# KRATOS DEFENSE & SECURITY SOLUTIONS, INC. (KTOS) FY 2023 MD&A

Verbatim Item 7 Management's Discussion and Analysis from KRATOS DEFENSE & SECURITY SOLUTIONS, INC.'s 10-K for fiscal year 2023.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1069258/000106925824000007/ktos-20231231.htm
Accession: 0001069258-24-000007
Filing date: 2024-02-13
Report date: 2023-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary. Published MD&A gate trimmed front/tail over-capture.
Confidence: high

Company profile: /company/KTOS/
All MD&A years: /company/KTOS/mda/
Previous year: /company/KTOS/mda/fy2022/ (FY 2022)
Next year: /company/KTOS/mda/fy2024/ (FY 2024)

Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations.

In addition to historical information, the following discussion contains forward-looking statements that are subject to risks and uncertainties. Our actual results may differ substantially from those expressed in or implied by any forward-looking statements herein due to a number of factors, including but not limited to the risks and uncertainties described in this Item 7, in Item 1A “Risk Factors” and elsewhere in this Annual Report. These forward-looking statements reflect our views and assumptions only as of the date such forward-looking statements are made. Except as required by law, we assume no responsibility for updating any forward-looking statements, whether as a result of new information, future events or otherwise.

The following discussion should be read in conjunction with our audited Consolidated Financial Statements and the related notes and other financial information appearing elsewhere in this Annual Report and other reports and filings made with the SEC. For discussion related to changes in financial condition and the results of operations for fiscal year 2022-related items, refer to Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 25, 2022, which was filed with the Securities and Exchange Commission on February 23, 2023.

Overview

Kratos is a technology, products, system and software company addressing the defense, national security, and commercial markets. Kratos makes true internally funded research, development, capital and other investments, to rapidly develop, produce and field solutions that address our customers’ mission critical needs and requirements. At Kratos, affordability is a technology, and we seek to utilize proven, leading edge approaches and technology, not unproven bleeding edge approaches or technology, with Kratos’ approach designed to reduce cost, schedule and risk, and enable us to be first to market with cost effective solutions. We believe that Kratos is known as an innovative disruptive change agent in the industry, a company that is an expert in designing products and systems up front for successful rapid, large quantity, low cost future manufacturing which is a value add competitive differentiator for our large traditional prime system integrator partners and also to our government and commercial customers. Kratos intends to pursue program and contract opportunities as the prime or lead contractor when we believe that our probability of win is high and any investment required by Kratos is within our capital resource comfort level. We intend to partner and team with a large, traditional system integrator when our assessment of probability of win is greater or required investment is beyond Kratos’ comfort level. Kratos’ primary business areas include, virtualized ground systems for satellites and space vehicles including software for command & control (C2) and telemetry, tracking and control (TT&C), jet powered unmanned aerial drone systems, hypersonic vehicles and rocket systems, propulsion systems for drones, missiles, loitering munitions, supersonic systems, space craft and launch systems, C5ISR and microwave electronic products for missile, radar, missile defense, space, satellite, counter UAS, directed energy, communication and other systems, and virtual & augmented reality training systems for the warfighter.

We believe that our technology, intellectual property, proprietary products, reputation and designed-in positions on our customers’ programs, platforms and systems, and our ability to rapidly develop, demonstrate and field affordable leading technology systems gives us a competitive advantage and creates a high barrier to entry into our markets. Our workforce is primarily engineering and technically oriented with a significant number of employees holding National Security clearances. Much of our work is performed at customer locations, facilities and sites, or in secure manufacturing and other facilities. Our primary end customers are National Security related agencies and large national and global commercial enterprises and entities. Our entire organization is focused on executing our strategy of being the leading technology and intellectual property based product and system company and being “first to market” in each of our industry leading core competency areas.

Our primary end customers are U.S. Government agencies, including the DoD, intelligence agencies, and other national and homeland security related agencies. We also conduct business with local, state and foreign governments and domestic and international commercial customers. In fiscal 2023, 2022 and 2021, we generated 69%, 69% and 70%, respectively, of our total revenues from contracts with the U.S. Government (including all branches of the U.S. military and including FMS), either as a prime contractor or a subcontractor. We believe our stable customer base, strong customer relationships, intellectual property, specialized and differentiated products, broad array of contract vehicles, “designed in” positions on strategic National Security platforms, our targeted investments in strategic growth areas, large employee base possessing specialized skills, security clearances, specialized manufacturing facilities and equipment, extensive list of past performance qualifications, and significant management and operational capabilities position us for success.

Industry Background

On March 9, 2023, President Biden’s fiscal year 2024 budget request was submitted to Congress, initiating the 2024 defense budget authorization and appropriations legislative process. The request includes an $886 billion proposed appropriation for national defense, of which $842 billion would be for the U.S. Department of Defense (“DoD”) base budget. The proposed legislation also caps national defense spending at $886 billion for fiscal year 2024 and $895 billion for fiscal year 2025. On June 3, 2023, President Biden signed into law a bill to suspend the $31.4 trillion debt ceiling through January 1, 2025.

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On July 14, 2023, the U.S. House of Representatives passed its version of a sweeping Bill setting Policy for the DoD, the Fiscal 2024 National Defense Authorization Act (“NDAA”), at $886 billion. The vote of 219-210 was largely along party lines, a departure from the typical bipartisan support for a bill that has passed every year since 1961. The Senate passed its version of the NDAA Bill on July 27, 2023 at $886 billion and included several significant differences from the previously passed U.S. House of Representative Bill. The NDAA is one of the major pieces of legislation Congress passes annually. The NDAA is closely watched by industry and other stakeholders and related interests, as the NDAA typically determines the specific spending outlays and purchases of the Department of Defense and other National Security related Agencies.

The two chambers of the legislative branch of the U.S. federal government (i.e. the House and Senate) continue the legislative process on the fiscal year 2024 budget. Congress is also expected to continue efforts to reschedule appropriations bills and conference agreements, but these actions depend on the Senate calendar. On January 19, 2024, President Biden signed a continuing resolution authorization (“CRA”) to continue funding the U.S Government. Under the bill, funding for agencies overseeing agriculture, veterans affairs, energy, transportation and housing runs through March 1, 2024. Funding for the rest of the federal government now runs through March 8, 2024, or if earlier, enactment of the Fiscal 2024 NDAA. Under such CRA, funding at amounts consistent with appropriated levels for fiscal year 2023 is available, subject to certain restrictions, but new contracts and program starts are not authorized. If Congress is not able to enact fiscal year 2024 appropriations bills or extend such CRA, the U.S government would be subject to a shutdown, which could result in program delays or, cancellations, payment issues and/or other disruptions.

The current budget environment, including Israel and Ukraine funding support, heightened levels of inflation, related supply chain disruption, and the appropriations process, continues to create significant short and long-term industry risks. Additionally, with the recent change of party in Congress in 2022, resulting with the Democrats controlling the Senate and the Presidency and the Republicans controlling the House of Representatives, considerable uncertainty exists regarding how future budgets, funding, timing and related program decisions will unfold, including the potential differing defense spending priorities of the Biden administration and of the Congress.

We believe continued budget pressures (which are expected), CRAs, (which are also expected), future Federal Government debt ceiling issues, or Federal Government shutdowns could have serious negative consequences for the security of our country and the defense industrial base, including the Company and the related customers, employees, suppliers, investors, and communities that rely on companies in the defense industrial base. It is likely that budget and program decisions made in such an uncertain environment would have long-term implications for our Company and the entire defense industry. Additionally, funding for certain programs, including those in which we currently participate, may be reduced, delayed or cancelled, and budget uncertainty or funding cuts globally could adversely affect the viability of our customers, partners, teammates, subcontractors, suppliers, and our employee base.

We believe that our business is well-positioned in areas that the DoD and other customers indicate are priorities for future defense spending, including those based on the 2022 National Security Strategy document, the 2023 U.S. National Security related budget and NDAA and the recently released fiscal 2024 National Security Budget request and NDAA, and also the related Future Years Defense Program or five year projection of the forces, resources and programs needed to support the DoD’s strategy and operations.

However, due to a divided Congress and Executive Branch, federal budgetary uncertainty, expected CRAs, potential budgetary restrictions or limitations, defense or other spending cuts, including the budgetary impacts of support for the conflicts in Israel and Ukraine, challenges in the appropriations process, the debt ceiling issue and ongoing fiscal debates, the short and long term impacts to the industry and to our business remain uncertain.

Such a challenging federal and DoD budgetary environment may negatively impact our customers, business and programs and could have a material adverse effect on our forecasts, estimates, financial position, results of operations and/or cash flows.

We continue to be affected by various unfavorable macroeconomic conditions including significant adverse supply chain disruptions that continue throughout the industry and for us, and related delays in the receipt and delivery of materials, parts, supplies, etc., which in certain instances and for certain items is significant. In addition, inflation and the related increased costs of inputs needed to execute our business, including materials, parts, supplies, consultants, subcontractors, vendors, etc. have significantly increased our business costs and have significantly adversely impacted our operations, profit margins and financial forecasts.

Also, a shortage of qualified labor, and the cost of that labor for the Company and its labor base is a significant operational challenge for the Company. The cost of labor has increased significantly and current challenges in hiring, obtaining

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and retaining employees, including those employees requiring National Security clearances, is adversely impacting Kratos’ ability to execute its business. There is also a significant industry wide labor shortage, including in the Science, Technology, Engineering, and Math (STEM) discipline areas, and also including employees willing and/or able to obtain National Security clearances, and for high level manufacturing and production disciplines.

In addition, recent actions by the Federal Reserve to increase interest rates have impacted our interest expense on our outstanding debt borrowings and the related cost of executing Kratos’ business. Each of these matters and issues are expected to continue for the foreseeable future and are expected to continue to adversely impact the Company’s operations, financial results and financial forecasts.

Our Consolidated Financial Statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations reflect estimates and assumptions made by management as of December 31, 2023. Events and changes in circumstances arising after December 31, 2023, including those resulting from the continuing impacts of the current unfavorable macroeconomic climate, will be reflected in management’s estimates for future periods.

Current Reporting Segments

We operate in two reportable segments. The KGS reportable segment is comprised of an aggregation of KGS operating segments, including its microwave electronic products, space, satellite and cyber, training solutions, C5ISR/modular systems, turbine technologies and defense and rocket support services operating segments. The US reportable segment consists of our unmanned aerial, unmanned ground and unmanned seaborne system products. Our KGS and US segments provide products, solutions and services for mission critical National Security programs. KGS and US customers primarily include National Security related agencies, the DoD, intelligence agencies and classified agencies, and to a lesser degree, international government agencies and domestic and international commercial customers. We organize our operating segments based primarily on the nature of the products, solutions and services offered. For additional information regarding our reportable segments, see Note 14 of the Notes to Consolidated Financial Statements. From a customer and solutions perspective, we view our business as an integrated whole, leveraging skills and assets wherever possible.

Key Financial Statement Concepts

As of December 31, 2023, we consider the following factors to be important in understanding our financial statements.

Our business with the U.S. Government and prime contractors is generally performed under fixed-price, cost reimbursable, or time and materials contracts. Cost reimbursable contracts for the U.S. Government provide for reimbursement of costs plus the payment of a fee. Some cost reimbursable contracts include award and incentive fees that are awarded based on performance on the contract. Under time and materials contracts, we are reimbursed for labor hours at negotiated hourly billing rates and reimbursed for travel and other direct expenses at actual costs plus applied general and administrative expenses.

For the majority of contracts, we satisfy the underlying performance obligations over time as the customer obtains control or receives benefits as work is performed on the contract. We generally recognize revenue over time as we perform on long-term contracts because of continuous transfer of control to the customer. For U.S. government contracts, this continuous transfer of control to the customer is supported by clauses in the contract that allow the customer to unilaterally terminate the contract for convenience, pay us for costs incurred plus a reasonable profit and take control of any work in process. Similarly, for non-U.S. government contracts, the customer typically controls the work in process as evidenced either by contractual termination clauses or by our rights to payment of the transaction price associated with work performed to date on products or services that do not have an alternative use to the Company. As a result, under ASC 606 revenue is recognized over time using the cost-to-cost method (cost incurred relative to total estimated cost at completion).

In accordance with ASC 606, we evaluate whether a contract with a customer exists by evaluating a number of criteria including whether collection of consideration is reasonably assured; comprehensive collection history; results of our communications with customers; the current financial position of the customer; and the relevant economic conditions in the customer’s country. If we have had no prior experience with the customer, we may review reports from various credit organizations to ensure that the customer has a history of paying its creditors in a reliable and effective manner. If the financial condition of our customers were to deteriorate and adversely affect their financial ability to make payments, allowances would be required.

We monitor our policies and procedures with respect to our contracts on a regular basis to ensure consistent application under similar terms and conditions as well as compliance with all applicable government regulations. In addition, costs incurred and allocated to contracts with the U.S. Government are routinely audited by the DCAA.

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We manage and assess the performance of our businesses based on our performance on individual contracts and programs obtained generally from government organizations. Due to the Federal Acquisition Regulation rules that govern our business, most types of costs are allowable, and we do not focus on individual cost groupings (such as cost of sales or general and administrative costs) as much as we do on total contract costs, which are a key factor in determining contract operating income. As a result, in evaluating our operating performance, we look primarily at changes in sales and service revenues and operating income, including the effects of significant changes in operating income. Changes in contract revenue and cost estimates are reviewed on a contract-by-contract basis and are revised periodically throughout the life of the contract such that adjustments to profit resulting from revisions are made cumulative to the date of the revision in accordance with accounting principles generally accepted in the U.S. (“GAAP”). Significant management judgments and estimates, including the estimated costs to complete the project, which determine the project’s percentage complete, must be made and used in connection with the revenue recognized in any accounting period. Material differences may result in the amount and timing of our revenue for any period if management makes different judgments or utilizes different estimates.

Results of Operations

Comparison of Results for the Year Ended December 31, 2023 to the Year Ended December 25, 2022

Revenues. Revenues by reportable segment for the years ended December 31, 2023 and December 25, 2022 are as follows (in millions):

[[GREPCENT_TABLE]]
[["","2023","","2022","","$ Change","","% Change"],["Kratos Government Solutions"],["Service revenues","$","395.9","","","$","320.0","","","$","75.9","","","23.7","%"],["Product sales","429.0","","","356.6","","","72.4","","","20.3","%"],["Total Kratos Government Solutions","824.9","","","676.6","","","148.3","","","21.9","%"],["Unmanned Systems"],["Service revenues","6.7","","","5.2","","","1.5","","","28.8","%"],["Product sales","205.5","","","216.5","","","(11.0)","","","(5.1)","%"],["Total Unmanned Systems","212.2","","","221.7","","","(9.5)","","","(4.3)","%"],["Total revenues","$","1,037.1","","","$","898.3","","","$","138.8","","","15.5","%"],["Total service revenues","$","402.6","","","$","325.2","","","$","77.4","","","23.8","%"],["Total product sales","634.5","","","573.1","","","61.4","","","10.7","%"],["Total revenues","$","1,037.1","","","$","898.3","","","$","138.8","","","15.5","%"]]
[[/GREPCENT_TABLE]]

Revenues increased $138.8 million to $1,037.1 million for the year ended December 31, 2023 from $898.3 million for the year ended December 25, 2022. Revenues in our KGS segment increased $148.3 million primarily due to a full year contribution of revenues from the acquisition of the Southern Research Institute’s Engineering Division (“SRE”), which increased $26.4 million, increased revenues in our space, satellite, training solutions and cyber business of $64.0 million, increases in our C5ISR, turbine technologies, and microwave electronics products businesses of $65.4 million, partially offset by an $7.5 million reduction of revenues in our defense and rocket support services. Revenues in our US segment decreased $9.5 million primarily due to a reduction in our tactical drone-based revenues, as compared to the twelve months ended December 25, 2022 offset with the contribution of $6.4 million in revenues from the recent acquisition of Sierra Technical Services, Inc. (“STS”).

Product sales increased $61.4 million to $634.5 million for the year ended December 31, 2023 from $573.1 million for the year ended December 25, 2022, primarily as a result of increased production activity in our KGS segment, offset partially by decreased volume in our US segment. As a percentage of total revenue, product sales were 61.2% for the year ended December 31, 2023, as compared to 63.8% for the year ended December 25, 2022. Service revenues increased by $77.4 million to $402.6 million for the year ended December 31, 2023, from $325.2 million for the year ended December 25, 2022. The increase was primarily a result of the recent SRE acquisition, as well as increased volume in the turbine technologies and space, satellite, training and cyber businesses.

Cost of revenues.  Cost of revenues increased to $768.5 million for the year ended December 31, 2023, from $672.3 million for the year ended December 25, 2022. The $96.2 million increase in cost of revenues was primarily a result of the overall increase in revenue discussed above.

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Gross margin percentage increased to 25.9% for the year ended December 31, 2023, compared to 25.2% for the year ended December 25, 2022. Margins on services decreased to 24.7% for the year ended December 31, 2023, from 26.5% for the year ended December 25, 2022. Margins on product sales increased to 26.7% for the year ended December 31, 2023, as compared to 24.4% for the year ended December 25, 2022. Margins in the KGS segment increased to 27.2% for the year ended December 31, 2023, from 26.8% for the year ended December 25, 2022. This change was primarily due to a more favorable mix of revenues for the year ended December 31, 2023. Margins in the US segment increased to 20.7% for the year ended December 31, 2023 from 20.1% for the year ended December 25, 2022. primarily due to a more favorable mix of products produced and shipped in the year ended December 31, 2023.

Selling, general and administrative expenses (SG&A).  SG&A increased $15.3 million to $197.8 million for the year ended December 31, 2023, from $182.5 million for the year ended December 25, 2022, primarily reflecting the increase in revenues. As a percentage of revenues, SG&A decreased to 19.1% for the year ended December 31, 2023 from 20.3% for the year ended December 25, 2022 due primarily to the increase in revenues in the year ended December 31, 2023.

Research and development (R&D) expenses. R&D expenses were $38.4 million for the year ended December 31, 2023 and $38.6 million for the year ended December 25, 2022, with the primary increases in expenses in our space and satellite communications business, offset by a net reduction in our unmanned systems business. As a percentage of revenues, R&D decreased to 3.7% of revenues for the year ended December 31, 2023, from 4.3% of revenues for the year ended December 25, 2022. R&D expenses are made by the Company, typically in conjunction with our customers, for the Company to achieve a “first to market” position with our products or technology. We also invest in R&D expenses to achieve market leading “designed in”and “first to market” positions on major programs, platforms or systems.

Restructuring expenses and other. Restructuring expenses and other decreased to $0.9 million for the year ended December 31, 2023 from $6.8 million for the year ended December 25, 2022, primarily as a result of the $5.5 million charge related to the litigation settlement of a dispute with an international customer in our US segment during the year ended December 25, 2022.

Total other expense, net. Other expense, net, decreased to $20.0 million from $30.1 million for the years ended December 31, 2023 and December 25, 2022, respectively. The decrease in other expense, net, of $10.1 million was primarily related to the $13.0 million loss on the extinguishment of our $300 million 6.5% Senior Secured Notes due November 2025 (“Senior Secured Notes”) during the year ended December 25, 2022, which was partially offset by a $2.8 million increase in interest expense for the year ended December 31, 2023 due to increased interest rates.

Provision for income taxes from continuing operations. The Company recorded an income tax provision of $8.9 million for the year ended December 31, 2023, and an income tax provision of $1.4 million for the year ended December 25, 2022. The income tax provision for 2022 includes a $4.9 million expense related to the increase in the Company’s valuation allowance on U.S. deferred tax assets related to certain state Net Operating Losses, capital loss carryforwards and federal research and development credits.

Income from discontinued operations. The income from discontinued operations was $0.2 million for the year ended December 31, 2023 and was $0.9 million for the year ended December 25, 2022, in each case primarily as a result of a gain from the release of an indemnification liability due to the lapse of the statute of limitations associated with a potential tax liability that was recorded in 2019 from the sale of PSS.

For a comparison of the Company’s results of operations for the fiscal year ended December 26, 2021 to the fiscal year ended December 25, 2022, see Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Company’s Annual Report on Form 10-K for the year ended December 25, 2022, which was filed with the U.S. Securities and Exchange Commission on February 23, 2023.

Liquidity and Capital Resources

As of December 31, 2023, we had cash and cash equivalents of $72.8 million compared with cash and cash equivalents of $81.3 million as of December 25, 2022, which includes $44.1 million and $18.9 million, respectively, of cash and cash equivalents held by our foreign subsidiaries. We are not presently aware of any restrictions on the repatriation of these funds; however, earnings of these foreign subsidiaries are essentially considered permanently invested in these foreign subsidiaries. If these funds were needed to fund our operations or satisfy obligations in the U.S. they could be repatriated, and their repatriation into the U.S. may cause us to incur additional foreign withholding taxes. We do not currently intend to repatriate these earnings.

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Our total long-term debt, decreased by $30.0 million to $227.5 million as of December 31, 2023 from $257.5 million as of December 25, 2022. On February 18, 2022, we completed the refinancing of our then-outstanding $90 million revolving credit facility and $300 million of Senior Secured Notes, with a new 5-year $200 million Revolving Credit Facility and 5-year $200 million Term Loan A issued pursuant to the 2022 Credit Facility. We incurred debt issuance costs of $3.3 million associated with the 2022 Credit Facility. We drew approximately $200 million under the Term Loan A and $100 million on the new Revolving Credit Facility at the time of the refinancing transaction (as more fully described in Note 5 of the accompanying Consolidated Financial Statements).

As of December 31, 2023, we have $192.5 million outstanding on the Term Loan A and net borrowings of $35.0 million outstanding on the Revolving Credit Facility, with $165.0 million remaining in borrowing capacity, less approximately $10.2 million for outstanding letters of credit.

We use our operating cash flow to finance trade accounts receivable, fund necessary increases in inventory and internal investments related to non-recurring engineering and software development, fund capital expenditures, fund our IR&D investments and our ongoing operations, service our debt and make strategic acquisitions. Financing trade accounts receivable is necessary because, on average, our customers do not pay us as quickly as we pay our vendors and employees for their goods and services since a number of our receivables are contractually billable and due to us only when certain contractual milestones are achieved, certain of which are not achieved until final shipment and acceptance of our products. Financing increases in inventory balances is necessary to fulfill shipment requirements to meet delivery schedules of our customers. Cash from continuing operations is primarily derived from our customer contracts in progress and associated changes in working capital components. Our days sales outstanding (“DSO”) have decreased to 116 days as of December 31, 2023 from 134 days as of December 25, 2022. Our DSOs are impacted by the achievement of contractual billing milestones, such as equipment shipments and deliveries on certain products, and for certain flight requirements that must be fulfilled on certain aerial target programs, or final billings which are not due until completion on certain projects, and therefore we are unable to contractually bill for amounts outstanding related to those milestones at this time.

In November 2019, a large training solutions program was terminated for convenience (“T for C”) by the customer. Under a T for C, a contractor is entitled to seek specified costs through a termination settlement process including (1) the contract price for completed supplies and services accepted by the government but not previously paid for; (2) the cost incurred in the performance of work terminated plus a reasonable profit on those costs; and (3) the costs incurred in settling with subcontractors and preparing and settling the termination proposal. However, we will not be able to collect the total withheld amounts until the settlement terms of the T for C have been negotiated and agreed to with the customer. At December 31, 2023, approximately $4.8 million in unbilled receivables remain outstanding on this project, which is subject to negotiation and settlement with the customer.

A summary of our net cash provided by (used in) operating activities from continuing operations from our Consolidated Statements of Cash Flows is as follows (in millions): 

[[GREPCENT_TABLE]]
[["","Year Ended"],["","December 31, 2023","","December 25, 2022"],["Net cash provided by (used in) operating activities from continuing operations","$","65.2","","","$","(25.6)"]]
[[/GREPCENT_TABLE]]

Our net cash provided by operating activities from continuing operations was $65.2 million for the year ended December 31, 2023, primarily as a result of the net income from continuing operations of $2.2 million and noncash charges of $74.2 million partially offset by changes in net working capital accounts of $11.2 million, which included customer advanced payments reflected as an increase in Billings in Excess of Costs of $28.4 million. Net cash used in operating activities from continuing operations was $25.6 million for the year ended December 25, 2022, primarily as a result of net loss from continuing operations of $34.1 million, and changes in working capital requirements of $74.9 million, including increases in receivables and inventory balances reflecting advance payments to mitigate supply chain disruptions, and internal investments we are making in certain rocket motors and software products of approximately $16.7 million, partially offset by noncash charges of $83.4 million.

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    Our net cash used in investing activities from continuing operations is summarized as follows (in millions): 

[[GREPCENT_TABLE]]
[["","Year Ended"],["","December 31, 2023","","December 25, 2022"],["Investing activities:"],["Cash paid for acquisitions, net of cash acquired","$","0.3","","","$","(132.2)"],["Proceeds from sale of assets","8.3","","","0.2"],["Capital expenditures","(52.4)","","","(45.4)"],["Net cash used in investing activities from continuing operations","$","(43.8)","","","$","(177.4)"]]
[[/GREPCENT_TABLE]]

    Net cash used in investing activities from continuing operations for year ended December 31, 2023 is comprised of $52.4 million in capital expenditures partially offset by the receipt of $8.3 million of proceeds from the sale of Valkyries which had been previously booked as capital assets as they were produced ahead of government contract award and $0.3 million cash acquired related to the acquisition of STS. Net cash used in investing activities from continuing operations for the year ended December 25, 2022 was comprised of $74.0 million related to the acquisition of SRE, $37.5 million related to the acquisition of Cosmic, $15.3 million for the remaining purchase price due on the acquisition of CTT, and a $5.4 million payment due under the acquisition agreement for KTT Core, of which we purchased a controlling interest in February 2019. During the year ended December 31, 2023, capital expenditures of approximately $25.1 million were incurred in our US business, primarily related to our unmanned combat target initiative. We expect our capital expenditures for our fiscal year 2024 to continue to be significant for investments we are making, including in our US business totaling approximately $28 to $32 million, including approximately $18 to $22 million for capital aerial targets and related support equipment.

Our net cash used in financing activities from continuing operations is summarized as follows (in millions): 

[[GREPCENT_TABLE]]
[["","Year Ended"],["","December 31, 2023","","December 25, 2022"],["Financing activities:"],["Proceeds from the issuance of long-term debt","$","\u2014","","","$","200.0"],["Borrowings under credit facility","69.0","","","100.0"],["Redemption of Senior Secured Notes","\u2014","","","(309.8)"],["Repayments under credit facility, term loan and other debt","(101.0)","","","(42.5)"],["Payments of employee taxes withheld from share-based awards","(3.7)","","","(12.5)"],["Debt issuance costs","\u2014","","","(3.3)"],["Payments under finance leases","(1.5)","","","(1.4)"],["Proceeds from shares issued under equity plans","6.5","","","6.2"],["Net cash used in financing activities from continuing operations","$","(30.7)","","","$","(63.3)"]]
[[/GREPCENT_TABLE]]

Net cash used in financing activities from continuing operations was $30.7 million for the year ended December 31, 2023, which included $5.0 million of principal payments on our $200 million Term Loan A, a $94.0 million payment (partially offset by a $69.0 million draw) on the new Revolving Credit Facility, and a $2.0 million payment to settle debt acquired related to the STS acquisition, payroll withholding taxes paid from vested restricted stock traded for taxes of $3.7 million and payments made on financing lease obligations of $1.5 million. These uses were partially offset by employee stock purchase plan receipts of $6.5 million. Net cash used in financing activities from continuing operations was $63.3 million for the year ended December 25, 2022, which included $309.8 million used to redeem our $300 million of Senior Secured Notes including the call premium of $9.8 million, debt issuance costs of $3.3 million, payroll withholding taxes paid from vested restricted stock traded for taxes of $12.5 million and payments made on financing lease obligations of $1.4 million. These uses were partially offset by $300 million in proceeds from our 2022 Credit Facility (partially offset by $2.5 million of principal payments on our $200 million Term Loan A and a $40 million payment on the new Revolving Credit Facility) and employee stock purchase plan receipts of $6.2 million.

2022 Credit Facility

On February 18, 2022, the Company completed the refinancing of its then-outstanding $90 million revolving credit facility and Senior Secured Notes, with the 2022 Credit Facility. The Company incurred debt issuance costs of $3.3 million

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associated with the 2022 Credit Facility. During the year ended December 31, 2023, the Company made $5.0 million of principal payments on Term Loan A. As of December 31, 2023, the Company has net borrowings of approximately $35.0 million outstanding on the new Revolving Credit Facility, with $165.0 million remaining in borrowing capacity, less approximately $10.2 million of letters of credit outstanding.

On February 18, 2022, the proceeds of $300 million from the 2022 Credit Facility, along with cash funded by the Company for the 3.25% call premium to redeem the Company’s outstanding Senior Secured Notes, plus accrued interest, was distributed to the trustee for redemption of the Senior Secured Notes. The redemption of the Company’s then-outstanding $300 million 6.5% Senior Secured Notes due November 2025 closed on March 14, 2022, for an amount of cash equal to 103.25% of the principal amount thereof plus accrued and unpaid interest thereon. The Company incurred a loss on the extinguishment of debt of $9.8 million related to the call premium on the Senior Secured Notes and the write-off of $3.2 million of unamortized debt issuance costs, resulting in a total loss on extinguishment of debt of $13.0 million.

The 2022 Credit Facility is governed by a Credit Agreement (the “Credit Agreement”), dated February 18, 2022, by and among the Company, the lenders from time to time party thereto (the “Lenders”), the Issuing Banks party thereto (as defined in the Credit Agreement) and Truist Bank, in its capacity as administrative agent for the Lenders, and as an issuing bank and as the swing line lender, which establishes the 5-year senior secured credit facility which is comprised of the $200 million Revolving Credit Facility (which includes sub-facilities for the incurrence of up to $10.0 million of swingline loans and the issuance of up to $50.0 million of Letters of Credit) and the $200 million Term Loan A. The Credit Agreement contemplates uncommitted incremental credit facilities of up to $200 million (which amount would be reduced by the aggregate amount of any and all incremental credit facilities actually established under the Credit Agreement) plus additional uncommitted incremental capacity subject to a limitation based on the Company’s pro forma total net leverage ratio (including any such additional uncommitted incremental capacity).

Borrowings under the revolving credit facility and the term loan credit facility may take the form of base rate loans or Secured Overnight Financing Rate (“SOFR”) loans. Base rate loans under the Credit Agreement will bear interest at a rate per annum equal to the sum of the Applicable Margin (as defined in the Credit Agreement) from time to time in effect plus the highest of (i) the Agent’s (as defined in the Credit Agreement) prime lending rate, as in effect at such time, (ii) the Federal Funds Rate (as defined in the Credit Agreement), as in effect at such time, plus 0.50%, (iii) the Adjusted Term SOFR (as defined in the Credit Agreement) for a one-month tenor in effect on such day, plus 1.00% and (iv) 1.00%. SOFR loans will bear interest at a rate per annum equal to the sum of the Applicable Margin from time to time in effect plus the Adjusted Term SOFR for an Interest Period (as defined in the Credit Agreement) selected by the Company of one, three or six months. The Applicable Margin varies between 1.25% and 2.25% per annum for SOFR loans and between 0.25% and 1.25% per annum for base rate loans, and is based on the Company’s total net leverage ratio from time to time.

Mandatory amortization on the Term Loan A is 2.5% in each of the first and second years and 5.0% in each of the third, fourth and fifth years, with the remaining outstanding balance due at maturity. The Credit Agreement contains certain covenants, which include, but are not limited to, restrictions on indebtedness, liens, fundamental changes, restricted payments, asset sales, and investments, and places limits on various other payments. The Company was in compliance with the covenants contained in the Credit Agreement as of December 31, 2023.

On April 28, 2023, the Company entered into an interest rate swap contract to hedge U.S. dollar-one month Term SOFR in order to fix the interest rate movements associated with the Company’s Term Loan A. The initial hedge amount was $195.0 million and amortizes in accordance with Term Loan A. The swap is at a fixed rate one-month term SOFR of 3.721% and settles monthly on the last day of each calendar month. The swap has an effective date of May 1, 2023 and terminates on May 1, 2026.

Other Liquidity Matters

The following is a discussion of how we expect to fund our short- and long-term liquidity needs from known contractual and other obligations.

The majority of our revenue is derived from contracts and programs that can span several years. We enter into agreements with suppliers and subcontractors for goods and services in support of these contracts and programs with payment terms that are generally aligned with the payment terms from our customers. In some instances, we require advance payments or deposits from our customers, which help fund our purchase commitments and reduce the risk of customer performance.

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As of December 31, 2023, we had contractual commitments to repay debt, make payments under finance and operating leases, repay obligations related to agreements to purchase goods and services and settle tax and other liabilities. The following table summarizes our contractual obligations and other commitments as of December 31, 2023, and the effect such obligations could have on our liquidity and cash flow in future periods (in millions):

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[[/GREPCENT_TABLE]]

As of December 31, 2023, we have $10.2 million of standby letters of credit outstanding. Our letters of credit are primarily related to milestone payments received from foreign customers for which the customer has not yet received the product. Information regarding our debt payments and lease agreements can be found in Notes 5 and 6 to the Consolidated Financial Statements contained in this Annual Report. Additional information regarding our financial commitments is provided in the Note 15 to Consolidated Financial Statements contained in this Annual Report.

We believe our cash on hand, together with funds available under the 2022 Credit Facility and cash expected to be generated from operating activities will be sufficient to fund our short- and long-term liquidity needs. As discussed in Item 1A “Risk Factors” contained within this Annual Report, our quarterly and annual operating results have fluctuated in the past and may vary in the future due to a variety of factors, many of which are external to our control. If the conditions in our industry deteriorate, our customers cancel or postpone projects or if we are unable to sufficiently increase our revenues or further reduce our expenses, we may experience, in the future, a significant long-term negative impact to our financial results and cash flows from operations. In such a situation, we could fall out of compliance with our financial and other covenants which, if not waived, could limit our liquidity and capital resources.

Critical Accounting Principles and Estimates

The preparation of our Consolidated Financial Statements in conformity with GAAP requires us to make estimates and judgments that affect the reported amounts of assets and liabilities, stockholders’ equity, revenues and expenses, and related disclosures of contingent assets and liabilities. On a periodic basis, as deemed necessary, we evaluate our estimates, including those related to revenue recognition, valuation of inventory including the reserves for excess and obsolete inventory, valuation of long-lived assets including identifiable intangibles and goodwill, accounting for income taxes including the related valuation allowance, warranties, contingencies and litigation, contingent acquisition consideration, and losses on unused office space. We explain these accounting policies in the Notes to Consolidated Financial Statements contained within this Annual Report and at relevant sections in this discussion and analysis. These estimates are based on the information that is currently available and on various other assumptions that are believed to be reasonable under the circumstances. Actual results could vary from those estimates under different assumptions or conditions and such differences may be material. We have identified the following critical accounting policies that affect our more significant judgments and estimates used in the preparation of our Consolidated Financial Statements.

Revenue recognition. Effective January 1, 2018, we adopted the FASB ASU 2014-09, Revenue from Contracts with Customers, and the related amendments, which are codified into Accounting Standards Codification (“ASC”) 606 (“ASC 606”).

To determine revenue recognition for arrangements that we determine are within the scope of ASC 606, we perform the following five steps: (i) identify the contract(s) with a customer; (ii) identify the performance obligation(s) in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligation(s) in the contract; and (v) recognize revenue when (or as) the entity satisfies a performance obligation. Once the contract is identified and determined to be within the scope of ASC 606, we assess the goods or services promised within each contract and determine those that are performance obligations, and assess whether each promised good or service is distinct. We then recognize as revenue the amount of the transaction price that is allocated to the respective performance obligation when (or as) the performance obligation is satisfied.

A performance obligation is a promise in a contract to transfer a distinct good or service to the customer and is the unit of account under ASC 606. The majority of our contracts have a single performance obligation as the promise to transfer the

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individual goods or services is not separately identifiable from other promises in the contracts and, therefore, not distinct. For contracts with multiple performance obligations, we allocate the contract’s transaction price to each performance obligation using the best estimate of the standalone selling price of each distinct good or service in the contract. The primary method used to estimate standalone selling price is the expected-cost-plus-margin approach, under which we forecast the expected costs of satisfying a performance obligation and then add an appropriate margin for that distinct good or service.

For the majority of contracts, we satisfy the underlying performance obligations over time as the customer obtains control or receives benefits as work is performed on the contract. We generally recognize revenue over time as we perform on long-term contracts because of continuous transfer of control to the customer. For U.S. government contracts, this continuous transfer of control to the customer is supported by clauses in the contract that allow the customer to unilaterally terminate the contract for convenience, pay us for costs incurred plus a reasonable profit and take control of any work in process. Similarly, for non-U.S. government contracts, the customer typically controls the work in process as evidenced either by contractual termination clauses or by our rights to payment of the transaction price associated with work performed to date on products or services that do not have an alternative use to the Company. As a result, under ASC 606 revenue is recognized over time using the percentage-of-completion cost-to-cost method (cost incurred relative to total estimated cost at completion).

For our federal contracts, we apply U.S. Government procurement and accounting standards in assessing the allowability and the allocability of costs to contracts. Due to the significance of the judgments and estimation processes, it is likely that materially different amounts could be recorded if we used different assumptions or if the underlying circumstances were to change. We closely monitor compliance with, and the consistent application of, our critical accounting policies related to contract accounting. Business operations personnel conduct periodic contract status and performance reviews. When adjustments in estimated contract revenues or costs are required, any changes from prior estimates are included in earnings in the current period. Also, regular and recurring evaluations of contract cost, scheduling and technical matters are performed by management personnel who are independent from the business operations personnel performing work under the contract. Costs incurred and allocated to contracts with the U.S. Government are scrutinized for compliance with regulatory standards by our personnel, and are subject to audit by the DCAA.

Long-lived and Intangible Assets. We account for long-lived assets in accordance with the provisions of FASB ASC Topic 360, Property, Plant, and Equipment (“Topic 360”). Topic 360 addresses financial accounting and reporting for the impairment or disposal of long-lived assets and requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability is measured by comparing the carrying amount of an asset to the expected future net cash flows generated by the asset. If it is determined that the asset may not be recoverable and if the carrying amount of an asset exceeds its estimated fair value, an impairment charge is recognized to the extent of the difference. Topic 360 requires companies to separately report discontinued operations, including components of an entity that either have been disposed of (by sale, abandonment or in a distribution to owners) or classified as held for sale. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.

In accordance with Topic 360, we assess the impairment of identifiable intangibles and long-lived assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors we consider important which could individually or in combination trigger an impairment review, include the following:

•significant underperformance relative to expected historical or projected future operating results;

•significant changes in the manner of our use of the acquired assets or the strategy for our overall business;

•significant negative industry or economic trends;

•significant decline in our stock price for a sustained period; and

•our market capitalization relative to net book value.

If we determined that the carrying value of intangibles and long-lived assets may not be recoverable based upon the existence of one or more of the above indicators of impairment, we would record an impairment equal to the excess of the carrying amount of the asset over its estimated fair value.

Goodwill. The purchase price of an acquired business is allocated to the underlying tangible and intangible assets acquired and liabilities assumed based upon their respective fair values, with the excess recorded as goodwill. Such fair value assessments require judgments and estimates that can be affected by contract performance and other factors over time, which may cause final amounts to differ materially from original estimates.

We perform our impairment test for goodwill in accordance with ASC Topic 350, Intangibles-Goodwill and Other (“Topic 350”). We assess goodwill for impairment at the reporting unit level, which is defined as an operating segment or one level below an operating segment, referred to as a component. We determine our reporting units by first identifying our

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operating segments, and then assessing whether any components of these segments constitute a business for which discrete financial information is available and where segment management regularly reviews the operating results of that component. We aggregate components within an operating segment that have similar economic characteristics.

KGS has five operating businesses: Defense and Rocket Support Systems (“DRSS”), Microwave Electronics (“ME”), Space, Training and Cybersecurity Solutions (“ST&C”), C5ISR Systems/Modular Systems (“MS”), and Kratos Turbine Technologies (“KTT”), that provide technology based defense solutions, involving products and services, primarily for mission critical U.S. National Security priorities, with the primary focus relating to the nation’s C5ISR requirements. The US reportable segment provides unmanned aerial systems, unmanned ground, and unmanned seaborne systems. We have identified our reporting units to be the DRSS, ME, ST&C, MS, and KTT operating segments, within the KGS reportable segment, and the US reportable segment, each of which has been assessed and evaluated for potential impairment in our fiscal year 2023 annual test.

We test goodwill for impairment by first performing a qualitative assessment, and then a quantitative assessment if necessary. If, after performing a qualitative assessment and after assessing the totality of events or circumstances such as macroeconomic, industry and market conditions, cost factors, and overall financial performance, we determine that it is more likely than not (that is, a likelihood of more than 50 percent) that the fair value of a reporting unit is greater than its carrying amount, then a quantitative assessment is not unnecessary. If, after performing a qualitative assessment we determine it is more likely than not that the fair value of a reporting unit is less than its carrying amount, including goodwill, then a quantitative assessment is performed to determine if an impairment exists. For operations where a quantitative assessment is performed, the identification and measurement of impairment involves the estimation of the fair value of reporting units to determine the amount of the impairment. When any impairment has occurred, a charge to operations is recorded. In order to test for potential impairment, we estimate the fair value of each of the impacted reporting units based on a comparison and weighting of the income approach, specifically the discounted cash flow (“DCF”) method and the market approach, which estimates the fair value of our reporting units based upon comparable market prices and recent transactions and also validates the reasonableness of the implied multiples from the income approach.

In testing for impairment of our goodwill using a quantitative assessment at a particular reporting unit, we make assumptions about the amount and timing of future expected cash flows, terminal growth rates, appropriate discount rates, market multiples, and the control premium a controlling shareholder could be expected to pay:

•The timing of future cash flows within our DCF analysis is based on our most recent forecasts and other estimates. Our historical growth rates and operating results are not indicative of our projected growth rates and operating results as a consequence of our acquisitions and divestitures.

•The terminal growth rate is used to calculate the value of cash flows beyond the last projected period in our DCF analysis and reflects our best estimates for stable, perpetual growth of our reporting units.

•We use estimates of market participant weighted average cost of capital (“WACC”) as a basis for determining the discount rates to apply to our reporting units’ future expected cash flows. The significant assumptions within our WACC are: (a) equity risk premium, (b) beta, (c) size premium adjustments, (d) cost of debt and (e) capital structure assumptions. In addition, we may use a company specific risk adjustment which is a subjective adjustment that, by its very nature does not include market related data, but instead examines the prospects of the reporting unit relative to the broader industry to determine if there are specific factors, which may make it more “risky” relative to the industry.

•Recent historical market multiples are used to estimate future market pricing.

The carrying value of goodwill of the US and KGS reportable segments, was $125.0 million and $444.1 million, respectively, at December 31, 2023.

In determining the fair value of our reporting units, there are key assumptions related to our future operating performance and revenue growth. If the actual operating performance and financial results are not consistent with our assumptions, an impairment in our $569.1 million goodwill and $62.4 million long-lived intangibles could occur in future periods. In particular, the US reporting unit fair value includes assumptions that the development of the high performance UCAS product is successful and we are awarded future contracts for new tactical unmanned aircraft systems. Additionally, the US reporting unit fair value assumes that the U.S. Navy will continue to award full rate production contracts for the Sub-Sonic Aerial Target. Additional risks for goodwill across all reporting units include, but are not limited to, the risks discussed in Item 1A “Risk Factors” contained within this Annual Report and:

•a decline in our stock price and resulting market capitalization, if we determine the decline is sustained and is indicative of a reduction in the fair value below the carrying value of our reporting units;

•a decrease in available government funding, including budgetary constraints affecting U.S. Government spending generally, or specific departments or agencies;

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•changes in U.S. Government programs or requirements, including the increased use of small business providers;

•our failure to reach our internal forecasts could impact our ability to achieve our forecasted levels of cash flows and reduce the estimated discounted value of our reporting units;

•volatility in equity and debt markets resulting in higher discount rates;

•market and political factors that could impact the success of new products, especially related to new unmanned systems platforms;

•continued impact to our businesses and the industry resulting from COVID-19; and

•continued impact to our businesses and the industry related to supply chain disruptions and inflation.

Accounting for income taxes and tax contingencies. FASB ASC Topic 740, Income Taxes (“Topic 740”) provides the accounting treatment for uncertainty in income taxes recognized in an enterprise’s financial statements. Topic 740 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Topic 740 also provides guidance on derecognizing, classification, interest and penalties, accounting in interim periods, disclosure and transition.

As part of the process of preparing our Consolidated Financial Statements, we are required to estimate our provision for income taxes in each of the tax jurisdictions in which we conduct business. This process involves estimating our actual current tax expense in conjunction with the evaluation and measurement of temporary differences resulting from differing treatment of certain items for tax and accounting purposes. These temporary differences result in the establishment of deferred tax assets and liabilities, which are recorded on a net basis. We then assess on a periodic basis the probability that our net deferred tax assets will be recovered and therefore realized from future taxable income and to the extent we believe that recovery is not more likely than not, a valuation allowance is established to address such risk resulting in an additional related provision for income taxes during the period.

Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities, tax contingencies, unrecognized tax benefits, and any required valuation allowance, including taking into consideration the probability of the tax contingencies being incurred. Management assesses this probability based upon information provided to us by our tax advisers, our legal advisers and similar tax cases. If at a later time our assessment of the probability of these tax contingencies changes, our accrual for such tax uncertainties may increase or decrease. During the fourth quarter of 2020, the Company released a significant portion of the valuation allowance. For further discussion see Note 8 “Income Taxes” in the Notes to the Consolidated Financial Statements in this Annual Report.

The effective tax rate at December 31, 2023 for annual and interim reporting periods could be impacted if uncertain tax positions that are not recognized at December 31, 2023 are settled at an amount which differs from our estimate.

Contingencies and litigation. We are currently involved in certain legal proceedings. We estimate a range of liability related to pending litigation where the amount and range of loss can be estimated. We record our estimate of a loss when the loss is considered probable and reasonably estimable. Where a liability is probable and there is a range of estimated loss and no amount in the range is more likely than any other number in the range, we record the minimum estimated liability related to the claim in accordance with FASB ASC Topic 450, Contingencies. As additional information becomes available, we assess the potential liability related to our pending litigation and revise our estimates. Revisions in our estimates of potential liability could materially impact our results of operations. See Note 15 of the Notes to Consolidated Financial Statements contained within this Annual Report for a further discussion of our legal proceedings.

Recent Accounting Pronouncements

See Note 1 of the Notes to Consolidated Financial Statements contained within this Annual Report for a discussion of recent accounting pronouncements.