future material and subsystem availability to support our manufacturing plans. In some cases, we have
elected to stock reserve material to ensure future availability.
Environmental
Our manufacturing operations are subject to many requirements under environmental laws. In the U.S., the U.S.
Environmental Protection Agency and similar state agencies administer laws that restrict the emission of pollutants into the air,
discharges of pollutants into bodies of water and disposal of pollutants in the ground. Violations of these laws can result in
significant civil and criminal penalties and incarceration. The failure to obtain a permit for certain activities may be a violation
of environmental law and subject the owner and operator to civil and criminal sanctions. Most environmental agencies also
have the power to shut down an operation if it is operating in violation of environmental law. U.S. laws also allow citizens to
bring private enforcement actions in some situations. Outside the U.S., the environmental laws and their enforcement vary and
may be more burdensome. We have management programs and processes in place that are intended to minimize the potential
for violations of these laws.
Other environmental laws, primarily in the U.S., address the contamination of land and groundwater and require the
clean-up of such contamination. These laws may apply not only to the owner or operator of an on-going business, but also to
the owner of land contaminated by a prior owner or operator. In addition, if a parcel is contaminated by the release of a
hazardous substance, such as through its historic use as a disposal site, any person or company that has contributed to that
contamination, whether or not it has a legal interest in the land, may be subject to a requirement to clean up the parcel.
Available Information
We file reports with the Securities and Exchange Commission (“SEC”). We make available on our website under
“Investor Relations/Financial Information/SEC Filings,” free of charge, our annual reports on Form 10-K, quarterly reports on
Form 10-Q, current reports on Form 8-K and amendments to those reports as soon as reasonably practicable after we
electronically file such materials with or furnish them to the SEC. Our website address is www.kratosdefense.com. The SEC
also maintains an Internet site that contains our reports, proxy and information statements, and other information at
www.sec.gov.
References to our website and the SEC’s website in this report are provided as a convenience and do not constitute,
and should not be viewed as, incorporation by reference of the information contained on, or available through, such websites.
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Such information should not be considered a part of this report, unless otherwise expressly incorporated by reference in this
report.
Item 1A. Risk Factors.
You should carefully consider the following risk factors and all other information contained herein as well as the
information included in this Annual Report and other reports and filings made with the SEC in evaluating our business and
prospects. Risks and uncertainties, in addition to those we describe below, that are not presently known to us or that we
currently believe are immaterial may also impair our business operations. If any of the following risks occur, our business and
financial results could be harmed and the price of our common stock could decline. You should also refer to the other
information contained in this Annual Report, including our Consolidated Financial Statements and the related Notes.
Risks Related to Our Business
The U.S. Government provides a significant portion of our revenue, and our business could be adversely affected by changes
in the fiscal policies of the U.S. Government and governmental entities.
In fiscal 2019, 2018 and 2017, we generated 71%, 72% and 75%, respectively, of our total revenues from contracts
with the U.S. Government (including all branches of the U.S. military and FMS), either as a prime contractor or a
subcontractor. We expect to continue to derive most of our revenues from work performed under U.S. Government contracts.
See the Industry Update section in Item 1 “Business” contained within this Annual Report for a discussion of the current
budgetary and funding constraints on U.S. Government spending and legislation enacted to reduce the U.S. federal deficit. As a
result, we have experienced and expect to continue to experience reduced or delayed awards on some of our programs, with a
related negative impact to our revenues, earnings and cash flows. Competitor bid protests also have become more prevalent in
the current competitive environment resulting from decreased government spending, which has led to further contract award
delays. In addition, any future changes to the fiscal policies of the U.S. Government and foreign governmental entities may
decrease overall government funding for defense and homeland security, result in delays in the procurement of our products and
services due to lack of funding, cause the U.S. Government and government agencies to reduce their purchases under existing
contracts, or cause them to exercise their rights to terminate contracts at-will or to abstain from exercising options to renew
contracts, any of which would have an adverse effect on our business, financial condition, results of operations and/or cash
flows.
Significant delays or reductions in appropriations for our programs and U.S. Government funding more broadly may
negatively impact our business and programs and could have a material adverse effect on our financial position, results of
operations and/or cash flows.
U.S. Government programs are subject to annual congressional budget authorization and appropriation processes. For
many programs, Congress appropriates funds on a fiscal year basis even though the program performance period may extend
over several years. Consequently, programs are often partially funded initially and additional funds are committed only as
Congress makes further appropriations. If we incur costs in excess of funds obligated on a contract, we may be at risk for
reimbursement of those costs unless and until additional funds are obligated to the contract. We cannot predict the extent to
which total funding and/or funding for individual programs will be included, increased or reduced as part of the annual budget
process ultimately approved by Congress and the President or in separate supplemental appropriations or continuing
resolutions, as applicable. Laws and plans adopted by the U.S. Government relating to, along with pressures on and uncertainty
surrounding the federal budget, potential changes in priorities and defense spending levels, sequestration, the appropriations
process, use of continuing resolutions (with restrictions, e.g., on new starts) and the permissible federal debt limit, could
adversely affect the funding for individual programs and delay purchasing or payment decisions by our customers. In the event
government funding for our significant programs becomes unavailable, or is reduced or delayed, or planned orders are reduced,
our contract or subcontract under such programs may be terminated or adjusted by the U.S. Government or the prime
contractor.
The federal budget and debt ceiling are expected to continue to be the subject of considerable debate, which could
have a significant impact on defense spending broadly and our programs in particular.
The budget environment, including budget caps mandated by the BCA for fiscal years 2020 and 2021, and uncertainty
surrounding the debt ceiling and the appropriations process, remain significant short and long-term risks. Considerable
uncertainty exists regarding how future budget and program decisions will unfold, including the defense spending priorities of
the Administration and Congress, what challenges budget reductions (required by the BCA and otherwise) will present for the
defense industry and whether annual appropriations bills for all agencies will be enacted in a timely manner. If annual
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appropriations bills are not timely enacted, the U.S. Government may again operate under a continuing resolution, restricting
new contract or program starts, presenting resource allocation challenges and placing limitations on some planned program
budgets, and we may face another government shutdown of unknown duration. If a prolonged government shutdown of the
DoD were to occur, it could result in program cancellations, disruptions and/or stop work orders and could limit the U.S.
Government’s ability to effectively progress programs and to make timely payments, and our ability to perform on our U.S.
Government contracts and successfully compete for new work.
We believe continued budget pressures would have serious negative consequences for the security of our country, the
defense industrial base, including the Company, and the customers, employees, suppliers, investors, and communities that rely
on companies in the defense industrial base. It is likely budget and program decisions made in this environment would have
long-term implications for us and the entire defense industry.
Additionally, funding for certain programs in which we participate may be reduced, delayed or cancelled, and budget
cuts globally could adversely affect the viability of our subcontractors and suppliers, and our employee base. While we believe
that our business is well-positioned in areas that the DoD and other customers have indicated are areas of focus for future
defense spending, the long-term impact of the BCA, other defense spending cuts, challenges in the appropriations process, the
debt ceiling and the ongoing fiscal debates remain uncertain.
Significant delays or reductions in appropriations; long-term funding under a continuing resolution; an extended debt
ceiling breach or government shutdown; and/or future budget and program decisions, among other items, may negatively
impact our business and programs and could have a material adverse effect on our financial position, results of operations and/
or cash flows.
If we fail to establish and maintain important relationships with government agencies and prime contractors, our ability to
successfully maintain and develop new business may be adversely affected.
Our reputation and relationship with the U.S. Government, and in particular with the agencies of the DoD and the U.S.
intelligence community, are key factors in maintaining and developing new business opportunities. In addition, we often act as
a subcontractor or in “teaming” arrangements in which we and other contractors bid together on particular contracts or
programs for the U.S. Government or government agencies. We expect to continue to depend on relationships with other prime
contractors for a portion of our revenue for the foreseeable future. Negative press reports regarding conflicts of interest, poor
contract performance, employee misconduct, information security breaches or other aspects of our business, regardless of
accuracy, could harm our reputation. Additionally, as a subcontractor or team member, we often lack control over fulfillment of
a contract, and poor performance on the contract could tarnish our reputation, even when we perform as required. As a result,
we may be unable to successfully maintain our relationships with government agencies or prime contractors, and any failure to
do so could adversely affect our ability to maintain our existing business and compete successfully for new business.
Many of our contracts contain performance obligations that require innovative design capabilities, are technologically
complex, require state-of-the-art manufacturing expertise, or are dependent upon factors not wholly within our control.
Failure to meet these obligations could adversely affect our profitability and future prospects. Early termination of client
contracts or contract penalties could adversely affect our results of operations.
We design, develop, and manufacture technologically advanced and innovative products and services, which are
applied by our customers in a variety of environments. Problems and delays in development or delivery as a result of issues
with respect to design, technology, licensing and intellectual property rights, labor, inability to achieve learning curve
assumptions, manufacturing materials or components could prevent us from meeting requirements. Either we or the customer
may generally terminate a contract as a result of a material uncured breach by the other. If we breach a contract or fail to
perform in accordance with contractual service levels, delivery schedules, performance specifications, or other contractual
requirements set forth therein, the other party thereto may terminate such contract for default, and we may be required to refund
money previously paid to us by the customer or to pay penalties or other damages. Even if we have not breached, we may deal
with various situations from time to time that may result in the amendment or termination of a contract. These steps can result
in significant current period charges and/or reductions in current or future revenue, and/or delays in collection of outstanding
receivables and costs incurred on the contract. Other factors that may affect revenue and profitability include inaccurate cost
estimates, design issues, unforeseen costs and expenses not covered by insurance or indemnification from the customer,
diversion of management focus in responding to unforeseen problems, and loss of follow-on work.
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If our subcontractors or suppliers fail to perform their contractual obligations, our performance and reputation as a
contractor and our ability to obtain future business could suffer.
As a prime contractor, we often rely upon other companies as subcontractors to perform work we are obligated to
perform for our customers. As we secure more work under certain of our contracts, we expect to require an increasing level of
support from subcontractors that provide complementary and supplementary services to our offerings. We are responsible for
the work performed by our subcontractors, even though in some cases we have limited involvement in that work. If one or more
of our subcontractors fails to satisfactorily perform the agreed-upon services on a timely basis or violates U.S. Government
contracting policies, laws or regulations, our ability to perform our obligations as a prime contractor or meet our customers’
expectations may be compromised. In extreme cases, performance or other deficiencies on the part of our subcontractors could
result in a customer terminating our contract for default. A termination for default could expose us to liability, including liability
for the agency’s costs of re-procurement, could damage our reputation and could hurt our ability to compete for future
contracts.
We also are required to procure certain materials and parts from supply sources approved by the U.S. Government. The
inability of a supplier to meet our needs or the appearance of counterfeit parts in our products could have a material adverse
effect on our financial position, results of operations or cash flows.
Our earnings and profitability depend, in part, on subcontractor and supplier performance and product availability.
We rely on other companies to provide major components for our products. For instance, we build the airframe,
electronics and flight control systems for our unmanned aerial systems. We primarily rely on our suppliers to provide the
engines and parachutes for landing the aircraft. Disruptions or performance problems caused by our subcontractors and
suppliers, or a misalignment between our contractual obligations to our customers and our agreements with our subcontractors
and suppliers, could have an adverse effect on our ability to meet our commitments to customers.
Our ability to perform our obligations on time could be adversely affected if one or more of our subcontractors or
suppliers were unable to provide the agreed-upon products or materials or perform the agreed-upon services in a timely,
compliant and cost-effective manner or otherwise to meet the requirements of the contract. Changes in economic conditions,
including changes in defense budgets or credit availability, or other changes impacting a subcontractor or supplier (including
changes in ownership or operations) could adversely affect the financial stability of our subcontractors and suppliers and/or
their ability to perform. The inability of our suppliers to perform, or their inability to perform adequately, could also result in
the need for us to transition to alternate suppliers, which could result in significant incremental cost and delay or the need for us
to provide other resources to support our existing suppliers.
In connection with our U.S. Government contracts, we are required to procure certain materials, components and parts
from supply sources approved by the customer. We also are facing increased and changing regulatory requirements, many of
which apply to our subcontractors and suppliers. In some cases, there may be only one supplier for certain components. If a sole
source supplier cannot meet our needs or is otherwise unavailable, we may be unable to find a suitable alternative.
Our procurement practices are intended to reduce the likelihood of our procurement of counterfeit, unauthorized or
otherwise non-compliant parts or materials. We rely on our subcontractors and suppliers to comply with applicable laws and
regulations, including regarding the parts or materials we procure from them; in some circumstances, we rely on certifications
provided by our subcontractors and suppliers regarding their compliance. We also rely on our subcontractors and suppliers to
effectively mitigate the risk of cyber and security threats or other disruptions with respect to the products and components they
deliver to us and the information entrusted to them by us or our customers.
If we are unable to procure, or experience significant delays in subcontractor or supplier deliveries of, needed
materials, components, intellectual property or parts; if our subcontractors or suppliers do not comply with all applicable laws
and regulations; if the certifications we receive from them are inaccurate; or if what we receive is counterfeit or otherwise
improper, it could have a material adverse effect on our financial position, results of operations and/or cash flows.
We face intense competition from many competitors that have greater resources than we do, which could result in price
reductions, reduced profitability or loss of market share.
We operate in highly competitive markets and generally encounter intense competition to win contracts from many
other firms, including mid-tier federal contractors with specialized capabilities, large defense contractors and IT service
providers. Competition in our markets may increase as a result of a number of factors, such as the entrance of new or larger
competitors, including those formed through alliances or consolidation, or the reduction in the overall number of government
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contracts. We may also face competition from prime contractors for whom we currently serve as subcontractors or teammates if
those prime contractors choose to offer customer services of the type that we are currently providing. In addition, we may face
competition from our subcontractors who, from time-to-time, seek to obtain prime contractor status on contracts for which they
currently serve as a subcontractor to us.
Many of our competitors have greater financial, technical, marketing and public relations resources, larger customer
bases and greater brand or name recognition than we do. Such competitors may be able to utilize their substantially greater
resources and economies of scale to, among other things:
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divert sales from us by winning very large scale government contracts, a risk that is enhanced by the recent
trend in government procurement practices to bundle services into larger contracts and the recent trend of
making award determinations on a LPTA basis;
divert sales from us by the award of government contracts to our competitors who may be willing to bid at
substantially lower prices;
force us to charge lower prices; or
adversely affect our relationships with current customers, including our ability to continue to win
competitively awarded engagements in which we are the incumbent.
In the event that the market for products in our US segment expands, we expect that competition will intensify as
additional competitors enter the market and current competitors expand their product lines. In order to secure contracts
successfully when competing with larger, well-financed companies, we may be forced to agree to contractual terms that provide
for lower aggregate payments to us over the life of the contract, which could adversely affect our margins. In addition, larger
diversified competitors serving as prime contractors may be able to supply underlying products and services from affiliated
entities, which would prevent us from competing for subcontracting opportunities on these contracts. If we lose business to our
competitors or are forced to lower our prices, our revenue and operating profits could decline.
Our business is dependent upon our ability to keep pace with the latest technological changes.
The market for our services is characterized by rapid change and technological improvements. Failure to respond in a
timely and cost-effective way to these technological developments would result in serious harm to our business and operating
results. We have derived, and we expect to continue to derive, a substantial portion of our revenues from providing innovative
engineering services and technical solutions that are based upon today’s leading technologies and that are capable of adapting to
future technologies. As a result, our success will depend, in part, on our ability to develop and market service offerings that
respond in a timely manner to the technological advances of our customers, evolving industry standards and changing customer
preferences.
We believe that, in order to remain competitive in the future, we will need to continue to invest significant financial
resources to develop new offerings and technologies or to adapt or modify our existing offerings and technologies, including
through internal research and development, acquisitions and joint ventures or other teaming arrangements. These expenditures
could divert our attention and resources from other projects, and we cannot be sure that these expenditures will ultimately lead
to the timely development of new offerings and technologies or identification of and expansion into new markets. Due to the
design complexity of our products, we may, in the future, experience delays in completing the development and introduction of
new products. Any delays could result in increased costs of development or deflect resources from other projects. In addition,
there can be no assurance that the market for our products will develop or continue to expand or that we will be successful in
newly identified markets as we currently anticipate. The failure of our technology to gain market acceptance could significantly
reduce our revenues and harm our business. Furthermore, we cannot be sure that our competitors will not develop competing
technologies that gain market acceptance in advance of our products.
Additionally, the possibility exists that our competitors might develop new technology or offerings that might cause
our existing technology and offerings to become obsolete. If we fail in our new product development efforts or our products or
services fail to achieve market acceptance more rapidly as compared to our competitors, our ability to procure new contracts
could be negatively impacted, which could negatively impact our results of operations and financial condition.
If the UAS and UGS markets do not experience significant growth, if we cannot expand our customer base or if our
products do not achieve broad acceptance, then we may not be able to achieve our anticipated level of growth.
For the fiscal year ended December 29, 2019, our US segment accounted for 22.5% of our total revenue. We cannot
accurately predict the future growth rate or size of this market. Demand for our products may not increase, or may decrease,
either generally or in specific markets, for particular types of products or during particular time periods. There are only a
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limited number of programs under which the U.S. military, our primary customer, is currently funding the development or
purchase of our UAS and UGS products. Although we are seeking to expand our US customer base to include foreign
governments, domestic non-military agencies and commercial customers, we cannot assure that our efforts will be successful.
The expansion of the UAS and UGS markets in general, and the market for our products in particular, depends on a number of
factors, including the following:
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customer satisfaction with these types of systems as solutions;
the cost, performance and reliability of our products and products offered by our competitors;
customer perceptions regarding the effectiveness and value of these types of systems;
limitations on our ability to market our US products and services outside the U.S. due to U.S.
government regulations; and
• marketing efforts and publicity regarding these types of systems.
Even if UAS and UGS gain wide market acceptance in general, our specific products may not adequately address
market requirements or may not gain market acceptance. If these types of systems generally, or our products specifically, do not
gain wide market acceptance, then we may not be able to achieve our anticipated level of growth and our revenue and results of
operations may suffer.
Loss of our General Services Administration (“GSA”) contracts or GWACs could impair our ability to attract new business.
We are a prime contractor under several GSA contracts and GWAC vehicles. We believe that our ability to provide
services under these contracts will continue to be important to our business because of the multiple opportunities for new
engagements each contract provides. If we were to lose our position as prime contractor on one or more of these contracts, we
could lose substantial revenues and our operating results could suffer. GSA contracts and other GWACs typically have a one or
two-year initial term with multiple options exercisable at the government customer’s discretion to extend the contract for one or
more years. We cannot be assured that our government customers will continue to exercise the options remaining on our current
contracts, nor can we be assured that our future customers will exercise options on any contracts we may receive in the future.
Government contracts differ materially from standard commercial contracts, involve competitive bidding and may be subject
to cancellation or delay without penalty.
Government contracts frequently include provisions that are not standard in private commercial transactions and are
subject to laws and regulations that give the U.S. Government rights and remedies not typically found in commercial contracts,
including provisions permitting the U.S. Government to:
terminate our existing contracts;
reduce potential future income from our existing contracts;
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• modify some of the terms and conditions in our existing contracts;
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suspend or permanently prohibit us from doing business with the U.S. Government or with any specific
government agency;
impose fines and penalties;
subject us to criminal prosecution;
suspend work under existing multiple year contracts and related task orders if the necessary funds are not
appropriated by Congress;
decline to exercise an option to extend an existing multiple year contract; and
claim rights in technologies and systems invented, developed or produced by us.
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In addition, government contracts are frequently awarded only after formal competitive bidding processes, which have
been and may continue to be protracted and typically impose provisions that permit cancellation in the event that necessary
funds are unavailable to the government agency. Competitive procurements impose substantial costs and managerial time and
effort in order to prepare bids and proposals for contracts that may not be awarded to us. In many cases, unsuccessful bidders
for government contracts are provided the opportunity to formally protest certain contract awards through various agencies,
administrative and judicial channels. We have experienced an increase in competitor bid protests on contracts on which we were
the successful bidder due to the competitive environment resulting from decreased government spending. In addition, we have
formally protested procurement awards in which we were not the initial successful bidder, but believed that the source selection
process was flawed. The protest process may substantially delay a successful bidder’s contract performance, result in
cancellation of the contract award entirely and distract management. We may not be awarded contracts for which we bid, and
substantial delays or cancellation of purchases may follow our successful bids as a result of such protests. We believe that this
environment of protracted competitive bidding processes and competitor bid protests will continue.
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Certain of our government contracts also contain “organizational conflict of interest” clauses that could limit our
ability to compete for certain related follow-on contracts. For example, when we work on the design of a particular solution, we
may be precluded from competing for the contract to install that solution. While we actively monitor our contracts to avoid
these conflicts, we cannot guarantee that we will be able to avoid all organizational conflict of interest issues.
We may not receive the full amounts estimated under the contracts in our backlog, which could reduce our revenue in future
periods below the levels anticipated. This makes backlog an uncertain indicator of future operating results.
Backlog is typically subject to large variations from quarter to quarter and comparisons of backlog from period to
period are not necessarily indicative of future revenues. The contracts comprising our backlog may not result in actual revenue
in any particular period or at all, and the actual revenue from such contracts may differ from our backlog estimates. The timing
of receipt of revenues, if any, on projects included in backlog could change because many factors affect the scheduling of
projects. Cancellation of or adjustments to contracts may occur. Additionally, all U.S. Government contracts included in
backlog, whether or not funded, may be terminated at the convenience of the U.S. Government. The failure to realize all
amounts in our backlog could adversely affect our revenues and gross margins. As a result, our funded, unfunded and total
backlog as of any particular date may not be an accurate indicator of our future earnings.
A preference for minority-owned, small and small disadvantaged businesses could impact our ability to be a prime
contractor and limit our opportunity to work as a subcontractor on certain governmental procurements.
As a result of the Small Business Administration (“SBA”) set-aside program, the federal government may decide to
restrict certain procurements only to bidders that qualify as minority-owned, small, or small disadvantaged businesses. As a
result, we would not be eligible to perform as a prime contractor on those programs and in general would be restricted to no
more than 49% of the work as a subcontractor on those programs. An increase in the amount of procurements under the SBA
set-aside program may impact our ability to bid on new procurements as a prime contractor, limit our opportunity to work as a
subcontractor or restrict our ability to compete on incumbent work that is placed in the set-aside program.
U.S. Government in-sourcing could result in loss of business opportunities and personnel.
The U.S. Government has continued to reduce the percentage of contracted services in favor of more federal
employees through an initiative called “in-sourcing.” Over time, in-sourcing could have an adverse effect on our business,
financial condition and results of operations. Specifically, as a result of in-sourcing, government procurements for services
could be fewer and smaller in the future. In addition, work we currently perform could be in-sourced by the federal government
and, as a result, our revenues could be reduced. Moreover, our employees could also be hired by the government. This loss of
our employees would necessitate the need to retain and train new employees. Accordingly, the effect of in-sourcing or the
continuation of in-sourcing at a faster-than-expected rate could have an adverse effect on our business, financial condition, and
results of operations.
Our business could be negatively impacted by cyber and other security threats or disruptions.
As a defense contractor, we face various cyber and other security threats, including attempts to gain unauthorized
access to and to harm sensitive information and networks; insider threats; threats to the safety of our directors, officers and
employees; threats to the security and viability of our facilities, infrastructure and supply chain; and threats from terrorist acts
or other acts of aggression. Our customers and partners (including our supply chain and joint ventures) face similar threats and
growing requirements. Although we utilize various procedures and controls to monitor and mitigate the risk of these threats,
there can be no assurance that these procedures and controls will be sufficient. These threats could lead to losses or misuse of
sensitive information or capabilities; theft of data; harm to personnel, infrastructure or products; and financial liabilities, as well
as damage to our reputation as a government contractor and provider of cyber-related or cyber-protected goods and services.
Cyber threats are evolving and include, but are not limited to: malicious software, destructive malware, attempts to
gain unauthorized access to data, disruption or denial of service attacks, and other electronic security breaches that could lead to
disruptions in mission critical systems; unauthorized release of confidential, personal or otherwise protected information (ours
or that of our employees, customers or partners); corruption of data, networks or systems; harm to individuals; and loss of
assets. In addition, we could be impacted by cyber threats or other disruptions or vulnerabilities found in products we use or in
our partners’ or customers’ systems that are used in connection with our business. These events, if not prevented or effectively
mitigated, could damage our reputation, require remedial actions and lead to loss of business, regulatory actions, potential
liability and other financial losses.
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We provide systems, products and services to various customers (government and commercial) who also face cyber
threats. Our systems, products and services may themselves be subject to cyber threats and/or they may not be able to detect or
deter threats, or effectively to mitigate resulting losses. These losses could adversely affect our customers and our Company.
The impact of these various factors is difficult to predict, but one or more of them could result in the loss of
information or capabilities, harm to individuals or property, damage to our reputation, loss of business, contractual or regulatory
actions and potential liabilities, any one of which could have a material adverse effect on our financial position, results of
operations and/or cash flows.
If we experience systems or service failure, our reputation could be harmed and our customers could assert claims against
us for damages or refunds.
We create, implement and maintain IT solutions that are often critical to our customers’ operations. We have
experienced, and may in the future experience, some systems and service failures, schedule or delivery delays and other
problems in connection with our work. If we experience these problems, we may:
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lose revenue due to adverse customer reaction;
be required to provide additional services to a customer at no charge;
cause customers to postpone, cancel or fail to renew contracts;
receive negative publicity, which could damage our reputation and adversely affect our ability to attract or
retain customers; and
suffer claims for substantial damages.
We cannot ensure that provisions in our customer contracts will be legally sufficient to protect us if we are sued.
In addition, our errors and omissions and product liability insurance coverage may not be adequate, may not continue
to be available on reasonable terms or in sufficient amounts to cover one or more large claims, or the insurer may disclaim
coverage as to some types of future claims. The successful assertion of any large claim against us could seriously harm our
business. Even if not successful, these claims may result in significant legal and other costs, be a distraction to our management
and harm our reputation.
Our products are complex and could have unknown defects or errors, which may increase our costs, harm our reputation
with customers, give rise to costly litigation, or divert our resources from other purposes.
Our products, including but not limited to unmanned vehicles, aerial targets, UAS and ballistic missile targets, are
extremely complex and must operate successfully with complex products from other vendors. Despite testing, our products
have contained defects and errors and may in the future contain defects or errors, or experience performance problems when
first introduced, when new versions or enhancements are released, or even after these products have been used by our
customers for a period of time. These problems could result in expensive and time-consuming design modifications or warranty
charges, delays in the introduction of new products or enhancements, significant increases in our service and maintenance costs,
diversion of our personnel’s attention from our product development efforts, exposure to liability for damages, damaged
customer relationships, and harm to our reputation, any of which could materially harm our results of operations. In addition,
increased development and warranty costs could be substantial and could reduce our operating margins.
The existence of any defects, errors, or failures in our products or the misuse of our products could also lead to
lawsuits against us, result in injury, death, or property damage, and significantly damage our reputation and support for our
products in general.
Although we maintain insurance policies, we cannot provide assurance that this insurance will be adequate to protect
us from all material judgments and expenses related to potential future claims or that these levels of insurance will be available
in the future at economical prices or at all. A successful liability claim could result in substantial cost to us. Even if we are fully
insured as it relates to a claim, the claim could nevertheless diminish our brand and divert management’s attention and
resources, which could have a negative impact on our business, financial condition, and results of operations.
Due to the volatile and flammable nature of certain components of our products and equipment, fires or explosions may
disrupt our business or cause significant injuries, which could adversely affect our financial results.
The development and manufacture of certain of our products involves the handling of a variety of explosive and
flammable materials as well as high power equipment. From time to time, these activities may result in incidents that could
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cause us to temporarily shut down or otherwise disrupt some manufacturing processes, causing production delays and resulting
in liability for workplace injuries and/or fatalities. We have safety and loss prevention programs that require detailed reviews of
process changes and new operations, along with routine safety audits of operations involving explosive materials, to mitigate
such incidents, as well as a variety of insurance policies. However, we cannot ensure that we will not experience such incidents
in the future or that any such incidents will not result in production delays or otherwise have a material adverse effect on our
business and financial condition. In addition, our microwave electronics business which is based in Israel may suffer disruption
or damage from acts of terrorism, or other conflicts in that geographic region.
Our financial results may vary significantly from quarter to quarter.
We expect our revenue and operating results to vary from quarter to quarter. Reductions in revenue in a particular
quarter could lead to lower profitability in that quarter because a relatively large amount of our expenses are fixed in the short-
term. We may incur significant operating expenses during the start-up and early stages of large contracts and may not be able to
recognize corresponding revenue in that same quarter. We may also incur additional expenses when contracts are terminated or
expire and are not renewed.
In addition, payments due to us from our customers may be delayed due to billing cycles or as a result of failures of
government budgets to gain congressional and administration approval in a timely manner. The U.S. Government’s fiscal year
ends September 30. If a federal budget for the next federal fiscal year has not been approved by that date in each year, our
customers may have to suspend engagements that we are working on until a budget has been approved. Any such suspensions
may reduce our revenue in the fourth quarter of the federal fiscal year or the first quarter of the subsequent year. The U.S.
Government’s fiscal year end can also trigger increased purchase requests from customers for equipment and materials. Any
increased purchase requests we receive as a result of the U.S. Government’s fiscal year end would serve to increase our third or
fourth quarter revenue, but will generally decrease profit margins for that quarter, as these activities generally are not as
profitable as our typical offerings.
Additional factors that may cause our financial results to fluctuate from quarter to quarter include those addressed
elsewhere in this Item 1A “Risk Factors” and the following factors, among others:
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the terms of customer contracts that affect the timing of revenue recognition;
variability in demand for our services and solutions;
commencement, completion or termination of contracts during any particular quarter;
timing of shipments and product deliveries;
timing of award or performance incentive fee notices;
timing of significant bid and proposal costs;
the costs of remediating unknown defects, errors or performance problems of our product offerings;
variable purchasing patterns under GSA contracts, GWACs, blanket purchase agreements and other IDIQ
contracts;
restrictions on and delays related to the export of defense articles and services;
costs related to government inquiries;
strategic decisions by us or our competitors, such as acquisitions, divestitures, spin-offs and joint ventures;
strategic investments or changes in business strategy;
changes in the extent to which we use subcontractors;
seasonal fluctuations in our staff utilization rates;
changes in our effective tax rate, including changes in our judgment as to the necessity of the valuation
allowance recorded against our deferred tax assets; and
the length of sales cycles.
Significant fluctuations in our operating results for a particular quarter could cause us to fall out of compliance with
the financial covenants related to our debt, which if not waived, could restrict our access to capital and cause us to take extreme
measures to pay down the debt, if any, under our $90.0 million Amended and Restated Credit and Security Agreement, dated
November 20, 2017 (as amended, the “Credit Agreement”), by and among the Company, the lenders named therein, SunTrust
Bank, as Agent (the “Agent”), and SunTrust Robinson Humphrey, Inc. as Lead Arranger and Sole Book Runner. In addition,
fluctuations in our financial results could cause our stock price to decline. See the risks and uncertainties related to our ability to
raise additional capital below in “We may need additional capital to fund the growth of our business, and financing may not be
available on favorable terms or at all.”
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Our margins and operating results may suffer if we experience unfavorable changes in the proportion of cost-plus-fee or
fixed price contracts in our total contract mix.
Although fixed-price contracts entail a greater risk of a reduced profit or financial loss on a contract compared to other
types of contracts we enter into, fixed-price contracts typically provide higher profit opportunities because we may be able to
benefit from cost savings and operating efficiencies. In contrast, cost-plus-fee contracts are subject to statutory limits on profit
margins and generally are the least profitable of our contract types. Our U.S. Government customers typically determine what
type of contract we enter into. Cost-plus-fee and fixed-price contracts in our federal business accounted for approximately 17%
and 79%, respectively, of our federal business revenues for the year ended December 29, 2019. To the extent that we enter into
more cost-plus-fee or less fixed-price contracts in proportion to our total contract mix in the future, our margins and operating
results may suffer. Our operating results may also suffer to the extent we have a contract mix that is focused on developmental
projects, which are typically at lower profit margins as compared to margins on production projects.
Our cash flow and profitability could be reduced if expenditures are incurred prior to the final receipt of a contract.
We provide various professional services, specialized products, and sometimes procure equipment and materials on
behalf of our customers under various contractual arrangements. From time to time, in order to ensure that we satisfy our
customers’ delivery requirements and schedules, we may elect to initiate procurement in advance of receiving final
authorization from the government customer or a prime contractor. In addition, from time to time, we may build production
units such as unmanned aerial vehicles in advance of receiving an anticipated contract award. If our government or prime
contractor customer’s requirements should change or if the government or the prime contractor should direct the anticipated
procurement to another contractor, or if the anticipated contract award does not materialize, or if the equipment or materials
become obsolete or require modification before we are under contract for the procurement, our investment in the equipment or
materials might be at risk if we cannot efficiently resell them. This could reduce anticipated earnings or result in a loss,
negatively affecting our cash flow and profitability.
We have incurred and may continue to incur goodwill impairment charges in our reporting entities, which could harm our
profitability.
As of December 29, 2019, goodwill represented approximately 38% of our total assets. We test for impairment
annually. If impairment testing indicates that the carrying value of a reporting unit exceeds its fair value, the goodwill of the
reporting unit is deemed impaired. Accordingly, an impairment charge would be recognized for that reporting unit in the period
identified.
We test goodwill for impairment by performing a qualitative assessment or using a two-step impairment process. If we
choose to perform a qualitative assessment and determine it is more likely than not that an impairment may exist, the two-step
impairment process is then performed. For operations where the two-step process is used, the identification and measurement of
impairment involves the estimation of the fair value of reporting units. If the fair value is determined to be less than the carrying
value, a second step is performed to determine the amount of the impairment. Accounting for impairment contains uncertainty
because management must make judgments in determining appropriate assumptions to be used in the measurement of fair
value. The estimates of fair value of reporting units are based on the best information available as of the date of the assessment,
incorporate management assumptions about expected future cash flows and contemplate other valuation techniques. Future cash
flows can be affected by changes in industry or market conditions, among other things.
Given the current market conditions and continued economic uncertainty in the U.S. defense industry, including
sequestration and issues surrounding the national debt ceiling, our future revenues, profits and cash flows could be substantially
lower than our current projections. Current market conditions including increased price competitiveness specifically in the
government services space, and procurements awarded on an LPTA rather than best value basis, can significantly impact our
current projections, which specifically resulted in an impairment of the carrying value in 2017 of our goodwill balance in our
DRSS reporting unit within our KGS reportable segment. In addition, our ability to penetrate new international markets could
also impact our current projections. Additional market factors could impact our projections and our ability to successfully
develop new products and platforms. For example, our US reporting unit forecasts include the successful completion of certain
performance criteria on new unmanned systems platforms, and acceptance of new unmanned systems platforms on a technical
basis as well as from a political and government budgetary standpoint. In addition, market-based inputs to the calculations in
the impairment test, such as weighted average cost of capital, and market multiples, could also be negatively impacted. Such
circumstances may result in the future deterioration of the fair value of our reporting units and an impairment of our goodwill.
Due to continual changes in market and general business conditions, we cannot predict whether, and to what extent, our
goodwill and long-lived intangible assets may be impaired in future periods. Any resulting impairment loss could harm our
profitability and financial condition.
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Failure to properly manage projects may result in additional costs or claims.
Our engagements often involve large scale, highly complex projects. The quality of our performance on such projects
depends in large part upon our ability to manage the relationship with our customers and to effectively manage the project and
deploy appropriate resources, including third-party contractors and our own personnel, in a timely manner. Any defects or
errors or failure to meet customers’ expectations could result in claims for substantial damages against us. Our contracts
generally limit our liability for damages that arise from negligent acts, errors, mistakes or omissions in rendering services to our
customers. However, we cannot be sure that these contractual provisions will protect us from liability for damages in the event
we are sued. In addition, in certain instances, we guarantee customers that we will complete a project by a scheduled date. If the
project experiences a performance problem, we may not be able to recover the additional costs we will incur, which could
exceed revenues realized from a project. Finally, if we underestimate the resources or time we need to complete a project with
capped or fixed fees, our operating results could be adversely affected.
We use estimates when accounting for contracts, and any changes in such estimates could have an adverse effect on our
profitability and our overall financial performance.
When agreeing to contractual terms, our management makes assumptions and projections about future conditions and
events, many of which extend over long periods. These projections assess the productivity and availability of labor, complexity
of the work to be performed, cost and availability of materials, impact of delayed performance and timing of product deliveries.
Contract accounting requires judgment relative to assessing risks, estimating contract revenues and costs, and making
assumptions for schedule and technical issues. Due to the size and nature of many of our contracts, the estimation of total
revenues and costs at completion is complicated and subject to many variables. For example, assumptions are made regarding
the length of time to complete a contract since costs also include expected increases in wages, prices for materials and allocated
fixed costs. Similarly, assumptions are made regarding the future impact of our efficiency initiatives and cost reduction efforts.
Incentives, awards or penalties related to performance on contracts are considered in estimating revenue and profit rates and are
recorded when there is sufficient information to assess anticipated performance. Suppliers’ assertions are also assessed and
considered in estimating costs and profit rates.
Because of the significance of the judgment and estimation processes described above, it is possible that materially
different amounts could be obtained if different assumptions were used or if the underlying circumstances were to change.
Changes in underlying assumptions, circumstances or estimates may have a material adverse effect upon the profitability of one
or more of the affected contracts, future period financial reporting and performance.
Our ability to utilize our net operating loss carryforwards and certain other tax attributes may be limited.
Federal and state income tax laws impose restrictions on the utilization of net operating loss (“NOL”) 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. We believe we underwent an ownership change in March 2010 that limited the Company’s
federal annual utilization of NOL carryforwards. If the entire limitation amount is not utilized in a year, the excess can be
carried forward and utilized in future years. For the year ended December 29, 2019, there was no impact of such limitations on
the income tax provision since the amount of taxable income did not exceed the cumulative annual limitation amount. In
addition, 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 NOL or other tax attributes may be
further limited.
We expect to incur substantial research and development costs and devote significant resources to identifying and
developing new products and services, which could significantly reduce our profitability and may never result in revenue to
us.
Our future growth depends on penetrating new markets, adapting existing products to new applications, and
introducing new products and services that achieve market acceptance. We plan to incur substantial research and development
costs as part of our efforts to design, develop and commercialize new products and services and enhance existing products. We
spent $18.0 million, or 2.5% of our revenue, in our fiscal year ended December 29, 2019 on internally funded research and
development activities. We believe that there are significant investment opportunities in a number of business areas. Because
we account for research and development as an operating expense, these expenditures will adversely affect our earnings in the
future. Further, our research and development programs may not produce successful results, and our new products and services
may not achieve market acceptance, create additional revenue or become profitable, which could materially harm our business,
prospects, financial results and liquidity.
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Risks Related to Our Operations
We may need additional capital to fund the growth of our business, and financing may not be available on favorable terms
or at all.
We currently anticipate that our available capital resources, including the cash we raised in our recent equity offerings,
the net proceeds from the divestiture of our PSS business, amounts available under our Credit Agreement and operating cash
flow will be sufficient to meet our expected working capital and capital expenditure requirements for at least the next
12 months. However, these resources may not be sufficient to fund the long-term growth of our business, especially in the event
that we are awarded future multiple sizable production awards related to our tactical drone programs which require significant
amounts of working capital to fund such growth. If we determine that it is necessary to raise additional funds, either through an
expansion or refinancing of our Credit Agreement or through public or private debt offerings or additional equity financings,
additional financing may not be available on terms favorable to us, or at all. Disruptions in the capital and credit markets could
adversely affect our ability to access these markets. Limitations on our borrowing base contained in our Credit Agreement may
limit our access to capital, and we could fall out of compliance with financial and other covenants contained in our Credit
Agreement which, if not waived, would restrict our access to capital and could require us to pay down any then-existing debt
under the Credit Agreement. Our lenders may not agree to extend additional or continuing credit under our Credit Agreement or
waive restrictions on our access to capital. If adequate funds are not available or are not available on acceptable terms, we may
not be able to take advantage of available opportunities, develop new products or otherwise respond to competitive pressures
and our business, operating results or financial condition could be materially adversely affected.
Past acquisitions and future acquisitions could prove difficult to integrate, disrupt our business, dilute stockholder value and
strain our resources.
We have in the past and may, in the future, acquire additional businesses that we believe could complement or expand
our business or increase our customer base. For example, in 2019 we completed the acquisition of FTT, a leading
turbomachinery design and manufacturing company. Whether we realize the anticipated benefits from these acquisitions and
related activities depends, in part, upon our ability to integrate the operations of the acquired business, the performance of the
underlying product and service portfolio, and the performance of the management team and other personnel of the acquired
operations. Integrating the operations of acquired businesses successfully or otherwise realizing any of the anticipated benefits
of acquisitions, including anticipated cost savings and additional revenue opportunities, involves a number of potential
challenges. The failure to meet these integration challenges could seriously harm our financial condition and results of
operations. Realizing the benefits of acquisitions depends in part on the integration of operations and personnel. These
integration activities are complex and time-consuming, and we may encounter unexpected difficulties or incur unexpected
costs, including:
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our inability to achieve the operating synergies anticipated in the acquisitions;
diversion of management attention from ongoing business concerns to integration matters;
difficulties in consolidating and rationalizing IT platforms and administrative infrastructures;
complexities associated with managing the geographic separation of the combined businesses and
consolidating multiple physical locations where management may determine consolidation is desirable;
difficulties in integrating personnel from different corporate cultures while maintaining focus on providing
consistent, high quality customer service;
difficulties or delays in transitioning U.S. Government contracts pursuant to federal acquisition regulations;
challenges in demonstrating to customers of Kratos and to customers of acquired businesses that the
acquisition will not result in adverse changes in customer service standards or business focus;
possible cash flow interruption or loss of revenue as a result of change of ownership transitional matters; and
inability to generate sufficient revenue to offset acquisition costs.
Acquired businesses may have liabilities or adverse operating issues that we fail to discover through due diligence
prior to the acquisition, including cyber and other security vulnerabilities. In particular, to the extent that prior owners of any
acquired businesses or properties failed to comply with or otherwise violated applicable laws or regulations, or failed to fulfill
their contractual obligations to the U.S. Government or other customers, we, as the successor owner, may be financially
responsible for these violations and failures and may suffer reputational harm or otherwise be adversely affected. Acquisitions
also frequently result in the recording of goodwill and other intangible assets that are subject to potential impairment in the
future that could harm our financial results. In addition, if we finance acquisitions by issuing debt or equity securities, our
existing stockholders may be diluted, which could affect the market price of our stock. Acquisitions and/or the related equity
financings could also impact our ability to utilize our NOL carryforwards. As a result, if we fail to properly evaluate
acquisitions or investments, we may not achieve the anticipated benefits of any such acquisitions, and we may incur costs in
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excess of what we anticipate. Acquisitions frequently involve benefits related to integration of operations. The failure to
successfully integrate the operations or to otherwise realize any of the anticipated benefits of the acquisition could seriously
harm our financial condition and results of operations. While we believe that we have established appropriate and adequate
procedures and processes to mitigate these risks, there is no assurance that these transactions will be successful.
We also evaluate from time to time the potential disposition of assets or business that may no longer meet our growth,
return and/or strategic objectives. Divestitures have inherent risks, including the possibility that any anticipated sale will be
delayed or will not occur, the potential failure to realize the perceived strategic or financial merits of the divestment, difficulties
in the separation of operations, services, information technology, products and personnel, unexpected costs associated with such
separation, diversion of management’s attention from other business concerns and potential post-closing claims for alleged
breaches of related agreements, indemnification or other disputes. A failure to successfully complete a disposition or to
otherwise realize any of the anticipated benefits of a disposition could seriously harm our financial condition and results of
operations.
If we are unable to manage our growth, our business and financial results could suffer.
Sustaining our growth has placed significant demands on our management, as well as on our administrative,
operational and financial resources. For us to continue to manage our growth, we must continue to improve our operational,
financial and management information systems and expand, motivate and manage our workforce. Additionally, our future
financial results depend in part on our ability to profitably manage our growth on a combined basis with the businesses we have
acquired and those we may acquire in the future. If we are unable to manage our growth while maintaining our quality of
service and profit margins, or if new systems that we implement to assist in managing our growth do not produce the expected
benefits, our business, prospects, financial condition or operating results could be adversely affected.
The loss of any member of our senior management could impair our relationships with U.S. Government customers and
disrupt the management of our business.
We believe that the success of our business and our ability to operate profitably depends on the continued contributions
of the members of our senior management. We rely on our senior management to generate business and execute programs
successfully. In addition, the relationships and reputation that many members of our senior management team have established
and maintain with U.S. Government personnel contribute to our ability to maintain strong customer relationships and to identify
new business opportunities. The loss of any member of our senior management could impair our ability to identify and secure
new contracts, to maintain good customer relations and to otherwise manage our business.
If we fail to attract and retain skilled employees or employees with the necessary national security clearances, we might not
be able to perform under our contracts or win new business.
The growth of our business and revenue depends in large part upon our ability to attract and retain sufficient numbers
of highly qualified individuals who have advanced technical and/or engineering skills. These employees are in great demand
and are likely to remain a limited resource in the foreseeable future. In addition, certain U.S. Government contracts require us,
and some of our employees, to maintain national security clearances. Obtaining and maintaining national security clearances for
employees involves a lengthy process, and it is difficult to identify, recruit and retain employees who already hold national
security clearances. Further, some of our contracts contain provisions requiring us to staff an engagement with personnel that
the customer considers key to our successful performance under the contract. In the event we are unable to provide these key
personnel or acceptable substitutions, the customer may terminate the contract. As a result, if we are unable to recruit and retain
a sufficient number of qualified employees, we may lose revenue and our ability to maintain and grow our business could be
limited.
Moreover, in a tight labor market our direct labor costs could increase or we may be required to engage large numbers
of subcontractor personnel, which could cause our profit margins to suffer. Conversely, if we maintain or increase our staffing
levels in anticipation of one or more projects and the projects are delayed, reduced or terminated, we may underutilize the
additional personnel, which would increase our general and administrative expenses, reduce our earnings and possibly harm our
results of operations.
We are subject to the requirements of the National Industrial Security Program Operating Manual for our facility security
clearance, which is a prerequisite to our ability to perform on classified contracts for the U.S. Government.
A facility security clearance is required for a company to perform on classified contracts for the DoD and certain other
agencies of the U.S. Government. Security clearances are subject to regulations and requirements including the National
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Industrial Security Program Operating Manual (“NISPOM”), which specifies the requirements for the protection of classified
information released or disclosed in connection with classified U.S. Government contracts.
We require certain facility and personnel security clearances to perform our classified U.S. Government related
business. As such, we must comply with the requirements of the NISPOM and any other applicable U.S. Government industrial
security regulations. If we were to violate the terms and requirements of the NISPOM or any other applicable U.S. Government
industrial security regulations (which apply to us under the terms of classified contracts), any of our cleared facilities could lose
its facility security clearance. We cannot be certain that we will be able to maintain our facility security clearances. If for some
reason one or more of our facility security clearances is invalidated or terminated, we would not be able to continue to perform
on classified contracts at that facility and would not be able to enter into new classified contracts, which could adversely affect
our revenues. Failure to comply with the NISPOM or other security requirements may subject us to civil or criminal penalties,
loss of access to classified information, loss of a U.S. Government contract, or potentially debarment as a government
contractor.
We will be subject to the new DoD Cybersecurity Maturity Model Certification (“CMMC”) requirement recently issued by
the Pentagon which may limit our ability to bid and win projects. The cost for the new CMMC requirement may be
significant.
The Pentagon, on January 31, 2020, released the official version of its unified Cybersecurity standard that all
contractors must meet by 2026. This standard, the CMMC, will apply to any company that does business with the Department
of Defense. CMMC will also apply to subcontractors as well as prime contractors. The DoD has stated that it expects a roll-out
of this requirement over a five-year timeline. CMMC borrows heavily from the existing NIST Cybersecurity Framework, and
intends to rely heavily on a CMMC accrediting body. The DoD is currently drafting a memorandum of understanding to
establish rules, roles and responsibilities between it and the accrediting body. Once up and running, companies will be able to
apply for certification through a portal run by the accrediting body. The CMMC certification will be good for three years; with
it, companies will be able to bid on contracts across the DoD and military services. There will be five levels of certification,
Level 1 through Level 5. The new certification will not be required for existing contracts already signed, only on new contracts.
The first “pathfinder” solicitations mandating CMMC are expected to come out in the fall of 2020. It is expected to take until
2026 to bring all contractors into compliance, since five years is the typical duration of a government contract.
Under CMMC, contractors will no longer “self-attest” they meet a given standard. Instead, Pentagon approved third
parties will assess each company, at the company’s expense. There will be no fines for non-compliance, however contractors
will not be able to be awarded new contracts that require a particular level of certification.
We may be unable to bid on new contract awards or on follow-on awards for existing work, depending on the level of
standard as required for each solicitation, which could adversely impact our revenues, operating margins and cash flows. The
cost to comply with the new CMMC requirement may be significant.
We may be unable to realize any benefit from our cost reduction and restructuring efforts and our profitability may be hurt
or our business otherwise might be adversely affected.
We have engaged in cost reduction and restructuring activities in the past, including recent restructuring actions in our
modular systems business and our divestiture of the Public Safety & Security business, and we may engage in other cost
reduction restructuring activities in the future. These types of cost reduction and restructuring activities are complex. If we do
not successfully manage our current cost reduction and restructuring activities, or any other cost reduction and restructuring
activities that we may take in the future, any expected efficiencies and benefits might be delayed or not realized, and our
operations and business could be disrupted. In addition, the costs associated with implementing cost reduction and restructuring
activities might exceed expectations, which could result in additional future charges.
Our operations expose us to the risk of material environmental liabilities.
We are subject to various U.S. federal, state, local and non-U.S. laws and regulations related to environmental
protection, including the discharge, treatment, storage, disposal and remediation of hazardous substances and wastes. We could
incur substantial costs, including cleanup costs, fines and civil or criminal sanctions, as well as third-party claims for property
damage or personal injury, if we were to violate or become liable under environmental laws or regulations. In some cases, we
may be subject to such costs due to environmental impacts attributable to our current or past manufacturing operations or the
operations of companies we have acquired. In other cases, we may become subject to such costs due to an indemnification
agreement between us and a third party relating to such environmental liabilities. In addition, new laws and regulations, more
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stringent enforcement of existing laws and regulations, the discovery of previously unknown contamination or the imposition of
new remediation requirements could result in additional costs.
Risks Related to Our International Operations
Revenues derived from our international business could be subject to global economic downturn and hardship.
Our international business represents 18% of our total revenue for the year ended December 29, 2019, which may be
impacted by changes in foreign national priorities and government budgets and may be further impacted by global economic
conditions and fluctuations in foreign currency exchange rates. Continued international economic uncertainty and reductions
in consumer spending may result in reductions in our revenue. In particular, recent events have caused increased attention on
U.S. defense sales to the Kingdom of Saudi Arabia (“KSA”). Although we currently do not expect to be prevented from doing
business in KSA, which represents nearly 8% of our sales (which are through FMS), if government action impairs our ability
to fulfill our contractual obligations or otherwise to continue to do business in KSA, it could have an adverse effect on our
financial results.
Additionally, disruptions in international credit markets may materially limit consumer credit availability and restrict
credit availability of our customers. Any reduction in international sales of our solutions resulting from reductions in consumer
spending or continued disruption in the availability of credit to retailers or consumers, could materially and adversely affect
our business, results of operations and financial condition.
Our international business exposes us to additional risks.
Our operations outside of the U.S. are subject to risks that are inherent in conducting business under non-U.S. laws,
regulations and customs, including those related to:
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foreign currency exchange rate fluctuations, potentially reducing the U.S. dollars we receive for sales
denominated in foreign currency;
the possibility that unfriendly nations or groups could boycott our solutions;
political conditions in the markets in which we operate;
potential increased costs associated with overlapping tax structures;
import-export control;
the ability to obtain required U.S. government agency issued export licenses to ship our product overseas;
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difficulties and costs associated with staffing and managing foreign operations;
unexpected changes in regulatory requirements;
the difficulties of compliance with a wide variety of foreign laws and regulations;
longer accounts receivable cycles in certain foreign countries, whether due to cultural differences, exchange
rate fluctuation or other factors;
technology transfer restrictions;
changes to our distribution networks;
our employees; and
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• war and terrorist events, including impacts to our international operations such as Microwave Electronics,
which is headquartered in Israel.
These risks, individually or in the aggregate, could have an adverse effect on our results of operations and financial
condition. For example, we are subject to compliance with the Foreign Corrupt Practices Act and similar anti-bribery laws,
which generally prohibit companies and their intermediaries from making improper payments to foreign government officials
for the purpose of obtaining or retaining business. While our employees and agents are required to comply with these laws, we
cannot be sure that our internal policies and procedures will always protect us from violations of these laws, despite our
commitment to legal compliance and corporate ethics. The occurrence or allegation of these types of risks may adversely
affect our business, performance, prospects, value, financial condition, and results of operations. In addition, our international
contracts may include industrial cooperation agreements requiring specific in-country purchases, investments, manufacturing
agreements or other financial obligations, known as offset obligations, and provide for penalties if we fail to meet such
requirements. In addition, due to the nature of our products, we must obtain licenses and authorizations from various U.S.
government agencies before selling our products outside of the U.S. Our ability to obtain these licenses and authorizations
timely or at all is subject to risks and uncertainties, including changing U.S. government policies or laws or delays in
Congressional action due to geopolitical and other factors. The impact of these factors is difficult to predict, but one or more of
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them could adversely affect our financial position, results of operations, or cash flows.
Violations of the International Traffic in Arms Regulations (“ITAR”) or other applicable trade compliance regulations
could result in significant sanctions including fines, more onerous compliance requirements and debarments from export
privileges or loss of authorizations needed to conduct aspects of our international business. A violation of ITAR or other
applicable trade regulations could have a materially adverse effect on our business, financial condition and results of operations.
Risks Related to Our Long-term Borrowings
We have substantial long-term borrowings, which could adversely affect our cash flow, financial condition and business.
As of December 29, 2019, we had approximately $295.1 million of long-term borrowings outstanding, which is net of
$4.9 million of unamortized debt issuance costs. As a result of this indebtedness, our interest payment obligations are
significant. The degree to which we are leveraged could have adverse effects on our business, including the following:
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it may limit our flexibility in planning for, or reacting to, changes in our business and the industries in which
we operate;
it may require us to dedicate a substantial portion of our cash flow from operations to payments on our
indebtedness, thereby reducing the availability of our cash flow to fund working capital, capital expenditures
and other general corporate purposes;
it may restrict us from making strategic acquisitions or exploiting business opportunities;
it may place us at a competitive disadvantage compared to our competitors that have less debt;
it may limit our ability to borrow additional funds;
it may prevent us from raising the funds necessary to repurchase our outstanding 6.5% Notes (as defined
below) tendered to us if there is a change of control, which would constitute a default under the Indenture (as
defined below) governing our 6.5% Notes and under our Credit Agreement; and
it may decrease our ability to compete effectively or operate successfully under adverse economic and
industry conditions.
Our level of long-term borrowings increases the risk that we may default on our debt obligations. We may be unable to
generate sufficient cash flow to pay the interest on our debt. If we are unable to service our indebtedness, we will be forced to
adopt an alternative strategy that may include actions such as reducing capital expenditures, reducing internal investments in
research and development efforts, selling assets, restructuring or refinancing our indebtedness or seeking additional equity
capital. These alternative strategies may not be affected on satisfactory terms, if at all, and they may not yield sufficient funds to
make required payments on our indebtedness.
If, for any reason, we are unable to meet our debt service and repayment obligations, we would be in default under the
terms of the agreements governing our debt, which would allow our creditors at that time to declare certain outstanding
indebtedness to be due and payable, which would in turn trigger cross acceleration or cross default rights between the relevant
agreements. In addition, the holders of our 6.5% Notes could foreclose against the assets securing the 6.5% Notes and we could
be forced into bankruptcy or liquidation and/or our lenders could compel us to apply all of our available cash to repay our
borrowings or they could prevent us from making payments on our indebtedness. If the amounts outstanding under any of our
indebtedness were to be accelerated, our assets may not be sufficient to repay in full the money owed to the lenders or to our
other debt holders.
We and our subsidiaries may incur more debt, which may increase the risks associated with our leverage, including our
ability to service our indebtedness.
The agreements governing our debt permit us, under some circumstances, to incur certain additional indebtedness or
obligations. To the extent that we incur additional indebtedness or such other obligations, the risks associated with our leverage
described above, including our possible inability to service our debt, would increase.
Changes in our credit ratings or macroeconomic conditions may affect our liquidity, increasing borrowing costs and
limiting our financing options.
Macroeconomic conditions, such as increased volatility or disruption in the credit markets, could adversely affect our
ability to refinance existing debt or obtain additional financing at terms satisfactory to us, thereby affecting our resources to
support operations or to fund new initiatives. In addition, if our credit ratings are lowered, borrowing costs for future long-term
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debt or short-term credit facilities may increase and our financing options, including our access to the unsecured credit market,
could be limited. We may also be subject to restrictive covenants that would reduce our flexibility.
A portion of our business is conducted through foreign subsidiaries, and the failure to generate sufficient cash flow from
these subsidiaries, or otherwise repatriate or receive cash from these subsidiaries, could result in our inability to repay our
indebtedness.
As of December 29, 2019, approximately 11% of our consolidated assets, based on book value, and 16% of our
consolidated revenues for the year ended December 29, 2019, were held by foreign subsidiaries, which do not guarantee the
6.5% Notes. Our ability to meet our debt service obligations with cash from foreign subsidiaries will depend upon the results of
operations of these subsidiaries and may be subject to legal, contractual or other restrictions and other business considerations.
In addition, dividend and interest payments to us from the foreign subsidiaries may be subject to foreign withholding taxes,
which would reduce the amount of funds we receive from such foreign subsidiaries. Therefore, to the extent that we must use
cash generated in foreign jurisdictions to make principal or interest payments on our debt, there may be a cost associated with
repatriating the cash to the U.S. Dividends and other distributions from our foreign subsidiaries may also be subject to
fluctuations in currency exchange rates and legal and other restrictions on repatriation, which could further reduce the amount
of funds we receive from such foreign subsidiaries.
The agreements governing our debt impose significant operating and financial restrictions on us and our subsidiaries that
may prevent us and our subsidiaries from pursuing certain business opportunities and restrict our ability to operate our
business.
The Indenture and the Credit Agreement subject us, and our subsidiaries, to several financial and other restrictive
covenants, including limitations on liens or indebtedness, payment of dividends, transactions with affiliates, and mergers, sales
or other dispositions of our assets.
Our Credit Agreement also requires us to comply with specified financial ratios, including a borrowing base
availability and minimum fixed charge coverage ratio which is required to be maintained if borrowing levels, as defined, under
the Credit Agreement, occur under the line of credit. Many factors, including events beyond our control, may affect our ability
to comply with these covenants and financial ratios. We cannot be sure we will meet our debt-related obligations or that lenders
will waive any failure to meet those obligations. Any failure to meet those debt-related obligations could result in an event of
default under our other indebtedness and the acceleration of such indebtedness.
The restrictions contained in the Indenture and in our Credit Agreement could also limit our ability to plan for or react
to market conditions, meet capital needs or otherwise restrict our activities or business plans and adversely affect our ability to
finance operations, enter into acquisitions or to engage in other business activities that would be in the Company’s interest.
Changes in the method for determining LIBOR and the potential replacement of LIBOR may affect interest rates on our
credit facilities and interest rate swaps.
LIBOR, the London interbank offered rate, is the basic rate of interest used in lending between banks on the London
interbank market and is widely used as a reference for setting the interest rate on loans globally. Interest rates under our Credit
Agreement are based partly on the LIBOR. On July 27, 2017, the United Kingdom’s Financial Conduct Authority, which
regulates LIBOR, announced that it intends to phase out LIBOR by the end of 2021. It is unclear if at that time LIBOR will
cease to exist or if new methods of calculating LIBOR will be established such that it continues to exist after 2021. If the
method for calculation of LIBOR changes, if LIBOR is no longer available or if lenders have increased costs due to changes in
LIBOR, we may suffer from potential increases in interest rates on our borrowings under the Credit Agreement. Further, we
may need to renegotiate our credit facilities or any other borrowings that utilize LIBOR as a factor in determining the interest
rate to replace LIBOR with the new standard that is established.
Risks Related to Our Intellectual Property
We may be unable to protect our intellectual property rights.
We rely on a combination of patents, trademarks, copyrights, trade secrets and nondisclosure agreements to protect our
proprietary intellectual property. Our efforts to protect our intellectual property and proprietary rights may not be sufficient. We
cannot be sure that our pending patent applications will result in the issuance of patents to us, that patents issued to or licensed
by us in the past or in the future will not be challenged or circumvented by competitors or that these patents will remain valid or
sufficiently broad to preclude our competitors from introducing technologies similar to those covered by our patents and patent
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applications. In addition, our ability to enforce and protect our intellectual property rights may be limited in certain countries
outside the U.S., which could make it easier for competitors to capture market position in such countries by utilizing
technologies that are similar to those developed or licensed by us. Competitors also may harm our sales by designing products
that mirror the capabilities of our products or technology without infringing on our intellectual property rights. If we do not
obtain sufficient protection for our intellectual property, or if we are unable to effectively enforce our intellectual property
rights, our competitiveness could be impaired, which would limit our growth and future revenue.
We may be harmed by intellectual property infringement claims.
We may become subject to claims from our employees or third parties who assert that software and other forms of
intellectual property that we use in delivering services and solutions to our customers infringe upon intellectual property rights
of such employees or third parties. Our employees develop some of the software and other forms of intellectual property that
we use to provide our services and solutions to our customers, but we also license technology from other vendors. If our
employees, vendors, or other third parties assert claims that we or our customers are infringing on their intellectual property
rights, we could incur substantial costs to defend those claims. If any such infringement claims were ultimately successful, we
could be required to cease selling or using products or services that incorporate the challenged software or technology, obtain a
license or additional licenses from our employees, vendors, or other third parties, or redesign our products and services that rely
on the challenged software or technology.
Disclosure of trade secrets could cause harm to our business.
We attempt to protect our trade secrets by entering into confidentiality and intellectual property assignment agreements
with third parties, our employees and consultants. However, these agreements can be breached and, if they are, there may not be
an adequate remedy available to us. In addition, others may independently discover our trade secrets and proprietary
information, and in such cases we could not assert any trade secret rights against such party. Enforcing a claim that a party
illegally obtained and is using our trade secret is difficult, expensive and time consuming, and the outcome is unpredictable. If
we are unable to protect our intellectual property, our competitors could market services or products similar to our services and
products, which could reduce demand for our offerings. Any litigation to enforce our intellectual property rights, protect our
trade secrets or determine the validity and scope of the proprietary rights of others could result in substantial costs and diversion
of resources, with no assurance of success.
Risks Related to Regulatory, Environmental and Legal Issues
Our failure to comply with complex procurement laws and regulations could cause us to lose business and subject us to a
variety of penalties.
We must comply with laws and regulations relating to the formation, administration and performance of U.S.
Government contracts, which affect how we do business with our customers, prime contractors, subcontractors and vendors and
may impose added costs on us. New regulations or procurement requirements (including, for example regulations regarding
counterfeit and corrupt parts, supply chain diligence and cyber security) or changes to current requirements could increase our
costs and risk of non-compliance. Our role as a contractor to agencies and departments of the U.S. Government results in our
being routinely subject to investigations and reviews relating to compliance with various laws and regulations, including those
associated with organizational conflicts of interest, procurement integrity, bid integrity and claim presentation, among others.
These investigations may be conducted without our knowledge. Adverse findings in these investigations or reviews can lead to
criminal, civil or administrative proceedings, and we could face civil and criminal penalties and administrative sanctions,
including termination of contracts, forfeiture of profits, suspension of payments, fines and suspension or debarment from doing
business with U.S. Government agencies. In addition, we could suffer serious harm to our reputation and competitive position if
allegations of impropriety were made against us, whether or not true. If our reputation or relationship with U.S. Government
agencies were impaired, or if the U.S. Government otherwise ceased doing business with us or significantly decreased the
amount of business it does with us, our revenue and operating profit would decline.
Our contracts and administrative processes and systems are subject to audits and cost adjustments by the U.S. Government,
which could reduce our revenue, disrupt our business or otherwise adversely affect our results of operations.
U.S. Government agencies, including the Defense Contract Audit Agency (“DCAA”), routinely audit and investigate
government contracts and government contractors’ administrative processes and systems. These agencies review our
performance on contracts, pricing practices, cost structure and compliance with applicable laws, regulations and standards.
They also review the adequacy of our compliance with government standards for our accounting and management of internal
control systems, including our: control environment and overall accounting system; general IT system; budget and planning
29
system; purchasing system; material management and accounting system; compensation system; labor system; indirect and
other direct costs system; billing system; and estimating system used for pricing on government contracts. Both contractors and
the U.S. Government agencies conducting these audits and reviews have come under increased scrutiny. The current audits and
reviews have become more rigorous, and the standards to which contractors are being held are being more strictly interpreted,
increasing the likelihood of an audit or review resulting in an adverse outcome. During the course of its current audits, the
DCAA is closely examining and questioning several of our established and disclosed practices that it had previously audited
and accepted, increasing the uncertainty as to the ultimate conclusion that will be reached.
A finding of significant control deficiencies in our system audits or other reviews can result in decremented billing
rates to our U.S. Government customers until the control deficiencies are corrected and our corrections are accepted by Defense
Contract Management Agency (“DCMA”). Government audits and reviews may conclude that our practices are not consistent
with applicable laws and regulations and result in adjustments to contract costs and mandatory customer refunds. Such
adjustments can be applied retroactively, which could result in significant customer refunds. Our receipt of adverse audit
findings or the failure to obtain an “approved” determination of our various accounting and management internal control
systems, including our changes to indirect cost and direct labor estimating systems, from the responsible U.S. Government
agency could significantly and adversely affect our business, including our ability to bid on new contracts and our competitive
position in the bidding process. A determination of non-compliance with applicable contracting and procurement laws,
regulations and standards could also result in the U.S. Government imposing penalties and sanctions against us, including
withholding of payments, suspension of payments and increased government scrutiny that could delay or adversely affect our
ability to invoice and receive timely payment on contracts, perform contracts or compete for contracts with the U.S.
Government.
We have submitted incurred cost claims through fiscal year 2018. The actual indirect cost audits by the DCAA have
been completed for our subsidiaries through fiscal year 2017. Although we have recorded contract revenues subsequent to fiscal
year 2017 based upon costs that we believe will be approved upon final audit or review, we do not know the outcome of any
ongoing or future audits or reviews and, if future adjustments exceed our estimates, our profitability would be adversely
affected.
Our employees or others acting on our behalf may engage in misconduct or other improper activities, which could cause us
to lose contracts or cause us to incur costs.
We are exposed to the risk that employee fraud or other misconduct from our employees or others acting on our behalf
could occur. Misconduct by employees or others could include intentional failures to comply with U.S. Government
procurement regulations, engaging in unauthorized activities, insider threats to our cybersecurity, or falsifying time records.
Misconduct by our employees or others acting on our behalf could also involve the improper use of our customers’ sensitive or
classified information, which could result in regulatory sanctions against us, serious harm to our reputation, a loss of contracts
and a reduction in revenues, or cause us to incur costs to respond to any related governmental inquiries. It is not always possible
to deter misconduct, and the precautions we take to prevent and detect this activity may not be effective in controlling unknown
or unmanaged risks or losses, which could cause us to lose contracts or cause a reduction in revenues. In addition, alleged or
actual misconduct by employees or others acting on our behalf could result in investigations or prosecutions of persons engaged
in the subject activities, which could result in unanticipated consequences or expenses and management distraction for us
regardless of whether we are alleged to have any responsibility.
We have in the past experienced and may in the future experience such misconduct, despite our various compliance
programs. Misconduct or improper actions by our employees, agents, subcontractors, suppliers, business partners and/or joint
ventures could subject us to administrative, civil or criminal investigations and enforcement actions; monetary and non-
monetary penalties; liabilities; and the loss of privileges and other sanctions, including suspension and debarment, which could
negatively impact our reputation and ability to conduct business and could have a material adverse effect on our financial
position, results of operations and/or cash flows.
If we fail to maintain an effective system of internal controls, we may not be able to accurately report our financial results or
prevent fraud.
Effective internal controls are necessary for us to provide reliable financial reports. If we cannot provide reliable
financial reports, our operating results could be misstated, our reputation may be harmed and the trading price of our stock
could be negatively affected. Our management has concluded that there are no material weaknesses in our internal controls over
financial reporting as of December 29, 2019. However, although we continue to devote substantial time and resources to the
documentation and testing of our controls, there can be no assurance that our controls over financial processes and reporting
30
will be effective in the future or that material weaknesses or significant deficiencies in our internal controls will not be
discovered in the future. Any failure to remediate any future material weaknesses or implement required new or improved
controls, or difficulties encountered in their implementation, could harm our operating results, cause us to fail to meet our
reporting obligations or result in material misstatements in our consolidated financial statements or other public disclosures.
Inferior internal controls could also cause investors to lose confidence in our reported financial information, which could have a
negative effect on the trading price of our stock.
We are subject to environmental laws and potential exposure to environmental liabilities. This may affect our ability to
develop, sell or rent our property or to borrow money where such property is required to be used as collateral.
We use hazardous materials common to the industries in which we operate. We are required to follow federal, state and
local environmental laws and regulations regarding the handling, storage and disposal of these materials, including the Clean
Air Act, the Clean Water Act, the Resource Conservation and Recovery Act, the Comprehensive Environmental Response,
Compensation and Liability Act (“CERCLA”), and the Toxic Substances Control Act. We could be subject to fines, suspensions
of production, alteration of our manufacturing processes or interruption or cessation of our operations if we fail to comply with
present or future laws or regulations related to the use, storage, handling, discharge or disposal of toxic, volatile or otherwise
hazardous chemicals used in our manufacturing processes. These regulations could require us to acquire expensive remediation
equipment or to incur significant other expenses to comply with environmental regulations. Our failure to control the handling,
use, storage or disposal of, or adequately restrict the discharge of, hazardous substances could subject us to liabilities and
production delays, which could cause us to miss our customers’ delivery schedules, thereby reducing our sales for a given
period. We may also have to pay regulatory fines, penalties or other costs (including remediation costs), which could materially
reduce our profits and adversely affect our financial condition. Permits are required for our operations, and these permits are
subject to renewal, modification and, in some cases, revocation.
In addition, under environmental laws, ordinances or regulations, a current or previous owner or operator of property
may be liable for the costs of removal or remediation of some kinds of petroleum products or other hazardous substances on,
under, or in its property, adjacent or nearby property, or offsite disposal locations, without regard to whether the owner or
operator knew of, or caused, the presence of the contaminants, and regardless of whether the practices that resulted in the
contamination were legal at the time they occurred. We have incurred, and may incur in the future, liabilities under CERCLA
and other environmental laws at our current or former facilities, adjacent or nearby properties or offsite disposal locations. The
costs associated with future cleanup activities that we may be required to conduct or finance may be material. The presence of,
or failure to remediate properly, hazardous substances may adversely affect the ability to sell or rent the property or to borrow
funds using the property as collateral. Additionally, we may become subject to claims by third parties based on damages,
including personal injury and property damage, and costs resulting from the disposal or release of hazardous substances into the
environment.
Regulations related to “conflict minerals” may cause us to incur additional expenses and could limit the supply and increase
the cost of certain metals used in manufacturing our products.
We are subject to regulations requiring disclosures of specified minerals, known as conflict minerals, that are
necessary to the functionality or production of products manufactured or contracted to be manufactured by public companies.
The rule requires companies to perform due diligence, disclose and report whether or not such minerals originate from the
Democratic Republic of the Congo or an adjoining country. The rule can affect sourcing at competitive prices and availability in
sufficient quantities of certain minerals used in the manufacture of our products, including tantalum, tin, gold and tungsten. The
number of suppliers who provide conflict-free minerals is limited. In addition, there are costs associated with complying with
the disclosure requirements, such as costs related to determining the source of certain minerals used in our products, as well as
costs of changes to products, processes, or sources of supply as a consequence of such verification activities. Since our supply
chain is complex, we are not always able to sufficiently verify the origins of the relevant minerals used in our products through
the due diligence procedures we implemented, which may harm our reputation. In addition, we may encounter challenges to
satisfy those customers who require that all of the components of our products be certified as conflict-free, which could place us
at a competitive disadvantage if we are unable to do so.
Litigation may distract us from operating our business, and adverse judgments or settlements could adversely affect our
financial results and operations.
Litigation that may be brought by or against us could cause us to incur significant expenditures and distract our
management from the operation of our business. Furthermore, there can be no assurance that we would prevail in such litigation
or resolve such litigation on terms favorable to us, which may adversely affect our financial results and operations. See Note 15
31
of the Notes to Consolidated Financial Statements contained within this Annual Report for a further discussion of our legal
proceedings.
Natural disasters or severe weather conditions could disrupt our business and result in loss of revenue or higher expenses.
Our business depends on maintaining operations at our facilities and being able to operate at our customer facilities
and project locations. A serious, prolonged interruption or damage due to power outage, telecommunications outage, terrorist
attack, earthquake, hurricane, fire, flood or other natural disaster, or other interruption could have a material adverse effect on
our business and financial results. While we insure against certain business interruption risks, such insurance may not
adequately compensate us for any losses incurred as a result of natural or other disasters.
Risks Related to Our Common Stock
Some of our contracts with the U.S. Government are classified, which may limit investor insight into portions of our
business.
We derive a portion of our revenues from programs with the U.S. Government that are subject to security restrictions
(classified programs) that preclude the dissemination of information that is classified for national security purposes. We are
limited in our ability to provide details about these classified programs, their risks or any disputes or claims relating to such
programs. As a result, investors and others might have less insight into our classified programs than our other businesses and,
therefore, less ability to fully evaluate the risks related to our classified business.
The market price of our common stock may be volatile.
The price of our stock has been in the past, and will continue to be, subject to fluctuations as a result of a number of
factors, most of which we cannot control, including: failure of our operating results to meet market or analysts’ expectations;
general fluctuations in the stock market; actual or anticipated fluctuations in our operating results based on reduced and/or
delayed government spending or the threat thereof; fluctuations in the stock prices of companies in our industry; changes in
earnings estimated by securities analysts or our ability to meet those estimates; rumors or dissemination of false information;
litigation and government inquiries; political and/or military events associated with current worldwide conflicts; and domestic
and foreign economic conditions. Such volatility has had a significant effect on the market prices of many companies’ securities
for reasons unrelated to their operating performance and, in the past, has led to securities class action litigation. Securities
litigation against us could result in substantial costs and a diversion of our management’s attention and resources, which could
have an adverse effect on our business.
Your percentage of ownership in us may be diluted in the future.
As with any publicly traded company, your percentage ownership in us may be diluted in the future because of equity
issuances for acquisitions, capital market transactions or otherwise, including equity awards that we expect will be granted to
our directors, officers and employees.
Future sales of our common stock could cause the market price for our common stock to decline.
We cannot predict the effect, if any, that market sales of shares of our common stock or the availability of shares of our
common stock for sale will have on the market price of our common stock prevailing from time to time. Sales of substantial
amounts of shares of our common stock in the public market, or the perception that those sales will occur, could cause the
market price of our common stock to decline or be depressed.
In the future, we may issue our securities if we need to raise capital in connection with a capital expenditure, working
capital requirement or acquisition. The amount of shares of our common stock issued in connection with a capital expenditure,
working capital requirement or acquisition could constitute a material portion of our then-outstanding shares of common stock.
Any perceived excess in the supply of our shares in the market could negatively impact our share price and any issuance of
additional securities in connection with investments or acquisitions may result in additional dilution to you.
We do not expect to pay any cash dividends or buyback any Kratos stock for the foreseeable future.
We have not declared any cash dividends since becoming a public company. We currently intend to retain any future
earnings to finance the growth and development of the business and, therefore, we do not anticipate that we will pay any cash
dividends on shares of our common stock in the foreseeable future. In addition, our ability to pay dividends and buyback Kratos
stock is restricted by both the Indenture and the Credit Agreement. Any determination to pay dividends or stock buybacks in the
32
future will be at the discretion of our board of directors and will be dependent upon our future financial condition, results of
operations and capital requirements, general business conditions and other relevant factors as determined by our board of
directors. See “Dividend Policy.”
Certain provisions in our amended and restated certificate of incorporation and second amended and restated bylaws, as
amended, and of Delaware law, may prevent or delay an acquisition of our Company, which could decrease the trading price
of our common stock.
Our amended and restated certificate of incorporation, our second amended and restated bylaws, as amended, and
Delaware law contain provisions that are intended to deter coercive takeover practices and inadequate takeover bids by making
such practices or bids unacceptably expensive to the raider and to encourage prospective acquirers to negotiate with our board
of directors rather than to attempt a hostile takeover. These provisions include, among others:
•
•
meetings;
•
•
•
the inability of our stockholders to call a special meeting;
rules regarding how stockholders may present proposals or nominate directors for election at stockholder
the right of our board of directors to issue preferred stock without stockholder approval;
a super-majority requirement to amend our certificate of incorporation or bylaws; and
the ability of our directors, and not stockholders, to fill vacancies on our board of directors.
Delaware law also imposes some restrictions on mergers and other business combinations between us and any holder
of 15% or more of our outstanding common stock.
We believe these provisions may help protect our stockholders from coercive or otherwise unfair takeover tactics by
requiring potential acquirers to negotiate with our board of directors and by providing our board of directors with more time to
assess any acquisition proposal. These provisions are not intended to make our Company immune from takeovers. In addition,
although we believe these provisions collectively provide for an opportunity to receive higher bids by requiring potential
acquirers to negotiate with our board, they would apply even if the offer may be considered beneficial by some stockholders.
These provisions may also frustrate or prevent any attempts by our stockholders to replace or remove our current management
team by making it more difficult for stockholders to replace members of our board, which is responsible for appointing the
members of our management.
Item 1B. Unresolved Staff Comments.
None.
Item 2. Properties.
At December 29, 2019, we owned or leased approximately 1.7 million square feet of floor space at 42 separate
locations, primarily in the U.S., for manufacturing, warehousing, research and development, administration and various other
uses. At December 29, 2019, we leased to third parties 131,451 square feet of our leased facilities, and had no vacant floor
space. We continually evaluate our current and future space capacity in relation to current and projected future staffing levels.
We maintain our properties in good operating condition and believe that the productive capacity of our properties is adequate to
meet current contractual requirements and those for the foreseeable future.
We have major operations at the following locations:
Kratos Government Solutions: Huntsville, AL; San Diego, CA; Colorado Springs, CO; Jupiter and Orlando, FL;
Baltimore and Lanham, MD; Bristow, OK; Dallastown, PA; and Alexandria and Chantilly, VA. Locations outside the U.S.
include Australia, Canada, England, France, Germany, Israel, Norway, and the United Kingdom.
Unmanned Systems: Roseville and Sacramento, CA; Fort Walton Beach, FL, and Oklahoma City, OK.
Corporate and other locations: San Diego, CA.
33
The following is a summary of our floor space at December 29, 2019:
Square feet (in thousands)
Kratos Government Solutions
Unmanned Systems
Corporate (includes San Diego, operations of KGS and US segments)
Total
Owned
Leased
Total
417
20
—
814
388
26
1,231
408
26
437
1,228
1,665
See Note 6 of the Notes to Consolidated Financial Statements contained within this Annual Report for information
regarding commitments under leases.
Item 3. Legal Proceedings.
See Note 15 of the Notes to Consolidated Financial Statements contained within this Annual Report for a further
discussion of our legal proceedings.
Item 4. Mine Safety Disclosures.
None.
PART II
Item 5. Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market Information
Our common stock is listed on the NASDAQ Global Select Market and is traded under the symbol “KTOS”.
Holders of Record
On February 20, 2020, there were 350 shareholders of record of our common stock.
Dividend Policy
We have not declared any cash dividends since becoming a public company. We currently intend to retain any future
earnings to finance the growth and development of the business and, therefore, do not anticipate paying any cash dividends in
the foreseeable future. In addition, our ability to pay dividends is restricted by both the Indenture and the Credit Agreement,
each as discussed in the section entitled “Liquidity and Capital Resources” in Item 7 “Management’s Discussion and Analysis
of Financial Condition and Results of Operations” and Note 5 of the Notes to Consolidated Financial Statements contained
within this Annual Report. Any future determination to pay cash dividends will be at the discretion of our board of directors
and will be dependent upon our future financial condition, results of operations and capital requirements, general business
conditions and other relevant factors as determined by our board of directors.
34
Performance Graph
The following performance graph and related information shall not be deemed “soliciting material” or to be “filed”
with the SEC, nor shall such information be incorporated by reference into any future filing under the Securities Act of 1933, as
amended (the “Securities Act”), or the Exchange Act of 1934 as amended (the “Exchange Act”), except to the extent that we
specifically incorporate it by reference into such filing.
The following performance graph presents a comparison of the five year cumulative stockholder return on our
common stock against the cumulative total return of a broad equity market index, the Russell 2000 Stock Index, and one
customized peer group consisting of the companies listed below, for the period commencing December 31, 2014 and ending
December 31, 2019. The performance graph assumes an initial investment of $100 in our common stock and in each of the
Russell 2000 Stock Index and the peer group, and further assumes that all dividends were reinvested and all returns are market-
cap weighted. The historical information set forth below is not necessarily indicative of future stock price performance.
COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
Among Kratos Defense & Security Solutions, Inc., the Russell 2000 Index,
and Peer Group
*$100 invested on 12/31/14 in stock or index, including reinvestment of dividends.
Fiscal year ending December 31.
The companies included in the Company’s Peer Group are: AAR Corp., Aerojet Rocketdyne Holdings, Inc.,
AeroVironment Inc., Comtech Telecommunications Corp., CPI Aerostructures Inc., Ducommun Inc., Frequency
Electronics Inc., and Mercury Systems Inc. Arotech Corp., which was included in the 2018 Peer Group has been excluded
from the current Peer Group as it is no longer publicly traded.
Recent Sales of Unregistered Securities; Use of Proceeds
None.
35
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
None.
Item 6. Selected Financial Data.
The following selected consolidated financial data should be read in conjunction with our Consolidated Financial
Statements and related notes thereto and with Item 7 “Management’s Discussion and Analysis of Financial Condition and
Results of Operations” contained within this Annual Report. Our historical results are not necessarily indicative of operating
results to be expected in the future.
Amounts in millions except per share amounts.
December 29,
2019
December 30,
2018
December 31,
2017
December 25,
2016
December 27,
2015
Consolidated Statements of Operations Data:
Revenues
Gross profit
Operating income (loss)
Provision (benefit) for income taxes
Income (loss) from continuing operations
Income (loss) from discontinued operations
Net income (loss)
Less: Net income attributable to noncontrolling
interest
$
717.5
$
618.0
$
603.3
$
541.9
$
190.0
38.0
4.8
10.9
1.7
12.6
0.1
169.7
30.5
4.6
4.1
(7.6)
(3.5)
—
157.6
(12.0)
(10.2)
(46.9)
4.2
(42.7)
—
120.5
(18.0)
5.8
(57.6)
(2.9)
(60.5)
—
Net income (loss) attributable to Kratos
$
12.5
$
(3.5) $
(42.7) $
(60.5) $
Income (loss) from continuing operations per common share attributable to Kratos:
Basic
Diluted
$
$
Income (loss) from discontinued operations per common share:
Basic
Diluted
$
$
Net income (loss) per common share attributable to Kratos:
Basic
Diluted
Weighted average shares:
Basic
Diluted
$
$
0.10
0.10
0.02
0.01
0.12
0.11
$
$
$
$
$
$
0.04
0.04
$
$
(0.52) $
(0.52) $
(0.94) $
(0.94) $
(0.07) $
(0.07) $
0.04
0.04
$
$
(0.05) $
(0.05) $
(0.03) $
(0.03) $
(0.48) $
(0.48) $
(0.99) $
(0.99) $
106.0
109.2
103.8
106.1
89.5
89.5
61.3
61.3
512.5
124.2
(9.6)
(13.8)
(35.8)
55.6
19.8
—
19.8
(0.61)
(0.61)
0.95
0.95
0.34
0.34
58.7
58.7
December 29,
2019
December 30,
2018
December 31,
2017
December 25,
2016
December 27,
2015
Consolidated Balance Sheet Data:
Cash and cash equivalents
Working capital
Total assets
Short-term debt
Long-term debt
$
172.6
$
182.7
$
130.5
$
70.2
$
339.5
1,186.0
—
295.1
330.0
1,010.1
—
294.2
282.5
1,024.0
0.8
293.5
176.5
948.6
1.0
431.0
Total stockholders’ equity
$
574.1
$
519.3
$
511.5
$
276.4
$
30.4
148.0
903.3
1.0
444.1
254.2
The 2015 Consolidated Statement of Operations Data includes an $80.8 million gain on the disposal of discontinued
operations before taxes and a loss of $3.4 million on extinguishment of debt. The 2015 Consolidated Balance Sheet Data
36
includes repayment of $41.0 million outstanding on our Credit Agreement and the repurchase of $175.0 million of our
previously outstanding 7.00% Senior Secured Notes due 2019 (the “7% Notes”) at par.
The 2016 Consolidated Balance Sheet Data includes our equity offering of 13.4 million shares of common stock,
which generated net proceeds of $76.2 million and our use of $14.1 million of the net proceeds from the offering to buy back
and redeem approximately $14.5 million of our 7% Notes. The 2016 Consolidated Statement of Operations Data and
Consolidated Balance Sheet Data were impacted by an $18.7 million loss accrual recorded in 2016 on the LCASD cost share
contract, which is expected to be incurred by us over the period of performance of the contract, and was incurred in order to
retain the intellectual property rights for the new LCASD platform.
The 2017 Consolidated Statement of Operations Data and Consolidated Balance Sheet Data includes a $24.2 million
impairment of the carrying value of the goodwill of our DRSS reporting unit within our KGS segment and a $17.3 million loss
on extinguishment of debt related to the refinancing of the remaining $372.8 million outstanding balance of the 7% Notes. The
2017 Consolidated Balance Sheet Data also includes our equity offerings of approximately 28.0 million shares of common
stock, which generated net proceeds of $269.1 million and our use of $64.0 million of the net proceeds from the offering to buy
back and redeem approximately $62.7 million of our 7% Notes. The 2017 Consolidated Balance Sheet Data also reflects the
refinancing of the remaining $372.8 million of our 7% Notes with $300.0 million of 6.5% Notes. We incurred debt issuance
costs of $6.6 million associated with the new 6.5% Notes. We utilized the net proceeds from the 6.5% Notes, along with cash of
$89.7 million to extinguish the 7% Notes.
The 2018 Consolidated Statement of Operations Data and Consolidated Balance Sheet Data includes the disposition of
the PSS business which was disposed of on June 11, 2018 and is reflected as a discontinued operation. The 2018 Consolidated
Statement of Operations Data and Consolidated Balance Sheet Data also reflects the adoption of FASB ASC 606, Revenue from
Contracts with Customers (“ASC 606”), effective January 1, 2018.
The 2019 Consolidated Statement of Operations Data and Consolidated Balance Sheet Data includes the February
2019 acquisition of FTT as well as the adoption of FASB ASC 842, Leases, on December 31, 2018.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
In addition to historical information, the following discussion contains forward-looking statements that are subject to
risks and uncertainties. Our actual results may differ substantially from those expressed in or implied by any forward-looking
statements herein due to a number of factors, including but not limited to the risks and uncertainties described in this Item 7, in
Item 1A “Risk Factors” and elsewhere in this Annual Report. These forward-looking statements reflect our views and
assumptions only as of the date such forward-looking statements are made. Except as required by law, we assume no
responsibility for updating any forward-looking statements, whether as a result of new information, future events or otherwise.
The following discussion should be read in conjunction with our audited Consolidated Financial Statements and the
related notes and other financial information appearing elsewhere in this Annual Report and other reports and filings made
with the SEC.
Overview
Kratos is a government contractor at the forefront of the DoD’s recapitalization of strategic weapon systems to address
peer and near peer threats and its related Rapid Innovation Initiatives. Kratos is a leading technology, intellectual property,
proprietary product and system company focused on the U.S. and its allies’ national security. Kratos is a recognized industry
leader in the rapid development, demonstration and fielding of high technology systems and products at an affordable cost.
Kratos’ primary focus areas are unmanned systems, space and satellite communications, microwave electronics, cyber security/
warfare, training systems, missile defense, turbine technologies, C5ISR and training systems. We believe that our technology,
intellectual property, proprietary products and designed-in positions on our customers’ programs, platforms and systems, and
our ability to rapidly develop, demonstrate and field affordable leading technology systems gives us a competitive advantage
and creates a high barrier to entry into our markets. Our work force is primarily technically oriented and highly skilled with a
significant number of employees holding national security clearances. Our entire organization is focused on executing our
strategy of becoming the leading technology and intellectual property based company in our industry.
Our primary end customers are U.S. Government agencies, including the DoD, intelligence agencies, and other
national and homeland security related agencies. We also conduct business with local, state and foreign governments and
domestic and international commercial customers. In fiscal 2019, 2018 and 2017, we generated 71%, 72% and 75%,
respectively, of our total revenues from contracts with the U.S. Government (including all branches of the U.S. military and
37
including FMS), either as a prime contractor or a subcontractor. We believe our stable customer base, strong customer
relationships, intellectual property, specialized and differentiated products, broad array of contract vehicles, “designed in”
positions on strategic national security platforms, our targeted investments in strategic growth areas, large employee base
possessing specialized skills, security clearances, specialized manufacturing facilities and equipment, extensive list of past
performance qualifications, and significant management and operational capabilities position us for success.
We were incorporated in the state of New York on December 19, 1994 and began operations in March 1995. We
reincorporated in the state of Delaware in 1998.
Industry Background
On December 18, 2019, President Trump signed two 2020 spending bills totaling $1.4 trillion. The bills allocate $738
billion to the military and $632 billion to non-defense agencies, representing increases over fiscal 2019 of $22 billion for the
Pentagon and $27 billion for non-defense agencies. The NDAA grants a base budget of approximately $666.5 billion (including
the establishment of a new, sixth armed service for space) and an additional $71.5 billion for overseas contingency operations
funding, a.k.a. the war budget. The federal budget and debt ceiling are expected to continue to be the subject of considerable
debate, which could have a significant impact on defense spending broadly and the Company’s programs in particular.
The budget environment, including budget caps mandated by the BCA for fiscal years 2020 and 2021, and uncertainty
surrounding the debt ceiling and the appropriations process, remain significant short and long-term risks. Considerable
uncertainty exists regarding how future budget and program decisions will unfold, including the defense spending priorities of
the Administration and Congress and what challenges budget reductions (required by the BCA and otherwise) will present for
the defense industry. If annual appropriations bills are not timely enacted for FY 2021 or beyond, the U.S. Government may
again operate under a continuing resolution, restricting new contract or program starts, presenting resource allocation
challenges and placing limitations on some planned program budgets, and we may face another government shutdown of
unknown duration. If a prolonged government shutdown of the DoD were to occur, it could result in program cancellations,
disruptions and/or stop work orders and could limit the U.S. Government’s ability to effectively progress programs and to make
timely payments, and our ability to perform on our U.S. Government contracts and successfully compete for new work.
We believe continued budget pressures would have serious negative consequences for the security of our country, the
defense industrial base, including the Company and the customers, employees, suppliers, investors, and communities that rely
on companies in the defense industrial base. It is likely budget and program decisions made in this environment would have
long-term implications for our Company and the entire defense industry.
Additionally, funding for certain programs in which we participate may be reduced, delayed or cancelled, and budget
cuts globally could adversely affect the viability of our subcontractors and suppliers, and our employee base. While we believe
that our business is well-positioned in areas that the DoD and other customers have indicated are areas of focus for future
defense spending, the long-term impact of the BCA, other defense spending cuts, challenges in the appropriations process, the
debt ceiling and the ongoing fiscal debates remain uncertain.
Significant delays or reductions in appropriations; long-term funding under a continuing resolution; an extended debt
ceiling breach or government shutdown; and/or future budget and program decisions, among other items, may negatively
impact our business and programs and could have a material adverse effect on our financial position, results of operations and/
or cash flows.
Current Reporting Segments
We operate in two reportable segments. The KGS reportable segment is comprised of an aggregation of KGS
operating segments, including microwave electronic products, space, training and cybersecurity, training systems, modular
systems, turbine technologies, and defense and rocket support services. The US reportable segment consists of our unmanned
aerial, unmanned ground and unmanned seaborne system products. Our KGS and US segments provide products, solutions and
services for mission critical national security programs. KGS and US customers primarily include national security related
agencies, the DoD, intelligence agencies and classified agencies, and to a lesser degree, international government agencies and
domestic and international commercial customers. We organize our operating segments based primarily on the nature of the
products, solutions and services offered. For additional information regarding our reportable segments, see Note 14 of the
Notes to Consolidated Financial Statements. From a customer and solutions perspective, we view our business as an integrated
whole, leveraging skills and assets wherever possible.
Discontinued Operations
On February 28, 2018, the Company entered into a Stock Purchase Agreement to sell the operations of Kratos Public
38
Safety & Security Solutions, Inc., a Delaware corporation and wholly owned subsidiary of the Company (“PSS”), to Securitas
Electronic Security, Inc., a Delaware corporation (“Buyer”). On June 11, 2018, we completed the sale of all of the issued and
outstanding capital stock of PSS to Buyer for a purchase price of $69 million in cash, subject to a closing net working capital
adjustment (the “Transaction”). We currently expect to receive approximately $70 million of aggregate net cash proceeds from
the Transaction, after taking into account amounts to be paid by us pursuant to a negotiated transaction services agreement
between us and the Buyer, receipt of approximately $7.0 million in net working capital retained by the Company, and
associated transaction fees and expenses, excluding the impact of the final settlement and determination of the closing net
working capital adjustment. To date, we have collected approximately $3.7 million of the retained net working capital. We
currently expect that the remaining net working capital retained by the Company will be collected during 2020 once certain
legacy projects are completed and the project close-out process has been completed. We are currently in dispute with the Buyer
regarding the closing net working capital adjustment. The amount in dispute is approximately $8 million. The Company
currently expects to recognize a net break-even on the sale of the PSS business once the aggregate net proceeds described
above have been collected, excluding the impact of the final settlement and determination of the closing net working capital
adjustment. Any changes or adjustments to the expected net proceeds will be reflected in future periods.
For additional information regarding discontinued operations, see Note 9 of the Notes to Consolidated Financial
Statements contained within this Annual Report.
Key Financial Statement Concepts
As of December 29, 2019, we consider the following factors to be important in understanding our financial statements.
The Company’s business with the U.S. Government and prime contractors is generally performed under fixed-price,
cost reimbursable, or time and materials contracts. Cost reimbursable contracts for the U.S. Government provide for
reimbursement of costs plus the payment of a fee. Some cost reimbursable contracts include incentive fees that are awarded
based on performance on the contract. Under time and materials contracts, we are reimbursed for labor hours at negotiated
hourly billing rates and reimbursed for travel and other direct expenses at actual costs plus applied general and administrative
expenses. Effective January 1, 2018, we adopted the requirements of ASC 606, utilizing the modified retrospective method as
discussed in Note 1 of the Notes to Consolidated Financial Statements contained within this Annual Report
The reported results for 2018 and 2019 reflect the application of ASC 606 guidance while the reported results for
periods prior to January 1, 2018 were prepared under the guidance of Financial Accounting Standards Board (“FASB”) ASC
605, Revenue Recognition (“ASC 605”). The adoption of ASC 606 represents a change in accounting principle. In accordance
with ASC 606, revenue is recognized when a customer obtains control of promised services and products. The amount of
revenue recognized reflects the consideration that we expect to be entitled to receive in exchange for these services and
products.
Prior to the adoption of ASC 606, we recognized the majority of our revenues using the percentage-of-completion
method of accounting. Based on the nature of products provided or services performed, revenue was recorded as costs were
incurred (the “percentage-of-completion cost-to-cost method”) or as units were delivered (the “percentage-of-completion units-
of-delivery method”). For the majority of contracts, we satisfy the underlying performance obligations over time as the
customer obtains control or receives benefits as work is performed on the contract. As a result, under ASC 606 revenue is
recognized over a period of time utilizing the percentage-of-completion cost-to-cost method. This change generally results in
an acceleration of revenue for contracts that were historically accounted for using the percentage-of-completion units-of-
delivery method as revenues are now recognized earlier in the performance period as costs are incurred rather than as the
products are delivered.
In accordance with ASC 606, we evaluate whether a contract with a customer exists by evaluating a number of criteria
including whether collection of consideration is reasonably assured; comprehensive collection history; results of our
communications with customers; the current financial position of the customer; and the relevant economic conditions in the
customer’s country. If we have had no prior experience with the customer, we may review reports from various credit
organizations to ensure that the customer has a history of paying its creditors in a reliable and effective manner. If the financial
condition of our customers were to deteriorate and adversely affect their financial ability to make payments, allowances would
be required.
We monitor our policies and procedures with respect to our contracts on a regular basis to ensure consistent
application under similar terms and conditions as well as compliance with all applicable government regulations. In addition,
costs incurred and allocated to contracts with the U.S. Government are routinely audited by the DCAA.
39
We manage and assess the performance of our businesses based on our performance on individual contracts and
programs obtained generally from government organizations with consideration given to our “Critical Accounting Principles
and Estimates” discussed below. Due to the Federal Acquisition Regulation rules that govern our business, most types of costs
are allowable, and we do not focus on individual cost groupings (such as cost of sales or general and administrative costs) as
much as we do on total contract costs, which are a key factor in determining contract operating income. As a result, in
evaluating our operating performance, we look primarily at changes in sales and service revenues and operating income,
including the effects of significant changes in operating income. Changes in contract estimates are reviewed on a contract-by-
contract basis and are revised periodically throughout the life of the contract such that adjustments to profit resulting from
revisions are made cumulative to the date of the revision in accordance with accounting principles generally accepted in the
U.S. (“GAAP”). Significant management judgments and estimates, including the estimated costs to complete the project, which
determine the project’s percentage complete, must be made and used in connection with the revenue recognized in any
accounting period. Material differences may result in the amount and timing of our revenue for any period if management
makes different judgments or utilizes different estimates.
Effective December 31, 2018, we adopted the requirements of ASU 2016-02, Leases, also referred to as
“ASC 842”, utilizing the optional transition method, as discussed in Note 1 to the accompanying Consolidated Financial
Statements. ASC 842 requires that lessees recognize assets and liabilities for the rights and obligations underlying leases with a
lease term of more than one year. The reported results for 2019 reflect the application of ASC 842 guidance while the reported
results for periods prior to December 31, 2018 were prepared under the guidance of FASB Topic 840, Leases. The adoption of
ASC 842 represents a change in accounting principle.
Results of Operations
Comparison of Results for the Year Ended December 29, 2019 to the Year Ended December 30, 2018
Revenues. Revenues by reportable segment for the years ended December 29, 2019 and December 30, 2018 are as
follows (in millions):
Kratos Government Solutions
Service revenues
Product sales
Total Kratos Government Solutions
Unmanned Systems - product sales
Total revenues
Total service revenues
Total product sales
Total revenues
2019
2018
$ Change
% Change
$
$
$
$
272.6
283.5
556.1
161.4
717.5
272.6
444.9
717.5
$
$
$
$
200.7
284.4
485.1
132.9
618.0
200.7
417.3
618.0
$
$
$
$
71.9
(0.9)
71.0
28.5
99.5
71.9
27.6
99.5
35.8 %
(0.3)%
14.6 %
21.4 %
16.1 %
35.8 %
6.6 %
16.1 %
Revenues increased $99.5 million to $717.5 million for the year ended December 29, 2019 from $618.0 million for the
year ended December 30, 2018. Revenues in our KGS segment increased $71.0 million due to the FTT acquisition which
contributed $52.5 million in revenues, along with increases in our satellite communications, modular systems, training systems,
microwave products, and our ballistic missile target businesses which contributed increased revenues of $30.5 million, partially
offset by reductions of approximately $7.7 million resulting from reduced revenues in our legacy government services business
which has been impacted by continued commoditization and price competitiveness in the government services industry due to
contract awards on a lowest price technically acceptable basis rather than on a best value basis. Revenues in our US segment
increased due to increased execution on low rate initial production of our SSAT/177 aerial targets for the U.S. Navy, and
production on our AFSAT 167 aerial targets for the U.S. Air Force, which resulted in increased revenues of $23.3 million.
Product sales increased $27.6 million to $444.9 million for the year ended December 29, 2019 from $417.3 million for
the year ended December 30, 2018, primarily as a result of increased production activity in our US segment and our modular
systems business. As a percentage of total revenue, product sales were 62.0% for the year ended December 29, 2019, as
compared to 67.5% for the year ended December 30, 2018. Service revenues increased by $71.9 million to $272.6 million for
the year ended December 29, 2019, from $200.7 million for the year ended December 30, 2018.
40
Cost of revenues. Cost of revenues increased to $527.5 million for the year ended December 29, 2019, from $448.3
million for the year ended December 30, 2018. The $79.2 million increase in cost of revenues was primarily a result of
increased revenue discussed above.
Gross margin percentage decreased to 26.5% for the year ended December 29, 2019, compared to 27.5% for the year
ended December 30, 2018. Margins on services decreased to 29.6% for the year ended December 29, 2019 from 31.3% for the
year ended December 30, 2018. Margins on product sales decreased for the year ended December 29, 2019, as compared to
December 30, 2018 to 24.6% from 25.6%, respectively, primarily as a result of a change in the mix of products. Margins in the
KGS segment decreased to 28.3% for the year ended December 29, 2019 from 29.1% for the year ended December 30, 2018.
Margins in the US segment decreased to 20.4% for the year ended December 29, 2019 from 21.3% for the year ended
December 30, 2018, primarily due to a less favorable mix of products sold in the year ended December 29, 2019.
Selling, general and administrative expenses (SG&A). SG&A increased $11.0 million to $130.8 million for the year
ended December 29, 2019, from $119.8 million for the year ended December 30, 2018. As a percentage of revenues, SG&A
decreased to 18.2% for the year ended December 29, 2019 from 19.4% for the year ended December 30, 2018. Excluding
amortization of intangibles of $7.4 million for the year ended December 29, 2019, and amortization of intangibles of $5.9
million for the year ended December 30, 2018, SG&A decreased as a percentage of revenues to 17.2% from 18.4% for the year
ended December 29, 2019 and December 30, 2018, respectively, which is primarily due to the leverage on the fixed SG&A
infrastructure as revenues have increased, as well as the impact of cost reduction actions taken by us.
Research and development (R&D) expenses. R&D expenses were $18.0 million for the year ended December 29,
2019 and $15.6 million for the year ended December 30, 2018. As a percentage of revenues, R&D remained consistent at 2.5%
of revenues for the years ended December 29, 2019 and December 30, 2018. R&D expenditures are primarily related to
investments we are making in coordination with our customers, as we work towards our objectives which include having our
products designated as the new platform for, or “designed-in” to, certain new long-term program opportunities , our ownership
of certain intellectual property rights for products that support these programs, and technology upgrades and refresh activities
that are necessary for the next generation of our existing product lines specifically in our space and satellite communications
business.
Restructuring Expenses and Other. The expense of $0.9 million for the year ended December 29, 2019, primarily
consisted of approximately $0.6 million in legal costs related to an ongoing dispute with an international aerial targets customer
and employee termination costs of approximately $0.3 million associated with personnel reduction actions taken during the
year. The expense of $3.8 million for the year ended December 30, 2018, consisted primarily of a litigation settlement and
related legal costs of approximately $2.8 million, and employee termination costs of approximately $1.0 million related to
personnel reduction actions taken in 2018.
Other expense, net. Other expense, net, increased to $22.3 million from $21.8 million for the years ended
December 29, 2019 and December 30, 2018, respectively, primarily as a result of a net increase in interest expense of $0.8
million related to finance type lease liabilities.
Provision for income taxes from continuing operations. The provision for income taxes from continuing operations
increased to $4.8 million on income from continuing operations before income taxes of $15.7 million for the year ended
December 29, 2019 from a provision $4.6 million on income from continuing operations before income taxes of $8.7 million
for the year ended December 30, 2018. The tax provision for the year ended December 29, 2019 was primarily comprised of an
increase in uncertain tax positions of $7.5 million, in addition to current state and foreign taxes of $2.5 million, and partially
offset by a benefit of $5.2 million related to the release of a valuation allowance due to the FTT acquisition. In accordance with
ASC 805, we established deferred tax liabilities for the increase in the financial statement basis of the acquired assets of FTT.
As a result of our ability to recognize deferred tax assets for some of these deferred tax liabilities, we released the valuation
allowance against our deferred tax assets and recognized an income tax benefit of $5.2 million for the year ended December 29,
2019. The tax provision for the year ended December 30, 2018 was primarily comprised of an increase in uncertain tax
positions of $4.0 million, in addition to state and foreign taxes.
Income (loss) from discontinued operations. The income from discontinued operations was $1.7 million for the year
ended December 29, 2019 and includes a $3.6 million gain as a result of the release of an indemnification liability following
the lapse of the statute of limitations associated with a potential tax liability that was recorded in 2015 as part of the previous
sale of our Electronics Products Division. This gain was offset by a loss of $1.7 million from operating activities primarily
reflecting the work performed in relation to outstanding tasks on legacy projects retained by us following the sale of the PSS
business and legal expenses related to the closing net working capital dispute with the buyer of the PSS business. The loss from
discontinued operations was $7.6 million for the year ended December 30, 2018, which includes a loss of $6.7 million from
41
operating activities through the completion of the divestiture of our PSS subsidiary in June 2018 and approximately $2.7
million of transaction-related expenses offset by related tax benefits of $1.8 million.
For a comparison of the Company’s results of operations for the fiscal year ended December 31, 2017 to the fiscal
year ended December 30, 2018, see Item 7, Management’s Discussion and Analysis of Financial Condition and Results of
Operations in the Company’s Annual Report on Form 10-K for the year ended December 30, 2018, which was filed with the
U.S. Securities and Exchange Commission on February 28, 2019.
Liquidity and Capital Resources
As of December 29, 2019, we had cash and cash equivalents of $172.6 million compared with cash and cash
equivalents of $182.7 million as of December 30, 2018, which includes $24.6 million and $12.0 million, respectively, of cash
and cash equivalents held by our foreign subsidiaries. We are not presently aware of any restrictions on the repatriation of these
funds, however, earnings of these foreign subsidiaries are essentially considered permanently invested in these foreign
subsidiaries. If these funds were needed to fund our operations or satisfy obligations in the U.S. they could be repatriated, and
their repatriation into the U.S. may cause us to incur additional foreign withholding taxes. We do not currently intend to
repatriate these earnings.
Our total debt, including principal due on the 6.5% Notes, net of debt issuance costs of $4.9 million, increased by $0.9
million to $295.1 million as of December 29, 2019 from $294.2 million as of December 30, 2018. The increase in total debt
was due to the amortization of debt issuance costs.
We use our operating cash flow to finance trade accounts receivable, fund necessary increases in inventory, which may
include leaning forward to procure long-lead materials for certain of our unmanned systems programs at our customers’
request, prior to receipt of customer contractual funding documents, fund capital expenditures, our IR&D investments, other
product investments, and our ongoing operations, service our debt and make strategic acquisitions. Financing trade accounts
receivable is necessary because, on average, our customers do not pay us as quickly as we pay our vendors and employees for
their goods and services since a number of our receivables are contractually billable and due to us only when certain
contractual milestones are achieved, certain of which are not achieved until final shipment and acceptance of our products.
Financing increases in inventory balances is necessary to fulfill shipment requirements to meet delivery schedules of our
customers. Cash from continuing operations is primarily derived from our customer contracts in progress and associated
changes in working capital components. Our days sales outstanding (“DSO”) have decreased to 134 days as of December 29,
2019 from 140 days as of December 30, 2018. Our DSOs can fluctuate from period to period, primarily as a result of certain
contractual billing milestones that have not yet been attained, such as equipment shipments and deliveries on certain products,
and for certain flight requirements that must be fulfilled on certain aerial target programs, or final billings which are not due
until completion on certain of our large training systems deliveries, and therefore we are unable to contractually bill for
amounts outstanding related to those milestones at this time. For instance, many of our programs, including in our training
solutions business, include progress payments for which the last 10 to 20 percent of our costs incurred are withheld, and not
payable until the acceptance and delivery of the system. In November 2019, a large training solutions program was terminated
for convenience (“T for C”) by the customer. Under a T for C, a contractor is entitled to seek specified costs through a
termination settlement process including (1) the contract price for completed supplies and services accepted by the government
but not previously paid for; (2) the cost incurred in the performance of work terminated plus a reasonable profit on those costs;
and (3) and its costs incurred in settling with subcontractors and preparing and settling the termination proposal. However, we
will not be able to collect the total withheld amounts until the settlement terms of the T for C have been negotiated and agreed
to with the customer. At December 29, 2019, approximately $11.5 million in unbilled receivables remain outstanding on this
project. In addition, we are currently in dispute with an international customer in our US segment over approximately $10.0
million in unbilled receivables outstanding as of December 29, 2019. The dispute concerns the completion of certain system
requirements and contractual milestones. Although there could be a delay in billing and collecting amounts due to us under the
aforementioned contracts, we have evaluated the present facts of the matters and performed a reassessment of the contractual
amounts due and have determined that no adjustment to previously recognized revenue, or the corresponding unbilled
receivables, is necessary at December 29, 2019.
42
A summary of our net cash provided by operating activities from continuing operations from our Consolidated
Statements of Cash Flows is as follows (in millions):
Year Ended
December 29, 2019
December 30, 2018
Net cash provided by operating activities from continuing operations
$
28.9
$
18.1
Our cash provided by operating activities from continuing operations for the year ended December 29, 2019 was
positively impacted by increased operating income as compared to the year ended December 30, 2018. Net cash provided by
operating activities from continuing operations was also impacted by interest expense we paid related to our 6.5% Notes. We
paid $19.9 million and $20.5 million in interest expense in 2019 and 2018, respectively. Cash provided by operating activities
in 2019 and 2018 was also negatively impacted by discretionary investments we have made in internally funded research and
development of $18.0 million in 2019 and $15.6 million in 2018, contract development costs on new platforms in our US
segment, and increased SG&A expenditures primarily related to business capture pursuits in the tactical unmanned aircraft
systems initiatives, as well as changes in working capital accounts. The net use in working capital accounts for 2019 and 2018
includes approximately $0.9 and $3.6 million, respectively, of internal development product development investments that are
non-capital expenditures we are making related to the LCASD or “Valkyrie”.
Our cash provided by (used in) investing activities from continuing operations is summarized as follows (in millions):
Investing activities:
Cash paid for acquisitions, net of cash acquired
Proceeds from sale of assets
Capital expenditures
Net cash provided by (used in) investing activities from continuing operations
Year Ended
December 29, 2019
December 30, 2018
$
$
(17.7) $
0.3
(26.3)
(43.7) $
(2.9)
66.0
(22.6)
40.5
Net cash used in investing activities from continuing operations for year ended December 29, 2019 is comprised of the
acquisition of FTT and capital expenditures which consist primarily of investments in machinery, computer hardware and
software and improvement of our physical properties in order to maintain suitable conditions in which to conduct our business.
Net cash provided by investing activities from continuing operations for year ended December 30, 2018 was positively
impacted by the approximately $66.0 million net proceeds, net of related transaction expenses, received from the sale of PSS.
These proceeds were partially offset by capital expenditures of $22.6 million, which consist of investments in machinery,
computer hardware and software and improvement of our physical properties in order to maintain suitable conditions in which
to conduct our business. During the year ended December 29, 2019, capital expenditures of approximately $13.9 million were
incurred in our US business, primarily related to our unmanned combat target initiative.
Cash provided by financing activities from continuing operations is summarized as follows (in millions):
Financing activities:
Expenses from the issuance of common stock
Repayment under credit facility and debt
Debt issuance costs
Payments under finance leases
Proceeds from exercise of restricted stock units, employee stock options, and employee
stock purchase plan
Net cash provided by financing activities from continuing operations
Year Ended
December 29, 2019
December 30, 2018
$
$
— $
—
—
(0.5)
4.0
3.5
$
(1.1)
(0.8)
(0.1)
—
3.7
1.7
Net cash provided by financing activities from continuing operations was $3.5 million for the year ended
December 29, 2019. Net cash provided by financing activities from continuing operations was $1.7 million for the year ended
43
December 30, 2018, which includes $1.1 million of fees paid in the beginning of 2018 related to the equity offerings that were
completed in 2017.
The net operating cash flows of discontinued operations is summarized as follows (in millions):
Net operating cash flows of discontinued operations
Year Ended
December 29, 2019
December 30, 2018
$
1.1
$
(7.7)
The net operating cash flow of discontinued operations for the year ended December 29, 2019 is substantially related
to the discontinued operations of our PSS business unit. During 2019, approximately $3.7 million was collected on amounts
due related to the legacy projects retained by us, less costs incurred to complete the legacy projects and legal costs related to the
ongoing working capital dispute with the buyer of PSS. This was also partially offset by a reduction in other current liabilities
of $1.8 million. The net operating cash flow of discontinued operations for the year ended December 30, 2018 is substantially
related to the discontinued operations of our PSS business unit, which includes the payment of $3.5 million to the Buyer of the
PSS business pursuant to a negotiated transaction services agreement.
6.5% Senior Secured Notes due 2025
In November 2017, we issued and sold $300 million aggregate principal amount of 6.5% Senior Secured Notes due 2025
(the “6.5% Notes”) in a private placement conducted pursuant to Rule 144A and Regulation S under the Securities Act of 1933,
as amended (the “Act”). The net proceeds from the issuance of the 6.5% Notes were $295.5 million after expenses of $4.5 million.
We utilized the net proceeds from the sale of the 6.5% Notes, as well as cash from our recent equity offering to extinguish our
previously outstanding 7% Notes. The total reacquisition price of the 7% Notes was $385.2 million, including a $12.0 million call
premium, and $0.3 million of accrued interest.
The 6.5% Notes are governed by the Indenture, dated as of November 20, 2017 (the “Indenture”), among the Company,
our existing and future domestic subsidiaries parties thereto (the “Subsidiary Guarantors”) and Wilmington Trust, National
Association, as trustee and collateral agent (in such capacity, the “2017 Trustee and Collateral Agent”). A Subsidiary Guarantor
can be released from its guarantee if (a) 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) we designate such Subsidiary Guarantor as an
Unrestricted Subsidiary; (c) we exercise our legal defeasance option or our 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 6.5% Notes.
The 6.5% Notes bear interest at a rate of 6.5% per year from the date of original issuance or from the most recent payment
date on which interest has been paid or provided for. Interest on the 6.5% Notes is payable in arrears on May 30 and November
30 of each year, beginning on May 30, 2018. The 6.5% Notes are fully and unconditionally guaranteed by the Subsidiary Guarantors.
The 6.5% Notes and the guarantees (as set forth in the Indenture, the “Guarantees”) are our senior secured obligations
and are equal in right of payment with all other senior obligations of the Subsidiary Guarantors’ existing and future secured debt
to the extent of the assets securing that secured debt. Our obligations under the 6.5% Notes are secured by a first priority lien on
substantially all of our 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 6.5% Notes have a second priority lien, junior to the lien securing our obligations under the Credit Agreement.
The 6.5% Notes will be redeemable, in whole or in part, at any time on or after November 30, 2020 at the respective
redemption prices specified in the Indenture. In addition, we may redeem up to 40% of the 6.5% Notes before November 30, 2020
with the net proceeds of certain equity offerings. We may also redeem some or all of the 6.5% Notes before November 30, 2020
at a redemption price of 100% of the principal amount thereof plus accrued and unpaid interest, to, but excluding, the redemption
date, if any, plus a “make whole” premium. In addition, during each 12-month period commencing on the issue date and ending
on or prior to November 30, 2020, we may redeem up to 10% of the original aggregate principal amount of the 6.5% Notes issued
under the Indenture at a redemption price of 103.000% of the principal amount thereof, plus accrued and unpaid interest, to, but
excluding, the date of redemption, if any. We may also be required to make an offer to purchase the 6.5% Notes upon a change of
control and certain sales of our assets.
The Indenture contains covenants limiting, among other things, our ability and the Subsidiary Guarantors’ ability to: (a)
pay dividends on or make distributions or repurchase or redeem the Company’s capital stock or make other restricted payments;
44
(b) incur additional debt and guarantee debt; (c) prepay, redeem or repurchase certain debt; (d) issue certain preferred stock or
similar equity securities; (e) make loans and investments; (f) sell assets; (g) incur liens; (h) consolidate, merge, sell or otherwise
dispose of all or substantially all of our assets; (i) enter into transactions with affiliates; and (j) enter into agreements restricting
our ability and certain of our subsidiaries’ ability to pay dividends. These covenants are subject to a number of exceptions. As of
December 29, 2019, we were in compliance with the covenants contained in the Indenture governing the 6.5% Notes.
The terms of the Indenture require that the net cash proceeds from asset dispositions be either utilized to (i) repay or
prepay amounts outstanding under the Credit Agreement unless such amounts are reinvested in similar collateral, (ii)
permanently reduce other indebtedness, (iii) make an investment in assets that replace the collateral of the 6.5% Notes or (iii) a
combination of (i), (ii) and (iii). To the extent there are any remaining net proceeds from the asset disposition after application
of (i), (ii) and (iii), such amounts are required to be utilized to repurchase 6.5% Notes at par.
The Indenture also provides for events of default which, if any of them occurs, would permit or require the principal,
premium, if any, interest, if any, and any other monetary obligations on all the then-outstanding 6.5% Notes to become or to be
declared due and payable immediately.
Other Indebtedness
Credit and Security Agreement
On May 14, 2014, we entered into a $110.0 million Credit and Security Agreement, dated May 14, 2014 (as amended
from time to time, 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 a first priority lien on our accounts receivable,
inventory, deposit accounts, securities accounts, cash, securities and general intangibles (other than intellectual property). The
obligations under the Credit Agreement are secured by a second priority lien, junior to the lien securing our senior secured notes,
on all of our other assets.
On November 20, 2017, we entered into an amended and restated Credit Agreement with the lenders from time to time
party thereto, 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. As amended and restated, the Credit Agreement
establishes a five year senior secured revolving credit facility in the aggregate principal amount of $90.0 million (subject to a
potential increase of the aggregate principal amount to $115.0 million, subject to SunTrust’s and applicable lenders’ approval),
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.
Borrowings under the revolving credit facility may take the form of a base rate revolving loan, Eurodollar revolving
loan or swing line loan. Base rate revolving loans and swing line loans will bear interest at a rate per annum equal to the sum of
the Applicable Margin (as defined in the Credit Agreement) 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 LIBOR Rate (as defined in the Credit Agreement) determined at such time for an interest period of one month, plus
1.00% per annum. Eurodollar revolving loans will bear interest a rate per annum equal to the sum of the Applicable Margin
from time to time in effect plus the Adjusted LIBOR Rate. The Applicable Margin varies between 1.00%-1.50% for base rate
revolving loans and swing line loans and 2.00%-2.50% for Eurodollar loans, and is based on several factors including our then-
existing borrowing base and the lenders’ total commitment amount and revolving credit exposure. The calculation of our
borrowing base takes into account several items relating to us and our subsidiaries, including amounts due and owing under
billed and unbilled accounts receivables, then held eligible raw materials inventory, work-in-process inventory, and applicable
reserves.
The measurement of a minimum fixed charge coverage ratio is required to be measured if Excess Availability, as
defined in the Credit Agreement, is less than fifty percent of the lesser of the Borrowing Base or the Total Commitment
Amount, each as defined in the Credit Agreement.
45
As of December 29, 2019, there were no borrowings outstanding on the Credit Agreement and $5.4 million was
outstanding on letters of credit, resulting in net borrowing base availability of $69.3 million. We were in compliance with the
financial covenants of the Credit Agreement as of December 29, 2019.
Off Balance Sheet Arrangements
We have no off-balance sheet arrangements as defined in Regulation S-K, Item 303(a)(4)(ii).
Contractual Obligations and Commitments
The following table summarizes our contractual obligations and other commitments at December 29, 2019, and the
effect such obligations could have on our liquidity and cash flow in future periods (in millions):
Debt, net of interest(1)
$
300.0
$
— $
— $
— $
300.0
Total
2020
2021 - 2022
2023 - 2024
2025 and After
Payments Due/Forecast by Period
Estimated interest on debt(2)
Purchase orders(3)
Operating leases(4)
Finance leases(4)
Unrecognized tax benefits, including
interest and penalties(5)
Total commitments and recorded
liabilities
136.5
153.1
57.2
70.2
—
19.5
112.4
12.6
3.1
—
39.0
40.6
18.6
6.5
—
39.0
0.1
14.4
6.6
—
39.0
—
11.6
54.0
—
$
717.0
$
147.6
$
104.7
$
60.1
$
404.6
(1)
(2)
(3)
(4)
(5)
The 6.5% Notes in the aggregate outstanding principal amount of $300.0 million are due November 30, 2025. See
Note 5 in the Notes to Consolidated Financial Statements contained within this Annual Report for further details.
Includes interest payments on the 6.5% Notes. See Note 5 in the Notes to Consolidated Financial Statements contained
within in this Annual Report for further details.
Purchase orders include commitments in which a written purchase order has been issued to a vendor, but the goods
have not been received or services have not been performed.
We have entered into or acquired various non-cancelable operating and finance lease agreements that expire on
various dates through 2038. See Note 6 in the Notes to Consolidated Financial Statements contained within this
Annual Report for further details.
As of December 29, 2019, we have a $15.7 million noncurrent liability for uncertain tax positions and a $2.8 million
guarantor liability, all of which may result in cash payments. The future payments related to uncertain tax positions
have not been presented in the table above due to the uncertainty of the amounts and timing of cash settlements with
the taxing authorities.
As of December 29, 2019, we have $5.4 million of standby letters of credit outstanding. Our letters of credit are
primarily related to milestone payments received from foreign customers for which the customer has not yet received the
product. Additional information regarding our financial commitments at December 29, 2019 is provided in the Notes to
Consolidated Financial Statements contained in this Annual Report, specifically Note 15.
Other Liquidity Matters
We believe our cash on hand, together with funds available under the Credit Agreement and cash expected to be
generated from operating activities will be sufficient to fund our anticipated working capital and other cash needs for at least
the next 12 months. As discussed in Item 1A “Risk Factors” contained within this Annual Report, our quarterly and annual
operating results have fluctuated in the past and may vary in the future due to a variety of factors, many of which are external to
our control. If the conditions in our industry deteriorate, our customers cancel or postpone projects or if we are unable to
sufficiently increase our revenues or further reduce our expenses, we may experience, in the future, a significant long-term
46
negative impact to our financial results and cash flows from operations. In such a situation, we could fall out of compliance
with our financial and other covenants which, if not waived, could limit our liquidity and capital resources.
Critical Accounting Principles and Estimates
We have identified the following critical accounting policies that affect our more significant judgments and estimates
used in the preparation of our Consolidated Financial Statements. The preparation of our Consolidated Financial Statements in
conformity with GAAP requires us to make estimates and judgments that affect the reported amounts of assets and liabilities,
stockholders’ equity, revenues and expenses, and related disclosures of contingent assets and liabilities. On a periodic basis, as
deemed necessary, we evaluate our estimates, including those related to revenue recognition, valuation of inventory including
the reserves for excess and obsolete inventory, valuation of long-lived assets including identifiable intangibles and goodwill,
accounting for income taxes including the related valuation allowance, warranties, contingencies and litigation, contingent
acquisition consideration, and losses on unused office space. We explain these accounting policies in the Notes to Consolidated
Financial Statements contained within this Annual Report and at relevant sections in this discussion and analysis. These
estimates are based on the information that is currently available and on various other assumptions that are believed to be
reasonable under the circumstances. Actual results could vary from those estimates under different assumptions or conditions
and such differences may be material.
Revenue recognition. Effective January 1, 2018, we adopted the Financial Accounting Standards Board (“FASB”)
ASU 2014-09, Revenue from Contracts with Customers, and the related amendments, which are codified into Accounting
Standards Codification (“ASC”) 606 (“ASC 606”), which establishes a broad principle that requires entities to assess the
products or services promised in contracts with customers at contract inception to determine the appropriate unit at which to
record revenues, which is referred to as a performance obligation. Revenue is recognized when control of the promised
products or services is transferred to customers, at an amount that reflects the consideration to which the entity expects to be
entitled in exchange for those products or services. The new standard requires disclosure of the nature, amount, timing, and
uncertainty of revenue and cash flows arising from contracts with customers. We adopted the requirements of ASC 606,
utilizing the modified retrospective method as discussed in Note 1 of the Notes to Consolidated Financial Statements contained
within this Annual Report.
The reported results for 2018 and 2019 reflect the application of ASC 606 guidance while the reported results for
periods prior to January 1, 2018 were prepared under the guidance of ASC 605. The adoption of ASC 606 represents a change
in accounting principle.
To determine revenue recognition for arrangements that we determine are within the scope of ASC 606, we perform
the following five steps: (i) identify the contract(s) with a customer; (ii) identify the performance obligation(s) in the contract;
(iii) determine the transaction price; (iv) allocate the transaction price to the performance obligation(s) in the contract; and (v)
recognize revenue when (or as) the entity satisfies a performance obligation. Once the contract is identified and determined to
be within the scope of ASC 606, we assess the goods or services promised within each contract and determine those that are
performance obligations, and assess whether each promised good or service is distinct. We then recognize as revenue the
amount of the transaction price that is allocated to the respective performance obligation when (or as) the performance
obligation is satisfied.
A performance obligation is a promise in a contract to transfer a distinct good or service to the customer and is the unit
of account under ASC 606. The majority of our contracts have a single performance obligation as the promise to transfer the
individual goods or services is not separately identifiable from other promises in the contracts and, therefore, not distinct. For
contracts with multiple performance obligations, we allocate the contract’s transaction price to each performance obligation
using the best estimate of the standalone selling price of each distinct good or service in the contract. The primary method used
to estimate standalone selling price is the expected-cost-plus-margin approach, under which we forecast the expected costs of
satisfying a performance obligation and then add an appropriate margin for that distinct good or service.
Prior to the adoption of ASC 606, we recognized the majority of our revenues using the percentage-of-completion
method of accounting. Based on the nature of products provided or services performed, revenue was recorded as costs were
incurred (the “percentage-of-completion cost-to-cost method”) or as units were delivered (the “percentage-of-completion units-
of-delivery method”). For the majority of contracts, we satisfy the underlying performance obligations over time as the
customer obtains control or receives benefits as work is performed on the contract. As a result, under ASC 606 revenue is
recognized over a period of time utilizing the percentage-of-completion cost-to-cost method. This change generally results in
an acceleration of revenue for contracts that were historically accounted for using the percentage-of-completion units-of-
delivery method as revenues are now recognized earlier in the performance period as costs are incurred.
47
For our federal contracts, we apply U.S. Government procurement and accounting standards in assessing the
allowability and the allocability of costs to contracts. Due to the significance of the judgments and estimation processes, it is
likely that materially different amounts could be recorded if we used different assumptions or if the underlying circumstances
were to change. We closely monitor compliance with, and the consistent application of, our critical accounting policies related
to contract accounting. Business operations personnel conduct periodic contract status and performance reviews. When
adjustments in estimated contract revenues or costs are required, any changes from prior estimates are included in earnings in
the current period. Also, regular and recurring evaluations of contract cost, scheduling and technical matters are performed by
management personnel who are independent from the business operations personnel performing work under the contract. Costs
incurred and allocated to contracts with the U.S. Government are scrutinized for compliance with regulatory standards by our
personnel, and are subject to audit by the DCAA.
Long-lived and Intangible Assets. We account for long-lived assets in accordance with the provisions of FASB ASC
Topic 360 Property, Plant, and Equipment (“Topic 360”). Topic 360 addresses financial accounting and reporting for the
impairment or disposal of long-lived assets and requires that long-lived assets be reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability is measured by
comparing the carrying amount of an asset to the expected future net cash flows generated by the asset. If it is determined that
the asset may not be recoverable and if the carrying amount of an asset exceeds its estimated fair value, an impairment charge
is recognized to the extent of the difference. Topic 360 requires companies to separately report discontinued operations,
including components of an entity that either have been disposed of (by sale, abandonment or in a distribution to owners) or
classified as held for sale. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to
sell.
In accordance with Topic 360, we assess the impairment of identifiable intangibles and long-lived assets whenever
events or changes in circumstances indicate that the carrying value may not be recoverable. Factors we consider important
which could individually or in combination trigger an impairment review, include the following:
•
•
•
•
•
significant underperformance relative to expected historical or projected future operating results;
significant changes in the manner of our use of the acquired assets or the strategy for our overall business;
significant negative industry or economic trends;
significant decline in our stock price for a sustained period; and
our market capitalization relative to net book value.
If we determined that the carrying value of intangibles and long-lived assets may not be recoverable based upon the
existence of one or more of the above indicators of impairment, we would record an impairment equal to the excess of the
carrying amount of the asset over its estimated fair value.
Goodwill. The purchase price of an acquired business is allocated to the underlying tangible and intangible assets
acquired and liabilities assumed based upon their respective fair values, with the excess recorded as goodwill. Such fair value
assessments require judgments and estimates that can be affected by contract performance and other factors over time, which
may cause final amounts to differ materially from original estimates.
We have established certain accruals in connection with indemnities and other contingencies from our acquisitions.
These accruals and subsequent adjustments have been recorded during the purchase price allocation period for acquisitions.
The accruals were determined based upon the terms of the purchase or sales agreements and, in most cases, involve a
significant degree of judgment. Management has recorded these accruals in accordance with its interpretation of the terms of
the purchase or sale agreements, known facts, and an estimation of probable future events based on management’s experience.
Any changes to recorded estimates will be recognized through earnings.
We perform our impairment test for goodwill in accordance with ASC Topic 350, Intangibles-Goodwill and Other
(“Topic 350”). We assess goodwill for impairment at the reporting unit level, which is defined as an operating segment or one
level below an operating segment, referred to as a component. We determine our reporting units by first identifying our
operating segments, and then assessing whether any components of these segments constitute a business for which discrete
financial information is available and where segment management regularly reviews the operating results of that component.
We aggregate components within an operating segment that have similar economic characteristics.
KGS has five operating segments: Defense Rocket Support Services (“DRSS”), Microwave Electronics (“ME”),
Space, Training and Cybersecurity Solutions (“ST&C”), Modular Systems (“MS”), and Kratos Turbine Technologies (“KTT”),
that provide technology based defense solutions, involving products and services, primarily for mission critical U.S. national
security priorities, with the primary focus relating to the nation’s Command, Control, Communications, Computing, Combat
48
Systems, Intelligence, Surveillance (“C5ISR”) and Reconnaissance requirements. The US reportable segment provides
unmanned aerial systems, unmanned ground, and unmanned seaborne systems. We have identified our reporting units to be the
DRSS, ME, ST&C, MS, and KTT operating segments, within the KGS reportable segment, and the US reportable segment,
each of which has been assessed and evaluated for potential impairment in our fiscal year 2019 annual test.
We test goodwill for impairment by performing a qualitative assessment or using a two-step impairment process. If we
choose to perform a qualitative assessment and determine it is more likely than not that an impairment may exist, the two-step
impairment process is then performed. For operations where the two-step process is used, the identification and measurement
of impairment involves the estimation of the fair value of reporting units. If the fair value is determined to be less than the
carrying value, a second step is performed to determine the amount of the impairment. When any impairment has occurred, a
charge to operations is recorded. In order to test for potential impairment, we estimate the fair value of each of the impacted
reporting units based on a comparison and weighting of the income approach, specifically the discounted cash flow (“DCF”)
method and the market approach, which estimates the fair value of our reporting units based upon comparable market prices
and recent transactions and also validates the reasonableness of the implied multiples from the income approach.
In testing for impairment of our goodwill using a two-step impairment process at a particular reporting unit, we make
assumptions about the amount and timing of future expected cash flows, terminal growth rates, appropriate discount rates,
market multiples, and the control premium a controlling shareholder could be expected to pay:
• The timing of future cash flows within our DCF analysis is based on our most recent forecasts and other
estimates. Our historical growth rates and operating results are not indicative of our projected growth rates and
operating results as a consequence of our acquisitions and divestitures.
• The terminal growth rate is used to calculate the value of cash flows beyond the last projected period in our DCF
analysis and reflects our best estimates for stable, perpetual growth of our reporting units.
• We use estimates of market participant weighted average cost of capital (“WACC”) as a basis for determining the
discount rates to apply to our reporting units’ future expected cash flows. The significant assumptions within our
WACC are: (a) equity risk premium, (b) beta, (c) size premium adjustments, (d) cost of debt and (e) capital
structure assumptions. In addition, we use a company specific risk adjustment which is a subjective adjustment
that, by its very nature does not include market related data, but instead examines the prospects of the reporting
unit relative to the broader industry to determine if there are specific factors, which may make it more “risky”
relative to the industry.
• Recent historical market multiples are used to estimate future market pricing.
During the fourth quarter of 2017, as a result of our annual impairment test of the carrying value of our goodwill
balances, we recorded a non-cash impairment charge of $24.2 million against the carrying value of the goodwill of our DRSS
reporting unit within the KGS segment, which includes our legacy government services business. In 2010, we changed our
strategy to focus on being a systems, product, technology and intellectual property based company and deemphasized the
legacy government services businesses. Over the past several years, similar to other businesses operating in the federal
government technical services space, this business has been adversely impacted by competitive pressures and commoditization
resulting from LPTA awards rather than awards based on best value or that are technologically or performance differentiated.
Specifically, we lost two sizable five-year contract opportunities where Kratos was underbid on cost, which significantly
impacted the expected future financial performance of this business.
The carrying value of goodwill of the US and KGS reportable segments, was $97.3 million and $358.3 million,
respectively, at December 29, 2019.
In determining the fair value of our reporting units, there are key assumptions related to our future operating
performance and revenue growth. If the actual operating performance and financial results are not consistent with our
assumptions, a further impairment in our $455.6 million goodwill and $39.5 million long-lived intangibles could occur in
future periods. In particular, the US reporting unit fair value includes assumptions that the development of the high
performance UCAS product is successful and we are awarded future contracts for the UCAS product and other new tactical
unmanned aircraft systems. Additionally, the US reporting unit fair value assumes that the U.S. Navy will exercise options
under the existing current contract and we will continue low rate initial production and commence full rate production for the
Sub-Sonic Aerial Target. Our goodwill impairment assessment includes assumptions of the entry to new international markets
for which we have not yet penetrated. Additional risks for goodwill across all reporting units include, but are not limited to, the
risks discussed in Item 1A “Risk Factors” contained within this Annual Report and:
•
a decline in our stock price and resulting market capitalization, if we determine the decline is sustained and is
indicative of a reduction in the fair value below the carrying value of our reporting units;
49
•
•
•
a decrease in available government funding, including budgetary constraints affecting U.S. Government spending
generally, or specific departments or agencies;
changes in U.S. Government programs or requirements, including the increased use of small business providers;
our failure to reach our internal forecasts could impact our ability to achieve our forecasted levels of cash flows
and reduce the estimated discounted value of our reporting units;
volatility in equity and debt markets resulting in higher discount rates; and
•
• market and political factors that could impact the success of new products, especially related to new unmanned
systems platforms.
Accounting for income taxes and tax contingencies. FASB ASC Topic 740 Income Taxes (“Topic 740”) provides the
accounting treatment for uncertainty in income taxes recognized in an enterprise’s financial statements. Topic 740 prescribes a
recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position
taken or expected to be taken in a tax return. Topic 740 also provides guidance on derecognizing, classification, interest and
penalties, accounting in interim periods, disclosure and transition.
As part of the process of preparing our Consolidated Financial Statements, we are required to estimate our provision
for income taxes in each of the tax jurisdictions in which we conduct business. This process involves estimating our actual
current tax expense in conjunction with the evaluation and measurement of temporary differences resulting from differing
treatment of certain items for tax and accounting purposes. These temporary differences result in the establishment of deferred
tax assets and liabilities, which are recorded on a net basis. We then assess on a periodic basis the probability that our net
deferred tax assets will be recovered and therefore realized from future taxable income and to the extent we believe that
recovery is not more likely than not, a valuation allowance is established to address such risk resulting in an additional related
provision for income taxes during the period.
Significant management judgment is required in determining our provision for income taxes, our deferred tax assets
and liabilities, tax contingencies, unrecognized tax benefits, and any required valuation allowance, including taking into
consideration the probability of the tax contingencies being incurred. Management assesses this probability based upon
information provided to us by our tax advisers, our legal advisers and similar tax cases. If at a later time our assessment of the
probability of these tax contingencies changes, our accrual for such tax uncertainties may increase or decrease.
We have a valuation allowance at December 29, 2019 due to management’s overall assessment of risks and
uncertainties related to our future ability to realize and, hence, utilize certain deferred tax assets, primarily consisting of net
operating losses, carry forward temporary differences and future tax deductions resulting from certain types of stock option
exercises, before they expire.
The 2019 effective tax rate at December 29, 2019 for annual and interim reporting periods could be impacted if
uncertain tax positions that are not recognized at December 29, 2019 are settled at an amount which differs from our estimate.
Finally, during 2019 and thereafter, if we are impacted by a change in the valuation allowance as of December 29, 2019
resulting from a change in judgment regarding the realizability of deferred tax assets beyond December 29, 2019, such effect
will be recognized in the interim period in which the change occurs.
Contingencies and litigation. We are currently involved in certain legal proceedings. We estimate a range of liability
related to pending litigation where the amount and range of loss can be estimated. We record our estimate of a loss when the
loss is considered probable and reasonably estimable. Where a liability is probable and there is a range of estimated loss and no
amount in the range is more likely than any other number in the range, we record the minimum estimated liability related to the
claim in accordance with FASB ASC Topic 450, Contingencies. As additional information becomes available, we assess the
potential liability related to our pending litigation and revise our estimates. Revisions in our estimates of potential liability
could materially impact our results of operations. See Note 15 of the Notes to Consolidated Financial Statements contained
within this Annual Report for a further discussion of our legal proceedings.
Recent Accounting Pronouncements
See Note 1 of the Notes to Consolidated Financial Statements contained within this Annual Report for a discussion of
recent accounting pronouncements.
50
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Interest Rate and Foreign Currency Risks
We are exposed to market risk, primarily related to interest rates and foreign currency exchange rates.
Exposure to market risk for changes in interest rates relates to our outstanding debt. We are exposed to interest rate
risk, primarily through our borrowing activities under the Credit Agreement discussed under “Liquidity and Capital Resources”
above. Based on our current outstanding balances, a 1% change in the LIBOR would not materially impact our financial
position. We manage exposure to these risks through our operating and financing activities and, when deemed appropriate,
through the use of derivative financial instruments. Derivative financial instruments are viewed as risk management tools and
are not used for speculation or for trading purposes. Derivative financial instruments were contracted with investment grade
counterparties to reduce exposure to interest rate risk on our prior credit facilities. We had no outstanding derivative financial
instruments as of December 29, 2019.
Exposure to market risk for foreign currency exchange rate risk is related to receipts from customers, payments to
suppliers and intercompany loans denominated in foreign currencies. Accordingly, a strengthening of the U.S. dollar (“USD”)
or a strengthening of certain foreign currencies, such as the Israeli Shekel, will negatively impact revenues and gross margins
expressed in consolidated USD terms. We currently enter into limited foreign currency forward contracts to manage foreign
currency exchange rate risk because exchange rate fluctuations have had, and we expect will have, minimal impact on our
operating results and cash flows.
Our cash and cash equivalents as of December 29, 2019 were $172.6 million and are primarily invested in money
market interest bearing accounts. A hypothetical 10% adverse change in the average interest rate on our money market cash
investments and short-term investments would have had no material effect on our net income for the year ended December 29,
2019.
Commodity Price Risk Management
We purchase commodities for use in our manufacturing processes. We typically purchase these commodities at market
prices, and as a result are affected by market price fluctuations. We have decided not to hedge these exposures as they are
deemed immaterial.
Item 8. Financial Statements and Supplementary Data.
Our Consolidated Financial Statements and supplementary data required by this item are set forth at the
pages indicated in Item 15(a) (1) and 15(a) (2), respectively.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A. Controls and Procedures.
Disclosure Controls and Procedures
We maintain disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) promulgated under the
Exchange Act, designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is
recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such
information is accumulated and communicated to our management, including our Principal Executive Officer and Principal
Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the
disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was
required to apply its judgment in evaluating the cost benefit relationship of possible controls and procedures.
As required by Rule 13a-15(b) and 15d-15(b) promulgated under the Exchange Act, we carried out an evaluation,
under the supervision and with the participation of our management, including our Principal Executive Officer and Principal
Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the
period covered by this Annual Report. Based on the foregoing, our Principal Executive Officer and Principal Financial Officer
51
concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of December 29,
2019.
Management’s Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as
such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f), designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are subject to the risk that internal controls may become
inadequate because of changes in conditions, or because the degree of compliance with the policies and procedures may
deteriorate.
Under the supervision and with the participation of our management, including our Principal Executive Officer and
Principal Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting
based on the framework in the 2013 Internal Control-Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Management's assessment of and conclusion on the effectiveness of internal
control over financial reporting as of December 29, 2019 did not include the internal controls of FTT, more fully described in
Part 1 of this Form 10-K, of which 80.1% of the ownership was acquired by the Company on February 27, 2019. The total
assets of FTT, which is now the KTT Division, in aggregate, are approximately 4.2% of the total assets of the Company, and
the revenues of FTT comprise approximately 7.3% of the revenues of the Company, as such amounts for the Company are
reflected in the Company’s consolidated financial statements as of and for the fiscal year ended December 29, 2019 included in
this Form 10-K. Management will perform an assessment of the effectiveness of FTT’s internal control over financial reporting
within one year of the date of acquisition. Aside from this exclusion and based on the results of our evaluation, our
management concluded that our internal control over financial reporting was effective at the reasonable assurance level as of
December 29, 2019.
Our internal control over financial reporting has been audited by Deloitte & Touche LLP, an independent registered
public accounting firm, as stated in their report appearing below, which expresses an unqualified opinion on the effectiveness of
our internal control over financial reporting as of December 29, 2019.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial accounting and reporting (as defined in
Rules 13a-15(f) and 15d-15(f) of the Exchange Act) during the fourth quarter of the fiscal year ended December 29, 2019 that
have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B. Other Information.
None.
Item 10. Directors, Executive Officers and Corporate Governance.
PART III
The information required by this item is incorporated by reference to our definitive proxy statement filed in
connection with our 2020 Annual Meeting of Stockholders or an amendment to this Annual Report to be filed with the SEC
within 120 days after the close of our fiscal year ended December 29, 2019.
Item 11. Executive Compensation.
The information required by this item is incorporated by reference to our definitive proxy statement filed in
connection with our 2020 Annual Meeting of Stockholders or an amendment to this Annual Report to be filed with the SEC
within 120 days after the close of our fiscal year ended December 29, 2019.
52
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The information required by this item is incorporated by reference to our definitive proxy statement filed in
connection with our 2020 Annual Meeting of Stockholders or an amendment to this Annual Report to be filed with the SEC
within 120 days after the close of our fiscal year ended December 29, 2019.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
The information required by this item is incorporated by reference to our definitive proxy statement filed in
connection with our 2020 Annual Meeting of Stockholders or an amendment to this Annual Report to be filed with the SEC
within 120 days after the close of our fiscal year ended December 29, 2019.
Item 14. Principal Accounting Fees and Services.
The information required by this item is incorporated by reference to our definitive proxy statement filed in
connection with our 2020 Annual Meeting of Stockholders or an amendment to this Annual Report to be filed with the SEC
within 120 days after the close of our fiscal year ended December 29, 2019.
Item 15. Exhibits, Financial Statement Schedules.
(a)(1) Financial Statements
PART IV
The Consolidated Financial Statements of Kratos Defense & Security Solutions, Inc. and Report of Deloitte & Touche
LLP, Independent Registered Public Accounting Firm, are included in a separate section of this Annual Report beginning on
page F-1.
(a)(2) Financial Statement Schedules
All schedules have been omitted because they are not applicable or are not required or the information required to be
set forth therein is included in the Consolidated Financial Statements or the notes thereto.
53
(a) (3) Exhibits
Exhibit
Number
2.1+*
2.2+
2.3+**
3.1
3.2
4.1
4.2
4.3
4.4
10.1#
10.2#
10.3#
10.4#
10.5#
10.6#
Exhibit Description
Stock Purchase Agreement, dated May 31,
2015, by and among Kratos Defense &
Security Solutions, Inc., Herley Industries,
Inc., Ultra Electronics Holdings plc and
Ultra Electronics Defense Inc.
Stock Purchase Agreement, dated February
28, 2018 among Kratos Defense & Security
Solutions, Inc., Kratos Public Safety
&Security Solutions, Inc. and Securitas
Electronic Security, Inc.
Purchase Agreement, dated February 27,
2019, by and among Kratos Defense &
Security Solutions, Inc., Shirley Brostmeyer,
(“SB”), Joseph Brostmeyer (“JB”), certain
trusts established by SB, JB and members of
their immediate family, and JB, as the
Sellers Representative.
Amended and Restated Certificate of
Incorporation of Kratos Defense & Security
Solutions, Inc., as amended.
Second Amended and Restated Bylaws of
Kratos Defense & Security Solutions, Inc.,
as amended.
Specimen Stock Certificate.
Indenture, dated as of November 20, 2017,
among Kratos Defense & Security Solutions,
Inc., as Issuer, the Guarantors party thereto,
and Wilmington Trust, National Association,
as Trustee and Collateral Agent.
First Supplemental Indenture, dated as of
December 21, 2017, among Kratos Defense
& Security Solutions, Inc., as Issuer, the
Guarantor as party thereto, and Wilmington
Trust, National Association, as Trustee.
Description of Equity Securities Registered
under Section 12 of the Exchange Act.
Form of Indemnification Agreement by and
between Kratos Defense & Security
Solutions, Inc. and its directors and
executive officers.
Amended and Restated 1999 Employee
Stock Purchase Plan.
2000 Nonstatutory Stock Option Plan.
Form of Stock Option Agreement and Form
of Stock Option Grant Notice used in
connection with the 2000 Nonstatutory
Stock Option Plan.
2005 Equity Incentive Plan.
Form of Stock Option Agreement pursuant
to the 2005 Equity Incentive Plan.
Incorporated by
Reference
Form
Filing Date
(File No.)
Exhibit
Filed-
Furnished
Herewith
10-Q
08/06/2015
(001-34460)
10-Q
5/10/2018
(001-34460)
10-Q
10-K
10-K
10-K
5/08/2019
(001-34460)
2/27/2017
(001-34460)
2/27/2017
(001-34460)
2/27/2017
(001-34460)
8-K
11/21/2017
(001-34460)
10-K
02/28/2018
(001-34460)
10-Q
S-8
10-Q
10-Q
S-8
S-8
08/04/2011
(001-34460)
07/31/2017
(001-34460)
11/14/2000
(000-27231)
11/14/2000
(000-27231)
08/01/2005
(333-127060)
08/01/2005
(333-127060)
2.4
2.2
2.3
3.1
3.2
4.1
4.1
4.5
10.8
99.1
10.2
10.3
99.2
99.1
54
*
*
10.7#
10.8#
10.9#
10.10#
10.11#
Form of Restricted Stock Unit Agreement
and Form of Notice of Grant of Restricted
Stock Units under the 2005 Equity Incentive
Plan.
Herley Industries, Inc. 1997 Stock Option
Plan.
Herley Industries, Inc. 2000 Stock Option
Plan.
Herley Industries, Inc. 2003 Stock Option
Plan.
Herley Industries, Inc. Amended and
Restated 2006 New Employee Stock Option
Plan.
10.12#
2011 Equity Incentive Plan.
10.13#
Form of Notice of Grant of Restricted Stock
Units and Restricted Stock Unit Award
Agreement pursuant to the 2011 Equity
Incentive Plan.
10.14#
2014 Equity Incentive Plan.
10.15#
10.16#
10.17#
10.18
10.19#
10.20#
10.21#
10.22#
Form of Restricted Stock Unit Grant &
Notice and Form of Restricted Stock Unit
Award Agreement pursuant to the 2014
Equity Incentive Plan.
Second Amended and Restated Executive
Employment Agreement, dated as of August
4, 2011, by and between Kratos Defense &
Security Solutions, Inc. and Eric DeMarco.
Second Amended and Restated Severance
and Change of Control Agreement, dated as
of August 4, 2011, by and between Kratos
Defense & Security Solutions, Inc. and
Deanna Lund.
Sublease Agreement, dated as of December
17, 2009, by and between Amylin
Pharmaceuticals, Inc., as Sublessor, and
Kratos Defense & Security Solutions, Inc.,
as Sublessee.
Herley Industries, Inc. Amended and
Restated 2010 Stock Plan, and the related
Form of Notice of Grant of Restricted Stock
Units and Restricted Stock Unit Award
Agreement.
Amended and Restated Integral Systems,
Inc. 2008 Stock Incentive Plan, and the
related Form of Notice of Grant of
Restricted Stock Units and Restricted Stock
Units and Restricted Stock Unit Award
Agreement.
Form of Notice of Grant of Restricted Stock
Units and Restricted Stock Unit Award
Agreement, entered into between Kratos
Defense & Security Solutions, Inc. and
certain employees of Composite
Engineering, Inc.
Employment Agreement, effective January
1, 2015, by and between Kratos Defense &
Security Solutions, Inc. and Richard Poirier.
8-K
S-8
S-8
S-8
S-8
DEF 14A
8-K
S-8
01/17/2007
(000-27231)
04/08/2011
(333-173383)
04/08/2011
(333-173383)
04/08/2011
(333-173383)
04/08/2011
(333-173383)
04/15/2011
(001-34460)
11/18/2011
(001-34460)
07/31/2017
(001-34460)
10-Q
08/04/2011
(001-34460)
10-Q
08/04/2011
(001-34460)
99.3
4.11
4.13
4.14
4.15
n/a
10.2
99.2
10.3
10.4
10-K
03/11/2010
(001-34460)
10.26
S-8
03/08/2012
(333-179977)
4.10
S-8
03/08/2012
(333-179977)
4.11
S-8
8-K
07/27/2012
(333-182910)
03/12/2015
(001-34460)
4.12
10.1
55
8-K
8-K
06/02/2015
(001-34460)
12/08/2016
(001-34460)
10.1
10.1
8-K
11/21/2017
(001-34460)
10.1
8-K
10-Q
10-K
06/13/2018
(001-34460)
05/04/2017
(001-34460)
10.1
10.2
02/28/2019
(001-34460)
10.34
10-Q
05/08/2019
(001-34460)
10-Q
07/31/2019
(001-34460)
10.2
10.1
*
*
*
*
*
*
10.23#
10.24#
10.25
10.26
10.27
10.28
10.29
10.30#
21.1
23.1
31.1
31.2
32.1
32.2
Bonus Agreement, dated June 1, 2015, by
and between Kratos Defense & Security
Solutions, Inc. and Richard Poirier.
Employment Agreement, effective January
1, 2017, by and between Kratos Defense &
Security Solutions, Inc. and Phil Carrai.
Amended and Restated Credit and Security
Agreement, dated as of November 20, 2017,
among Kratos Defense & Security Solutions,
Inc., as Borrower, the lenders named therein,
SunTrust Bank, as Agent, and SunTrust
Robinson Humphrey, Inc., as Lead Arranger
and Sole Book Runner.
First Amendment to Amended and Restated
Credit and Security Agreement, dated June
11, 2018, among Kratos Defense & Security
Solutions, Inc., as Borrower, each of the
Credit Parties and Required Lenders party
thereto and SunTrust Bank as Agent.
Office Lease, dated as of May 1, 2017, by
and between Kratos Defense & Security
Solutions, Inc. and TPP 212 Scripps, LLC.
Amended and Restated Lease Agreement,
dated as of January 1, 2019, by and between
STORE Capital Acquisitions, LLC and
Kratos RT Logic, Inc.
Exchange Agreement, dated February 27,
2019, by and among Kratos Defense &
Security Solutions, Inc., FTT CORE, LLC,
Florida Turbine Technologies, Inc., Shirley
Brostmeyer (“SB”), Joseph Brostmeyer
(“JB”), and certain trusts established by S
Executive Employment Agreement, dated
January 1, 2017, by and between Kratos
Defense & Security Solutions, Inc. and Ben
Goodwin
List of Subsidiaries.
Consent of Independent Registered Public
Accounting Firm.
Certification of Chief Executive Officer
pursuant to Section 302 of the Sarbanes
Oxley Act of 2002.
Certification of Chief Financial Officer
pursuant to Section 302 of the Sarbanes
Oxley Act of 2002.
Certification pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of
2002 for Eric M. DeMarco.
Certification pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of
2002 for Deanna Lund.
56
101
104
Financial statements from the Annual Report
on Form 10-K of Kratos Defense & Security
Solutions, Inc. for the year ended December
29, 2019, formatted in XBRL: (i) the
Consolidated Balance Sheets, (ii) the
Consolidated Statements of Operations, (iii)
the Consolidated Statement of
Comprehensive Loss, (iv) the Consolidated
Statements of Cash Flows, (v) the Notes to
the Consolidated Financial Statements.
Cover Page Interactive Data File (formatted
as inline XBRL and contained in Exhibit
101)
*
*
Certain schedules and exhibits referenced in this document have been omitted in accordance with Item 601(b)(2) of
+
Regulation S-K. A copy of any omitted schedule and/or exhibit will be furnished supplementally to the Securities and Exchange
Commission upon request.
*
separately with the SEC.
Certain portions have been omitted pursuant to a confidential treatment request. Omitted information has been filed
**
would be competitively harmful if publicly disclosed.
Certain confidential information contained in this Exhibit has been omitted because it is both (i) not material and (ii)
#
Management contract or compensatory plan or arrangement.
(b) Exhibits
See Item 15(a)(3) above.
(c) Financial Statement Schedules
See Item 15(a)(2) above.
Item 16. Form 10-K Summary.
None.
57
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: February 24, 2020
Kratos Defense & Security Solutions, Inc.
By:
/s/ Eric M. DeMarco
Eric M. DeMarco
President and Chief Executive Officer (Principal
Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the dates indicated:
Signature
Title
Date
/s/ Eric M. DeMarco
Eric M. DeMarco
President, Chief Executive Officer and Director
(Principal Executive Officer)
February 24, 2020
/s/ Deanna H. Lund
Deanna H. Lund
Executive Vice President, Chief Financial Officer
(Principal Financial Officer)
February 24, 2020
/s/ Maria Cervantes de Burgreen
Maria Cervantes de Burgreen
Vice President and Corporate Controller
(Principal Accounting Officer)
February 24, 2020
/s/ Scott Anderson
Scott Anderson
/s/ William Hoglund
William Hoglund
/s/ Scot Jarvis
Scot Jarvis
/s/ Jane E. Judd
Jane E. Judd
/s/ Sam Liberatore
Sam Liberatore
/s/ Amy Zegart
Amy Zegart
Director
Director
Director
Director
Director
Director
58
February 24, 2020
February 24, 2020
February 24, 2020
February 24, 2020
February 24, 2020
February 24, 2020
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
KRATOS DEFENSE & SECURITY SOLUTIONS, INC.
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 29, 2019 and December 30, 2018
Consolidated Statements of Operations for the Years Ended December 29, 2019, December 30, 2018, and December
31, 2017
Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 29, 2019, December 30,
2018, and December 31, 2017
Consolidated Statements of Stockholders’ Equity for the Years Ended December 29, 2019, December 30, 2018, and
December 31, 2017
Consolidated Statements of Cash Flows for the Years Ended December 29, 2019, December 30, 2018, and December
31, 2017
Notes to Consolidated Financial Statements
F-2
F-4
F-5
F-6
F-7
F-8
F-10
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the stockholders and the Board of Directors of Kratos Defense & Security Solutions, Inc.
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of Kratos Defense & Security Solutions, Inc. and subsidiaries (the
"Company") as of December 29, 2019 and December 30, 2018, and the related consolidated statements of operations and comprehensive
income (loss), stockholders’ equity, and cash flows, for each of the three fiscal years in the period ended December 29, 2019, and the related
notes (collectively referred to as the "financial statements"). We also have audited the Company’s internal control over financial reporting as
of December 29, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of
December 29, 2019 and December 30, 2018, and the results of its operations and its cash flows for each of the three fiscal years in the period
ended December 29, 2019, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion,
the Company maintained, in all material respects, effective internal control over financial reporting as of December 29, 2019, based on
criteria established in Internal Control - Integrated Framework (2013) issued by COSO.
As described in Management’s Report on Internal Control over Financial Reporting, management excluded from its assessment the internal
control over financial reporting at the KTT Division, which was acquired on February 27, 2019, and whose financial statements constitute
approximately 4.2% of total assets, and approximately 7.3% of revenues of the consolidated financial statement amounts as of and for the
year ended December 29, 2019. Accordingly, our audit did not include the internal control over financial reporting at the KTT Division.
Adoption of New Accounting Pronouncements
As discussed in Note 1 to the financial statements, the Company adopted ASU 2016-02, Leases, and has changed its method of accounting for
leases using the optional transition method beginning December 31, 2018, relating to the manner in which it recognizes assets and liabilities
for the rights and obligations underlying leases.
As discussed in Note 1 to the financial statements, the Company previously adopted ASU 2014-09, Revenue from Contracts with Customers,
and changed its method of accounting for revenue using the modified retrospective transition approach beginning January 1, 2018, relating to
the manner in which it accounts for revenues from contracts with customers.
Basis for Opinions
The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting,
and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on
Internal Control over Financial Reporting. Our responsibility is to express an opinion on these financial statements and an opinion on the
Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company
Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with
the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to
obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud, and
whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements,
whether due to error or fraud, and performing procedures to respond to those risks. Such procedures included examining, on a test basis,
evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles
used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. Our audit of
internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk
that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed
risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits
provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting
principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of
records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide
reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally
accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of
management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
F-2
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or
that the degree of compliance with the policies or procedures may deteriorate.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current-period audit of the financial statements that was
communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the
financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit
matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical
audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Cost Estimates for Fixed-Price Contracts - Refer to Note 1 to the consolidated financial statements
Critical Audit Matter Description
The Company recognizes revenue over time using the cost-to-cost method (cost incurred relative to total estimated cost at completion) for
most of its fixed-price contracts. Management must make various assumptions and estimates regarding technical, schedule and cost aspects of
these contracts to develop estimates of cost at completion. A significant change in cost estimates could affect the overall profitability and
timing of revenue recognition related to one or more of its fixed price contracts.
Given the complexity of certain of the Company’s fixed-price contracts, the limited amount of historical activity in certain instances, and
significant judgment and estimates necessary to estimate future costs and margin at completion, auditing these estimates involved especially
subjective judgment.
How the Critical Audit Matter Was Addressed in the Audit
Our auditing procedures related to the cost estimates for fixed-price contracts included the following:
• We tested the effectiveness of internal controls over the development of cost estimates, including the underlying assumptions and key
inputs into the development of the estimated cost at completion.
• We selected certain contracts for testing and performed the following procedures:
- Tested management’s identification of distinct performance obligations by evaluating whether the underlying goods and services were
highly interdependent and interrelated.
- Evaluated the reasonableness of management’s estimates of cost at completion to actual costs and profits of similar previously
completed contracts, when applicable.
- Performed inquiries of the Company’s project managers and others directly involved with the contracts to evaluate project status and
project challenges, which may affect total estimated costs to complete.
• We performed retrospective reviews on selected contracts, comparing actual performance to estimated performance, when evaluating
management’s ability to estimate costs.
/s/ Deloitte & Touche LLP
San Diego, California
February 24, 2020
We have served as the Company’s auditor since 2013.
F-3
KRATOS DEFENSE & SECURITY SOLUTIONS, INC.
CONSOLIDATED BALANCE SHEETS
December 29, 2019 and December 30, 2018
(in millions, except par value and number of shares)
2019
2018
$
172.6
$
—
85.0
179.4
61.1
9.4
11.4
3.3
522.2
116.9
42.1
455.6
39.5
9.7
182.7
0.3
64.6
172.8
46.8
8.9
10.3
8.3
494.7
67.1
—
425.7
16.1
6.5
1,186.0
$
1,010.1
$
$
Assets
Current assets:
Cash and cash equivalents
Restricted cash
Accounts receivable, net
Unbilled receivables, net
Inventoried costs
Prepaid expenses
Other current assets
Current assets of discontinued operations
Total current assets
Property, plant and equipment, net
Operating lease right-of-use assets
Goodwill
Intangible assets, net
Other assets
Total assets
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable
Accrued expenses
Accrued compensation
Accrued interest
$
53.8
32.7
37.1
1.6
34.3
9.9
10.0
3.3
182.7
295.1
37.6
78.7
2.8
596.9
15.0
—
—
1,286.5
(0.4)
(712.0)
574.1
46.6
38.1
33.5
1.6
34.9
—
4.7
5.3
164.7
294.2
—
25.5
6.4
490.8
—
—
—
1,244.5
(0.7)
(724.5)
519.3
1,010.1
Billings in excess of costs and earnings on uncompleted contracts
Current portion of operating lease liabilities
Other current liabilities
Current liabilities of discontinued operations
Total current liabilities
Long-term debt
Operating lease liabilities, net of current portion
Other long-term liabilities
Long-term liabilities of discontinued operations
Total liabilities
Commitments and contingencies (Note 15)
Redeemable noncontrolling interest
Stockholders’ equity:
Preferred stock, $0.001 par value, 5,000,000 authorized, 0 shares outstanding at December
29, 2019 and December 30, 2018
Common stock, $0.001 par value, 195,000,000 shares authorized; 106,635,508 and
103,766,899 shares issued and outstanding at December 29, 2019 and December 30, 2018,
respectively
Additional paid-in capital
Accumulated other comprehensive loss
Accumulated deficit
Total stockholders’ equity
Total liabilities and stockholders’ equity
$
1,186.0
$
The accompanying notes are an integral part of these Consolidated Financial Statements.
F-4
KRATOS DEFENSE & SECURITY SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Years ended December 29, 2019, December 30, 2018, and December 31, 2017
(in millions, except per share amounts)
2019
2018
2017
$
272.6
$
200.7
$
Service revenues
Product sales
Total revenues
Cost of service revenues
Cost of product sales
Total costs
Gross profit
Selling, general and administrative expenses
Merger and acquisition related items
Research and development expenses
Impairment of goodwill
Restructuring expenses and other
Operating income (loss)
Other income (expense):
Interest expense, net
Loss on extinguishment of debt
Other income (expense), net
Total other expense, net
Income (loss) from continuing operations before income taxes
Provision (benefit) for income taxes from continuing operations
Income (loss) from continuing operations
Discontinued operations
Income (loss) from operations of discontinued component (including
gain on disposal of $0.0 million for the year ended December 30,
2018)
Income tax expense (benefit)
Income (loss) from discontinued operations
Net income (loss)
Less: Net income attributable to noncontrolling interest
Net income (loss) attributable to Kratos
Basic income and (loss) per common share attributable to Kratos:
Income (loss) from continuing operations
Income (loss) from discontinued operations
Net income (loss) per common share
Diluted income and (loss) per common share attributable to Kratos:
Income (loss) from continuing operations
Income (loss) from discontinued operations
Net income (loss) per common share
Weighted average common shares outstanding:
Basic
Diluted
$
$
$
$
$
$
444.9
717.5
192.0
335.5
527.5
190.0
130.8
2.3
18.0
—
0.9
38.0
(21.6)
—
(0.7)
(22.3)
15.7
4.8
10.9
1.9
0.2
1.7
12.6
$
0.1
12.5
$
$
$
$
$
0.10
0.02
0.12
0.10
0.01
0.11
106.0
109.2
417.3
618.0
137.8
310.5
448.3
169.7
119.8
—
15.6
—
3.8
30.5
(20.8)
—
(1.0)
(21.8)
8.7
4.6
4.1
(9.4)
(1.8)
(7.6)
(3.5) $
—
(3.5) $
0.04
$
(0.07)
(0.03) $
0.04
$
(0.07)
(0.03) $
103.8
106.1
197.8
405.5
603.3
138.6
307.1
445.7
157.6
127.3
—
17.8
24.2
0.3
(12.0)
(28.6)
(17.3)
0.8
(45.1)
(57.1)
(10.2)
(46.9)
6.3
2.1
4.2
(42.7)
—
(42.7)
(0.52)
0.04
(0.48)
(0.52)
0.04
(0.48)
89.5
89.5
The accompanying notes are an integral part of these Consolidated Financial Statements.
F-5
KRATOS DEFENSE & SECURITY SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
Years ended December 29, 2019, December 30, 2018, and December 31, 2017
(in millions, except per share amounts)
Net income (loss)
Other comprehensive income:
Change in cumulative translation adjustment
Postretirement benefit reserve adjustment net of tax expense
Other comprehensive income, net of tax
Comprehensive income (loss)
Less: Comprehensive income attributable to noncontrolling interest
Comprehensive income (loss) attributable to Kratos
$
$
2019
2018
2017
12.6
$
(3.5) $
0.1
0.2
0.3
12.9
0.1
0.4
0.3
0.7
(2.8)
—
12.8
$
(2.8) $
(42.7)
0.1
0.2
0.3
(42.4)
—
(42.4)
The accompanying notes are an integral part of these Consolidated Financial Statements.
F-6
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T
KRATOS DEFENSE & SECURITY SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 29, 2019, December 30, 2018, and December 31, 2017
(in millions)
2019
2018
2017
Operating activities:
Net income (loss)
Income (loss) from discontinued operations
Income (loss) from continuing operations
Adjustments to reconcile income (loss) from continuing operations to net cash
provided by (used in) operating activities from continuing operations:
Depreciation and amortization
Deferred income taxes
Amortization of lease right-of-use assets
Stock-based compensation
Goodwill impairment charge
Loss on extinguishment of debt
Amortization of deferred financing costs
Amortization of premium and discount on Senior Secured Notes
Provision for doubtful accounts
Changes in assets and liabilities, net of acquisitions:
Accounts receivable
Unbilled receivables
Inventoried costs
Prepaid expenses
Other assets
Operating lease liabilities
Accounts payable
Accrued expenses
Accrued compensation
Accrued interest
Billings in excess of costs and earnings on uncompleted contracts
Income tax receivable and payable
Other liabilities
Net cash provided by (used in) operating activities from continuing operations
Investing activities:
Cash paid for acquisitions, net of cash acquired
Proceeds from sale of assets
Capital expenditures
Net cash provided by (used in) investing activities from continuing operations
Financing activities:
Proceeds from the issuance of long-term debt
Extinguishment of long-term debt
Proceeds (expenses) from the issuance of common stock
Repayment under credit facility and debt
Debt issuance costs
Payments under finance leases
Proceeds from exercise of restricted stock units, employee stock options, and
employee stock purchase plan
Other
F-8
$
12.6
$
(3.5) $
1.7
10.9
23.4
(4.9)
11.7
11.0
—
—
1.0
—
(0.2)
(11.6)
(1.6)
(4.6)
0.3
(0.9)
(6.3)
4.8
(6.4)
1.7
(0.1)
(2.4)
1.8
1.3
28.9
(17.7)
0.3
(26.3)
(43.7)
—
—
—
—
—
(0.5)
4.0
—
(7.6)
4.1
17.9
(0.4)
—
7.2
—
—
1.0
—
1.8
8.2
(35.9)
2.0
2.2
1.2
—
12.2
(1.7)
3.3
(0.1)
(6.9)
0.2
1.8
18.1
(2.9)
66.0
(22.6)
40.5
—
—
(1.1)
(0.8)
(0.1)
—
3.7
—
(42.7)
4.2
(46.9)
22.2
(9.5)
—
7.8
24.2
17.3
1.3
0.7
—
0.5
(35.2)
7.2
(3.0)
(2.7)
—
(8.3)
(3.8)
(2.9)
(1.9)
6.3
1.4
(1.6)
(26.9)
—
0.7
(26.1)
(25.4)
300.0
(448.8)
269.1
(1.0)
(6.6)
—
1.5
(0.8)
Net cash provided by financing activities from continuing operations
Net cash flows of continuing operations
Net operating cash flows of discontinued operations
Net investing cash flows of discontinued operations
Effect of exchange rate changes on cash, cash equivalents and restricted cash
Net increase (decrease) in cash, cash equivalents and restricted cash
Cash, cash equivalents and restricted cash at beginning of year
Cash, cash equivalents and restricted cash at end of year
Supplemental disclosure of cash flow information:
Cash paid during the year for interest
Net cash paid during the year for income taxes
Non-cash financing and investing activities:
Capital expenditures included in accounts payable and accrued expenses
Liability for contingent consideration and goodwill related to acquisition
3.5
(11.3)
1.1
—
(0.2)
(10.4)
183.0
172.6
19.9
0.6
1.4
$
$
$
$
1.7
60.3
(7.7)
—
(0.5)
52.1
130.9
183.0
20.5
1.5
1.3
$
$
$
$
— $
— $
113.4
61.1
(0.8)
(0.6)
0.5
60.2
70.7
130.9
28.3
(0.6)
1.6
2.9
$
$
$
$
$
The accompanying notes are an integral part of these Consolidated Financial Statements.
F-9
KRATOS DEFENSE & SECURITY SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1.
Organization and Summary of Significant Accounting Policies
(a)
Description of Business
Kratos is a mid-tier government contractor at the forefront of the U.S. Department of Defense’s (the “DoD”)
recapitalization of strategic weapon systems to address peer and near peer threats and its related Rapid Innovation Initiatives.
Kratos is a leading technology, intellectual property, proprietary product and system company focused on the U.S. and its allies’
national security. Kratos is a recognized industry leader in the rapid development, demonstration and fielding of high
technology systems and products at an affordable cost. Kratos’ primary focus areas are unmanned systems, space and satellite
communications, training solutions, microwave electronics, cyber security/warfare, missile defense, and hypersonic systems,
turbine technologies, and combat systems. The Company believes that its technology, intellectual property, proprietary products
and designed-in positions on its customers’ programs, platforms and systems, and the ability to rapidly develop, demonstrate
and field affordable leading technology systems is a competitive advantage and high barrier to entry to the markets in which it
operates. The Company’s work force is primarily engineering and technically oriented, highly skilled with a significant number
holding national security clearances. The Company’s entire organization is focused on executing its strategy of becoming the
leading technology and intellectual property based company in its industry.
The Company conducts most of its business with the U.S. Government (which includes foreign military sales) and
performs work as the prime contractor, subcontractor, or preferred supplier. The Company also conducts business with local,
state, and foreign governments and domestic and international commercial customers.
The Company operates in two reportable segments. The Kratos Government Solutions (“KGS”) reportable segment is
comprised of an aggregation of KGS operating segments, including its microwave electronic products, space, training and
cybersecurity, C5ISR/modular systems, turbine technologies and defense and rocket support services operating segments. The
Unmanned Systems (“US”) reportable segment consists of its unmanned aerial system and unmanned ground and seaborne
system products. The Public Safety & Security (“PSS”) reportable segment (which was divested in June 2018 and has been
classified as discontinued operations - see Note 9 of these notes to the consolidated financial statements) previously provided
independent integrated solutions for advanced homeland security, public safety, critical infrastructure, and security and
surveillance systems for government and commercial applications.
The Company organizes its operating segments based primarily on the nature of the products, solutions and services
offered. Transactions between segments are negotiated and accounted for under terms and conditions similar to other
government and commercial contracts, and these intercompany transactions are eliminated in consolidation. For additional
information regarding the Company’s operating segments, see Note 14 of these notes to consolidated financial statements.
(b)
Principles of Consolidation and Basis of Presentation
The consolidated financial statements include the accounts of Kratos and its 100% owned subsidiaries, for which all
intercompany 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. There were 52 calendar weeks in the fiscal years ending on December 29,
2019 and December 30, 2018 and 53 calendar weeks in the fiscal year ended on December 31, 2017.
(d)
Use of Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in
the U.S. (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and
liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported
amounts of revenues and expenses during the reporting period. Such estimates include revenue recognition, valuation of long-
lived assets including identifiable intangibles and goodwill, accounting for income taxes including the related valuation
allowance on the deferred tax asset and uncertain tax positions, contingencies and litigation, contingent acquisition
consideration, and stock-based compensation. In the future, the Company may realize actual results that differ from the current
F-10
reported estimates and if the estimates that the Company has used change in the future, such changes could have a material
impact on the Company’s consolidated financial position, results of operations and cash flows.
(e)
Revenue Recognition
Effective January 1, 2018, the Company adopted the Financial Accounting Standards Board (“FASB”) ASU 2014-09,
Revenue from Contracts with Customers, and the related amendments, which are codified into Accounting Standards
Codification (“ASC”) 606 (“ASC 606”), which establishes a broad principle that requires entities to assess the products or
services promised in contracts with customers at contract inception to determine the appropriate unit at which to record
revenues, which is referred to as a performance obligation. Revenue is recognized when control of the promised products or
services is transferred to customers, at an amount that reflects the consideration to which the entity expects to be entitled in
exchange for those products or services. The new standard requires disclosure of the nature, amount, timing, and uncertainty of
revenue and cash flows arising from contracts with customers.
The Company adopted ASC 606 on January 1, 2018, using the modified retrospective method and recognized and
recorded a decrease in opening equity of $0.2 million as of January 1, 2018 due to the cumulative impact of adopting ASC 606.
The impact of adopting ASC 606 for the year ended December 30, 2018 was an increase of $30.0 million to revenues and a
corresponding increase in cost of revenues of $21.9 million. Total net cash provided by operating activities from continuing
operations, total net cash provided by investing activities from continuing operations and total net cash provided by financing
activities on the Company’s consolidated statements of cash flows were not impacted by the adoption of ASC 606.
Discontinued operations were not affected by the adoption of ASC 606.
The reported results for 2018 and 2019 reflect the application of ASC 606 guidance while the reported results for
periods prior to January 1, 2018 were prepared under the guidance of FASB ASC 605. The adoption of ASC 606 represents a
change in accounting principle.
To determine revenue recognition for arrangements that the Company determines are within the scope of ASC 606, the
Company performs the following five steps: (i) identify the contract(s) with a customer; (ii) identify the performance
obligation(s) in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance
obligation(s) in the contract; and (v) recognize revenue when (or as) the entity satisfies a performance obligation. Once the
contract is identified and determined to be within the scope of ASC 606, the Company assesses the goods or services promised
within each contract and determines those that are performance obligations, and assesses whether each promised good or
service is distinct. The Company then recognizes as revenue the amount of the transaction price that is allocated to the
respective performance obligation when (or as) the performance obligation is satisfied.
A performance obligation is a promise in a contract to transfer a distinct good or service to the customer and is the unit
of account under ASC 606. The majority of the Company’s contracts have a single performance obligation as the promise to
transfer the individual goods or services is not separately identifiable from other promises in the contracts and, therefore, not
distinct. For contracts with multiple performance obligations, the Company allocates the contract’s transaction price to each
performance obligation using the best estimate of the standalone selling price of each distinct good or service in the contract.
The primary method used to estimate standalone selling price is the expected-cost-plus-margin approach, under which the
Company forecasts the expected costs of satisfying a performance obligation and then adds an appropriate margin for that
distinct good or service.
Prior to the adoption of ASC 606, the Company recognized the majority of its revenues using the percentage-of
completion method of accounting. Based on the nature of products provided or services performed, revenue was recorded as
costs were incurred (the “percentage-of-completion cost-to-cost method”) or as units were delivered (the “percentage-of-
completion units-of-delivery method”). For the majority of contracts, the Company satisfies the underlying performance
obligations over time as the customer obtains control or receives benefits as work is performed on the contract. As a result,
under ASC 606 revenue is recognized over a time using the cost-to-cost method (cost incurred relative to total estimated cost at
completion). This change generally results in an acceleration of revenue for contracts that were historically accounted for using
the percentage-of-completion units-of-delivery method as revenues are now recognized earlier in the performance period as
costs are incurred rather than as units are delivered.
Remaining Performance Obligations
Since the Company’s adoption of ASC 606 on January 1, 2018, revenues from remaining performance obligations are
now calculated as the dollar value of the remaining performance obligations on executed contracts. On December 29, 2019, the
Company had approximately $601.2 million of remaining performance obligations. The Company expects to recognize
F-11
approximately 62.0% of the remaining performance obligations as revenue in 2020, an additional 21.0% in 2021, and the
balance thereafter.
Contract Estimates
Due to the nature of the work required to be performed on many performance obligations, the estimation of total cost
at completion is complex, subject to many variables and requires significant judgment. On a quarterly basis, the Company
conducts its contract cost Estimate at Completion (“EAC”) process by reviewing the progress and execution of outstanding
performance obligations within its contracts. As part of this process, management reviews information including, but not
limited to, any outstanding key contract matters, progress towards completion and the related program schedule, identified risks
and opportunities and the related changes in estimates of revenues and costs. The risks and opportunities include management’s
judgment about the ability and cost to achieve the schedule (e.g., the number and type of milestone events), technical
requirements (e.g., a newly-developed product versus a mature product) and other contract requirements. Management must
make assumptions and estimates regarding labor productivity and availability, the complexity of the work to be performed, the
availability of materials, the length of time to complete the performance obligation (e.g., to estimate increases in wages and
prices for materials and related support cost allocations), execution by subcontractors, the availability and timing of funding
from customers and overhead cost rates, among other variables.
In addition, certain of the Company’s long-term contracts contain award fees, incentive fees, or other provisions that
can either increase or decrease the transaction price. These variable amounts generally are awarded upon achievement of
certain performance metrics, program milestones or cost targets and can be based upon customer discretion. Variable
consideration is estimated at the most likely amount to which the Company is expected to be entitled. Estimated amounts are
included in the transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will not
occur when the uncertainty associated with the variable consideration is resolved. Estimates of variable consideration and
determination of whether to include estimated amounts in the transaction price are based largely on an assessment of the
Company’s anticipated performance and all information (historical, current and forecasted) that is reasonably available.
Contracts are often modified to account for changes in contract specifications and requirements. Contract
modifications are considered to exist when the modification either creates new or changes the existing enforceable rights and
obligations. Most of the Company’s contract modifications are for goods or services that are not distinct from the existing
contract due to the significant integration service provided in the context of the contract and are accounted for as if they were
part of that existing contract. The effect of a contract modification on the transaction price, and the measure of progress for the
performance obligation to which it relates, is recognized as an adjustment to revenue (either as an increase in or a reduction of
revenue) on a cumulative catch-up basis.
As a result of the EAC process, any quarterly adjustments to revenues, cost of sales, and the related impact to
operating income are recognized as necessary in the period they become known. These adjustments may result from positive
program performance, and may result in an increase in operating income during the performance of individual performance
obligations, if it is determined the Company will be successful in mitigating risks surrounding the technical, schedule and cost
aspects of those performance obligations or realizing related opportunities. Likewise, these adjustments may result in a
decrease in operating income if it is determined the Company will not be successful in mitigating these risks or realizing related
opportunities. Changes in estimates of net sales, cost of sales and the related impact to operating income are recognized
quarterly on a cumulative catch-up basis, which recognizes in the current period the cumulative effect of the changes on current
and prior periods. A significant change in one or more of these estimates could affect the profitability of one or more of the
Company’s contracts. When estimates of total costs to be incurred on a performance obligation exceed total estimates of
revenue to be earned, a provision for the entire loss on the performance obligation is recognized in the period the loss is
determined. No cumulative catch-up adjustment on any one contract was material to the Company’s consolidated financial
statements for the years ended December 29, 2019, December 30, 2018 and December 31, 2017. Likewise, total cumulative
catch-up adjustments were not material for the years ended December 29, 2019, December 30, 2018 and December 31, 2017.
As of December 29, 2019 and December 30, 2018, accrued expenses included the accrual for losses on contracts of $3.1
million and $5.1 million, respectively.
Contract Assets and Liabilities
For each of the Company’s contracts, the timing of revenue recognition, customer billings, and cash collections results
in a net contract asset or liability at the end of each reporting period. Fixed-price contracts are typically billed to the customer
either using progress payments, whereby amounts are billed monthly as costs are incurred or work is completed, or
performance based payments, which are based upon the achievement of specific, measurable events or accomplishments
F-12
defined and valued at contract inception. Cost-type contracts are typically billed to the customer on a monthly or semi-monthly
basis.
Contract assets consist of unbilled receivables, primarily related to long-term contracts where revenue recognized
under the cost-to-cost method exceeds amounts billed to customers. Unbilled receivables are classified as current assets and, in
accordance with industry practice, include amounts that may be billed and collected beyond one year due to the long term
nature of many of the Company’s contracts. Accumulated contract costs in unbilled receivables include direct production costs,
factory and engineering overhead, production tooling costs, and, for government contracts, recovery of allowable general and
administrative expenses. Unbilled receivables also include certain estimates of variable consideration described above. The
Company’s contracts that give rise to contract assets are not considered to include a significant financing component as the
payment terms are intended to protect the customer in the event the Company does not perform on its obligations under the
contract.
Contract liabilities include advance payments and billings in excess of revenue recognized. Certain customers make
advance payments prior to the satisfaction of the Company’s performance obligations on the contract. These amounts are
recorded as contract liabilities until such performance obligations are satisfied, either over time as costs are incurred or at a
point in time when deliveries are made. The Company’s contracts that give rise to contract liabilities do not include a
significant financing component as the underlying advance payments received are generally utilized to pay for contract costs
within a one-year period or are used to ensure the customer meets contractual requirements.
Net contract assets and liabilities are as follows (in millions):
Contract assets
Contract liabilities
Net contract assets
December 29, 2019 December 30, 2018
172.8
$
37.0
$
135.8
$
179.4
34.3
145.1
$
$
$
Net Change
$
$
$
6.6
(2.7)
9.3
Contract assets increased $6.6 million during the year ended December 29, 2019, primarily due to the recognition of
revenue related to the satisfaction or partial satisfaction of performance obligations during the year ended December 29,
2019 for which the Company has not yet billed the customers. There were no significant impairment losses related to any
receivables or contract assets arising from the Company’s contracts with customers during the year ended December 29, 2019.
Contract liabilities decreased $2.7 million during the year ended December 29, 2019, primarily due to revenue recognized in
excess of payments received on these performance obligations. For the years ended December 29, 2019 and December 30,
2018, the Company recognized revenue of $30.5 million and $35.5 million, respectively, that was previously included in the
beginning balance of contract liabilities.
In November 2019, a large training solutions program was terminated for convenience (“T for C”) by the customer.
Under a T for C, a contractor is entitled to seek specified costs through a termination settlement process including (1) the
contract price for completed supplies and services accepted by the government but not previously paid for; (2) the cost incurred
in the performance of work terminated plus a reasonable profit on those costs; and (3) its costs incurred in settling with
subcontractors and preparing and settling the termination proposal. Under a T for C, the Company would not be able to collect
the total withheld amounts until the settlement terms of the T for C have been negotiated and agreed to with the customer. At
December 29, 2019, approximately $11.5 million in unbilled receivables is outstanding on this project. In addition, the
Company is currently in dispute with an international customer in the US segment over approximately $10.0 million in unbilled
receivables outstanding as of December 29, 2019. The dispute concerns the completion of system requirements and contractual
milestones. Although there could be a delay in billing and collecting amounts due to the Company under the aforementioned
contracts, management has evaluated the present facts of the matters and performed a reassessment of the contractual amounts
due and have determined that no adjustment to previously recognized revenue, or the corresponding unbilled receivables, is
necessary at December 29, 2019.
F-13
Disaggregation of Revenue
The following series of tables presents the Company’s revenue disaggregated by several categories. For the majority
of contracts, revenue is recognized over time as work is performed on the contract. Revenue by contract type was as follows (in
millions):
Kratos Government Solutions
Fixed price
Cost plus fee
Time and materials
Total Kratos Government Solutions
Unmanned Systems
Fixed price
Cost plus fee
Time and materials
Total Unmanned Systems
Total Revenues
Revenue by customer was as follows (in millions):
Kratos Government Solutions
U.S. Government (1)
International (2)
U.S. Commercial and other customers
Total Kratos Government Solutions
Unmanned Systems
U.S. Government (1)
International (2)
U.S. Commercial and other customers
Total Unmanned Systems
Total Revenues
Year Ended
December 29,
2019
Year Ended
December 30,
2018
$
$
469.4
54.3
32.4
556.1
126.2
33.8
1.4
161.4
717.5
$
$
424.9
32.6
27.6
485.1
104.8
26.5
1.6
132.9
618.0
Year Ended
December 29,
2019
Year Ended
December 30,
2018
$
$
368.6
111.4
76.1
556.1
138.8
21.1
1.5
161.4
717.5
$
$
333.5
96.0
55.6
485.1
113.5
18.3
1.1
132.9
618.0
(1) Sales to the U.S. Government include sales 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. Each of the Company’s segments derives substantial revenue
from the U.S. Government. These sales include foreign military sales contracted through the U.S. Government.
(2)
International sales include sales 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 an international customer. These sales include direct sales with governments outside the U.S. and
commercial sales with customers outside the U.S.
For federal contracts, the Company follows U.S. Government procurement and accounting standards in assessing the
allowability and the allocability of costs to contracts. Recurring evaluations of contract cost, scheduling and technical matters
are performed by management. Costs incurred and allocated to contracts with the U.S. Government are scrutinized for
compliance with regulatory standards by the Company’s personnel, and are subject to audit by the Defense Contract Audit
Agency (“DCAA”).
From time to time, the Company may proceed with work based on customer direction prior to the completion and
signing of formal contract documents. The Company has a formal review process for approving any such work. Revenue
associated with such work is recognized only when the criteria to establish a contract under ASC 606 are met and the
obligations under the contract are legally enforceable. As of December 29, 2019 and December 30, 2018, approximately
F-14
$4.7 million and $3.8 million, respectively, of the Company’s unbilled accounts receivable balance were under an authorization
to proceed or work order from its customers where a formal purchase order had not yet been received.
(f)
Inventoried costs
Inventoried costs are stated at the lower of cost or estimated net realizable value. Cost is determined using the average
cost or first-in, first-out methods and the applicable method is applied consistently within an operating entity. The Company
capitalizes labor, material, subcontractor and overhead costs as work-in-process for contracts where control has not yet passed
to the customer. In addition, the Company capitalizes costs incurred to fulfill a contract in advance of contract award in
inventories as work-in-process if it is determined that contract award is probable. Pursuant to contract provisions of U.S.
Government contracts, such customers may have title to, or a security interest in inventories related to such contracts as a result
of advances, performance-based payments, and progress payments.
The Company regularly reviews inventory quantities on hand, future purchase commitments with its suppliers, and the
estimated utility of its inventory. If the Company’s review indicates a reduction in utility below carrying value, it reduces its
inventory to a new cost basis.
(g)
Research and Development
Costs incurred in research and development activities are expensed as incurred in accordance with FASB ASC Topic
730, Research and Development.
(h)
Income Taxes
The Company records deferred tax assets and liabilities for the future tax consequences attributable to differences
between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating
loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected to be realized. The effect on deferred tax assets
and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
The Company maintains a valuation allowance on the deferred tax assets for which it is more likely than not that the
Company will not realize the benefits of these tax assets in future tax periods. The valuation allowance is based on estimates of
future taxable income by tax jurisdiction in which the Company operates, the number of years over which the deferred tax
assets will be recoverable, and scheduled reversals of deferred tax liabilities.
In accordance with the recognition standards established by ASC Topic 740, Income Taxes, (“Topic 740”), the
Company makes a comprehensive review of its portfolio of uncertain tax positions regularly. In this regard, an uncertain tax
position represents the Company’s expected treatment of a tax position taken in a filed tax return, or planned to be taken in a
future tax return or claim, which has not been reflected in measuring income tax expense for financial reporting purposes. Until
these positions are sustained by the taxing authorities, the Company has not recognized the tax benefits resulting from such
positions and reports the tax effects as a liability for uncertain tax positions in its consolidated balance sheets.
(i)
Stock-Based Compensation
The Company accounts for stock-based compensation in accordance with ASC Topic 718, Compensation-Stock
Compensation. All of the Company’s stock-based compensation plans are considered equity plans under Topic 718, and
compensation expense recognized is net of estimated forfeitures over the vesting period. The Company issues stock options and
stock awards under its existing plans. The fair value of stock options is estimated on the date of grant using a Black-Scholes
option-pricing model or a trinomial lattice options pricing model and is expensed on a straight-line basis over the remaining
vesting period of the options, which is generally six or less years. The fair value of stock awards is determined based on the
closing market price of the Company’s common stock on the grant date and is adjusted at each reporting date based on the
amount of shares ultimately expected to vest. Compensation expense for stock awards is expensed over the vesting period,
usually five to ten years. Compensation expense for stock issued under the Company’s employee stock purchase plan is
estimated at the beginning date of the offering period using a Black-Scholes option-pricing model and is expensed on a
straight-line basis over the period of the offering, which is generally six months.
When tax deductions from stock options and awards are greater than the cumulative book compensation expense, the
tax effect of the resulting difference is a windfall. For the year ended December 29, 2019, an income tax benefit of $2.1 million
F-15
was recorded for windfalls generated from stock options and awards exercised in 2019. For the tax years ended December 30,
2018 and December 31, 2017, there were no incremental tax benefits from stock options exercised in the periods.
The following table shows the amounts recognized in the consolidated financial statements for stock-based
compensation expense related to stock options, stock awards and stock offered under the Company’s employee stock purchase
plan (in millions, except per share amounts).
Selling, general and administrative expenses
Total cost of employee stock-based compensation included in operating
income (loss) from continuing operations
(j)
Allowance for Doubtful Accounts
Year ended
December 29,
2019
Year ended
December 30,
2018
Year ended
December 31,
2017
$
$
11.0
11.0
$
$
7.2
7.2
$
$
7.8
7.8
The Company maintains an allowance for doubtful accounts for estimated losses resulting from the inability of its
customers to make required payments, which results in bad debt expense. Management determines the adequacy of this
allowance by periodically evaluating the comprehensive risk profiles of all individual customer receivable balances including,
but not limited to, the customer’s financial condition, credit agency reports, financial statements and overall current economic
conditions. Additionally, on certain contracts whereby the Company performs services for a prime/general contractor, a
specified percentage of the invoiced trade accounts receivable may be retained by the customer until the project is completed.
The Company periodically reviews all retainages for collectability and records allowances for doubtful accounts when deemed
appropriate, based on its assessment of the associated credit risks. Changes to estimates of contract value are recorded as
adjustments to revenue and not as a component of the allowance for doubtful accounts. Individual accounts receivable are
written off to the allowance for doubtful accounts when the Company becomes aware of a specific customer’s inability to meet
its financial obligation, and all collection efforts are exhausted.
The following table outlines the balance of the Company’s allowance for doubtful accounts for 2019, 2018 and 2017.
The table identifies the additional provisions each year as well as the write-offs that utilized the allowance (in millions).
Allowance for Doubtful Accounts
Year ended December 31, 2017
Year ended December 30, 2018
Year ended December 29, 2019
(k)
Cash and Cash Equivalents
Balance at
Beginning of
Year
Provisions
Write-offs/
Recoveries
Balance at End
of Year
$
$
$
1.5
0.5
2.3
$
$
$
— $
$
1.8
(0.2) $
(1.0) $
— $
(0.2) $
0.5
2.3
1.9
The Company’s cash equivalents consist of its highly liquid investments with an original maturity of three months or
less when purchased by the Company.
The Company had no restricted cash accounts at December 29, 2019 and approximately $0.3 million at December 30,
2018. As of December 30, 2018, restricted cash consisted primarily of a deposit securing foreign letters of credit related to
payment and performance bonds on international contracts.
(l)
Property and Equipment, Net
Property and equipment, net owned by the Company is depreciated over the estimated useful lives of individual assets.
Equipment acquired under capital leases are amortized over the shorter of the lease term or the estimated useful life of the
asset. Improvements, which significantly improve and extend the useful life of an asset, are capitalized and depreciated over the
shorter of the lease period or the estimated useful life. Expenditures for maintenance and repairs are charged to operations as
incurred.
F-16
Assets are depreciated predominately using the straight-line method, with the following lives:
Buildings and improvements
Machinery and equipment
Computer equipment and software
Vehicles, furniture, and office equipment
Leasehold improvements
(m)
Leases
Years
15 – 39
3 – 10
1 – 10
5
Shorter of useful life
or length of lease
In February 2016, the FASB issued ASU 2016-02 (“ASU 2016-02”), Leases, also referred to as “ASC 842”. ASC 842
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. In July 2018,
the FASB issued ASU 2018-11, Leases; Targeted Improvements, which, among other things, allowed the Company to elect an
optional transition method that applies the new lease requirements through a cumulative-effect adjustment in the period of
adoption. The Company adopted ASC 842 on December 31, 2018 using the optional transition method, and, as a result, did not
recast prior period comparative financial statements. All prior period amounts and disclosures are presented under Accounting
Standards Codification Topic 840, Leases (“ASC 840”).
The Company has elected the package of practical expedients, which, among other things, allows carry-forward of
prior lease classifications under the prior standard. However, the Company has not elected to adopt the hindsight practical
expedient and is therefore maintaining the lease terms previously determined under the prior lease standard. For all new and
modified leases after adoption of ASC 842, the Company has taken the component election allowing the Company to account
for lease components together with non-lease components in the calculation of the lease asset and corresponding liability.
Adoption of the new standard resulted in the recording of additional lease assets and lease liabilities on the consolidated
balance sheet. No cumulative-effect adjustment was recognized as the amount was not material, and the impact on the
Company’s results of operations and cash flows was also not material.
The Company leases certain facilities, office space, vehicles and equipment. Lease assets and lease liabilities are
recognized at the commencement of an arrangement where it is determined at inception that a lease exists. Lease assets
represent the right to use an underlying asset for the lease term, and lease liabilities represent the obligation to make lease
payments arising from the lease. These assets and liabilities are initially recognized based on the present value of lease
payments over the lease term calculated using an incremental borrowing rate generally applicable to the location of the lease
asset, unless the implicit rate is readily determinable. Lease assets also include any upfront lease payments made and exclude
lease incentives. Lease terms include options to extend or terminate the lease when it is reasonably certain that those options
will be exercised. The Company has operating lease arrangements with lease and non-lease components. The non-lease
components in these arrangements are not significant when compared to the lease components. For all operating leases, the
Company accounts for the lease and non-lease components as a single component.
Variable lease payments are generally expensed as incurred. Leases with an initial term of 12 months or less are not
recorded on the balance sheet, and the expense for these short-term leases is recognized on a straight-line basis over the lease
term.
The depreciable life of lease assets and leasehold improvements is limited by the expected lease term, unless there is a
transfer of title or purchase option reasonably certain of exercise.
See Note 6 for additional disclosures related to the Company’s lease obligations.
(n)
Goodwill and Other Intangible Assets, Net
In accordance with the provisions of ASC Topic 350, Intangibles-Goodwill and Other (“Topic 350”), the Company
performs impairment tests for goodwill and indefinite lived intangibles as of the last day of its fiscal October, or when evidence
of potential impairment exists. When it is determined that impairment has occurred, a charge to operations is recorded.
Goodwill and other purchased intangible asset balances are included in the identifiable assets of the operating segment to which
F-17
they have been assigned. Any goodwill impairment, as well as the amortization of other purchased intangible assets, is charged
against the respective segments’ operating income.
In accordance with Topic 350, the Company classifies intangible assets into two categories: (1) intangible assets with
finite lives subject to amortization and (2) intangible assets with indefinite lives not subject to amortization. Separately, the
Company tests intangible assets with finite lives for impairment if conditions exist that indicate the carrying value may not be
recoverable. Such conditions may include an economic downturn in a geographic market or a change in the assessment of
future operations. The Company records an impairment charge when the carrying value of the finite lived intangible asset is not
recoverable by the cash flows generated from the use of the asset.
The Company determines the useful lives of identifiable intangible assets after considering the specific facts and
circumstances related to each intangible asset. Factors considered when determining useful lives include the contractual term of
any agreement, the history of the asset, the Company’s long-term strategy for the use of the asset, any laws or other local
regulations which could impact the useful life of the asset, and other economic factors, including competition and specific
market conditions. Intangible assets that are deemed to have finite lives are amortized, generally on a straight-line basis, over
their useful lives, ranging from one to 15 years.
(o)
Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of
Long-lived assets are reviewed for impairment in accordance with ASC Topic 360, Property, Plant, and Equipment,
whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.
Recoverability of assets to be held and used is measured by a comparison of the carrying amount of the assets to future net cash
flows (undiscounted and without interest) expected to be generated by the asset. If such assets are considered to be impaired,
the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value
of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.
(p)
Fair Value of Financial Instruments
ASC Topic 825, Financial Instruments, requires that fair values be disclosed for the Company’s financial instruments.
The carrying amounts of cash equivalents, accounts receivable, accounts payable, accrued expenses, billings in excess of costs
and earnings on uncompleted contracts, and income taxes payable, approximate fair value due to the short-term nature of these
instruments. The fair value of the Company’s long-term debt is based upon quoted market prices.
(q)
Concentrations and Uncertainties
The Company maintains cash balances at various financial institutions and such balances commonly exceed the
$250,000 insured amount by the Federal Deposit Insurance Corporation. The Company has not experienced any losses in such
accounts and management believes that the Company is not exposed to any significant credit risk with respect to such cash and
cash equivalents.
Financial instruments, which subject the Company to potential concentrations of credit risk, consist principally of the
Company’s billed and unbilled accounts receivable. The Company’s accounts receivable result from sales to customers within
the U.S. Government, state and local agencies and with commercial customers in various industries. The Company performs
ongoing credit evaluations of its commercial customers. Credit is extended based on evaluation of the customer’s financial
condition and collateral is not required. Accounts receivable are recorded at the invoiced amount and do not bear interest. See
Note 13 for a discussion of the Company’s significant customers.
(r)
Debt Issuance Costs
Fees paid to obtain debt financing and revolving credit facilities or amendments under such debt financing and
revolving credit facilities are treated as debt issuance costs and are capitalized and amortized over the expected term of the
related debt or revolving credit facility and are shown as a financing activity in the consolidated statements of cash flows.
Issuance costs related to debt are presented in the consolidated balance sheets as a direct deduction from the carrying amount of
the associated debt liability. Issuance costs related to a revolving credit facility are included in other assets in the consolidated
balance sheets.
F-18
(s)
Interest Expense, Net
Interest expense, net is summarized in the following table (in millions):
Interest expense incurred primarily on the Senior Secured Notes
Miscellaneous interest income
Interest expense, net
(t)
Foreign Currency
Year ended
December 29,
2019
Year ended
December 30,
2018
Year ended
December 31,
2017
$
$
(23.5) $
1.9
(21.6) $
(21.6) $
0.8
(20.8) $
(29.1)
0.5
(28.6)
For operations outside the U.S. that prepare financial statements in currencies other than the U.S. dollar, results of
operations and cash flows are translated at average exchange rates during the period, and assets and liabilities are generally
translated at end-of-period exchange rates. Translation adjustments are included as a separate component of accumulated other
comprehensive loss.
The Company transacts with foreign customers in currencies other than the U.S. dollar. It experiences realized and
unrealized foreign currency gains or losses on foreign denominated receivables. In addition, certain intercompany transactions
give rise to realized and unrealized foreign currency gains or losses. Also, any other transactions between the Company or its
subsidiaries and a third-party, denominated in a currency different from the functional currency, are foreign currency
transactions.
The aggregate foreign currency transaction gain (loss) included in determining net income (loss) for the years ended
December 29, 2019, December 30, 2018, and December 31, 2017 was approximately $(1.1) million, $(1.1) million, and $0.4
million, respectively, which is included in other income (expense), net on the accompanying consolidated statements of
operations and comprehensive loss.
(u)
Recent Accounting Pronouncements
In June 2016, the FASB issued ASU 2016-13 (“ASU 2016-13”), Financial Instruments-Credit Losses (Topic 326):
Measurement of Credit Losses on Financial Instruments. The main objective of this update is to provide financial statement
users with more decision-useful information about the expected credit losses on financial instruments and other commitments
to extend credit held by a reporting entity at each reporting date. To achieve this objective, the amendments in this update
replace the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and
requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. ASU
2016-13 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The
Company has adopted ASU 2016-13 effective December 30, 2019. The implementation of this guidance did not have a material
impact on its consolidated financial statements.
Note 2.
Acquisition
On February 27, 2019, the Company acquired 80.1% of the issued and outstanding shares of capital stock of Florida
Turbine Technologies Inc., a Florida corporation (“FTT Inc.”), and 80.1% of the membership interests in FTT CORE, LLC, a
Delaware limited liability company (“FTT Core” and, together with FTT Inc. and their respective subsidiaries, “FTT”), for an
aggregate purchase price of approximately $60 million. The purchase price was $33 million in cash, with approximately $17.7
million paid at close and approximately $15.3 million to be paid over a three-year period, subject to adjustments for transaction
expenses, indebtedness, cash on hand, certain amounts payable or potentially payable to employees of FTT and post-closing
working capital adjustments, and 1,825,406 shares of common stock (with a value of approximately $27 million).
FTT is a leading turbomachinery design and manufacturing company specializing in engineering, development, and
testing of gas turbines, propulsion components, engine and other systems for military and commercial applications. FTT is now
the KTT Division, which is focused on the development and production of small, affordable, high-performance jet engines for
the next generation of tactical weapon systems and tactical jet UAS. The KTT Division is included in the KGS segment.
F-19
The excess of the purchase price over the fair value of the tangible and identifiable intangible assets acquired and
liabilities assumed in the acquisition was allocated to goodwill. The goodwill represents the value the Company expects to be
created by enabling it to accelerate FTT’s small engine development programs, and facilitate integration of these leading-edge
engine solutions with evolving Kratos tactical systems.
Simultaneously with the execution of the Purchase Agreement among the Company and the Sellers (as defined in such
agreement) (the “Purchase Agreement”) and completion of the acquisition, the Company, FTT Inc., FTT Core and the Sellers
entered into an exchange agreement (the “Exchange Agreement”) pursuant to which, among other things, (i) FTT Core was
converted into a Delaware corporation, (ii) beginning in January 2024, the Holders (as defined in the Exchange Agreement)
will have an annual right (the “Put Right”) to sell all of the minority interests in FTT Inc. and FTT Core (the “Minority
Interests”) to the Company at a purchase price based on a specified multiple of the trailing 12 months EBITDA of FTT Inc.,
FTT Core and each of their respective subsidiaries (the “Acquired Companies”) as set forth in the Exchange Agreement (the
“Minority Interest Purchase Price”) (provided, however, that following certain events, including a change of control, the Put
Right will be accelerated and the Minority Interest Purchase Price will be a specified increased multiple of of the trailing 12
months EBITDA of the Acquired Companies as set forth in th Exchange Agreement), and (iii) beginning in January 2025, the
Company will have an annual right to purchase all of the Minority Interests from the Holders at the Minority Interest Purchase
Price.
The transaction has been accounted for using the acquisition method of accounting, which requires, among other
things, that the assets acquired, the liabilities assumed, and the noncontrolling interest be recognized at their fair values as of
the acquisition date. The fair value measurements are based primarily on significant inputs not observable in the marketplace
and thus represent Level 3 measurements. The following table summarizes the allocation of the purchase price over the
estimated fair values of the major assets acquired, liabilities assumed, and noncontrolling interest (in millions):
Accounts receivable
Unbilled receivables
Inventoried costs
Other current assets
Property and equipment
Intangible assets
Goodwill
Total identifiable net assets acquired
Total identifiable net liabilities assumed
Net assets before noncontrolling interest
Noncontrolling interest
Net assets acquired, excluding cash
$
$
8.1
4.9
7.8
2.1
5.7
30.8
23.0
82.4
(7.5)
74.9
(14.9)
60.0
As of February 27, 2019, net liabilities include $7.5 million of current liabilities. There was no contingent purchase
consideration associated with the acquisition of an 80.1% majority interest in FTT. The identifiable intangible assets include
customer relationships of $19.7 million with a useful life of 13 years, in-process research and development of $8.5 million that
will commence amortization at the completion of the development project, backlog of $2.1 million with a useful life of 2 years,
and trade name of $0.5 million with a useful life of 2 years. The Company also established a deferred tax liability of $7.0
million for the increase in the financial statement basis of the acquired assets of FTT and a corresponding increase in goodwill.
The goodwill recorded in this transaction is not expected to be tax-deductible.
The value of customer relationships was estimated using the multi-period excess earnings method (“MPEEM”), an
income approach (Level 3), which converts projected revenues and costs into cash flows. To reflect the fact that certain other
assets contribute to the cash flows generated, the returns for these contributory assets were removed to arrive at estimated cash
flows solely attributable to the acquired customer relationships, which were discounted at a rate of 12.5% to determine the fair
value. The value of backlog was also valued using MPEEM. The value of in-process research and development was estimated
using the relief-from-royalty method, an income approach (Level 3), which estimates the cost savings that accrue to the owner
of the intangible asset that would otherwise be payable as royalties or license fees on revenues earned through the use of the
asset. A royalty rate was applied to the projected revenues associated with the intangible asset to determine the amount of
savings, which was at a rate of 10% to determine the fair value.
F-20
The amounts of revenue and operating loss of FTT included in the Company's consolidated statement of operations for
the year ended December 29, 2019 are $52.5 million and $0.7 million, respectively. Included in the merger and acquisition
expenses for the year ended December 29, 2019 are transaction expenses of $1.4 million related to the acquisition of FTT.
A summary of the consideration paid for the acquired ownership in FTT is as follow:
Cash paid
Deferred purchase consideration
Common stock issued
Less: Cash acquired
Total consideration
$
$
20.7
15.3
27.0
63.0
(3.0)
60.0
Pro Forma Financial Information (Unaudited)
The following table summarizes the supplemental condensed consolidated statement of operations information on an
unaudited pro forma basis as if the acquisition of FTT occurred on December 31, 2018 and includes adjustments that were
directly attributable to the foregoing transactions. There are no material, nonrecurring pro forma adjustments directly
attributable to the business combination included in the reported pro forma revenue and earnings. The pro forma results are for
illustrative purposes only for the applicable period and do not purport to be indicative of the actual results that would have
occurred had the transaction been completed as of the beginning of the period, nor are they indicative of results of operations
that may occur in the future:
For the year ended December 29, 2019 (all amounts, except per share amounts, are in millions):
Pro forma revenues
Pro forma net income before tax
Pro forma net income
Pro forma net income attributable to Kratos
Basic pro forma income per share attributable to Kratos
Diluted pro forma income per share attributable to Kratos
$
$
$
$
$
$
725.6
14.8
11.7
11.8
0.11
0.11
The weighted average common shares used to calculate income per share also reflects the issuance of 1,825,406 shares
of our common stock in conjunction with the acquisition.
Note 3.
Goodwill and Other Intangible Assets
(a)
Goodwill
The Company performs its annual impairment test for goodwill in accordance with Topic 350 as of the last day of its
fiscal October or when evidence of potential impairment exists.
The Company assesses goodwill for impairment at the reporting unit level, which is defined as an operating segment
or one level below an operating segment, referred to as a component. The Company determines its reporting units by first
identifying its operating segments, and then assessing whether any components of these segments constitute a business for
which discrete financial information is available and where segment management regularly reviews the operating results of that
component. The Company aggregates components within an operating segment that have similar economic characteristics.
The KGS reportable segment has five operating segments: Defense Rocket Support Services (“DRSS”), Microwave
Electronics (“ME”), Space, Training and Cybersecurity Solutions (ST&C), Modular Systems (“MS”), and Kratos Turbine
Technologies (“KTT”). All of the KGS operating segments provide technology based defense solutions, involving products and
services, primarily for mission critical U.S. national security priorities, with the primary focus relating to the nation’s
Command, Control, Communications, Computing, Combat Systems, Intelligence, Surveillance and Reconnaissance
F-21
requirements. The US reportable segment consists of its unmanned aerial system, unmanned ground, and unmanned seaborne
system products.
The Company identified its reporting units to be the DRSS, ME, ST&C, MS, KTT and US operating segments. The
Company tests goodwill for impairment by performing a qualitative assessment or using a two-step impairment process. If the
Company chooses to perform a qualitative assessment and determines it is not more likely than not that the fair value of the
reporting unit exceeds its carrying value, the two-step impairment process is then performed. For operations where the two-step
process is used, the identification and measurement of impairment involves the estimation of the fair value of reporting units. If
the fair value is determined to be less than the carrying value, a second step is performed to determine the amount of the
impairment. When any impairment has occurred, a charge to operations is recorded. In order to test for potential impairment,
the Company estimates the fair value of each of the reporting units based on a comparison and weighting of the income
approach, specifically the discounted cash flow method and the market approach, which estimates the fair value of the
reporting units based upon comparable market prices and recent transactions and also validates the reasonableness of the
implied multiples from the income approach.
In determining the fair value for the reporting units, where the two-step process is used, there are key assumptions
relating to future expected cash flows, terminal growth rates, appropriate discount rates, market multiples, and the control
premium a controlling shareholder could be expected to pay.
During the fourth quarter of 2017, as a result of the Company’s annual impairment test of the carrying value of its goodwill
balances, the Company recorded an impairment charge of $24.2 million of the carrying value of the goodwill of its DRSS business
reported in its KGS segment, which majority of business and revenue at the time included the Company’s legacy government
services business. In 2010, the Company changed its strategy to focus on being a system, product, technology and intellectual
property based company and deemphasized its legacy government services businesses which are no longer considered a core
business. Over the past several years, similar to other businesses operating in the federal government technical services space, this
business has been adversely impacted by competitive pressures and commoditization resulting from lower priced technically
acceptable awards rather than awards based on best value or that are technologically or performance differentiated. Specifically,
the Company lost two sizable five-year contract opportunities where Kratos was underbid on cost, which significantly impacted
the expected future financial performance of this business. There was no impairment recognized for the years ended December 29,
2019 and December 30, 2018.
The carrying amounts of goodwill as of December 29, 2019 and December 30, 2018 by reportable segment are as follows (in
millions):
Gross value
Less accumulated impairment
Net
Gross value
Less accumulated impairment
Net
As of December 29, 2019
US
KGS
Total
111.1
13.8
97.3
$
$
597.8
239.5
358.3
$
$
708.9
253.3
455.6
As of December 30, 2018
US
KGS
Total
111.1
13.8
97.3
$
$
567.9
239.5
328.4
$
$
679.0
253.3
425.7
$
$
$
$
F-22
(b)
Purchased Intangible Assets
The following table sets forth information for acquired finite-lived and indefinite-lived intangible assets (in millions):
As of December 29, 2019
As of December 30, 2018
Gross
Value
Accumulated
Amortization
Net
Value
Gross
Value
Accumulated
Amortization
Net
Value
Acquired finite-lived intangible assets:
Customer relationships
Contracts and backlog
Developed technology and technical
know-how
Trade names
In-process research and development
Total finite-lived intangible assets
Indefinite-lived trade names
Total intangible assets
$
$
72.3
32.0
25.0
1.9
8.5
139.7
6.9
146.6
$
(53.3) $
(28.4)
(23.8)
(1.6)
—
(107.1)
—
(107.1) $
$
19.0
$
3.6
1.2
0.3
8.5
32.6
6.9
39.5
$
52.6
29.9
25.0
1.4
—
108.9
6.9
115.8
$
(50.6) $
(26.4)
(21.3)
(1.4)
—
(99.7)
—
(99.7) $
$
2.0
3.5
3.7
—
—
9.2
6.9
16.1
The aggregate amortization expense for finite-lived intangible assets was $7.4 million, $5.9 million and $10.4 million,
for the years ended December 29, 2019, December 30, 2018, and December 31, 2017, respectively. The Company records all
amortization expense in selling, general and administrative expenses.
The estimated future amortization expense of acquired intangible assets with finite lives as of December 29, 2019 is as
follows (in millions):
Fiscal Year
2020
2021
2022
2023
2024
Thereafter
Total
Amount
5.8
3.7
2.4
2.4
2.4
15.9
32.6
$
Note 4.
Balance Sheet Details
The detail of certain assets in the consolidated balance sheets consists of the following:
Cash and cash equivalents
The Company’s cash equivalents consist of overnight cash sweep accounts that are invested on a daily basis. Cash and
cash equivalents at December 29, 2019 and December 30, 2018 were $172.6 million and $182.7 million, respectively, and
approximated their fair value.
F-23
Accounts receivable, net and Unbilled Receivables, net
Receivables including amounts due under long-term contracts are summarized as follows (in millions):
Billed, current
Unbilled, current
Total current accounts receivable
Allowance for doubtful accounts
Total accounts receivable and unbilled receivables, net
December 29,
2019
December 30,
2018
$
$
86.6
179.7
266.3
(1.9)
264.4
$
$
66.5
173.2
239.7
(2.3)
237.4
Substantially all accounts receivable at December 29, 2019, are expected to be collected in 2020. The Company does
not believe it has significant exposure to credit risk, as accounts receivable and the related unbilled amounts are primarily from
contracts associated with the U.S. Government.
U.S. Government contract receivables where the Company is the prime contractor included in accounts receivable, net (in
millions):
Billed
Unbilled
Total U.S. Government contract receivables
Inventoried costs, net of progress payments (in
millions):
Raw materials
Work in process
Finished goods
Total inventoried costs
Property, plant and equipment, net (in millions)
Finance lease right of use assets
Land and buildings
Computer equipment and software
Machinery and equipment
Furniture and office equipment
Leasehold improvements
Construction in progress
Property and equipment
Accumulated depreciation and amortization
Total property and equipment, net
December 29,
2019
December 30,
2018
$
$
16.6
86.4
103.0
$
$
16.5
83.1
99.6
December 29,
2019
December 30,
2018
$
$
$
39.1
20.3
1.7
61.1
$
34.7
10.3
1.8
46.8
December 29,
2019
December 30,
2018
$
$
$
39.6
12.2
32.7
78.7
7.1
12.3
16.0
198.6
(81.7)
116.9
$
$
$
—
11.9
28.3
56.8
6.3
10.9
21.5
135.7
(68.6)
67.1
Depreciation expense was $16.0 million, $12.0 million and $11.8 million for the years ended December 29, 2019,
December 30, 2018, and December 31, 2017, respectively.
F-24
Note 5.
Debt
(a)
Issuance of 6.5% Senior Secured Notes due 2025
In November 2017, the Company issued and sold $300 million aggregate principal amount of 6.5% Senior Secured Notes
due 2025 (the “6.5% Notes”) in a private placement conducted pursuant to Rule 144A and Regulation S under the Securities Act
of 1933, as amended (the “Act”). The Company incurred debt issuance costs of $6.6 million associated with the new 6.5% Notes.
The Company utilized the net proceeds from the sale of the 6.5% Notes, as well as cash from its recent equity offering to extinguish
the previously outstanding 7.00% Senior Secured Notes due 2019 (the “7% Notes”). The total reacquisition price of the 7% Notes
was $385.2 million, including a $12.0 million call premium, and $0.3 million of accrued interest.
The 6.5% Notes are governed by the Indenture, dated as of November 20, 2017 (the “Indenture”), among the Company,
the Company’s existing and future domestic subsidiaries parties thereto (the “Subsidiary Guarantors”) and Wilmington Trust,
National Association, as trustee and collateral agent (in such capacity, the “2017 Trustee and Collateral Agent”). A Subsidiary
Guarantor can be released from its guarantee if (a) 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) the Company designates such Subsidiary
Guarantor as an Unrestricted Subsidiary; (c) 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 6.5% Notes.
The 6.5% Notes bear interest at a rate of 6.5% per year from the date of original issuance or from the most recent payment
date on which interest has been paid or provided for. Interest on the 6.5% Notes is payable in arrears on May 30 and November
30 of each year, beginning on May 30, 2018. The 6.5% Notes are fully and unconditionally guaranteed by the Subsidiary Guarantors.
The 6.5% Notes and the guarantees (as set forth in the Indenture, the “Guarantees”) are the Company’s senior secured
obligations and are equal in right of payment with all other senior obligations of the Subsidiary Guarantors’ existing and future
secured debt to the extent of the assets securing that secured debt. The Company’s obligations under the 6.5% Notes are secured
by 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 6.5% Notes have a second priority lien, junior to the lien securing the Company’s
obligations under the Credit Agreement.
The 6.5% Notes will be redeemable, in whole or in part, at any time on or after November 30, 2020 at the respective
redemption prices specified in the Indenture. In addition, the Company may redeem up to 40% of the 6.5% Notes before November
30, 2020 with the net proceeds of certain equity offerings. The Company may also redeem some or all of the 6.5% Notes before
November 30, 2020 at a redemption price of 100% of the principal amount thereof plus accrued and unpaid interest, to, but
excluding, the redemption date, if any, plus a “make whole” premium. In addition, during each 12-month period commencing on
the issue date and ending on or prior to November 30, 2020, the Company may redeem up to 10% of the original aggregate principal
amount of the 6.5% Notes issued under the Indenture at a redemption price of 103.000% of the principal amount thereof, plus
accrued and unpaid interest, to, but excluding, the date of redemption, if any. The Company may also be required to make an offer
to purchase the 6.5% Notes upon a change of control and certain sales of its assets.
The Indenture contains covenants limiting, among other things, the Company’s ability and the Subsidiary Guarantors’
ability to: (a) pay dividends on or make distributions or repurchase or redeem the Company’s capital stock or make other restricted
payments; (b) incur additional debt and guarantee debt; (c) prepay, redeem or repurchase certain debt; (d) issue certain preferred
stock or similar equity securities; (e) make loans and investments; (f) sell assets; (g) incur liens; (h) consolidate, merge, sell or
otherwise dispose of all or substantially all of the Company’s assets; (i) enter into transactions with affiliates; and (j) enter into
agreements restricting the Company’s ability and certain of its subsidiaries’ ability to pay dividends. These covenants are subject
to a number of exceptions. As of December 29, 2019, the Company was in compliance with the covenants contained in the Indenture
governing the 6.5% Notes.
The terms of the Indenture require that the net cash proceeds from asset dispositions be either utilized to (i) repay or
prepay amounts outstanding under the Credit Agreement unless such amounts are reinvested in similar collateral, (ii)
permanently reduce other indebtedness, (iii) make an investment in assets that replace the collateral of the 6.5% Notes or (iii) a
combination of (i), (ii) and (iii). To the extent there are any remaining net proceeds from the asset disposition after application
of (i), (ii) and (iii), such amounts are required to be utilized to repurchase 6.5% Notes at par.
F-25
The Indenture also provides for events of default which, if any of them occurs, would permit or require the principal,
premium, if any, interest, if any, and any other monetary obligations on all the then-outstanding 6.5% Notes to become or to be
declared due and payable immediately.
(b)
Other Indebtedness
Credit and Security Agreement
On May 14, 2014, the Company entered into a $110.0 million Credit and Security Agreement, dated May 14, 2014 (as
amended from time to time, 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 a first priority
lien on the Company’s accounts receivable, inventory, deposit accounts, securities accounts, cash, securities and general
intangibles (other than intellectual property). The obligations under the Credit Agreement are secured by a second priority lien,
junior to the lien securing the Notes, on all of the Company’s other assets.
On November 20, 2017, the Company entered into an amended and restated Credit Agreement with the lenders from
time to time party thereto, 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. As amended and restated, the Credit
Agreement establishes a five year senior secured revolving credit facility in the aggregate principal amount of $90.0 million
(subject to a potential increase of the aggregate principal amount to $115.0 million, subject to SunTrust’s and applicable
lenders’ approval), 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.
Borrowings under the revolving credit facility may take the form of a base rate revolving loan, Eurodollar revolving
loan or 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 (as defined in the Credit Agreement) 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 LIBOR Rate (as defined in the Credit Agreement) determined at such time for an interest period of one month, plus
1.00% per annum. Eurodollar revolving loans will bear interest a rate per annum equal to the sum of the Applicable Margin
from time to time in effect plus the Adjusted LIBOR Rate. The Applicable Margin varies between 1.00%-1.50% for base rate
revolving loans and swingline loans and 2.00%-2.50% for Eurodollar loans, and is based on several factors including the
Company’s then-existing borrowing base and the lenders’ 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 amounts due and owing under billed and unbilled accounts receivables, then held eligible raw materials inventory,
work-in-process inventory, and applicable reserves.
The measurement of a minimum fixed charge coverage ratio is required to be measured if Excess Availability, as
defined in the Credit Agreement, is less than fifty percent of the lesser of the Borrowing Base or the Total Commitment
Amount, each as defined in the Credit Agreement.
As of December 29, 2019 and December 30, 2018, there were no borrowings outstanding on the Credit Agreement;
there was $5.4 million outstanding on letters of credit, resulting in net borrowing base availability of $69.3 million as of
December 29, 2019. The Company was in compliance with the financial covenants of the Credit Agreement as of December 29,
2019.
F-26
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 December 29, 2019 and December 30, 2018 are presented in the following table:
$ in millions
Long-term debt
As of December 29, 2019
As of December 30, 2018
Principal
Carrying
Amount
Fair Value
Principal
Carrying
Amount
Fair Value
$
300.0
$
295.1
$
322.1
$
300.0
$
294.2
$
305.3
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 December 29, 2019, the difference between the carrying amount of $295.1 million and the principal amount of
$300.0 million presented in the previous table, is the unamortized debt issuance costs of $4.9 million, which are being accreted
to interest expense over the term of the related debt. As of December 30, 2018, the difference between the carrying amount of
$294.2 million and the principal amount of $300.0 million presented in the above table also related to the same unamortized
debt issuance costs of $5.8 million.
Future maturity of long-term debt is $300.0 million in 2025.
Note 6.
Leases
As a result of a lease modification for its expanded facilities in Colorado, in the first quarter of 2019, the Company
was required to reassess the classification of the lease which previously had been accounted for as an operating lease. This
reassessment resulted in the reclassification of the operating lease to a $39.3 million finance lease.
The components of lease expense for the year ended December 29, 2019 were as follows (in millions):
Amortization of right of use assets - finance leases
Interest expense on lease liabilities - finance leases
Operating lease cost (expense resulting from amortization of total lease payments)
Short-term lease cost
Variable lease cost (cost excluded from lease payments)
Sublease income
Total lease cost
The components of leases on the balance sheet were as follows (in millions):
Operating Leases:
Operating lease right-of-use assets
Current portion of operating lease liabilities
Operating lease liabilities, net of current portion
Finance leases:
Property, plant and equipment, net
Other current liabilities
Other long-term liabilities
$
$
$
$
$
$
$
$
2.0
2.5
13.2
0.6
0.1
(3.3)
15.1
December 29,
2019
42.1
9.9
37.6
38.1
0.6
38.4
F-27
Cash paid for amounts included in the measurement of lease liabilities for the year ended December 29, 2019 was as
follows (in millions):
Finance lease - cash paid for interest
Finance lease - financing cash flows
Operating lease - operating cash flows (fixed payments)
Other supplemental noncash information (in millions):
Operating lease liabilities arising from obtaining right-of-use assets, including impact of ASC 842 adoption
Finance lease liabilities arising from obtaining right-of-use assets, including impact of ASC 842 adoption
$
$
$
$
$
2.5
0.5
14.8
59.3
39.6
5.77
18.91
6.50%
6.52%
Operating Leases
Finance Leases
$
$
12.6
10.0
8.6
8.2
6.2
11.6
57.2
(9.6)
47.6
$
$
3.1
3.2
3.3
3.3
3.3
54.0
70.2
(31.2)
39.0
Weighted-average remaining lease term (in years):
Operating leases
Finance leases
Weighted-average discount rate:
Operating leases
Finance leases
The maturity of lease liabilities is (in millions):
2020
2021
2022
2023
2024
Thereafter
Total lease payments
Less: imputed interest
Total present value of lease liabilities
Rental expense for operating leases classified under ASC 840 for the years ended December 30, 2018, and
December 31, 2017 was $23.7 million, and $18.6 million, respectively. Total sublease income for the years ended
December 30, 2018, and December 31, 2017, totaling $3.3 million, and $3.4 million, respectively, has been netted against rent
expense.
As of December 30, 2018, future minimum lease payments under ASC 840 for operating leases, which does not
include $4.3 million in sublease income on the Company’s operating leases, were as follows (in millions):
Year
2019
2020
2021
2022
2023
Thereafter
Total minimum lease payments
F-28
Operating
Leases
16.5
12.0
9.6
8.1
7.9
63.1
117.2
$
$
Note 7.
Net Income (Loss) Per Common Share
The Company calculates net income (loss) per share in accordance with FASB ASC Topic 260, Earnings per Share
(“Topic 260”). Under Topic 260, basic net income (loss) per common share is calculated by dividing net income (loss) by the
weighted-average number of common shares outstanding during the reporting period. Diluted net income (loss) per common
share reflects the effects of potentially dilutive securities.
The following shares were excluded from the calculation of diluted loss per share because their inclusion would have been anti-
dilutive (in millions):
Shares from stock options and awards
Note 8.
Income Taxes
December 29,
2019
Year Ended
December 30,
2018
December 31,
2017
—
0.1
0.1
In December 2017, the Tax Cuts and Jobs Act (“TCJA”) was enacted, which included a number of changes to previous
U.S. tax laws that impacted the Company, most notably a reduction of the U.S. corporate income tax rate from 35% to 21% for
tax years beginning after December 31, 2017.
Effective January 1, 2018, the TCJA requires the acceleration of certain types of revenue for tax purposes. The new
rules prohibit the Company from deferring revenue on unbilled accounts receivable later than when the amounts are recognized
as revenue for book purposes. This change impacts several accounting methods previously used by the Company and is
expected to result in an acceleration of taxability of such revenue as compared with prior U.S. tax laws. Additionally, future
interest deductions of the Company will be limited to 30% of tax adjusted EBITDA through 2021.
Additionally, effective January 1, 2018, the TCJA imposes a U.S. tax on global intangible low taxed income (“GILTI”)
that is earned by certain foreign affiliates owned by a U.S. shareholder each year. The computation of GILTI is generally
intended to impose tax on the earnings of a foreign corporation that are deemed to exceed a certain threshold return relative to
the underlying business investment. The Company has made a policy election to treat future taxes related to GILTI as a current
period expense in the reporting period in which the tax is incurred.
The components of income (loss) from continuing operations before income taxes are comprised of the following (in
millions):
Domestic
Foreign
Total
December 29,
2019
December 30,
2018
December 31,
2017
$
$
6.8
8.9
15.7
$
$
2.2
6.5
8.7
$
$
(60.5)
3.4
(57.1)
F-29
The provision (benefit) for income taxes from continuing operations are comprised of the following (in millions):
Federal income taxes:
Current
Deferred
Total Federal
State and local income taxes:
Current
Deferred
Total State and local
Foreign income taxes:
Current
Deferred
Total Foreign
Total
December 29,
2019
Year Ended
December 30,
2018
December 31,
2017
$
$
(0.2) $
(3.9)
(4.1)
(0.4) $
(1.8)
(2.2)
1.0
(0.9)
0.1
9.0
(0.2)
8.8
4.8
$
0.4
1.4
1.8
4.8
0.2
5.0
4.6
$
(2.9)
(9.0)
(11.9)
0.5
(0.3)
0.2
2.0
(0.5)
1.5
(10.2)
A reconciliation of the total income tax provision (benefit) to the amount computed by applying the statutory federal
income tax rate of 21% to the income from continuing operations before income taxes for the years ended December 29, 2019
and December 30, 2018, and applying the statutory federal income tax rate of 35% to the loss from continuing operations
before income taxes for the year ended December 31, 2017 is as follows (in millions):
Income tax (benefit) at federal statutory rate
State taxes, net of federal tax benefit and valuation allowance
Difference in tax rates between U.S. and foreign
Increase (decrease) in valuation allowance
Nondeductible expense
Increase in reserve for uncertain tax positions
Changes to indefinite life items and separate state deferred taxes
One-time transition tax on previously undistributed foreign earnings
Goodwill impairment
Decrease in deferred taxes related to disposition
Impact related to the 2017 Tax Cuts and Jobs Act
Release of valuation allowance due to FTT acquisition
Stock-based compensation
Total
December 29,
2019
Year Ended
December 30,
2018
December 31,
2017
$
$
3.3
0.6
1.9
(3.3)
1.0
7.7
0.4
—
—
—
—
(5.2)
(1.6)
4.8
$
$
1.8
0.9
0.7
4.7
0.6
4.0
(0.7)
2.2
—
(9.6)
—
—
—
4.6
$
$
(20.0)
0.5
—
(45.6)
1.1
1.3
(1.8)
6.2
8.1
—
40.0
—
—
(10.2)
F-30
The tax effects of temporary differences that give rise to deferred tax assets and deferred tax liabilities are as follows
(in millions):
Deferred tax assets:
Allowance for doubtful accounts
Sundry accruals
Vacation accrual
Stock-based compensation
Payroll related accruals
Lease accruals
Investments
Net operating loss carryforwards
Capital loss carryforwards
Tax credit carryforwards
Deferred revenue
Reserves and other
Valuation allowance
Total deferred tax assets, net of valuation allowance
Deferred tax liabilities:
Unearned revenue
Operating lease right-of-use assets
Other intangibles
Property and equipment, principally due to differences in depreciation
Other
Total deferred tax liabilities
Net deferred tax liability
December 29, 2019
December 30, 2018
$
$
$
0.6
2.3
3.0
5.3
6.2
22.1
1.3
75.1
1.3
11.2
1.1
13.6
143.1
(88.6)
54.5
(19.0)
(20.2)
(21.0)
(2.0)
(1.3)
(63.5)
(9.0) $
0.6
1.1
2.7
4.2
2.4
2.0
1.3
81.7
1.9
9.9
1.5
10.8
120.1
(92.2)
27.9
(23.9)
(8.9)
(0.9)
(1.2)
(34.9)
(7.0)
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 its deferred tax assets will not be realized. In making this assessment, the
Company has concluded that negative evidence, including cumulative losses in recent years, continues to outweigh the positive
evidence. Accordingly, the Company has maintained a full valuation allowance against the Company’s U.S. federal, combined
state and certain foreign net deferred tax assets. However, given the Company’s more recent earnings history, management
believes that there is a reasonable possibility that within the next 12 months, sufficient positive evidence may become available
to allow management to reach a conclusion that a significant portion of the valuation allowance will no longer be needed.
Release of valuation allowance would result in the recognition of certain deferred tax assets with a corresponding decrease to
income tax expense for the period the release is recorded. The exact timing and amount of the valuation allowance release will
be predicated on the basis of the level of profitability that the Company is able to actually achieve. During fiscal 2019, the
Company recorded a net decrease in its valuation allowance of $3.6 million.
At December 29, 2019, the Company had federal tax loss carryforwards of $307.8 million and various state tax loss
carryforwards of $266.9 million. The federal tax loss carryforwards will begin to expire in 2027 and state tax loss
carryforwards will begin to expire in 2020 in certain states. Additionally, the state capital loss carryforward generated in 2018
will begin to expire in 2023.
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 3-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.
F-31
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 tax years 2010 and 2011 the Company experienced a Section 382 “ownership change” that will limit the utilization
of NOL carryforwards. Additionally, 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. For the year ended December 29, 2019, there was no impact of such Section 382 limitations on 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 of December 31, 2017, all accumulated undistributed earnings of our foreign subsidiaries were subject to the one-
time transition tax on foreign earnings required by the 2017 Tax Cuts and Jobs Act. It is the Company’s intention to
permanently reinvest undistributed earnings of its foreign subsidiaries. As such, the Company has not provided deferred U.S.
income taxes or foreign withholding taxes of approximately $9.4 million on temporary differences relating to the outside basis
in its investment in foreign subsidiaries. As of December 29, 2019, the Company has $24.6 million of cash and cash
equivalents available for distribution.
The Company is subject to taxation in the U.S., various state tax jurisdictions and various 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 NOL carryforwards. Generally, the Company’s tax years for 2002 and later are subject to examination by various foreign tax
authorities, as well.
During 2018 the Company was notified by the Internal Revenue Service that its federal income tax return for the
calendar year ending December 27, 2015 had been selected for examination. The Company is currently awaiting a final
determination letter from the Internal Revenue Service and does not anticipate any significant changes in tax liability to the
year under audit.
The following table summarizes the activity related to the Company’s unrecognized tax benefits (in millions):
Balance as of December 25, 2016
Increases related to prior periods
Increases related to current year tax positions
Expiration of applicable statutes of limitations
Decrease in federal tax rate
Balance as of December 31, 2017
Increases related to prior periods
Increases related to current year tax positions
Expiration of applicable statutes of limitations
Decreases related to prior year tax positions
Decreases related to disposition
Balance as of December 30, 2018
Increases related to prior periods
Increases related to current year tax positions
Expiration of applicable statutes of limitations
Decreases related to settlement with tax authorities
Balance as of December 29, 2019
$
$
18.6
0.4
1.1
(0.6)
(3.9)
15.6
0.5
4.0
(0.4)
(0.3)
(1.7)
17.7
0.2
6.3
(0.1)
(0.1)
24.0
Included in the balance of unrecognized tax benefits at December 29, 2019, are $24.0 million of tax benefits that, if
recognized, would affect the effective tax rate. Included in this amount is $11.1 million that would become a deferred tax asset
if the tax benefit were recognized. As such, this benefit may be impacted by a corresponding valuation allowance depending
upon the Company’s assessment of the realizability of the deferred tax asset at the time the benefits are recognized.
F-32
The Company recognizes interest and penalties related to unrecognized tax benefits in its provision for income taxes.
For the years ended December 29, 2019, December 30, 2018 and December 31, 2017, the Company recorded $1.3 million, $0.6
million, and $0.5 million, respectively, in interest or penalty expenses. These amounts are netted by a benefit for interest and
penalties related to the reversal of prior positions and the disposition of PSS in the prior year of $0.1 million, $1.1 million, and
$0.2 million for the years ended December 29, 2019, December 30, 2018, and December 31, 2017, respectively. As of
December 29, 2019, December 30, 2018, and December 31, 2017, the Company had accrued total interest and penalties of $2.8
million, $1.6 million and $2.2 million, respectively.
The Company believes that it is reasonably possible that as much as $0.1 million of the liabilities for uncertain tax
positions will expire within 12 months of December 29, 2019 due to the expiration of various applicable statues of limitations.
Note 9.
Discontinued Operations
On February 28, 2018, the Company entered into a Stock Purchase Agreement to sell the operations of Kratos Public
Safety & Security Solutions, Inc., a Delaware corporation and wholly owned subsidiary of the Company (“PSS”), to Securitas
Electronic Security, Inc., a Delaware corporation (“Buyer”). On June 11, 2018, the Company completed the sale of all of the
issued and outstanding capital stock of PSS to Buyer for a purchase price of $69 million in cash, subject to a closing net
working capital adjustment (the “Transaction”). The Company and the Buyer are currently in a dispute regarding the closing
net working capital adjustment. The amount in dispute is approximately $8 million. To date, the Company has collected
approximately $3.7 million of the retained net working capital. The Company currently expects that the remaining net working
capital retained by the Company will be collected during 2020 once certain legacy projects are completed and the project close-
out process has been completed. The Company currently expects to recognize a net break-even on the sale of the PSS business
once the aggregate net proceeds described above have been collected excluding the impact of the final settlement and
determination of the closing net working capital adjustment. Any changes or adjustments to the expected net proceeds will be
reflected in future periods.
In accordance with ASC 360-10-45-9, Property, Plant, and Equipment (Topic 360) and ASC 205-20-45-3 Presentation
of Financial Statements (Topic 205), PSS and its subsidiaries have been reported in discontinued operations in the
accompanying consolidated financial statements for all periods presented.
The following table presents the results of discontinued operations (in millions):
Revenue
Cost of sales
Selling, general and administrative expenses
Other (income) expense items that are not major
Income (loss) from discontinued operations before income taxes
Gain on disposal of discontinued operations before income taxes
Total gain (loss) of discontinued operations before income taxes
Income tax (benefit) expense
Income (loss) from discontinued operations
Year ended
December 29,
2019
Year ended
December 30,
2018
Year ended
December 31,
2017
$
$
0.3
0.9
1.1
(3.6)
1.9
—
1.9
0.2
1.7
$
$
$
44.2
34.2
16.7
2.7
(9.4)
—
(9.4)
(1.8)
(7.6) $
149.9
110.1
33.6
(0.1)
6.3
—
6.3
2.1
4.2
Revenue and operating results for the year ended December 29, 2019 reflect the performance on the contracts and
working capital retained by the Company. Included in the year ended December 29, 2019, is a $3.6 million gain recorded as a
result of the release of an indemnification liability following the lapse of the statute of limitations associated with a potential
tax liability that was recorded in 2015 as part of the previous sale of our Electronic Products Division. Discontinued operations
for year ended December 30, 2018 were impacted by approximately $2.0 million of cost adjustments on certain security system
deployment projects for a mass transit authority. Transaction expenses of $2.7 million, primarily comprised of investment
advisory fees, legal fees, and other direct transaction expenses related to the Transaction, were included in Other (income)
expense items that are not major for the year ended December 30, 2018. Depreciation expense included in Selling, general and
administrative expenses was $0.0 million, $0.1 million and $0.3 million for the years ended December 29, 2019, December 30,
2018, and December 31, 2017 respectively.
F-33
Intra-period tax allocation rules require the Company to allocate its provision for income taxes between continuing
operations and other categories of earnings. Upon closing of the PSS sale, amounts historically carried as unrecognized tax
benefits were reclassified to guarantor liability in accordance with ASC 460. As a result of the reclassification, the Company
recorded a $2.1 million tax benefit in discontinued operations for the year ended December 30, 2018.
The following is a summary of the assets and liabilities of discontinued operations as of December 29, 2019 and
December 30, 2018 (in millions):
Accounts receivable, net
Other current assets
Current assets of discontinued operations
Accounts payable
Accrued expenses
Other current liabilities
Current liabilities of discontinued operations
Other long-term liabilities of discontinued operations
Note 10.
Fair Value Measurement
December 29, 2019
December 30, 2018
3.3
—
3.3
0.2
0.3
2.8
3.3
2.8
$
$
$
$
8.2
0.1
8.3
0.3
0.4
4.6
5.3
6.4
$
$
$
$
ASC Topic 820, Fair Value Measurement, establishes a valuation hierarchy for disclosure of the inputs to valuation
used to measure fair value. This hierarchy prioritizes the inputs into three broad levels as follows. Level 1 inputs are quoted
prices (unadjusted) in active markets for identical assets or liabilities. Level 2 inputs are quoted prices for similar assets and
liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market
corroboration, for substantially the full term of the financial instrument. Level 3 inputs are unobservable inputs based on the
Company’s own assumptions used to measure assets and liabilities at fair value. A financial asset or liability’s classification
within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.
Note 11.
Stockholders’ Equity
(a)
Common Stock
On March 7, 2017 and September 12, 2017, the Company sold approximately 11.9 million and 16.1 million,
respectively, shares of common stock at a purchase price of $7.25 and $12.25, respectively, per share in underwritten public
offerings. The Company received gross proceeds of approximately $283.5 million. After deducting underwriting fees and other
offering expenses, the Company received approximately $269.1 million in net proceeds. The Company used the net proceeds to
repurchase and extinguish $135.5 million of its outstanding 7% Notes.
(b)
Stock Option Plans and Restricted Stock Unit Plans
In March 2014 the Company’s board of directors (the “Board”) approved the 2014 Equity Incentive Plan (the “2014
Plan”). The 2014 Plan is the successor to the Kratos Defense & Security Solutions, Inc. 2011 Equity Incentive Plan, the Kratos
Defense & Security Solutions, Inc. Amended and Restated 2005 Equity Incentive Plan, the Kratos Defense & Security
Solutions, Inc. 2000 Nonstatutory Stock Option Plan, the Kratos Defense & Security Solutions, Inc. 1999 Equity Incentive
Plan, the Amended and Restated Integral Systems, Inc. 2008 Stock Incentive Plan, the Amended and Restated Herley
Industries, Inc. 2010 Stock Plan, the Herley Industries, Inc. 2003 Stock Option Plan, the Henry Bros. Electronics, Inc. 2007
Stock Option Plan, the Henry Bros. Electronics, Inc. 2006 Stock Option Plan, the Amended and Restated 2005 Digital
Fusion, Inc. Equity Incentive Plan, the 2000 Digital Fusion, Inc. Stock Option Plan, the 1999 Digital Fusion, Inc. Stock Option
Plan, and the 1998 Digital Fusion, Inc. Stock Option Plan (collectively, the “Prior Plans”).
The 2014 Plan became effective May 14, 2014 and no additional stock awards will be granted under the Prior Plans as
of April 1, 2014. All outstanding stock awards granted subject to the terms of the Prior Plans will continue to be subject to the
terms and conditions as set forth in the agreements evidencing such stock awards and the terms of the respective Prior Plans.
Any shares subject to outstanding stock awards granted under the Prior Plans or granted outside of a Prior Plan that, at any time
after March 27, 2014, (i) expire or terminate for any reason prior to exercise or settlement; (ii) are forfeited, canceled or
otherwise returned to the Company because of the failure to meet a contingency or condition required to vest such shares; or
F-34
(iii) are reacquired, withheld (or not issued) to satisfy a tax withholding obligation in connection with an award or to satisfy the
purchase price or exercise price of a stock award (collectively, the “Returning Shares”) will immediately be added to the share
reserve of the 2014 Plan and become available for issuance pursuant to stock awards granted under the 2014 Plan.
As of March 27, 2014, there were 2,306,256 shares remaining available for issuance under the Prior Plans. The total
number of awards outstanding under all of the Prior Plans and outside of any Prior Plan was 5,511,322 as of March 27, 2014.
The 2014 Plan decreased the number of shares remaining available for issuance under its equity compensation plans from
2,306,256 to 1,550,000, although, per the 2014 Plan, up to 5,511,322 shares subject to outstanding awards under the Prior Plans
and non-plan grants could potentially become Returning Shares available for issuance under the 2014 Plan. In May 2017, the
Company’s shareholders approved an amendment to the 2014 Plan to increase the aggregate number of shares that may be
issued under the plan by 2,500,000 shares.
The Board may grant equity-based awards to selected employees, directors and consultants of the Company pursuant
to its 2014 Plan. As of December 29, 2019, there were 1,736,561 shares reserved for issuance for future grant under the 2014
Plan. The Board may amend or terminate the 2014 Plan at any time. Certain amendments, including an increase in the share
reserve, require stockholder approval. Generally, options and restricted stock units outstanding vest over periods not exceeding
ten years. When the Company grants stock options, they are granted with a per share exercise price not less than the fair market
value of the Company’s common stock on the date of grant, and generally would be exercisable for up to ten years from the
grant date.
The Company records compensation expense for employee stock options based on the estimated fair value of the
options on the date of grant using the Black-Scholes option-pricing model or a trinomial lattice options pricing model with the
weighted average assumptions (annualized percentages) included in the following table. Awards with graded vesting are
recognized using the straight-line method with the following assumptions:
2019
2018
2017
Stock Options
Expected life
Risk-free interest rate(1)
Volatility(2)
Forfeiture rate(3)
Dividend yield(4)
10.0
10.0
10.0
2.2% - 2.5%
2.9% - 3.2%
2.5% - 2.6%
47.5% - 49.1% 52.9% - 53.4% 53.8% - 55.0%
5.1%
—%
5.1%
—%
5.0%
—%
(1) The risk-free interest rate is based on U.S. Treasury yields in effect at the time of grant with a term equal to
the expected term of the options.
(2) In 2019, 2018, and 2017, the Company estimated implied volatility based upon trailing volatility.
(3) Forfeitures are estimated at the time of grant based upon historical information. Forfeitures will be revised, if
necessary, in subsequent periods if actual forfeitures differ from estimates.
(4) The Company has no history or expectation of paying dividends on its common stock.
A summary of the status of the Company’s stock option plan as of December 29, 2019, and changes in options
outstanding under the plan for the year ended December 29, 2019, is as follows:
Options outstanding at December 30, 2018
Granted
Exercised
Forfeited or expired
Options outstanding at December 29, 2019
Options exercisable at December 29, 2019
768
$
$
2
(619) $
(5) $
$
$
146
146
5.17
16.81
5.23
7.87
4.98
4.98
F-35
Weighted-
Average
Exercise
Price per
Share
Weighted-
Average
Remaining
Contractual
Term
(in years)
Number of
Shares Under
Option
(000’s)
Aggregate
Intrinsic
Value
(000’s)
$ 6,587.5
4.2
3.0
3.0
$ 1,866.3
$ 1,866.3
Upon exercise of an option, the Company issues new shares of common stock.
During the years ended December 29, 2019, December 30, 2018, and December 31, 2017, the following values relate
to the grants and exercises under the Company’s option plans:
Weighted average grant date fair value of options granted
Total intrinsic value of options exercised (in thousands)
2019
2018
2017
$
$
10.25
8,874.9
$
$
7.54
40.6
$
$
6.39
67.1
The following table summarizes the Company’s Restricted Stock Unit activity:
Nonvested balance at December 30, 2018
Grants
Vested
Vested but not released
Nonvested balance at December 29, 2019
Restricted
Stock Units
(000’s)
Weighted-
Average
Grant Date
Fair Value
8.22
$
3,293
13.86
1,147
$
(228) $
15.22
(163) $
9.29
9.38
$
4,049
As of December 29, 2019, there was $19.2 million of total unrecognized stock-based compensation expense related to
nonvested restricted stock units which is expected to be recognized over a remaining weighted-average vesting period of 2.2
years. The fair value of restricted stock unit awards that vested in 2019, 2018, and 2017 was $3.5 million, $0.8 million, and
$6.3 million, respectively.
(c)
Amended and Restated Employee Stock Purchase Plan
In August 1999, the Board approved the 1999 Employee Stock Purchase Plan (as amended from time to time, the
“Purchase Plan”). A total of 5,200,000 shares of common stock had been previously approved for reservation of the Company’s
common stock for purchase by employees under the Purchase Plan. In May 2017, the Company’s shareholders approved an
amendment to the Purchase Plan to increase the maximum number of shares of common stock that may be issued under the
Purchase Plan by 3,000,000 shares. The Purchase Plan qualifies as an employee stock purchase plan within the meaning of
Section 423 of the Internal Revenue Service Code. Unless otherwise determined by the Compensation Committee of the Board,
all employees are eligible to participate in the Purchase Plan, so long as they are employed by the Company (or a subsidiary
designated by the Board) for at least 20 hours per week and were customarily employed by the Company (or a subsidiary
designated by the Board) for at least 5 months per calendar year.
Employees who actively participate in the Purchase Plan are eligible to have up to 15% of their earnings for each
purchase period withheld pursuant to the Purchase Plan. The amount that is withheld is used at various purchase dates within
the offering period to purchase shares of common stock. The price paid for common stock at each such purchase date is equal
to the lower of 85% of the fair market value of the common stock at the commencement date of that offering period or 85% of
the fair market value of the common stock on the relevant purchase date. Employees are also able to end their participation in
the offering at any time during the offering period, and participation ends automatically upon termination of employment. From
the Purchase Plan’s inception through December 29, 2019, the cumulative number of shares of common stock that have been
issued under the Purchase Plan is 5.5 million and approximately 2.7 million shares are available for future issuance. During
fiscal 2019, approximately 356,000 shares were issued under the plan at an average price of $10.79.
F-36
The fair value of Kratos’ Purchase Plan shares for 2019 was estimated using the Black-Scholes option pricing model.
The assumptions and resulting fair values of options granted for 2019, 2018 and 2017 were as follows:
Expected term (in years)(1)
Risk-free interest rate(2)
Expected volatility(3)
Expected dividend yield(4)
Weighted average grant-date fair value per share
Offering
Periods
January 1 to
December 31
2019
0.5
2.09% - 2.56%
Offering
Periods
January 1 to
December 31,
2018
0.5
1.53% - 2.11%
Offering
Periods
January 1 to
December 31,
2017
0.5
0.62% - 1.14%
37.22% - 43.70% 40.24% - 44.83% 44.38% - 53.70%
—%
$3.03
—%
$2.51
—%
$4.74
(1) The expected term is equivalent to the offering period.
(2) The risk-free interest rate is based on U.S. Treasury yields in effect at the time of grant with a term equal to
the expected term.
(3) The Company estimated implied volatility based upon trailing volatility.
(4) The Company has no history or expectation of paying dividends on its common stock.
As of December 29, 2019, there was no material unrecognized compensation expense related to the Purchase Plan.
Note 12.
Retirement Plans
The Company provides eligible employees the opportunity to participate in defined-contribution savings plans
(commonly known as 401(k) plans), which permit contributions on a before-tax basis. Generally, salaried employees and
certain hourly employees are eligible to participate in the plans. Under most plans, the employee may contribute to various
investment alternatives. In certain plans, the Company matches a portion of the employees’ contributions. The Company’s
matching contributions to these defined-contribution savings plans totaled $4.4 million in 2019, $3.9 million in 2018, and $3.8
million in 2017.
Note 13.
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 $507.4 million, $447.0 million, and $451.9 million or 71%, 72%, and 75%, of
total revenue for the years ended December 29, 2019, December 30, 2018, and December 31, 2017, respectively.
Note 14.
Segment Information
The Company operates in two reportable segments. The KGS reportable segment is comprised of an aggregation of
KGS operating segments, including DRSS, ME, TTS, MS, and KTT. The US reportable segment consists of the Company’s
unmanned aerial, unmanned ground, unmanned seaborne and command, control and communications system business. The
KGS and US segments provide products, solutions and services for mission critical national security programs. KGS and US
customers primarily include national security related agencies, the DoD, intelligence agencies and classified agencies, and to a
lesser degree, international government agencies and domestic and international commercial 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. 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.
F-37
As discussed in “Discontinued Operations” in Note 9 of these notes to consolidated financial statements, the Company
began reporting the PSS business as discontinued operations effective in the first quarter of fiscal 2018. Prior to the decision to
sell the PSS business, the Company reported their financial results in a separate PSS reportable segment.
As certain overhead type costs previously allocated to the PSS business were not allocable to discontinued operations,
prior period corporate costs have been reallocated amongst the continuing reportable segments.
F-38
Revenues, operating income (loss) and assets disclosed below provided by the Company’s reportable segments for the
years ended December 29, 2019, December 30, 2018, and December 31, 2017, are as follows (in millions):
Revenues:
Kratos Government Solutions
Service revenues
Product sales
Total Kratos Government Solutions
Unmanned Systems
Service revenues
Product sales
Total Unmanned Systems
Total revenues
Depreciation and amortization:
Kratos Government Solutions
Unmanned Systems
Total depreciation and amortization
Operating income (loss):
Kratos Government Solutions
Unmanned Systems
Corporate activities
Total operating income (loss)
2019
2018
2017
$
$
$
$
$
$
272.6
283.5
556.1
—
161.4
161.4
717.5
18.2
5.2
23.4
45.2
6.1
(13.3)
38.0
$
$
$
$
$
$
200.7
284.4
485.1
—
132.9
132.9
618.0
13.2
4.7
17.9
35.5
5.1
(10.1)
30.5
$
$
$
$
$
$
197.8
283.8
481.6
—
121.7
121.7
603.3
14.4
7.8
22.2
(0.1)
(3.6)
(8.3)
(12.0)
Revenues from foreign customers were approximately $132.5 million or 18%, $114.3 million or 19% and $84.7
million or 14% of total revenue for the years ended December 29, 2019, December 30, 2018, and December 31, 2017,
respectively.
Included in the 2017 operating loss for the KGS reportable segment is a $24.2 million impairment of the carrying
value of the goodwill of the DRSS business within the KGS segment.
Reportable segment assets are as follows (in millions):
Assets:
Kratos Government Solutions
Unmanned Systems
Discontinued operations
Corporate activities
Total assets
December 29, 2019 December 30, 2018 December 31, 2017
$
$
777.6
246.3
3.3
158.8
1,186.0
$
$
602.8
220.9
8.3
178.1
1,010.1
$
$
597.9
201.9
97.4
126.8
1,024.0
Assets of foreign subsidiaries in the KGS segment were $124.7 million, $126.7 million and $116.7 million as of
December 29, 2019, December 30, 2018 and December 31, 2017, respectively.
Note 15.
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 consolidated financial statements. An estimated loss
contingency is accrued in the Company’s 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
F-39
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 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 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. Costs incurred and allocated to contracts with the U.S.
Government are regularly scrutinized for compliance with regulatory standards by the Company’s personnel. 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 its financial condition, results of operations
or cash flows.
Note 16.
Redeemable Noncontrolling Interest
As discussed in “Acquisition” in Note 2, in connection with the Company’s acquisition of FTT, (i) beginning in
January 2024, the Holders will have an annual Put Right to sell all of the Minority Interests to the Company at a purchase price
based on a specified multiple of the trailing 12 months EBITDA of the Acquired Companies, subject to adjustment as set forth
in the Exchange Agreement (provided, however, that following certain events, including a change of control, the Put Right will
be accelerated and the Minority Interest Purchase Price will be a specified increased multiple of the trailing 12 months
EBITDA of the Acquired Companies); and (ii) beginning in January 2025, the Company will have an annual right to purchase
all of the Minority Interests from the Holders at the Minority Interest Purchase Price.
The Company adjusts the carrying value of such redeemable noncontrolling interest based on an allocation of
subsidiary earnings based on ownership interest. Redeemable noncontrolling interest is recorded outside of permanent equity at
the higher of its carrying value or management’s estimate of the amount (the “Redemption Amount”) that the Company could
be required to pay in connection with the Put Rights. Adjustments to Redemption Amount will have a corresponding effect on
net income per share attributable to Kratos shareholders. As of December 29, 2019, no adjustment of the carrying value of the
redeemable noncontrolling interest was required.
F-40
Note 17.
Quarterly Financial Data (Unaudited)
The following financial information reflects all normal and recurring adjustments that are, in the opinion of
management, necessary for a fair statement of the results of the interim periods. As discussed in “Discontinued Operations” in
Note 9 of these notes to consolidated financial statements, the Company began reporting the PSS business as discontinued
operations effective in the first quarter of fiscal 2018. Accordingly, the financial results for the PSS business have been reported
in discontinued operations for all periods presented.
Summarized quarterly data for the years ended December 29, 2019 and December 30, 2018, is as follows (in millions,
except per share data):
First
Quarter
Second
Quarter
Third
Quarter
Fourth
Quarter
Fiscal year 2019
Revenues
Gross profit
Operating income
Provision (benefit) for income taxes
Income from continuing operations
Income (loss) from discontinued operations
Net income
Less: Net income (loss) attributable to noncontrolling interest
Net income attributable to Kratos
Basic income (loss) per common share attributable to Kratos:
Income from continuing operations
Income (loss) from discontinued operations
Net income per common share
Diluted income per common share attributable to Kratos:
Income from continuing operations
Income from discontinued operations
Net income per common share
$
$
$
$
$
$
$
$
$
$
160.4
44.9
8.2
(1.5)
3.7
(0.6)
3.1
—
3.1
0.04
$
(0.01) $
$
0.03
0.03
$
— $
$
0.03
187.9
48.1
9.0
2.5
1.3
3.0
4.3
0.4
3.9
0.01
0.03
0.04
0.01
0.03
0.04
$
$
$
$
$
$
$
$
$
$
184.1
48.6
11.5
2.8
2.6
—
2.6
0.1
2.5
0.02
$
— $
$
0.02
0.02
$
— $
$
0.02
185.1
48.4
9.3
1.0
3.3
(0.7)
2.6
(0.4)
3.0
0.03
—
0.03
0.03
—
0.03
Fiscal year 2018
Revenues
Gross profit
Operating income
Provision for income taxes
Income (loss) from continuing operations
Income (loss) from discontinued operations
Net income (loss)
Basic income (loss) per common share:
Income (loss) from continuing operations
Income (loss) from discontinued operations
Net income (loss) per common share
Diluted income (loss) per common share:
Income (loss) from continuing operations
Income (loss) from discontinued operations
Net income (loss) per common share
First
Quarter
Second
Quarter
Third
Quarter
Fourth
Quarter
$
$
$
$
$
$
$
$
$
143.0
40.8
7.0
0.9
1.3
(3.5)
(2.2) $
$
151.2
39.3
2.6
0.1
(3.8)
(3.9)
(7.7) $
$
0.01
(0.03) $
(0.02) $
(0.04) $
(0.03) $
(0.07) $
0.01
$
(0.03) $
(0.02) $
(0.04) $
(0.03) $
(0.07) $
159.4
44.1
10.1
3.4
1.4
0.3
1.7
0.01
0.01
0.02
0.01
0.01
0.02
$
$
$
$
$
$
$
$
164.4
45.5
10.8
0.2
5.2
(0.5)
4.7
0.05
—
0.05
0.05
(0.01)
0.04
F-41
Note 18.
Subsequent Events
On February 24, 2020, the Company acquired a turbine technology company focused on tactical unmanned aerial
drones and other systems for approximately $10.5 million in cash, subject to adjustments for transaction expenses,
indebtedness, cash on hand, and post-closing working capital adjustments.
F-42
EXHIBIT 31.1
CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Eric M. DeMarco, certify that:
1.
2.
3.
4.
I have reviewed this Annual report on Form 10-K of Kratos Defense & Security Solutions, Inc.;
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with
respect to the period covered by this report;
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all
material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in
this report;
The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures
(as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange
Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a)
(b)
(c)
(d)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed
under our supervision, to ensure that material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is
being prepared;
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be
designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this
report based on such evaluation; and
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the
registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has
materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting;
and
5.
The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over
financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing
the equivalent functions):
(a)
(b)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting
which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial
information; and
Any fraud, whether or not material, that involves management or other employees who have a significant role in the
registrant’s internal control over financial reporting.
Date: February 24, 2020
KRATOS DEFENSE & SECURITY SOLUTIONS, INC.
/s/ ERIC M. DEMARCO
Eric M. DeMarco
Chief Executive Officer, President
(Principal Executive Officer)
EXHIBIT 31.2
CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Deanna H. Lund, certify that:
1.
2.
3.
4.
I have reviewed this Annual report on Form 10-K of Kratos Defense & Security Solutions, Inc.;
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with
respect to the period covered by this report;
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all
material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in
this report;
The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures
(as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange
Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a)
(b)
(c)
(d)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed
under our supervision, to ensure that material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is
being prepared;
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be
designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this
report based on such evaluation; and
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the
registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has
materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting;
and
5.
The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over
financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing
the equivalent functions):
(a)
(b)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting
which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial
information; and
Any fraud, whether or not material, that involves management or other employees who have a significant role in the
registrant’s internal control over financial reporting.
Date: February 24, 2020
KRATOS DEFENSE & SECURITY SOLUTIONS, INC.
/s/ DEANNA H. LUND
Deanna H. Lund
Executive Vice President, Chief Financial Officer
(Principal Financial Officer)
CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
(18 U.S.C. SECTION 1350)
In connection with the accompanying Annual Report of Kratos Defense & Security Solutions, Inc. (the “Company”) on Form 10-K
for the year ended December 29, 2019 (the “Report”), I, Eric M. DeMarco, Chief Executive Officer of the Company, certify, pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
(1)
(2)
The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as
amended; and
The information contained in the Report fairly presents, in all material respects, the financial condition and results of
operations of the Company.
EXHIBIT 32.1
Date: February 24, 2020
KRATOS DEFENSE & SECURITY SOLUTIONS, INC.
/s/ ERIC M. DEMARCO
Eric M. DeMarco
Chief Executive Officer, President
(Principal Executive Officer)
CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
(18 U.S.C. SECTION 1350)
In connection with the accompanying Annual Report of Kratos Defense & Security Solutions, Inc. (the “Company”) on Form 10-K
for the year ended December 29, 2019 (the “Report”), I, Deanna H. Lund, Chief Financial Officer of the Company, certify, pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
(1)
(2)
The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as
amended; and
The information contained in the Report fairly presents, in all material respects, the financial condition and results of
operations of the Company.
EXHIBIT 32.2
Date: February 24, 2020
KRATOS DEFENSE & SECURITY SOLUTIONS, INC.
/s/ DEANNA H. LUND
Deanna H. Lund
Executive Vice President, Chief Financial Officer
(Principal Financial Officer)
Kratos Master Cover Artwork.pdf 2 4/14/2020 5:30:09 PM
Turbine Technologies
Missile Defense
Unmanned Aerial Systems
Space Situational Awareness
Satellite C2
Microwave Electronics
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CM
MY
CY
CMY
K
Unmanned Ground Systems
Directed Energy Systems
Kratos develops transformative, affordable technology
for the Department of Defense and is changing
the way breakthrough technologies are brought
to the defense industry.
Officers
Directors
Corporate Headquarters
Eric DeMarco
President and Chief Executive Officer
Deanna Lund
Executive Vice President and
Chief Financial Officer
Jonah Adelman
Senior Vice President
President, Microwave Electronics
Phil Carrai
Senior Vice President
President, Technology & Training Solutions
Dave Carter
Senior Vice President
President, Defense & Rocket Support
Services
Scott Anderson
President and Chief Executive Officer
NE Wireless Networks, LLC
Eric DeMarco
President and Chief Executive Officer
Kratos Defense & Security Solutions, Inc.
William Hoglund
Chairman of the Kratos Board
Safeboats International, LLP
Scot Jarvis
Principal
Cedar Grove Partners, LLC
Jane Judd
Senior Financial Executive (Ret.)
Titan Corporation
Steve Fendley
Senior Vice President
President, Unmanned Systems
Sam Liberatore
Senior Vice President (Ret.)
Madison Research Division
Amy Zegart
Senior Fellow, The Hoover Institution
Stanford University
Registrar/Transfer Agent
EQ
Shareowner Services
1110 Center Pointe Curve, Suite 101
Mendota Heights, MN 55120
Thomas Mills
Senior Vice President
President, C5ISR
Stacey Rock
Senior Vice President
President, Turbine Technologies
Ben Goodwin
Senior Vice President
Corporate Development & Government
Affairs
Maria Cervantes de Burgreen
Vice President and Corporate Controller
Marie Mendoza
Vice President and General Counsel
Kratos Defense & Security Solutions, Inc.
10680 Treena Street, Suite 600
San Diego, CA 92131
Phone. 858.812.7300
Fax: 858.812.7301
External Legal Counsel
Paul Hastings, LLP
4747 Executive Drive, 12th Floor
San Diego, CA 92121
Independent Accountants
Deloitte & Touche, LLP
655 W. Broadway, Suite 700
San Diego, CA 92101
Corporate Contact Information
Corporate Communications/
Investor Relations
Kratos Defense & Security Solutions, Inc.
Corporate Headquarters
Toll Free: 877.934.4687
Corporate News Releases, SEC Forms
including 10-K and 10-Q, and other
information may be found at:
www.KratosDefense.com
COPYRIGHT 2020. All rights reserved. Kratos is a
registered trademark of Kratos Defense & Security
Solutions, Inc. Certain other product names, brand
names and company names may be trademarks or
designations of their respective owners.
Kratos Defense & Security Solutions, Inc. is traded on the Nasdaq Global Select Market Exchange under the stock ticker: KTOS
2019 Annual Report
Kratos Master Cover Artwork.pdf 1 4/14/2020 5:29:58 PM
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Kratos Defense & Security Solutions
10680 Treena Street
Suite 600
San Diego, CA 92131
Phone: 858.812.7300
Fax: 858.812.7301
www.KratosDefense.com
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