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Document and Entity Information - shares	3 Months Ended
Document and Entity Information - shares	Mar. 25, 2012	Apr. 27, 2012
Document and Entity Information
Entity Registrant Name	KRATOS DEFENSE & SECURITY SOLUTIONS, INC.
Entity Central Index Key	0001069258
Document Type	10-Q
Document Period End Date	Mar. 25, 2012
Amendment Flag	false
Current Fiscal Year End Date	--12-30
Entity Current Reporting Status	Yes
Entity Filer Category	Accelerated Filer
Entity Common Stock, Shares Outstanding		32,511,587
Document Fiscal Year Focus	2012
Document Fiscal Period Focus	Q1

CONDENSED CONSOLIDATED BALANCE SHEETS - USD ($) $ in Millions	Mar. 25, 2012	Dec. 25, 2011
Current assets:
Cash and cash equivalents	$ 74.8	$ 69.8
Restricted cash	0.7	1.1
Accounts receivable, net	259.6	250.6
Inventoried costs	87.4	80.6
Prepaid expenses	11.7	12.8
Other current assets	14.4	6.1
Total current assets	448.6	421.0
Property, plant and equipment, net	72.7	73.0
Goodwill	577.0	573.2
Intangible assets, net	116.1	124.6
Other assets	23.0	24.3
Total assets	1,237.4	1,216.1
Current liabilities:
Accounts payable	80.3	54.8
Accrued expenses	50.4	52.0
Accrued compensation	42.0	40.5
Billings in excess of costs and earnings on uncompleted contracts	39.8	37.7
Other current liabilities	26.3	28.7
Total current liabilities	238.8	213.7
Long-term debt principal, net of current portion	630.5	630.8
Long-term debt premium	21.8	22.8
Other long-term liabilities	35.6	36.2
Total liabilities	926.7	903.5
Commitments and contingencies
Stockholders' equity:
Preferred stock, 5,000,000 shares authorized, $0.001 par value, 0 shares outstanding at December 25, 2011 and March 25, 2012
Common stock, $0.001 par value, 195,000,000 shares authorized; 32,421,135 and 32,511,287 shares issued and outstanding at December 25, 2011 and March 25, 2012, respectively
Additional paid-in capital	721.7	720.6
Accumulated other comprehensive loss	(0.2)	(0.2)
Accumulated deficit	(410.8)	(407.8)
Total stockholders' equity	310.7	312.6
Total liabilities and stockholders' equity	$ 1,237.4	$ 1,216.1

CONDENSED CONSOLIDATED BALANCE SHEETS (Parenthetical) - $ / shares	Mar. 25, 2012	Dec. 25, 2011
CONDENSED CONSOLIDATED BALANCE SHEETS
Preferred stock, shares authorized	5,000,000	5,000,000
Preferred stock, par value (in dollars per share)	$ 0.001	$ 0.001
Preferred stock, shares outstanding	0	0
Common stock, par value (in dollars per share)	$ 0.001	$ 0.001
Common stock, shares authorized	195,000,000	195,000,000
Common stock, shares issued	32,511,287	32,421,135
Common stock, shares outstanding	32,511,287	32,421,135

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS - USD ($) shares in Millions, $ in Millions	3 Months Ended
	Mar. 25, 2012	Mar. 27, 2011
Service revenues	$ 105.2	$ 79.8
Product sales	109.8	43.0
Total revenues	215.0	122.8
Cost of service revenue	81.8	60.3
Cost of product sales	75.3	35.1
Total costs	157.1	95.4
Gross profit	57.9	27.4
Selling, general and administrative expenses	45.0	19.6
Merger and acquisition expenses	0.9	5.8
Research and development expenses	3.8	0.6
Operating income from continuing operations	8.2	1.4
Other income (expense):
Interest expense, net	(16.1)	(6.7)
Other income	0.5	0.3
Total other expense, net	(15.6)	(6.4)
Loss from continuing operations before income taxes	(7.4)	(5.0)
Benefit for income taxes from continuing operations	(4.2)	(1.2)
Loss from continuing operations	(3.2)	(3.8)
Net income from discontinued operations	0.2	0.3
Net loss	$ (3.0)	$ (3.5)
Basic income (loss) per common share:
Net loss from continuing operations (in dollars per share)	$ (0.10)	$ (0.18)
Net income from discontinued operations (in dollars per share)	0.01	0.01
Net loss per common share (in dollars per share)	(0.09)	(0.17)
Diluted income (loss) per common share:
Net loss from continuing operations (in dollars per share)	(0.10)	(0.18)
Net income from discontinued operations (in dollars per share)	0.01	0.01
Net loss per common share (in dollars per share)	$ (0.09)	$ (0.17)
Weighted average common shares outstanding:
Basic (in shares)	32.5	21.3
Diluted (in shares)	32.5	21.3
Comprehensive Loss
Net loss from above	$ (3.0)	$ (3.5)
Other comprehensive income (loss)	0.0	0.0
Comprehensive loss	$ (3.0)	$ (3.5)

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - USD ($) $ in Millions	3 Months Ended
	Mar. 25, 2012	Mar. 27, 2011
Operating activities:
Net loss	$ (3.0)	$ (3.5)
Less: Income from discontinued operations	0.2	0.3
Loss from continuing operations	(3.2)	(3.8)
Adjustments to reconcile loss from continuing operations to net cash provided by (used in) operating activities from continuing operations:
Depreciation and amortization	13.7	4.8
Deferred income taxes		0.3
Stock-based compensation	1.1	0.6
Mark to market on swaps		(0.3)
Amortization of deferred financing costs	1.3	0.4
Amortization of premium on Senior Secured Notes	(1.0)
Provision for doubtful accounts	0.3
Changes in assets and liabilities, net of acquisitions:
Accounts receivable	14.1	3.0
Inventoried costs	(6.3)	1.3
Prepaid expenses and other assets	(2.2)	0.9
Accounts payable	26.8	3.1
Accrued compensation	0.9	2.0
Accrued expenses	(8.6)	(9.0)
Billings in excess of costs and earnings on uncompleted contracts	(1.2)	(4.3)
Income tax receivable and payable	(5.1)	(2.2)
Other liabilities	(1.1)
Net cash provided by (used in) operating activities from continuing operations	29.5	(3.2)
Investing activities:
Cash paid for acquisitions, net of cash acquired	(20.0)	(224.1)
Decrease (increase) in restricted cash	0.4	(101.1)
Cash paid for contingent acquisition consideration	(1.5)
Capital expenditures	(2.7)	(0.5)
Net cash used in investing activities from continuing operations	(23.8)	(325.7)
Financing activities:
Proceeds from the issuance of long-term debt		314.0
Proceeds from the issuance of common stock		61.5
Repayment of term loan	(0.3)
Debt issuance costs		(13.0)
Other	(0.1)	1.2
Net cash provided by (used in) financing activities from continuing operations	(0.4)	363.7
Net cash flows of continuing operations	5.3	34.8
Net operating cash flows of discontinued operations	(0.2)	(0.1)
Effect of exchange rate changes on cash and cash equivalents	(0.1)
Net increase in cash and cash equivalents	5.0	34.7
Cash and cash equivalents at beginning of period	69.8	10.8
Cash and cash equivalents at end of period	$ 74.8	$ 45.5

Summary of Significant Accounting Policies

3 Months Ended

Mar. 25, 2012

Summary of Significant Accounting Policies

Summary of Significant Accounting Policies

Note 1. Summary of Significant Accounting Policies

All references to the “Company” and “Kratos” refer to Kratos Defense & Security Solutions, Inc., a Delaware corporation, and its wholly owned subsidiaries.

(a) Basis of Presentation

The information as of March 25, 2012 and for the three months ended March 27, 2011 and March 25, 2012 is unaudited. The condensed consolidated balance sheet as of December 25, 2011 was derived from the Company’s audited consolidated financial statements at that date. In the opinion of management, these unaudited condensed consolidated financial statements include all adjustments, consisting of normal recurring adjustments necessary for a fair presentation of the Company’s financial position, results of operations and cash flows for the interim periods presented. The results have been prepared in accordance with the instructions to Form 10-Q and do not necessarily include all information and footnotes necessary for presentation in accordance with accounting principles generally accepted in the U.S. (“GAAP”). These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the related notes included in the Company’s audited annual consolidated financial statements and footnotes for the fiscal year ended December 25, 2011, included in the Company’s Annual Report on Form 10-K, filed with the U.S. Securities and Exchange Commission on March 7, 2012 (the “Form 10-K”). Interim operating results are not necessarily indicative of operating results expected in subsequent periods or for the year as a whole.

(b) Principles of Consolidation

The condensed consolidated financial statements include the accounts of the Company and its wholly-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 year, with interim fiscal periods ending on the last Sunday of the last month of each calendar quarter. The three months ended March 27, 2011 and March 25, 2012 consisted of 13 week periods. There were 52 calendar weeks in the fiscal year ended on December 25, 2011 and there are 53 calendar weeks in the fiscal year ending December 30, 2012.

(d) Accounting Policies and Accounting Standards Updates

There have been no changes in the Company’s significant accounting policies for the three months ended March 25, 2012 as compared to the significant accounting policies described in the Form 10-K. In addition, there were no new accounting standards updates issued by the Financial Accounting Standards Board during the three months ended March 25, 2012.

(e) 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 federal 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 12 for a discussion of the Company’s significant customers.

The Company has outstanding 10% Senior Secured Notes with an aggregate principal amount of $625.0 million which is due on June 1, 2017. The Company pays interest at the rate of 10% per annum semi-annually, in arrears, on June 1 and December 1 of each year. As of March 25, 2012, the principal amount of $625.0 million is outstanding under these notes. In addition, the Company has $73.6 million available under its existing revolving credit agreement. See Note 9 for a complete description of the Company’s debt.

The Company intends to fund its cash requirements with cash on hand, cash flows from operating activities and borrowings under its existing revolving credit facility. Management believes these sources of liquidity should be sufficient to meet the Company’s cash needs for at least the next 12 months. The Company’s 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 outside of its control. The Company may experience, in the future, a significant long-term negative impact to its financial results and cash flows from operations if the conditions in its industry deteriorate, its customers cancel or postpone projects or if the Company is unable to sufficiently increase its revenues or further reduce its expenses. In such a situation, the Company could fall out of compliance with its financial and other covenants which, if not waived, could limit its liquidity and capital resources.

- Definition

The entire disclosure for the organization, consolidation and basis of presentation of financial statements disclosure, and significant accounting policies of the reporting entity. May be provided in more than one note to the financial statements, as long as users are provided with an understanding of (1) the significant judgments and assumptions made by an enterprise in determining whether it must consolidate a VIE and/or disclose information about its involvement with a VIE, (2) the nature of restrictions on a consolidated VIE's assets reported by an enterprise in its statement of financial position, including the carrying amounts of such assets, (3) the nature of, and changes in, the risks associated with an enterprise's involvement with the VIE, and (4) how an enterprise's involvement with the VIE affects the enterprise's financial position, financial performance, and cash flows. Describes procedure if disclosures are provided in more than one note to the financial statements.

+ References + Details

Acquisitions

3 Months Ended

Mar. 25, 2012

Acquisitions

Acquisitions

Note 2. Acquisitions

(a) Summary of Recent Acquisitions

Asset Purchase

On December 30, 2011, the Company acquired selected assets of a critical infrastructure security and public safety system integration business (the “Critical Infrastructure Business”) for approximately $20.0 million. The asset purchase agreement provides that the purchase price will be (i) increased on a dollar for dollar basis if the working capital on the closing date (as defined in the asset purchase agreement) exceeds $17.0 million or (ii) decreased on a dollar for dollar basis if the working capital is less than $17.0 million. In accordance with the terms of the asset purchase agreement, the Company submitted its computation of the working capital to the Seller on April 27, 2012, which reflected a deficiency to the minimum required working capital. The seller has 60 days to object to the Company’s computation of the closing working capital. As the Seller and the Company have not yet agreed on the working capital adjustment, the Company has not reflected an adjustment to the purchase price.

The Critical Infrastructure Business designs, engineers, deploys, manages and maintains specialty security systems at some of the most strategic asset and critical infrastructure locations in the U.S. Additionally, these security systems are typically integrated into command and control system infrastructure or command centers. Approximately 15% of the revenues of the Critical Infrastructure Business are recurring in nature due to the operation, maintenance or sustainment of the security systems once deployed. The Critical Infrastructure Business is part of the Company’s Public Safety & Security (“PSS”) segment.

The transaction has been accounted for using the acquisition method of accounting which requires, among other things, that the assets acquired and liabilities assumed be recognized at their fair values as of the acquisition date. The following table summarizes the preliminary estimated fair values of major assets acquired and liabilities assumed (in millions):

Accounts receivable	$	23.4
Other assets	0.5
Intangible assets	2.0
Goodwill	3.8
Total assets	29.7
Current liabilities	(9.7		)
Net assets acquired	$	20.0

The goodwill recorded in this transaction is tax deductible.

As of December 30, 2011, the expected fair value of accounts receivable approximated historical cost. The gross accounts receivable was $24.4 million, of which approximately $1.0 million is not expected to be collectible.

The amounts of revenue and operating loss included in the Company’s consolidated statement of operations for the three months ended March 25, 2012 were $13.8 million and $0.6 million, respectively.

SecureInfo Corporation

On November 15, 2011, the Company acquired SecureInfo Corporation (“SecureInfo”) for $20.3 million in cash, which includes a $1.5 million earn-out that was paid in March 2012. Upon completion of the SecureInfo transaction, the Company deposited $1.8 million of the purchase price (“the holdback”) into an escrow account as security for SecureInfo’s indemnification obligations as set forth in the SecureInfo purchase agreement. In addition, the SecureInfo purchase agreement provided that the purchase price would be (i) increased on a dollar for dollar basis if the working capital on the closing date (as defined in the SecureInfo purchase agreement) exceeded $2.2 million or (ii) decreased on a dollar for dollar basis if the working capital was less than $2.2 million. The SecureInfo working capital was $2.1 million and the Company and SecureInfo agreed to a working capital adjustment of $0.1 million.

Based in northern Virginia, SecureInfo is a cybersecurity company specializing in assisting defense, intelligence, civilian government and commercial customers to identify, understand, document, manage, mitigate and protect against cybersecurity risks while reducing information security costs and achieving compliance with applicable regulations, standards and guidance. SecureInfo offers strategic advisory, operational cybersecurity and cybersecurity risk management services and is a recognized leader in the rapidly evolving fields of cloud security, continuous monitoring and cybersecurity training. Customers include the Department of Defense, the Department of Homeland Security (“DHS”) and large commercial customers, including market leading cloud computing service providers. SecureInfo is part of the Kratos Government Solutions (“KGS”) segment.

The SecureInfo transaction has been accounted for using the acquisition method of accounting which requires, among other things, that the assets acquired and liabilities assumed be recognized at their fair values as of the merger date. The following table summarizes the preliminary estimated fair values of major assets acquired and liabilities assumed (in millions):

Cash	$	1.4
Other assets	3.1
Property and equipment	0.1
Intangible assets	4.5
Goodwill	12.1
Total assets	21.2
Current liabilities	(0.9		)
Net assets acquired	$	20.3

The goodwill recorded in this transaction is not tax deductible.

As of November 15, 2011, the expected fair value of accounts receivable approximated historical cost. The gross accounts receivable was $2.9 million, of which $0.0 million is not expected to be collectible.

The amounts of revenue and operating income included in the Company’s consolidated statement of operations for the three months ended March 25, 2012 were $3.7 million and $0.2 million, respectively.

Integral Systems, Inc.

On July 27, 2011, the Company acquired Integral Systems, Inc., a Maryland corporation (“Integral”), in a cash and stock transaction valued at $241.1 million. Upon completion of the acquisition the Company paid an aggregate of $131.4 million in cash, issued approximately 10.4 million shares of the Company’s common stock valued at $108.7 million and issued replacement stock options with a fair value of $1.0 million.

To fund the cash portion of the acquisition, on July 27, 2011, the Company issued $115.0 million aggregate principal amount of 10% Senior Secured Notes due 2017 (the “Notes”). The Notes were issued at a premium of 105% for an effective interest rate of approximately 8.9%. The gross proceeds of approximately $120.8 million, which includes an approximate $5.8 million issuance premium and excludes accrued interest received of $1.8 million, were used to finance, in part, the cash portion of the purchase price for the acquisition of Integral, to refinance existing indebtedness of Integral and its subsidiaries, to pay certain severance payments in connection with the merger and to pay related fees and expenses. See Note 9 for a complete description of the Company’s debt.

As consideration for the acquisition of Integral, each Integral stockholder received (i) $5.00 in cash, without interest, and (ii) 0.588 shares of the Company’s common stock for each share of Integral common stock. In addition, upon completion of the merger (i) each outstanding Integral stock option with an exercise price less than $13.00 per share was, if the holder thereof had so elected in writing, cancelled in exchange for an amount in cash equal to the product of the total number of shares of Integral common stock subject to such in-the-money option, multiplied by the aggregate value of the excess, if any, of $13.00 over the exercise price per share subject to such option, less the amount of any tax withholding, (ii) each outstanding Integral stock option with an exercise price equal to or greater than $13.00 per share and each Integral in-the-money option the holder of which had not made the election described in (i) above, was converted into an option to purchase Company common stock, with the number of shares subject to such option adjusted to equal the number of shares of Integral common stock subject to such out-of-the-money option multiplied by 0.9559, rounded up to the nearest whole share, and the per share exercise price under each such option adjusted by dividing the per share exercise price under such option by 0.9559, rounded up to the nearest whole cent, and (iii) each outstanding share of restricted stock granted under an Integral equity plan or otherwise, whether vested or unvested, was cancelled and converted into the right to receive $13.00, less the amount of any tax withholding.

Integral is a global provider of products, systems and services for satellite command and control, telemetry and digital signal processing, data communications, enterprise network management and communications information assurance. Integral specializes in developing, managing and operating secure communications networks, both satellite and terrestrial, as well as systems and services to detect, characterize and geolocate sources of radio frequency interference. Integral’s customers include U.S. and foreign commercial, government, military and intelligence organizations. For almost 30 years, customers have relied on Integral to design and deliver innovative commercial-based products, solutions and services that are cost-effective and reduce delivery schedules and risk. Integral is part of the Company’s KGS segment.

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 value of the goodwill represents the value the Company expects to be created by Integral’s significant expertise with satellite operations, ground systems, signal processing and other areas of satellite command and control, and also advanced technologies for Unmanned Aerial Vehicles, situational awareness, remote management and numerous established electronic attack and electronic warfare platforms, tactical missile systems, and strategic deterrence systems. The Integral transaction has been accounted for using the acquisition method of accounting which requires, among other things, that the assets acquired and liabilities assumed be recognized at their fair values as of the merger date. The following table summarizes the preliminary fair values of major assets acquired and liabilities assumed (in millions):

Cash	$	6.8
Accounts receivable	68.4
Inventoried costs	15.8
Deferred tax assets	36.4
Other assets	3.5
Property and equipment	12.9
Intangible assets	32.0
Goodwill	187.9
Total assets	363.7
Current liabilities	(84.5		)
Deferred tax liabilities	(19.5		)
Long-term liabilities	(18.6		)
Net assets acquired	$	241.1

The goodwill recorded in this transaction is not tax deductible.

As of July 27, 2011, the expected fair value of accounts receivable approximated historical cost. The gross accounts receivable was $68.6 million, of which $0.2 million is not expected to be collectible. There were no contingent liabilities associated with the acquisition of Integral.

The amounts of revenue and operating income included in the Company’s consolidated statement of operations for the three months ended March 25, 2012 were $49.5 million and $1.0 million, respectively.

Herley Industries, Inc.

On March 25, 2011, the Company acquired approximately 13.2 million shares of Herley Industries, Inc. (“Herley”) common stock representing approximately 94% of the total outstanding shares of Herley common stock in a tender offer to purchase all of the outstanding shares of Herley common stock. The fair value of the non-controlling interest related to Herley as of March 25, 2011 was $16.9 million, which represents the market trading price of $19.00 per share multiplied by the approximately 0.9 million shares that were not tendered as of March 25, 2011. On March 30, 2011, following purchases of the remaining non-controlling interest in a subsequent offering period, Herley became a wholly owned subsidiary of the Company. The shares of Herley common stock were purchased at a price of $19.00 per share. Accordingly, the Company paid approximately $245.5 million in cash consideration as of March 27, 2011 and as of April 15, 2011 had paid total aggregate cash consideration of $270.7 million in respect of the shares of Herley common stock and certain in-the-money options, which were exercised upon the change in control of Herley. In addition, upon completion of the acquisition, all unexercised options to purchase Herley common stock were assumed by the Company and converted into options to purchase the Company’s common stock, entitling the holders thereof to receive 1.3495 shares of the Company’s common stock for each share of Herley common stock underlying the options (the “Herley Options”). The Company assumed each Herley Option in accordance with the terms (as in effect as of the date of the Herley merger agreement) of the applicable Herley equity plan and the option agreement pursuant to which such Herley Option was granted. The Herley Options are exercisable for an aggregate of approximately 0.8 million shares of the Company’s common stock. All Herley Options were fully vested upon the change in control and the fair value of the Herley Options assumed was $1.9 million. The total aggregate consideration for the purchase of Herley was $272.5 million. In addition, the Company assumed change in control obligations of $4.0 million related to the transaction and transaction expenses of $11.1 million. The final payment related to the change in control obligations of $0.6 million was paid in March 2012.

To fund the acquisition of Herley, on February 11, 2011, the Company sold approximately 4.9 million shares of its common stock at a purchase price of $13.25 per share in an underwritten public offering. The Company received gross proceeds of approximately $64.8 million and net proceeds of approximately $61.1 million after deducting underwriting fees and other offering expenses. The Company used the net proceeds from this offering to fund a portion of the purchase price for the acquisition of Herley and for general corporate purposes. To fund the remaining purchase price, the Company issued $285.0 million in aggregate principal amount of Notes at a premium of 107% through its wholly owned subsidiary, Acquisition Co. Lanza Parent (“Lanza”), on March 25, 2011, in an unregistered offering pursuant to Rule 144A and Regulation S under the Securities Act of 1933, as amended. On April 4, 2011, after the acquisition of Herley was complete, Lanza was merged with and into the Company and all assets and liabilities of Lanza became assets and liabilities of the Company. See Note 9 for a complete description of the Company’s debt.

Herley is a leading provider of microwave technologies for use in command and control systems, flight instrumentation, weapons sensors, radar, communication systems, electronic warfare and electronic attack systems. Herley has served the defense industry for approximately 45 years by designing and manufacturing microwave devices for use in high-technology defense electronics applications. It has established relationships, experience and expertise in the military electronics, electronic warfare and electronic attack industry. Herley’s products represent key components in the national security efforts of the U.S., as they are employed in mission-critical electronic warfare, electronic attack, electronic warfare threat and radar simulation, command and control network, and cyber warfare/cybersecurity applications. Herley is part of the Company’s KGS segment.

The Herley transaction has been accounted for using the acquisition method of accounting which requires, among other things, that the assets acquired and liabilities assumed be recognized at their fair values as of the merger date. The following table summarizes the fair values of major assets acquired and liabilities assumed (in millions):

Cash	$	21.8
Accounts receivable	39.1
Inventoried costs	42.8
Deferred tax assets	17.3
Other assets	7.2
Property and equipment	34.2
Intangible assets	37.0
Goodwill	146.4
Total assets	345.8
Current liabilities	(40.8		)
Deferred tax liabilities	(16.8		)
Debt	(9.5		)
Long-term liabilities	(6.2		)
Net assets acquired	$	272.5

The goodwill recorded in this transaction is not tax deductible.

As of March 25, 2011, the expected fair value of accounts receivable approximated historical cost. The gross accounts receivable was $39.3 million, of which $0.2 million is not expected to be collectible. There were no contingent liabilities associated with the acquisition of Herley. The Company initially recorded $47.9 million of inventory and $30.4 million in property and equipment. The Company decreased the value of acquired inventory to $42.8 million and increased the value of acquired property and equipment to $34.2 million based on its updated valuations during 2011.

The amounts of revenue and operating income included in the Company’s consolidated statement of operations for the three months ended March 25, 2012 were $47.3 million and $6.2 million, respectively.

In accordance with FASB ASC Topic 805, Business Combinations, (“Topic 805”) the allocation of the purchase price for the Company’s acquisitions of Integral, SecureInfo, and the Critical Infrastructure Business are subject to adjustment during the measurement period after the respective closing dates when additional information on asset and liability valuations become available. The above estimated fair values of assets acquired and liabilities assumed are provisional and are based on the information that was available as of the respective acquisition dates to estimate the fair value of assets acquired and liabilities assumed. Measurement period adjustments reflect new information obtained about facts and circumstances that existed as of the respective acquisition dates. The Company believes that information available provides a reasonable basis for estimating the fair values of assets acquired and liabilities assumed but the Company is waiting for additional information necessary to finalize those fair values. The Company has not finalized its valuation of certain assets and liabilities recorded in connection with these transactions, including, intangible assets, inventory, property and equipment and deferred taxes. Thus, the provisional measurements recorded are subject to change and any changes will be recorded as adjustments to the fair value of those assets and liabilities and residual amounts will be allocated to goodwill. The final valuation adjustments may also require adjustment to the consolidated statements of operations.

Pro Forma Financial Information

The following tables summarize the supplemental statements of operations information on an unaudited pro forma basis as if the acquisitions of SecureInfo, Integral, Herley, and the Critical Infrastructure Business occurred on December 27, 2010, and include adjustments that were directly attributable to the foregoing transactions or were not expected to have a continuing impact on the Company. All acquisitions except the acquisition of the Critical Infrastructure Business were included in the Company’s results of operations for the full three months ended March 25, 2012. The Critical Infrastructure Business was included in the Company’s results of operations as of December 30, 2011. There are no material, nonrecurring pro forma adjustments directly attributable to the business combinations included in the reported pro forma revenue and earnings for 2011. The pro forma results are for illustrative purposes only for the applicable period and do not purport to be indicative of the actual results which would have occurred had the transactions been completed as of the beginning of the period, nor are they indicative of results of operations which may occur in the future (all amounts, except per share amounts are in millions):

	For the Three Months Ended
	March 27, 2011
Pro forma revenues	$	244.4
Pro forma loss before tax	(35.4		)
Pro forma net loss	(34.4		)
Net loss attributable to the registrant	(3.8		)
Basic and diluted pro forma loss per share	$	(0.9	)

The pro forma results for the three month period ended March 27, 2011 include $5.8 million of acquisition related expenses. The pro forma financial information also reflects pro forma adjustments for the additional amortization associated with finite lived intangible assets acquired, additional incremental interest expense, deferred financing costs related to the financing undertaken for the Integral and Herley transactions, the change in stock compensation expense as a result of the exercise of stock options and restricted stock immediately prior to closing of the Integral and Herley transactions offset by stock-based compensation expense for stock options assumed, and the tax effect of the increased interest expense and intangible amortization. The weighted average common shares also reflect the issuance of 4.9 million shares in February 2011 for the Herley acquisition and 10.4 million shares in July 2011 for the Integral acquisition. These adjustments are as follows (in millions):

	For the Three Months Ended
	March 27, 2011
Intangible amortization	$	10.2
Net change in stock compensation expense	(3.0		)
Net change in interest expense	10.8
Net change in income tax benefit	(1.3		)
Increase in weighted average common shares outstanding for shares issued and not already included in the weighted average common shares outstanding	15.3

Contingent Acquisition Consideration

In connection with some of its acquisitions, the Company agreed to make additional future payments to the seller contingent upon achievement of specific performance-based milestones by the acquired entities. Pursuant to the provisions of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 805, Business Combinations (“Topic 805”), the Company will re-measure these liabilities each reporting period and record changes in the fair value in its consolidated statement of operations. Increases or decreases in the fair value of the contingent consideration liability can result from changes in discount periods and rates, as well as changes in the estimates on the achievement of the performance-based milestones.

A summary of contingent acquisition consideration as of December 25, 2011 and March 25, 2012 is summarized in the following table (in millions):

Balance as of December 25, 2011	$	7.6
Cash payments	(1.5		)
Balance as of March 25, 2012	$	6.1

As of March 25, 2012, $2.5 million is reflected in other current liabilities and $3.6 million is reflected in other long-term liabilities in the condensed consolidated balance sheet.

- Definition

The entire disclosure for a business combination (or series of individually immaterial business combinations) completed during the period, including background, timing, and recognized assets and liabilities. The disclosure may include leverage buyout transactions (as applicable).

+ References

Reference 1: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name Emerging Issues Task Force (EITF)
-Number 88-16
-LegacyDoc This reference is SUPERSEDED by the Accounting Standards Codification effective for interim and annual periods ending after September 15, 2009. This reference is included to help users transition from the previous accounting hierarchy and will be removed from future versions of this taxonomy.

Reference 2: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name Statement of Financial Accounting Standard (FAS)
-Number 141
-Paragraph 51, 52
-LegacyDoc This reference is SUPERSEDED by the Accounting Standards Codification effective for interim and annual periods ending after September 15, 2009. This reference is included to help users transition from the previous accounting hierarchy and will be removed from future versions of this taxonomy.

Reference 3: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name Statement of Financial Accounting Standard (FAS)
-Number 141R
-Appendix F
-Paragraph F4
-Subparagraph e

Reference 4: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name Statement of Financial Accounting Standard (FAS)
-Number 141R
-Paragraph 67-73
-LegacyDoc This reference is SUPERSEDED by the Accounting Standards Codification effective for interim and annual periods ending after September 15, 2009. This reference is included to help users transition from the previous accounting hierarchy and will be removed from future versions of this taxonomy.

Reference 5: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name Accounting Standards Codification
-Topic 805
-SubTopic 30
-Section 50
-Paragraph 1
-URI http://asc.fasb.org/extlink&oid=6911361&loc=d3e6927-128479

Reference 6: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name Accounting Standards Codification
-Topic 805
-SubTopic 10
-Section 50
-Paragraph 4
-URI http://asc.fasb.org/extlink&oid=6972119&loc=d3e1490-128463

Reference 7: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name Accounting Standards Codification
-Topic 805
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-URI http://asc.fasb.org/extlink&oid=6911361&loc=d3e7008-128479

Reference 8: http://www.xbrl.org/2003/role/presentationRef
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-Name Accounting Standards Codification
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Reference 9: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
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Reference 10: http://www.xbrl.org/2003/role/presentationRef
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Reference 11: http://www.xbrl.org/2003/role/presentationRef
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Reference 14: http://www.xbrl.org/2003/role/presentationRef
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Reference 17: http://www.xbrl.org/2003/role/presentationRef
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Reference 18: http://www.xbrl.org/2003/role/presentationRef
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Reference 19: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name Accounting Standards Codification
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-URI http://asc.fasb.org/extlink&oid=6972119&loc=d3e1383-128463

+ Details

Goodwill and Intangible Assets

3 Months Ended

Mar. 25, 2012

Goodwill and Intangible Assets

Goodwill and Intangible Assets

Note 3. Goodwill and Intangible Assets

(a) Goodwill

The Company performs its annual impairment test for goodwill in accordance with ASC Topic 350, Intangibles—Goodwill and Other (“Topic 350”) as of the last day of each fiscal year 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. For the annual and, if necessary, interim impairment assessment the Company identified its reporting units to be its KGS and PSS operating segments.

In order to test for potential impairment, the Company estimates the fair value of each of its 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 its reporting units based upon comparable market prices and recent transactions and also validates the reasonableness of the implied multiples from the income approach. The Company reconciles the fair value of its reporting units to its market capitalization by calculating its market capitalization based upon an average of its stock price prior to and subsequent to the date the Company performs its analysis and assuming a control premium. The Company uses these methodologies to determine the fair value of its reporting units for comparison to their corresponding book values because there are no observable inputs available (Level 3 hierarchy as defined by FASB ASC Topic 820 Fair Value Measurements and Disclosures (“Topic 820”)). If the book value exceeds the estimated fair value for a reporting unit, a potential impairment is indicated and Topic 350 prescribes the approach for determining the impairment amount, if any.

The changes in the carrying amount of goodwill for the three months ended March 25, 2012 are as follows (in millions):

	Public Safety & Security		Government Solutions			Total

Balance as of December 25, 2011	$	33.0	$	540.5		$	573.5
Retrospective adjustments	—		(0.3		)	(0.3		)
Balance as of December 25, 2011 after retrospective adjustments	33.0		540.2			573.2
Additions due to business combinations	3.8		—			3.8
Balance as of March 25, 2012	$	36.8	$	540.2		$	577.0

The accumulated impairment losses as of December 25, 2011 and March 25, 2012 were $165.4 million; $147.1 million associated with the KGS segment and $18.3 million associated with the PSS segment.

(b) Purchased Intangible Assets

The following table sets forth information for finite-life intangible assets subject to amortization (in millions):

	As of December 25, 2011							As of March 25, 2012
	Gross Value		Accumulated Amortization			Net Value		Gross Value		Accumulated Amortization			Net Value
Acquired finite-lived intangible assets:
Customer relationships	$	78.1	$	(19.8	)	$	58.3	$	79.2	$	(23.5	)	$	55.7
Contracts and backlog	60.1		(39.6		)	20.5		61.0		(45.7		)	15.3
Developed technology and technical know-how	22.1		(4.1		)	18.0		22.1		(4.7		)	17.4
Trade names	2.6		(0.8		)	1.8		2.6		(0.9		)	1.7
Favorable operating lease	1.8		(0.3		)	1.5		1.8		(0.3		)	1.5
Total	$	164.7	$	(64.6	)	$	100.1	$	166.7	$	(75.1	)	$	91.6

In addition to the finite-life intangible assets listed in the table above, the Company has $24.5 million of indefinite-life intangible assets consisting of trade names at both December 25, 2011 and March 25, 2012.

Consolidated amortization expense related to intangible assets subject to amortization was $3.4 million and $10.5 million for the three months ended March 27, 2011 and March 25, 2012, respectively.

The estimated future amortization expense of purchased intangible assets with finite lives as of March 25, 2012 is as follows (in millions):

Fiscal Year	Amount
2012 (remaining nine months)	$	25.4
2013	18.5
2014	16.8
2015	11.0
2016	6.3
Thereafter	13.6
Total	$	91.6

- Definition

The entire disclosure for the aggregate amount of goodwill and a description of intangible assets, which may include (a) for amortizable intangible assets (also referred to as finite-lived intangible assets), the carrying amount, the amount of any significant residual value, and the weighted-average amortization period, (b) for intangible assets not subject to amortization (also referred to as indefinite-lived intangible assets), the carrying amount, and (c) the amount of research and development assets acquired and written off in the period, including the line item in the income statement in which the amounts written off are aggregated, if not readily apparent from the income statement. Also discloses (a) for amortizable intangibles assets in total and by major class, the gross carrying amount and accumulated amortization, the total amortization expense for the period, and the estimated aggregate amortization expense for each of the five succeeding fiscal years, (b) for intangible assets not subject to amortization the carrying amount in total and by major class, and (c) for goodwill, in total and for each reportable segment, the changes in the carrying amount of goodwill during the period (including the aggregate amount of goodwill acquired, the aggregate amount of impairment losses recognized, and the amount of goodwill included in the gain (loss) on disposal of a reporting unit). If any part of goodwill has not been allocated to a reportable segment, discloses the unallocated amount and the reasons for not allocating. For each impairment loss recognized related to an intangible asset (excluding goodwill), discloses: (a) a description of the impaired intangible asset and the facts and circumstances leading to the impairment, (b) the amount of the impairment loss and the method for determining fair value, (c) the caption in the income statement or the statement of activities in which the impairment loss is aggregated, and (d) the segment in which the impaired intangible asset is reported. For each goodwill impairment loss recognized, discloses: (a) a description of the facts and circumstances leading to the impairment, (b) the amount of the impairment loss and the method of determining the fair value of the associated reporting unit, and (c) if a recognized impairment loss is an estimate not finalized and the reasons why the estimate is not final. May also disclose the nature and amount of any significant adjustments made to a previous estimate of an impairment loss.

+ References + Details

Balance Sheet Details

3 Months Ended

Mar. 25, 2012

Balance Sheet Details

Balance Sheet Details

Note 4. Balance Sheet Details

The detail of certain assets in the condensed consolidated balance sheets consists of the following (in millions).

Accounts receivable, net

Receivables including amounts due under long-term contracts are summarized as follows (in millions):

	December 25, 2011			March 25, 2012
Billed, current	$	131.5		$	144.0
Unbilled, current	121.1			117.5
Total current accounts receivable	252.6			261.5
Allowance for doubtful accounts	(2.0		)	(1.9		)
Total current accounts receivable, net	$	250.6		$	259.6

Unbilled receivables represent the balance of recoverable costs and accrued profit, comprised principally of revenue recognized on contracts for which billings have not been presented to the customer because the amounts were earned but not contractually billable as of the balance sheet date. Retainages receivables were $3.9 million as of December 25, 2011 and $4.9 million as of March 25, 2012 and are included in accounts receivable, net in the condensed consolidated balance sheets.

Inventoried costs, net of progress payments

Inventoried costs are stated at the lower of cost or market. Cost is determined using the average cost or first-in, first-out method and is applied consistently within an operating entity. Inventoried costs primarily relate to work in process under fixed-price contracts using costs as the basis of the percentage-of-completion calculation under the units produced method of revenue recognition. These costs represent accumulated contract costs less the portion of such costs allocated to delivered items. Accumulated contract costs include direct production costs, factory and engineering overhead and production tooling costs. 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 reflects those advances and payments as an offset against the related inventory balances.

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.

Inventoried costs consisted of the following components (in millions):

	December 25, 2011			March 25, 2012
Raw materials	$	45.3		$	48.6
Work in process	27.7			29.7
Finished goods	6.9			9.8
Supplies and other	4.0			1.1
Subtotal inventoried costs	83.9			89.2
Less customer advances and progress payments	(3.3		)	(1.8		)
Total inventoried costs	$	80.6		$	87.4

Stockholders' Equity

3 Months Ended

Mar. 25, 2012

Stockholders' Equity

Stockholders' Equity

Note 5. Stockholders’ Equity

On February 11, 2011, the Company sold approximately 4.9 million shares of its common stock at a purchase price of $13.25 per share in an underwritten public offering. The Company received gross proceeds of approximately $64.8 million. After deducting underwriting and other offering expenses, the Company received approximately $61.1 million in net proceeds.

A summary of the changes in stockholders’ equity is provided below (in millions):

	Three Months Ended March 27, 2011			Three Months Ended March 25, 2012
Stockholders’ equity at beginning of period	$	169.9		$	312.6
Comprehensive loss:
Net loss	(3.5		)	(3.0		)
Total comprehensive loss	(3.5		)	(3.0		)
Additional paid-in-capital from the issuance of common stock for cash	61.1			—
Fair value of options assumed in acquisitions	1.4			—
Stock-based compensation	0.6			1.1
Employee stock purchase plan and restricted stock units settled in cash	0.4			—
Exercise of stock options and warrants	1.1			—
Kratos Defense & Security Solutions, Inc. stockholders’ equity	231.0			310.7
Noncontrolling interest	16.9			—
Stockholders’ equity at end of period	$	247.9		$	310.7

In prior reporting periods, the Company had two classes of outstanding stock, Series B Convertible Preferred Stock and common stock. On March 8, 2011, all of the 10,000 shares of the previously issued and outstanding shares of Series B Convertible Preferred Stock were redeemed for 100,000 shares of common stock. Common stock issued by the Company for the three months ended March 27, 2011 and March 25, 2012, was as follows (in millions):

	Three Months Ended March 27, 2011	Three Months Ended March 25, 2012
Shares outstanding at beginning of the period	18.6	32.4
Stock issued for employee stock purchase plan, stock options and restricted stock units exercised	0.2	0.1
Redemption of Series B Convertible Preferred Stock	0.1	—
Common stock issued for cash	4.9	—
Shares outstanding at end of the period	23.8	32.5

- Definition

The entire disclosure for shareholders' equity, comprised of portions attributable to the parent entity and noncontrolling interest, if any, including other comprehensive income (as applicable). Including, but not limited to: (1) balances of common stock, preferred stock, additional paid-in capital, other capital and retained earnings; (2) accumulated balance for each classification of other comprehensive income and total amount of comprehensive income; (3) amount and nature of changes in separate accounts, including the number of shares authorized and outstanding, number of shares issued upon exercise and conversion, and for other comprehensive income, the adjustments for reclassifications to net income; (4) rights and privileges of each class of stock authorized; (5) basis of treasury stock, if other than cost, and amounts paid and accounting treatment for treasury stock purchased significantly in excess of market; (6) dividends paid or payable per share and in the aggregate for each class of stock for each period presented; (7) dividend restrictions and accumulated preferred dividends in arrears (in aggregate and per share amount); (8) retained earnings appropriations or restrictions, such as dividend restrictions; (9) impact of change in accounting principle, initial adoption of new accounting principle and correction of an error in previously issued financial statements; (10) shares held in trust for Employee Stock Ownership Plan (ESOP); (11) deferred compensation related to issuance of capital stock; (12) note received for issuance of stock; (13) unamortized discount on shares; (14) description, terms, and number of warrants or rights outstanding; (15) shares under subscription and subscription receivables, effective date of new retained earnings after quasi-reorganization and deficit eliminated by quasi-reorganization and, for a period of at least ten years after the effective date, the point in time from which the new retained dates; and (16) retroactive effective of subsequent change in capital structure.

+ References

Reference 1: http://www.xbrl.org/2003/role/presentationRef
-Publisher AICPA
-Name Accounting Principles Board Opinion (APB)
-Number 12
-Paragraph 10
-LegacyDoc This reference is SUPERSEDED by the Accounting Standards Codification effective for interim and annual periods ending after September 15, 2009. This reference is included to help users transition from the previous accounting hierarchy and will be removed from future versions of this taxonomy.

Reference 2: http://www.xbrl.org/2003/role/presentationRef
-Publisher SEC
-Name Regulation S-X (SX)
-Number 210
-Section 04
-Article 3

Reference 3: http://www.xbrl.org/2003/role/presentationRef
-Publisher SEC
-Name Regulation S-X (SX)
-Number 210
-Article 4
-Section 08
-Paragraph d

Reference 4: http://www.xbrl.org/2003/role/presentationRef
-Publisher AICPA
-Name Accounting Research Bulletin (ARB)
-Number 43
-Chapter 1
-Section B
-Paragraph 7, 11A
-LegacyDoc This reference is SUPERSEDED by the Accounting Standards Codification effective for interim and annual periods ending after September 15, 2009. This reference is included to help users transition from the previous accounting hierarchy and will be removed from future versions of this taxonomy.

Reference 5: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name Statement of Financial Accounting Standard (FAS)
-Number 129
-Paragraph 2, 3, 4, 5, 6, 7, 8
-LegacyDoc This reference is SUPERSEDED by the Accounting Standards Codification effective for interim and annual periods ending after September 15, 2009. This reference is included to help users transition from the previous accounting hierarchy and will be removed from future versions of this taxonomy.

Reference 6: http://www.xbrl.org/2003/role/presentationRef
-Publisher SEC
-Name Regulation S-X (SX)
-Number 210
-Section 08
-Article 4

Reference 7: http://www.xbrl.org/2003/role/presentationRef
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-Name Statement of Financial Accounting Standard (FAS)
-Number 5
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-LegacyDoc This reference is SUPERSEDED by the Accounting Standards Codification effective for interim and annual periods ending after September 15, 2009. This reference is included to help users transition from the previous accounting hierarchy and will be removed from future versions of this taxonomy.

Reference 8: http://www.xbrl.org/2003/role/presentationRef
-Publisher SEC
-Name Regulation S-X (SX)
-Number 210
-Section 02
-Paragraph 29, 30, 31
-Article 5

Reference 9: http://www.xbrl.org/2003/role/presentationRef
-Publisher SEC
-Name Staff Accounting Bulletin (SAB)
-Number Topic 4
-Section E

Reference 10: http://www.xbrl.org/2003/role/presentationRef
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-Name Staff Accounting Bulletin (SAB)
-Number Topic 4
-Section C

Reference 11: http://www.xbrl.org/2003/role/presentationRef
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-Name Accounting Standards Codification
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-SubTopic 10
-Section S99
-Paragraph 1
-Subparagraph (SX 210.3-04)
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+ Details

Net Loss Per Common Share

3 Months Ended

Mar. 25, 2012

Net Loss Per Common Share

Net Loss Per Common Share

Note 6. Net Loss Per Common Share

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

The following shares were excluded from the calculation of diluted income per share because their inclusion would have been anti-dilutive.

(In millions)	Three Months Ended March 27, 2011	Three Months Ended March 25, 2012
Shares from stock options and awards	0.9	2.8
Shares from preferred stock	0.1	—

Income Taxes

3 Months Ended

Mar. 25, 2012

Income Taxes

Income Taxes

Note 7. Income Taxes

As of December 25, 2011, the Company had $10.2 million of unrecognized tax benefits that if recognized would affect the effective tax rate, subject to possible offset by an increase in the valuation allowance. During the three months ended March 25, 2012, this amount was reduced by $0.1 million relating to the expiration of statutes of limitations. This reduction in unrecognized tax benefits was recorded as a tax benefit from discontinued operations. Additionally, the unrecognized tax benefit amount was reduced by $0.3 million as a result of the completion of an Internal Revenue Service (“IRS”) audit. This reduction in unrecognized tax benefits was recorded as a benefit from continuing operations.

During the first quarter of 2012, the Company decreased the unrecognized tax benefits of Integral by $0.2 million based on its updated analysis. The decrease in unrecognized tax benefits was recorded as an adjustment to goodwill. Integral’s unrecognized tax benefits are related to various federal tax issues.

The Company recognizes interest and penalties related to unrecognized tax benefits in its provision for income taxes. There was no material expense recorded during the three months ended March 27, 2011. During the three months ended March 25, 2012, a $0.2 million expense was recorded related to interest and penalties. The Company recorded a benefit for interest and penalties related to the reversal of prior positions of $0.7 million and $0.1 million for the three months ended March 27, 2011 and March 25, 2012, respectively. The Company believes that it is reasonably possible that as much as $1.5 million of the liabilities for uncertain tax positions will expire within 12 months of March 25, 2012 due to the expiration of various applicable statutes of limitations.

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 net operating loss (“NOL”) carryforwards. Generally, the Company’s tax years for 2002 and later are subject to examination by various foreign tax authorities.

In assessing the Company’s ability to realize deferred tax assets, management considers, on a periodic basis, whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. As such, management has determined that it is appropriate to maintain a full valuation allowance against the Company’s deferred tax assets, with the exception of an amount equal to its deferred tax liabilities which can be expected to reverse over a definite life. Management will continue to evaluate the necessity to maintain a valuation allowance against the Company’s net deferred tax asset.

A reconciliation of total income tax provision to the amount computed by applying the statutory federal income tax rate of 35% to loss from continuing operations before income tax provision for the three months ended March 27, 2011 and March 25, 2012 is as follows (in millions):

	For the Three Months Ended
	March 27, 2011			March 25, 2012
Income tax benefit at federal statutory rate	$	(1.8	)	$	(2.6	)
State and foreign taxes, net of federal tax benefit and valuation allowance	0.5			(4.0		)
Nondeductible expenses and other	0.9			0.4
Impact of indefinite lived deferred tax liabilities and state law changes	0.3			—
Decrease in reserves for uncertain tax position	(2.1		)	(0.1		)
Increase in federal valuation allowance	1.0			2.1
Total	$	(1.2	)	$	(4.2	)

Federal and state income tax laws impose restrictions on the utilization of NOL and tax credit carryforwards in the event that an “ownership change” occurs for tax purposes, as defined by Section 382 (“Section 382”) of the Internal Revenue Code (the “Code”). In general, an ownership change occurs when shareholders owning 5% or more of a “loss corporation” (a corporation entitled to use NOL 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 (which may be modified for certain recent increases to capital) at the time of the ownership change times the greater of the long-term tax-exempt rate determined by the Internal Revenue Service (“IRS”) in the month of the ownership change or the two preceding months. In March 2010, an “ownership change” occurred which will limit the utilization of the loss carryforwards. As a result, the Company’s federal annual utilization of NOL carryforwards will be limited to $28.1 million a year for the five years succeeding the ownership change and $11.6 million per year thereafter. If the entire limitation amount is not utilized in a year, any excess can be carried forward and utilized in future years. For the three months ended March 25, 2012, there was no impact of such limitations on the income tax provision since the amount of taxable income did not exceed the annual limitation amount. In addition, future equity offerings or acquisitions that have equity as a component of the purchase price could also result in an “ownership change”. If and when any other “ownership change” occurs, utilization of the NOL or other tax attributes may be further limited. As discussed elsewhere, deferred tax assets relating to the NOL and credit carryforwards are offset by a full valuation allowance. In addition, utilization of state tax loss carryforwards is dependent upon sufficient taxable income apportioned to the states.

- Definition

The entire disclosure for income taxes. Disclosures may include net deferred tax liability or asset recognized in an enterprise's statement of financial position, net change during the year in the total valuation allowance, approximate tax effect of each type of temporary difference and carryforward that gives rise to a significant portion of deferred tax liabilities and deferred tax assets, utilization of a tax carryback, and tax uncertainties information.

+ References

Reference 1: http://www.xbrl.org/2003/role/presentationRef
-Publisher SEC
-Name Regulation S-X (SX)
-Number 210
-Section 08
-Paragraph h
-Article 4

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-Name Statement of Financial Accounting Standard (FAS)
-Number 109
-Paragraph 136, 172
-LegacyDoc This reference is SUPERSEDED by the Accounting Standards Codification effective for interim and annual periods ending after September 15, 2009. This reference is included to help users transition from the previous accounting hierarchy and will be removed from future versions of this taxonomy.

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-Subparagraph (SX 210.4-08.(h))
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+ Details

Discontinued Operations

3 Months Ended

Mar. 25, 2012

Discontinued Operations

Discontinued Operations

Note 8. Discontinued Operations

The following is a summary of the liabilities of discontinued operations which are in other current liabilities and other long-term liabilities in the accompanying condensed consolidated balance sheets as of December 25, 2011 and March 25, 2012 (in millions):

	December 25, 2011		March 25, 2012
Accrued expenses	$	1.5	$	1.1
Other current liabilities	0.3		0.3
Current liabilities of discontinued operations	$	1.8	$	1.4
Non-current unrecognized tax benefits	$	0.5	$	—
Other non-current liabilities	—		0.4
Non-current liabilities of discontinued operations	$	0.5	$	0.4

- Definition

The entire disclosure for the facts and circumstances leading to the completed or expected disposal, manner and timing of disposal, the gain (loss) recognized in the income statement and the income statement caption that includes that gain (loss), amounts of revenues and pretax profit or loss reported in discontinued operations, the segment in which the disposal group was reported, and the classification (whether sold or classified as held for sale) and carrying value of the assets and liabilities comprising the disposal group. Includes all disposal groups, including those classified as components of the entity (discontinued operations).

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+ Details

Debt

3 Months Ended

Mar. 25, 2012

Debt

Debt

Note 9. Debt

(a) Issuance of 10% Senior Secured Notes due 2017

On May 19, 2010, the Company entered into an indenture with the guarantors set forth therein and Wilmington Trust FSB, as trustee and collateral agent (the “Indenture”), to issue the Notes. As of March 25, 2012, the Company has issued Notes in the aggregate principal amount of $625.0 million under the Indenture, of which $225.0 million were issued on May 19, 2010, $285.0 million were issued on March 25, 2011 at a $20.0 million premium and an effective interest rate of 8.5 %, and $115.0 million were issued on July 27, 2011 at a $5.8 million premium and an effective interest rate of 8.9%. These Notes have been used to fund acquisitions and for general corporate purposes. The holders of the Notes have a first priority lien on substantially all of the Company’s assets and the assets of the guarantors, except accounts receivable, inventory, deposit accounts, securities accounts, cash, securities and general intangibles (other than intellectual property) where the holders of the senior secured borrowings have a second priority lien to the $90.0 million credit facility described below.

The Company pays interest on the Notes semi-annually, in arrears, on June 1 and December 1 of each year. The Notes include customary covenants and events of default as well as a consolidated fixed charge ratio of 2.0:1.0 for the incurrence of additional indebtedness. Negative covenants include, among other things, limitations on additional debt, liens, negative pledges, investments, dividends, stock repurchases, asset sales and affiliate transactions. Events of default include, among other events, non-performance of covenants, breach of representations, cross-default to other material debt, bankruptcy, insolvency, material judgments and changes in control. As of March 25, 2012, the Company was in compliance with the covenants contained in the indentures related to the Notes.

On or after June 1, 2014, the Company may redeem some or all of the Notes at 105% of the aggregate principal amount of such Notes through June 1, 2015, 102.5% of the aggregate principal amount of such Notes through June 1, 2016 and 100% of the aggregate principal amount of such Notes thereafter, plus accrued and unpaid interest to the date of redemption. Prior to June 1, 2013, the Company may redeem up to 35% of the aggregate principal amount of the Notes at 110% of the aggregate principal amount of the Notes, plus accrued and unpaid interest to the redemption date, with the net cash proceeds of certain equity offerings. In addition, the Company may, at its option, redeem some or all of the Notes at any time prior to June 1, 2014, by paying a “make whole” premium, plus accrued and unpaid interest, if any, to the date of redemption. The Company may also purchase outstanding Notes traded on the open market at any time.

(b) Other Indebtedness

$90 Million Credit Facility

On July 27, 2011, the Company entered into a credit and security agreement with KeyBank National Association (“KeyBank”), as lead arranger, sole book runner and administrative agent, and East West Bank and Bank of the West, as the lenders (the “2011 Credit Agreement”). The 2011 Credit Agreement amends and restates in its entirety the credit and security agreement, dated as of May 19, 2010, by and among the Company, KeyBank and the lenders named therein (as amended). The 2011 Credit Agreement establishes a five year senior secured revolving credit facility in the amount of $65.0 million (the “Amended Revolver”). The Amended Revolver is secured by a lien on substantially all of the Company’s assets and the assets of the guarantors thereunder, subject to certain exceptions and permitted liens. The Amended Revolver has a first priority lien on accounts receivable, inventory, deposit accounts, securities accounts, cash, securities and general intangibles (other than intellectual property). On all other assets, the Amended Revolver has a second priority lien junior to the lien securing the Notes.

Borrowings under the Amended Revolver are subject to mandatory prepayment upon the occurrence of certain events, including the issuance of certain securities, the incurrence of certain debt and the sale or other disposition of certain assets. The Amended Revolver includes customary affirmative and negative covenants and events of default, as well as a financial covenant relating to a minimum fixed charge coverage ratio of 1.25. Negative covenants include, among other limitations, limitations on additional debt, liens, negative pledges, investments, dividends, stock repurchases, asset sales and affiliate transactions. Events of default include, among other events, non-performance of covenants, breach of representations, cross-default to other material debt, bankruptcy and insolvency, material judgments and changes in control.

On November 14, 2011, the Company entered into a First Amendment Agreement (the “Amendment Agreement”), with certain lenders and with KeyBank, that amended the 2011 Credit Agreement. Among other things, the Amendment Agreement: (i) increased the amount of the Amended Revolver from $65.0 million to $90.0 million; (ii) added to and modified the definitions of certain terms contained in the 2011 Credit Agreement; (iii) added PNC Bank, National Association as a lender under the 2011 Credit Agreement; and (iv) updated certain schedules to the 2011 Credit Agreement.

The amounts of borrowings that may be made under the Amended Revolver are based on a borrowing base and are comprised of specified percentages of eligible receivables, eligible unbilled receivables and eligible inventory. If the amount of borrowings outstanding under the Amended Revolver exceeds the borrowing base then in effect, the Company is required to repay such borrowings in an amount sufficient to eliminate such excess. The Amended Revolver includes $30.0 million of availability for letters of credit and $5.0 million of availability for swing line loans.

The Company may borrow funds under the Amended Revolver at a rate based either on LIBOR or a base rate established by KeyBank. Base rate borrowings bear interest at an applicable margin of 1.00% to 1.75% over the base rate (which will be the greater of the prime rate or 0.5% over the federal funds rate, with a floor of 1.0% over one month LIBOR). LIBOR rate borrowings will bear interest at an applicable margin of 3.00% to 3.75% over the LIBOR rate. The applicable margin for base rate borrowings and LIBOR borrowings will depend on the average monthly revolving credit availability. The Amended Revolver also has a commitment fee of 0.50% to 0.75%, depending on the average monthly revolving credit availability. As of March 25, 2012, there were no outstanding borrowings on the Amended Revolver and $16.4 million was outstanding on letters of credit resulting in net availability of $73.6 million. The Company was in compliance with the financial covenants as of March 25, 2012.

Debt Acquired in Acquisition of Herley

The Company assumed a $10.0 million ten-year term loan with a bank in Israel that Herley entered into on September 16, 2008 in connection with the acquisition of one of its wholly owned subsidiaries. The balance as of March 25, 2012 was $6.5 million, and the loan is payable in quarterly installments of $0.3 million plus interest at LIBOR plus a margin of 1.5%. The loan agreement contains various covenants including a minimum net equity covenant as defined in the loan agreement. The Company was in compliance with all covenants, including the minimum net equity covenant, as of March 25, 2012.

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 25, 2011 and March 25, 2012 are presented in the following table.

	As of December 25, 2011						As of March 25, 2012
$ in millions	Principal		Carrying Amount		Fair Value		Principal		Carrying Amount		Fair Value
Long-term debt	$	631.8	$	654.6	$	642.7	$	631.5	$	653.3	$	680.0

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) and it is the estimated amount the Company would have to pay to repurchase its debt, including any premium or discount attributable to the difference between the stated interest rate and market value of interest at the balance sheet date.

The net unamortized debt premium, of $21.8 million as of March 25, 2012, which is the difference between the carrying amount of $653.3 million and the principal amount of $631.5 million represented in the previous table, is being amortized to interest expense over the terms of the related debt.

- Definition

The entire disclosure for information about short-term and long-term debt arrangements, which includes amounts of borrowings under each line of credit, note payable, commercial paper issue, bonds indenture, debenture issue, own-share lending arrangements and any other contractual agreement to repay funds, and about the underlying arrangements, rationale for a classification as long-term, including repayment terms, interest rates, collateral provided, restrictions on use of assets and activities, whether or not in compliance with debt covenants, and other matters important to users of the financial statements, such as the effects of refinancing and noncompliance with debt covenants.

+ References + Details

Fair Value of Financial Instruments

3 Months Ended

Mar. 25, 2012

Fair Value of Financial Instruments

Fair Value of Financial Instruments

Note 10. Fair Value of Financial Instruments

The carrying amounts and the related estimated fair values of the Company’s long-term debt financial instruments not measured at fair value on a recurring basis at December 25, 2011 and March 25, 2012 are presented in Note 9. The carrying value of all other financial instruments, including cash and cash equivalents, accounts receivable, accounts payable and short-term debt, approximated their estimated fair values at December 25, 2011 and March 25, 2012.

Derivatives

3 Months Ended

Mar. 25, 2012

Derivatives

Derivatives

Note 11. Derivatives

The Company used derivative financial instruments, in particular, interest rate swaps, to reduce the Company’s exposure to certain previously outstanding variable rate debt. The primary objective of the interest rate swaps was to eliminate the variability of cash flows and interest rate risk for payments made on variable rate debt, the sole source of which is due to changes in the benchmark three month LIBOR interest rate. Changes in the cash flows of the interest rate swap were expected to exactly offset the changes in cash flows (i.e., changes in interest rate payments) attributable to fluctuations in the three month LIBOR on certain previously outstanding variable-rate debt.

The Company records derivatives at their fair value. The classification of gains and losses resulting from changes in the fair values of derivatives is dependent on the Company’s intended use of the derivative and its resulting designation as effective or ineffective. Adjustments to reflect changes in fair values of derivatives that the Company considers highly effective hedges are either reflected in earnings and largely offset by corresponding adjustments to the hedged items, or reflected net of income taxes in accumulated other comprehensive income (loss) until the hedged transaction is recognized in earnings, to the extent these derivatives are effective hedges. Changes in the fair value of these derivatives that are attributable to the ineffective portion of the hedges, or of derivatives that are not considered to be highly effective hedges, if any, are immediately recognized in earnings. There were no interest rate swaps outstanding as of and for the three months ended March 25, 2012.

The Company’s derivative financial instruments, which are cash flow hedges, were considered ineffective as a result of the interest rate floor that occurred with the first amendment of the first credit facility with KeyBank of $85.0 million, prior to March 3, 2010, in March 2008. The effect of marking the derivative instruments to market for the three months ended March 27, 2011 was income of $0.3 million. There were no derivative liabilities outstanding as of December 25, 2011 or March 25, 2012.

- Definition

The entire disclosure for the entity's entire derivative instruments and hedging activities. Describes an entity's risk management strategies, derivatives in hedging activities and non-hedging derivative instruments, the assets, obligations, liabilities, revenues and expenses arising therefrom, and the amounts of and methodologies and assumptions used in determining the amounts of such items.

+ References

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-Name Accounting Standards Codification
-Topic 815
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-Section 45
-Paragraph 1
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+ Details

Significant Customers

3 Months Ended

Mar. 25, 2012

Significant Customers

Significant Customers

Note 12. 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 segment has substantial revenue from the U.S. Government. Sales to the U.S. Government amounted to approximately $94.1 million and $143.5 million, or 77% and 67%, of total revenue for the three months ended March 27, 2011 and March 25, 2012, respectively.

The U.S. Government continues to focus on developing and implementing spending, tax, and other initiatives to reduce the deficit, create jobs, and stimulate the economy. Although defense spending is expected to remain a national priority within future federal budgets, the Budget Control Act of 2011 (“Budget Control Act”) committed the U.S. Government to reduce the federal deficit over the next ten years. Under the Budget Control Act the Bi-Partisan Congressional Joint Select Committee on Deficit Reduction (“the Joint Committee”) was responsible for identifying $1.2 to $1.5 trillion in deficit reductions by November 30, 2011. The Joint Committee was unable to identify the reductions by this deadline and thereby triggered a provision of the Budget Control Act called “sequestration” which requires very substantial automatic spending cuts which will start in 2013 and be split between defense and non-defense programs and continue over a nine-year period. Any automatic reductions in national defense programs could impact the Company’s significant customers. The impact of the Budget Control Act remains unknown and the Company’s business and industry could be adversely affected.

- Definition

The entire disclosure for any concentrations existing at the date of the financial statements that make an entity vulnerable to a reasonably possible, near-term, severe impact. This disclosure informs financial statement users about the general nature of the risk associated with the concentration, and may indicate the percentage of concentration risk as of the balance sheet date.

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+ Details

Segment Information

3 Months Ended

Mar. 25, 2012

Segment Information

Segment Information

Note 13. Segment Information

The Company operates in two principal business segments: Kratos Government Solutions and Public Safety & Security. The Company organizes its business segments based on the nature of the services offered. In the following table, total operating income of the 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 operating segments, and other miscellaneous corporate activities. Transactions between segments are generally negotiated and accounted for under terms and conditions similar to other government and commercial contracts.

Revenues, operating income and assets disclosed below provided by the Company’s segments for the three months ended March 27, 2011 and March 25, 2012 are as follows (in millions):

	Three months ended
	March 27, 2011			March 25, 2012
Revenues:
Kratos Government Solutions	$	97.4		$	174.4
Public Safety & Security	25.4			40.6
Total revenues	$	122.8		$	215.0
Depreciation and amortization:
Kratos Government Solutions	$	4.1		$	12.8
Public Safety & Security	0.7			0.9
Total depreciation and amortization	$	4.8		$	13.7
Operating income:
Kratos Government Solutions	$	6.6		$	9.0
Public Safety & Security	1.2			1.2
Unallocated corporate expense, net	(6.4		)	(2.0		)
Total operating income	$	1.4		$	8.2

Merger and acquisition expenses which were included in unallocated corporate expense, net for the three months ended March 27, 2011 and March 25, 2012 were $5.8 million and $0.9 million, respectively.

	As of December 25, 2011		As of March 25, 2012
Assets:
Kratos Government Solutions	$	1,041.1	$	1,028.2
Public Safety & Security	88.6		116.3
Corporate activities	86.4		92.9
Total assets	$	1,216.1	$	1,237.4

The increase in assets in the PSS segment is primarily attributable to the acquisition of assets on December 30, 2011.

- Definition

The entire disclosure for reporting segments including data and tables. Reportable segments include those that meet any of the following quantitative thresholds a) it's reported revenue, including sales to external customers and intersegment sales or transfers is 10 percent or more of the combined revenue, internal and external, of all operating segments b) the absolute amount of its reported profit or loss is 10 percent or more of the greater, in absolute amount of 1) the combined reported profit of all operating segments that did not report a loss or 2) the combined reported loss of all operating segments that did report a loss c) its assets are 10 percent or more of the combined assets of all operating segments.

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+ Details

Commitments and Contingencies

3 Months Ended

Mar. 25, 2012

Commitments and Contingencies

Commitments and Contingencies

Note 14. Commitments and Contingencies

(a) Legal Matters

For additional information regarding the Company’s legal proceedings, see Item 3, “Legal Proceedings” in the Form 10-K.

Integral, which the Company acquired on July 27, 2011, was previously the subject of a Securities and Exchange Commission (“SEC”) investigation. On July 30, 2009, the SEC and Integral each announced that a final administrative settlement had been reached concluding the SEC’s investigation.

In conjunction with its announcement of the administrative settlement, the SEC also disclosed that it was instituting separate civil actions against three former officers of Integral. Integral has indemnification obligations to these individuals, as well as other former directors and officers of Integral who may incur indemnifiable costs in connection with these actions, pursuant to the terms of separate indemnification agreements entered into with each of them effective as of December 4, 2002. As a result of the acquisition of Integral, the Company has assumed these indemnification obligations. The indemnification agreements each provide that, subject to certain terms and conditions, that the Company shall indemnify the individual to the fullest extent permissible by Maryland law against judgments, penalties, fines, settlements and reasonable expenses actually incurred in the event that the individual is made a party to a legal proceeding by reason of his or her present or prior service as an officer or employee of Integral, and shall also advance reasonable litigation expenses actually incurred subject to, among other conditions, receipt of a written undertaking to repay any costs or expenses advanced if it shall ultimately be determined that the individual has not met the standard of conduct required for indemnification under Maryland law. Certain costs and expenses were previously covered under Integral’s applicable directors and officers liability insurance policy. The policy limits were exhausted in 2011, and the Company is advancing payment of indemnifiable costs pursuant to the indemnification agreements.

From time to time, the Company may become involved in various claims, lawsuits and legal proceedings that arise in the ordinary course of business. However, litigation is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm the Company’s business. The Company is currently not aware of any such legal proceedings or claims that it believes will have, individually or in the aggregate, a material adverse effect on the Company’s business, financial condition, operating results or cash flows.

(b) Warranty

Certain of the Company’s products, product finishes, and services are covered by a warranty to be free from defects in material and workmanship for periods ranging from one to ten years. Optional extended warranty contracts can also be purchased with the revenue deferred and amortized over the extended warranty period. The Company accrues a warranty liability for estimated costs to provide products, parts or services to repair or replace products in satisfaction of warranty obligations. Warranty revenues related to extended warranty contracts are amortized to income, over the life of the contract, using the straight-line method. Costs under extended warranty contracts are expensed as incurred.

The Company’s estimate of costs to service its warranty obligations is based upon historical experience and expectations of future conditions. To the extent that the Company experiences any changes in warranty claim activity or costs associated with servicing those claims, its warranty liability is adjusted accordingly.

The changes in the Company’s aggregate product warranty liabilities, which are included in other current liabilities and other long term-liabilities on the Company’s condensed consolidated balance sheets, were as follows (in millions):

	Three months ended
	March 27, 2011			March 25, 2012
Balance at beginning of the period	$	1.1		$	4.3
Costs accrued and revenues deferred	0.2			0.2
Warranty liabilities assumed from acquisitions	1.4			0.5
Settlements made (in cash or kind) and revenues recognized	(0.2		)	(0.3		)
Balance at end of period	$	2.5		$	4.7

- Definition

The entire disclosure for commitments and contingencies.

+ References

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+ Details