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Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
 
      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the Quarterly Period Ended June 28, 2020
or 
        TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________ 
Commission file number 001-34460
 
KRATOS DEFENSE & SECURITY SOLUTIONS, INC.
(Exact name of registrant as specified in its charter)
Delaware13-3818604
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer Identification No.)
10680 Treena St., Suite 600
San Diego, CA 92131
(858812-7300
(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 classTrading Symbol(s)Name of each exchange on which registered
Common Stock, $0.001 par valueKTOSThe NASDAQ Global Select Market
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes ý  No o
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).   Yes ý  No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
ý
Accelerated filer
 
Non-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.  o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes   No 
As of July 31, 2020, 122,718,510 shares of the registrant’s common stock were outstanding.


Table of Contents
KRATOS DEFENSE & SECURITY SOLUTIONS, INC.
 
FORM 10-Q
 
FOR THE QUARTERLY PERIOD ENDED JUNE 28, 2020
 
INDEX
  Page
  
   
  
 
  
 
 
 
  
  
  
  
 
  
  
  
  
  
  
  
2

Table of Contents
PART I. FINANCIAL INFORMATION

Item 1.  Financial Statements.
3

Table of Contents
KRATOS DEFENSE & SECURITY SOLUTIONS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
 (in millions, except par value and number of shares)
 June 28, 2020
(Unaudited)December 29, 2019
Assets  
Current assets:  
Cash and cash equivalents$397.2  $172.6  
Accounts receivable, net59.8  85.0  
Unbilled receivables, net186.4  179.4  
Inventoried costs66.9  61.1  
Prepaid expenses14.6  9.4  
Other current assets19.6  11.4  
Current assets of discontinued operations0.5  3.3  
Total current assets745.0  522.2  
Property, plant and equipment, net122.3  116.9  
Operating lease right-of-use assets38.0  42.1  
Goodwill465.5  455.6  
Intangible assets, net39.2  39.5  
Other assets9.2  9.7  
Total assets$1,419.2  $1,186.0  
Liabilities and Stockholders Equity
  
Current liabilities:  
Accounts payable$44.9  $53.8  
Accrued expenses28.5  32.7  
Accrued compensation38.8  37.1  
Accrued interest1.6  1.6  
Billings in excess of costs and earnings on uncompleted contracts34.4  34.3  
Current portion of operating lease liabilities8.3  9.9  
Other current liabilities10.5  10.0  
Current liabilities of discontinued operations3.0  3.3  
Total current liabilities170.0  182.7  
Long-term debt295.9  295.1  
Operating lease liabilities, net of current portion34.3  37.6  
Other long-term liabilities77.0  78.7  
Long-term liabilities of discontinued operations2.6  2.8  
Total liabilities579.8  596.9  
Commitments and contingencies (Note 15)
Redeemable noncontrolling interest14.9  15.0  
Stockholders equity:
  
Preferred stock, $0.001 par value, 5,000,000 shares authorized, 0 shares outstanding at June 28, 2020 and December 29, 2019
    
Common stock, $0.001 par value, 195,000,000 shares authorized; 122,510,125 and 106,635,508 shares issued and outstanding at June 28, 2020 and December 29, 2019, respectively
    
Additional paid-in capital1,537.9  1,286.5  
Accumulated other comprehensive loss(0.5) (0.4) 
Accumulated deficit(712.9) (712.0) 
Total stockholders equity
824.5  574.1  
Total liabilities and stockholders equity
$1,419.2  $1,186.0  
The accompanying notes are an integral part of these condensed consolidated financial statements.
4

Table of Contents
KRATOS DEFENSE & SECURITY SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(in millions, except per share amounts)
 (Unaudited)
 Three Months EndedSix Months Ended
 June 28, 2020June 30, 2019June 28, 2020June 30, 2019
Service revenues$62.9  $73.7  $126.5  $136.3  
Product sales107.5  114.2  212.8  212.0  
Total revenues170.4  187.9  339.3  348.3  
Cost of service revenues46.2  50.6  91.4  92.6  
Cost of product sales78.2  89.2  156.1  162.7  
Total costs124.4  139.8  247.5  255.3  
Gross profit46.0  48.1  91.8  93.0  
Selling, general and administrative expenses36.0  33.7  70.9  65.2  
Merger and acquisition expenses1.0  0.6  1.4  1.8  
Research and development expenses6.0  4.5  11.7  8.4  
Restructuring expenses and other0.1  0.3  0.2  0.4  
Operating income from continuing operations2.9  9.0  7.6  17.2  
Other expense:    
Interest expense, net(5.6) (5.3) (11.0) (10.8) 
Other income (expense), net0.3  0.1  (0.2) (0.4) 
Total other expense, net(5.3) (5.2) (11.2) (11.2) 
Income (loss) from continuing operations before income taxes(2.4) 3.8  (3.6) 6.0  
Provision (benefit) for income taxes from continuing operations(1.8) 2.5  (3.2) 1.0  
Income (loss) from continuing operations(0.6) 1.3  (0.4) 5.0  
Discontinued operations:
Income (loss) from operations of discontinued component(0.4) 2.9  (0.8) 2.4  
Income tax benefit0.2  0.1  0.2    
Income (loss) from discontinued operations(0.2) 3.0  (0.6) 2.4  
Net income (loss)(0.8) 4.3  (1.0) 7.4  
Less: Net income (loss) attributable to noncontrolling interest(0.1) 0.4  (0.1) 0.4  
Net income (loss) attributable to Kratos$(0.7) $3.9  $(0.9) $7.0  
Basic income (loss) per common share attributable to Kratos:    
Income (loss) from continuing operations$(0.01) $0.01  $  $0.04  
Income (loss) from discontinued operations  0.03  (0.01) 0.02  
Net income (loss) per common share$(0.01) $0.04  $(0.01) $0.06  
Diluted income (loss) per common share attributable to Kratos:
Income (loss) from continuing operations$(0.01) $0.01  $  $0.04  
Income (loss) from discontinued operations  0.03  (0.01) 0.02  
Net income (loss) per common share$(0.01) $0.04  $(0.01) $0.06  
Weighted average common shares outstanding:
Basic108.3  106.1  107.8  105.5  
Diluted108.3  109.4  107.8  108.6  
Comprehensive Income (Loss)
Net income (loss) (from above)$(0.8) $4.3  $(1.0) $7.4  
Change in cumulative translation adjustment(0.3) (0.1) (0.1) (0.1) 
Comprehensive income (loss)(1.1) 4.2  (1.1) 7.3  
Less: Comprehensive income (loss) attributable to noncontrolling interest(0.1) 0.4  (0.1) 0.4  
Comprehensive income (loss) attributable to Kratos$(1.0) $3.8  $(1.0) $6.9  
 
The accompanying notes are an integral part of these condensed consolidated financial statements.
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KRATOS DEFENSE & SECURITY SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
For the three months ended June 30, 2019 and June 28, 2020
(in millions)
(Unaudited)
Redeemable Noncontrolling InterestCommon StockAdditional Paid-In CapitalAccumulated Other Comprehensive LossAccumulated DeficitTotal Stockholders’ Equity
SharesAmounts
Balance, March 31, 2019$15.0  $105.9  $  $1,275.0  $(0.7) $(721.4) $552.9  
Stock-based compensation—  —  —  2.8  —  —  2.8  
Net income0.4  —  —  —  —  3.9  3.9  
Other comprehensive loss, net of tax—  —  —  —  (0.1) —  (0.1) 
Balance, June 30, 2019$15.4  105.9  $  $1,277.8  $(0.8) $(717.5) $559.5  
Redeemable Noncontrolling InterestCommon StockAdditional Paid-In CapitalAccumulated Other Comprehensive LossAccumulated DeficitTotal Stockholders’ Equity
SharesAmounts
Balance, March 29, 2020$15.0  107.0  $  $1,292.6  $(0.2) $(712.2) $580.2  
Stock-based compensation—  —  —  4.8  —  —  4.8  
Issuance of common stock for cash
—  15.5  —  240.5  —  —  240.5  
Net loss(0.1) —  —  —  —  (0.7) (0.7) 
Other comprehensive loss, net of tax—  —  —  —  (0.3) —  (0.3) 
Balance, June 28, 2020$14.9  122.5  $  $1,537.9  $(0.5) $(712.9) $824.5  
The accompanying notes are an integral part of these condensed consolidated financial statements.

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KRATOS DEFENSE & SECURITY SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
For the six months ended June 30, 2019 and June 28, 2020
(in millions)
(Unaudited)
Redeemable Noncontrolling InterestCommon StockAdditional Paid-In CapitalAccumulated Other Comprehensive LossAccumulated DeficitTotal Stockholders’ Equity
SharesAmounts
Balance, December 30, 2018$  103.8  $  $1,244.5  $(0.7) $(724.5) $519.3  
Stock-based compensation—  —  —  5.4  —  —  5.4  
Issuance of common stock for employee stock purchase plan, options and warrants
—  0.2  —  1.7  —  —  1.7  
Restricted stock issued and related taxes—  0.1  —  (0.8) —  —  (0.8) 
Issuance of common stock for acquisitions
—  1.8  —  27.0  —  —  27.0  
Net income0.4  —  —  —  —  7.0  7.0  
Other comprehensive loss, net of tax
—  —  —  —  (0.1) —  (0.1) 
Changes in noncontrolling interest15.0  —  —  —  —  —  —  
Balance, June 30, 201915.4  105.9  $  $1,277.8  $(0.8) $(717.5) $559.5  
Redeemable Noncontrolling InterestCommon StockAdditional Paid-In CapitalAccumulated Other Comprehensive LossAccumulated DeficitTotal Stockholders’ Equity
SharesAmounts
Balance, December 29, 2019$15.0  106.6  $  $1,286.5  $(0.4) $(712.0) $574.1  
Stock-based compensation—  —  —  9.5  —  —  9.5  
Issuance of common stock for employee stock purchase plan, options and warrants
—  0.2  —  2.6  —  —  2.6  
Restricted stock issued and related taxes
—  0.2  —  (1.2) —  —  (1.2) 
Issuance of common stock for cash—  15.5  —  240.5  —  —  240.5  
Net loss(0.1) —  —  —  —  (0.9) (0.9) 
Other comprehensive loss, net of tax
—  —  —  —  (0.1) —  (0.1) 
Balance, June 28, 2020$14.9  122.5  $  $1,537.9  $(0.5) $(712.9) $824.5  
The accompanying notes are an integral part of these condensed consolidated financial statements.
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KRATOS DEFENSE & SECURITY SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions)
(Unaudited)
Six Months Ended
June 28, 2020June 30, 2019
Operating activities: 
Net income (loss)$(1.0) $7.4  
Income (loss) from discontinued operations(0.6) 2.4  
Income (loss) from continuing operations(0.4) 5.0  
Adjustments to reconcile income (loss) from continuing operations to net cash provided by operating activities from continuing operations:  
Depreciation and amortization12.3  11.1  
Amortization of lease right-of-use assets5.3  5.4  
Stock-based compensation9.5  5.4  
Deferred income taxes(1.1) (3.1) 
Amortization of deferred financing costs0.5  0.5  
Provision for doubtful accounts0.2    
Changes in assets and liabilities, net of acquisitions:  
Accounts receivable24.7  4.4  
Unbilled receivables(6.8) 8.6  
Inventoried costs(4.5) (16.3) 
Prepaid expenses and other assets(10.8) (0.4) 
Operating lease liabilities(6.0) 0.8  
Accounts payable(9.1) 3.6  
Accrued expenses(4.2)   
Accrued compensation1.4  (2.1) 
Advance payments received on contracts  0.1  
Billings in excess of costs and earnings on uncompleted contracts(0.5) 2.0  
Income tax receivable and payable(3.0) 1.2  
Other liabilities3.3  (6.2) 
Net cash provided by operating activities from continuing operations10.8  20.0  
Investing activities:  
Cash paid for acquisitions, net of cash acquired(15.5) (17.6) 
Capital expenditures(14.1) (9.8) 
Proceeds from sale of assets0.1    
Net cash used in investing activities from continuing operations(29.5) (27.4) 
Financing activities: 
Proceeds from the issuance of common stock, net of issuance costs240.5    
Repayment of debt(0.1)   
Payments under finance leases(0.3) (0.2) 
Proceeds from exercise of restricted stock units, employee stock options, and employee stock purchase plan1.4  0.9  
Net cash provided by financing activities from continuing operations241.5  0.7  
Net cash flows of continuing operations222.8  (6.7) 
Net operating cash flows of discontinued operations1.7    
Effect of exchange rate changes on cash, cash equivalents and restricted cash0.1  (0.1) 
Net increase (decrease) in cash, cash equivalents and restricted cash224.6  (6.8) 
Cash, cash equivalents and restricted cash at beginning of period172.6  183.0  
Cash, cash equivalents and restricted cash at end of period$397.2  $176.2  
The accompanying notes are an integral part of these condensed consolidated financial statements.
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KRATOS DEFENSE & SECURITY SOLUTIONS, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
(Unaudited)
 
Note 1. Summary of Significant Accounting Policies
 
All references to the “Company” and “Kratos” refer to Kratos Defense & Security Solutions, Inc., a Delaware corporation, and its subsidiaries.
 
(a) Basis of Presentation

 The information as of June 28, 2020 and for the three and six months ended June 28, 2020 and June 30, 2019 is unaudited. The condensed consolidated balance sheet as of December 29, 2019 was derived from the Company’s audited consolidated financial statements at that date. In the opinion of management, these unaudited condensed consolidated financial statements include all adjustments, consisting of normal recurring adjustments necessary for a fair presentation of the Company’s financial position, results of operations and cash flows for the interim periods presented. The results have been prepared in accordance with the instructions to Form 10-Q and do not necessarily include all information and footnotes necessary for presentation in accordance with accounting principles generally accepted in the U.S. (“GAAP”). These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the related notes included in the Company’s audited annual consolidated financial statements for the fiscal year ended December 29, 2019, included in the Company’s Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission (the “SEC”) on February 24, 2020 (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, its 100% owned subsidiaries and its majority owned subsidiaries, FTT Inc. and FTT Core (each as defined below), each of which is 80.1% owned. All inter-company transactions have been eliminated in consolidation. Noncontrolling interest consists of the remaining 19.9% interest in FTT Inc. and FTT Core. See Note 12 for further information related to the redeemable noncontrolling interest.
 
(c) Fiscal Year
 
The Company has a 52/53 week fiscal year ending on the last Sunday of the calendar year. The three month periods ended June 28, 2020 and June 30, 2019 consisted of 13-week periods. The six month periods ended June 28, 2020 and June 30, 2019 consisted of 26-week periods. There are 52 calendar weeks in the fiscal years ending on December 27, 2020 and December 29, 2019.
 
(d) Accounting Estimates

There have been no significant changes in the Company’s accounting estimates for the six months ended June 28, 2020 as compared to the accounting estimates described in the Form 10-K.

(e) Accounting Standards Updates

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 unaudited condensed consolidated financial statements.

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(f) Fair Value of Financial Instruments
 
The carrying amounts and the related estimated fair values of the Company’s long-term debt financial instruments not measured at fair value on a recurring basis at June 28, 2020 and December 29, 2019 are presented in Note 10. The carrying value of all other financial instruments, including cash equivalents, accounts receivable, unbilled receivables, accounts payable, accrued expenses, billings in excess of cost and earnings on uncompleted contracts, income taxes payable and short-term debt, approximated their estimated fair values at June 28, 2020 and December 29, 2019 due to the short-term nature of these instruments.

Note 2. Acquisitions

FTT Entities

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). During the six months ended June 28, 2020, approximately $4.8 million of the remaining purchase price was paid.

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 Kratos Turbine Technologies Division (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. The KTT Division is included in the Kratos Government Solutions (“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 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”), subject to adjustment 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 the trailing 12 months EBITDA of the Acquired Companies), 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
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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 $8.1  
Unbilled receivables4.9  
Inventoried costs7.8  
Other current assets1.8  
Property and equipment5.7  
Intangible assets30.8  
Goodwill23.3  
  Total identifiable net assets acquired82.4  
Total identifiable net liabilities assumed(7.5) 
  Net assets before noncontrolling interest74.9  
Noncontrolling interest(14.9) 
  Net assets acquired, excluding cash $60.0  

As of February 27, 2019, net liabilities included $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 two years, and trade name of $0.5 million with a useful life of two 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 amounts of revenue and operating income of FTT included in the Company's condensed consolidated statement of operations for the three months ended June 30, 2019 were $17.2 million and $1.6 million, respectively. The amounts of revenue and operating income of FTT included in the Company's condensed consolidated statement of operations for the six months ended June 30, 2019 were $21.4 million and $1.7 million, respectively. Included in the merger and acquisition expenses for the three and six months ended June 30, 2019 were transaction expenses of $0.1 million and $1.3 million, respectively, related to the acquisition of FTT.

A summary of the consideration paid for the acquired ownership in FTT is as follow:
Cash paid$20.7  
Deferred purchase consideration15.3