KRATOS DEFENSE & SECURITY SOLUTIONS, INC. 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
Overview
Kratos is a government contractor at the forefront of theDoD's recapitalization of strategic weapon systems to address peer and near peer threats and its related Rapid Innovation Initiatives. Kratos is a leading technology, intellectual property, proprietary product and system company focused on theU.S. and its allies' national security. Kratos is a recognized industry leader in the rapid development, demonstration and fielding of disruptive, transformative and high technology systems and products at an affordable cost. At Kratos, affordability is a technology. Kratos' primary focus areas are unmanned systems, space and satellite communications, microwave electronics, cybersecurity/warfare, rocket, hypersonic and missile defense systems, turbine technologies, C5ISR Systems and training systems. We believe that our technology, intellectual property, proprietary products and designed-in positions on our customers' programs, platforms and systems, and our ability to rapidly develop, demonstrate and field affordable leading technology systems gives us a competitive advantage. We believe that our extensive past performance qualifications and demonstrated ability to meet or exceed our customers' demanding requirements creates a high barrier to entry into our markets. Our workforce is primarily engineering and technically oriented with a significant number of Kratos employees holding national 45 -------------------------------------------------------------------------------- security clearances. Much of our work is performed at customer locations, or in a secure manufacturing facility. Our primary end customers are national security related agencies. Our entire organization is focused on executing our strategy of being the leading technology and intellectual property based product and system company in our industry. Our primary end customers areU.S. Government agencies, including theDoD , 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 2020, 2019 and 2018, we generated 73%, 71% and 72%, respectively, of our total revenues from contracts with theU.S. Government (including all branches of theU.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.
We were incorporated in the state of
Industry Background
OnDecember 27, 2020 , the Consolidated Appropriations Act, 2021, was signed into law. The$2.3 trillion spending bill combines$900 billion in stimulus relief for the COVID-19 pandemic inthe United States with a$1.4 trillion omnibus spending bill for the FY 2021 (combining 12 separate annual appropriations bills). The bills allocate$695.9 billion for theDoD , a decrease of$9.7 billion from FY 2020. The federal budget and debt ceiling are expected to continue to be the subject of considerable debate, which could have a significant impact on defense spending broadly and the Company's programs in particular. TheU.S. Government's fiscal year endsSeptember 30 . The budget environment, including COVID-19 spending increases proposed by the new Biden administration, and uncertainty surrounding the debt ceiling and the appropriations process, remain significant short and long-term risks. Considerable uncertainty exists regarding how future budget and program decisions will unfold, including the defense spending priorities of the Administration andCongress and what challenges budget reductions (required by the BCA and otherwise) will present for the defense industry. If annual appropriations bills are not timely enacted, theU.S. Government may again operate under a CRA, restricting new contract or program starts, restricting increased funding or additional quantities on existing contracts, presenting resource allocation and forecasting challenges and placing limitations on some planned program budgets, and we may face another government shutdown of unknown duration. If a prolonged government shutdown of theDoD were to occur, it could result in program cancellations, disruptions and/or stop work orders and could limit theU.S. Government's ability to effectively progress programs and to make timely payments, and our ability to perform on ourU.S. Government contracts and successfully compete for new work. We believe continued budget pressures, CRAs orU.S. Government shutdowns would have serious negative consequences for the security of our country and the defense industrial base, including the Company and the customers, employees, suppliers, investors, and communities that rely on companies in the defense industrial base. It is likely budget and program decisions made in such an uncertain environment would have long-term implications for our Company and the entire defense industry. Additionally, funding for certain programs 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 partners, teammates, subcontractors and suppliers, and our employee base. While we believe that our business is well-positioned in areas that theDoD and other customers indicate are priorities for future defense spending, including in the 2018 and 2020 National Defense Strategy documents, the short and long-term impact of federal budgetary uncertainty, CRAs, the BCA, other defense spending cuts, challenges in the appropriations process, the debt ceiling and the ongoing fiscal debates remain uncertain. Such a challenging federal andDoD budgetary environment may negatively impact our business and programs and could have a material adverse effect on our forecasts, estimates, financial position, results of operations and/or cash flows. The nature of our operations expose us to risks associated with pandemics, epidemics or other public health emergencies, such as the outbreak of COVID-19 in many countries across the globe, includingthe United States . InMarch 2020 , theWorld Health Organization categorized COVID-19 as a pandemic, and the President ofthe United States declared the COVID-19 outbreak a national emergency. The outbreak has resulted in governments around the world, including theU.S. Government and state and local governments, implementing increasingly stringent measures to help control the spread of the virus, including quarantines, "shelter in place" and "stay at home" orders, travel restrictions, business curtailments, school 46 --------------------------------------------------------------------------------
closures, and other measures. In addition, governments and central banks in several parts of the world have enacted fiscal and monetary stimulus measures to counteract the impacts of COVID-19.
We are a company operating in a "critical infrastructure industry", as defined by theU.S. Department of Homeland Security . Consistent with federal guidelines and with state and local orders to date, we currently continue to operate, including our international operations. Notwithstanding our continued operations, COVID-19 has had negative impacts on certain of our operations, our supply chain, vendors, transportation networks and customers, which have reduced certain of our sales and our margins, including as a result of preventative and precautionary measures that we, our suppliers, other businesses and governments are taking. The COVID-19 outbreak is a widespread public health crisis that is adversely affecting the economies and financial markets globally. Any resulting economic downturn could adversely affect demand for our products. The progression of this matter could also negatively impact our business or results of operations through the temporary or extended closure of our operating locations or those of our customers or suppliers. The ability of our employees, our suppliers' employees and our customers' employees to work may be significantly impacted by individuals contracting or being exposed to COVID-19, or as a result of the control measures noted above, which may significantly hamper our production and operations, including throughout the supply chain. In addition to the$900 billion in stimulus relief for the COVID-19 pandemic included in the current spending bill, onMarch 27, 2020 , the CARES Act, a$2 trillion economic relief bill was signed into law. We are continuing to evaluate the impact of the CARES Act including related stimulus and economic relief actions on our business. Since the end of our first quarter, COVID-19 has continued to impact our customers, markets and operations, including supply chain disruptions, delays of certain supplier deliveries, difficulties gaining access to certain locations, difficulties gaining access to customers, and decreased demand requirements of certain of our commercial aero, power and satcom customers. Importantly, COVID-19 customer and contractor-related travel and social distancing restrictions have delayed a number of our target drone, tactical drone and rocket system programs, missions and exercises. The extent to which COVID-19 may further impact our business depends on future developments, which are highly uncertain and unpredictable, including new information concerning the severity of the outbreak and the effectiveness of actions globally to contain or mitigate its effects. While we currently do not expect this matter to have a material impact on our results of operations, cash flows and financial position, the current level of uncertainty over the economic, business and operational impacts of COVID-19 means the related financial impact cannot be reasonably estimated at this time. 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 ofDecember 27, 2020 . Events and changes in circumstances arising afterDecember 27, 2020 , including those resulting from the continuing impacts of COVID-19, 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, training and cybersecurity, 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, theDoD , intelligence agencies and classified agencies, and to a lesser degree, international government agencies and domestic and international commercial customers. We organize our operating segments based primarily on the nature of the products, solutions and services offered. For additional information regarding our reportable segments, see Note 14 of the Notes to Consolidated Financial Statements. From a customer and solutions perspective, we view our business as an integrated whole, leveraging skills and assets wherever possible.
Discontinued Operations
OnFebruary 28, 2018 , the Company entered into a Stock Purchase Agreement to sell the operations ofKratos Public Safety & Security Solutions, Inc. , aDelaware corporation and wholly owned subsidiary of the Company ("PSS"), toSecuritas Electronic Security, Inc. , aDelaware corporation ("Buyer"). OnJune 11, 2018 , we completed the sale of all of the issued and outstanding capital stock of PSS to Buyer for a purchase price of$69 million in cash, subject to a closing net working capital adjustment (the "Transaction"). To date, we have received approximately$70 million of aggregate net cash proceeds from the Transaction, after taking into account amounts that were paid by us pursuant to a negotiated transaction services agreement between us and the Buyer, receipt of approximately$6.8 million in net working capital retained by the Company, and associated transaction fees and expenses, excluding the impact of the final settlement and determination of the closing net working capital adjustment. We are currently in dispute with the Buyer regarding the closing net working capital adjustment. 47 -------------------------------------------------------------------------------- The amount in dispute is approximately$8 million . The Company has recorded a net break-even on the sale of the PSS business which includes the aggregate net proceeds described above that have been collected, excluding the impact of the final settlement and determination of the closing net working capital adjustment. The resolution of the ongoing dispute will be recorded in future periods when resolved.
For additional information regarding discontinued operations, see Note 9 of the Notes to Consolidated Financial Statements contained within this Annual Report.
Key Financial Statement Concepts
As of
The Company's business with theU.S. Government and prime contractors is generally performed under fixed-price, cost reimbursable, or time and materials contracts. Cost reimbursable contracts for theU.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. As a result, under ASC 606 revenue is recognized over a period of time utilizing the percentage-of-completion cost-to-cost method. 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 theU.S. Government are routinely audited by the DCAA. We manage and assess the performance of our businesses based on our performance on individual contracts and programs obtained generally from government organizations with consideration given to our "Critical Accounting Principles and Estimates" discussed below. Due to the Federal Acquisition Regulation rules that govern our business, most types of costs are allowable, and we do not focus on individual cost groupings (such as cost of sales or general and administrative costs) as much as we do on total contract costs, which are a key factor in determining contract operating income. As a result, in evaluating our operating performance, we look primarily at changes in sales and service revenues and operating income, including the effects of significant changes in operating income. Changes in contract 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 theU.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. EffectiveDecember 31, 2018 , we adopted the requirements of ASU 2016-02, Leases, also referred to as "ASC 842", utilizing the optional transition method, as discussed in Note 1 to the accompanying Consolidated Financial Statements. ASC 842 requires that lessees recognize assets and liabilities for the rights and obligations underlying leases with a lease term of more than one year. The reported results for 2019 and 2020 reflect the application of ASC 842 guidance while the reported results for periods prior toDecember 31, 2018 were prepared under the guidance of FASB Topic 840, Leases. The adoption of ASC 842 represented a change in accounting principle. 48 --------------------------------------------------------------------------------
Results of Operations
Comparison of Results for the Year Ended
Revenues. Revenues by reportable segment for the years ended
2020 2019 $ Change % Change
Kratos Government Solutions
Service revenues $ 248.7 $ 272.6 $ (23.9) (8.8) %
Product sales 312.0 283.5 28.5 10.1 %
Total Kratos Government Solutions 560.7 556.1 4.6 0.8 %
Unmanned Systems - product sales 187.0 161.4 25.6 15.9 %
Total revenues $ 747.7 $ 717.5 $ 30.2 4.2 %
Total service revenues $ 248.7 $ 272.6 $ (23.9) (8.8) %
Total product sales 499.0 444.9 54.1 12.2 %
Total revenues $ 747.7 $ 717.5 $ 30.2 4.2 %
Revenues increased $30.2 million to $747.7 million for the year ended
December 27, 2020 from $717.5 million for the year ended December 29, 2019 .
Revenues in our KGS segment increased $4.6 million due to revenues from the
recent ASC Signal acquisition, which contributed an aggregate of approximately
$21.9 million , and increases in our microwave products, defense and rocket
support and C5ISR businesses of approximately $17.9 million . These increases
were offset by reduced revenues in our legacy services, commercial satellite and
training solutions business of $36.2 million primarily reflecting the completion
and rescoping of certain international and foreign military sales contracts and
reductions in our commercial satellite business as a result of the completion of
large foreign satellite infrastructure deployments and from impacts resulting
from COVID-19. Revenues in our US segment increased $25.6 million primarily due
to work performed on certain confidential drone programs, and due to
contributions of approximately $2.5 million from the recent TDI and 5-D
acquisitions.
Product sales increased $54.1 million to $499.0 million for the year ended
December 27, 2020 from $444.9 million for the year ended December 29, 2019 ,
primarily as a result of increased production activity in our US segment,
increased production in our microwave products, modular systems and rocket
support businesses and increases from our recent ASC Signal acquisition, offset
partially by reductions in our commercial satellite and training solutions
businesses. As a percentage of total revenue, product sales were 66.7% for the
year ended December 27, 2020 , as compared to 62.0% for the year ended
December 29, 2019 . Service revenues decreased by $23.9 million to $248.7 million
for the year ended December 27, 2020 , from $272.6 million for the year ended
December 29, 2019 . The decrease was primarily related to the completion or
rescoping of certain international contracts in our training solutions business,
reductions in our commercial space and satellite communications business
primarily due to COVID-19 related travel restrictions, and reduced demand in our
commercial turbine business as a result of COVID-19.
Cost of revenues. Cost of revenues increased to $544.5 million for the year
ended December 27, 2020 , from $527.5 million for the year ended December 29,
2019 . The $17.0 million increase in cost of revenues was primarily a result of
the overall increase in revenue discussed above.
Gross margin percentage increased to 27.2% for the year ended December 27, 2020 ,
compared to 26.5% for the year ended December 29, 2019 . Margins on services
decreased to 26.6% for the year ended December 27, 2020 , from 29.6% for the year
ended December 29, 2019 , due primarily to a less favorable mix of revenues,
primarily in our Space, Training & Cyber business and our recently acquired FTT
business. Margins on product sales increased for the year ended December 27,
2020 , as compared to December 29, 2019 to 27.5% from 24.6%, respectively,
primarily due to a more favorable mix of certain programs and products in more
mature lifecycles. Margins in the KGS segment increased to 29.2% for the year
ended December 27, 2020 , from 28.3% for the year ended December 29, 2019 ,
primarily due to a more favorable mix of products including products in more
mature production lifecycles during the year ended December 27, 2020 . Margins in
the US segment increased to 21.0% for the year ended December 27, 2020 from
20.4% for the year ended December 29, 2019 , primarily due to a more favorable
mix of products produced and shipped in the year ended December 27, 2020 .
Selling, general and administrative expenses (SG&A). SG&A increased
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increased to 19.3% for the year ended December 27, 2020 from 18.2% for the year
ended December 29, 2019 due primarily to an increase in stock compensation
expense from $11.0 million in the year ended December 29, 2019 to $21.0 million
in the year ended December 27, 2020 .
Research and development (R&D) expenses. R&D expenses were $27.0 million for
the year ended December 27, 2020 and $18.0 million for the year ended
December 29, 2019 . As a percentage of revenues, R&D increased to 3.6% of
revenues for the year ended December 27, 2020 , from 2.5% of revenues for the
year ended December 29, 2019 . 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" positions on major programs, platforms or
systems.
Restructuring expenses and other. The expense of $0.7 million for the year ended
December 27, 2020 , primarily consisted of employee termination costs related to
personnel reduction actions taken during the year. The expense of $0.9 million
for the year ended December 29, 2019 primarily consisted of approximately
$0.6 million in legal costs related to a dispute with an international aerial
targets customer and employee termination costs of approximately $0.3 million
associated with personnel reduction actions taken during the year.
Other expense, net. Other expense, net, increased to
Provision (benefit) for income taxes from continuing operations. The Company recorded an income tax benefit of$73.5 million for the year endedDecember 27, 2020 , compared to an income tax provision of$4.8 million for the year endedDecember 29, 2019 . The income tax benefit for 2020 includes a non-cash benefit of$80.1 million related to the reversal of a significant portion of the Company's valuation allowance on itsU.S. deferred tax assets. Income (loss) from discontinued operations. The loss from discontinued operations was$0.9 million for the year endedDecember 27, 2020 , primarily reflecting the work performed in relation to outstanding tasks on legacy projects retained by us following the sale of the PSS business and legal expenses related to the closing net working capital dispute with the buyer of the PSS business. The income from discontinued operations was$1.7 million for the year endedDecember 29, 2019 , which includes a$3.6 million gain as a result of the release of an indemnification liability following the lapse of the statute of limitations associated with a potential tax liability that was recorded in 2015 as part of the previous sale of our Electronics Products Division. This gain was offset by a loss of$1.7 million from operating activities primarily reflecting the work performed in relation to outstanding tasks on legacy projects retained by us following the sale of the PSS business and legal expenses related to the closing net working capital dispute with the buyer of the PSS business.
For a comparison of the Company's results of operations for the fiscal year
ended
Liquidity and Capital Resources
As ofDecember 27, 2020 , we had cash and cash equivalents of$380.8 million compared with cash and cash equivalents of$172.6 million as ofDecember 29, 2019 , which includes$29.2 million and$24.6 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 theU.S. they could be repatriated, and their repatriation into theU.S. may cause us to incur additional foreign withholding taxes. We do not currently intend to repatriate these earnings. Our total debt, including principal due on the 6.5% Notes, net of debt issuance costs of$4.1 million , increased by$6.4 million to$301.5 million as ofDecember 27, 2020 from$295.1 million as ofDecember 29, 2019 . The increase in total debt was due to the amortization of debt issuance costs, approximately$5.1 million in new loans entered into with two banks inIsrael (as fully described below) and$0.5 million in loans assumed in connection with the acquisition of 5-D Systems (as fully described below). We use our operating cash flow to finance trade accounts receivable, fund necessary increases in inventory and non-recurring engineering, fund capital expenditures, our internal research and development investments and our ongoing operations, service our debt and make strategic acquisitions. Financing trade accounts receivable is necessary because, on 50 -------------------------------------------------------------------------------- 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 133 days as ofDecember 27, 2020 from 134 days as ofDecember 29, 2019 . 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. InNovember 2019 , a large training solutions program was terminated for convenience ("T for C") by the customer. Under a T for C, a contractor is entitled to seek specified costs through a termination settlement process including (1) the contract price for completed supplies and services accepted by the government but not previously paid for; (2) the cost incurred in the performance of work terminated plus a reasonable profit on those costs; and (3) its costs incurred in settling with subcontractors and preparing and settling the termination proposal. 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. AtDecember 27, 2020 , approximately$11.5 million in unbilled receivables remain outstanding on this project. In addition, we are currently in dispute with an international customer in our US segment over approximately$10.0 million in unbilled receivables outstanding as ofDecember 27, 2020 . The dispute concerns the completion of certain system requirements and contractual milestones. The Company alleges breach of contract, as well as other claims against the customer and seeks damages and other equitable relief. The customer has asserted counterclaims seeking liquidated damages and additional relief. We have evaluated the present facts of the matters and performed a reassessment of the contractual amounts due, as well as the claims asserted by each of the parties, and have determined that no adjustment to previously recognized revenue, or the corresponding unbilled receivables, is necessary atDecember 27, 2020 . A summary of our net cash provided by operating activities from continuing operations from our Consolidated Statements of Cash Flows is as follows (in millions): Year Ended December 27, 2020 December 29, 2019 Net cash provided by operating activities from continuing operations $ 44.7 $ 28.9 Our net cash provided by operating activities from continuing operations for the year endedDecember 27, 2020 increased by$15.8 million to$44.7 million for the year endedDecember 27, 2020 compared to$28.9 million for the year endedDecember 29, 2019 . Net cash provided by operating activities from continuing operations was impacted by an increase in income from continuing operations of$69.4 million to$80.3 million for the year endedDecember 27, 2020 compared to$10.9 million for the year endedDecember 29, 2019 . This increase was offset by a change in deferred income taxes of$73.3 million as a result of the release of the valuation allowance described in Provision (benefit) for income taxes from continuing operations above as well as by an increase in stock-based compensation of$10.0 million , a decrease in amortization of lease right-of-use assets of$2.3 million and other net changes in working capital accounts of$10.6 million in the year endedDecember 27, 2020 as compared to the year endedDecember 29, 2019 . Included in the changes in working capital accounts is an increase in collections from accounts receivable, as well as approximately$9.5 million of payroll related taxes that were deferred during 2020 under the CARES Act, of which 50 percent of the amount is required to be paid by end of the 2021 with the remainder required to be paid by the end of 2022.
Our net cash used in investing activities from continuing operations is summarized as follows (in millions):
Year Ended
December 27, 2020 December 29, 2019
Investing activities:
Cash paid for acquisitions, net of cash acquired $ (51.5) $ (17.7)
Proceeds from sale of assets 0.1 0.3
Capital expenditures (35.9) (26.3)Net cash used in investing activities from continuing operations $
(87.3) $ (43.7)
Net cash used in investing activities from continuing operations for year
ended
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expenditures which consist primarily of investments in machinery, computer
hardware and software and improvement of our physical properties in order to
maintain suitable conditions in which to conduct our business. Net cash used in
investing activities from continuing operations for the year ended December 29,
2019 was comprised of the acquisition of FTT and capital expenditures which
consist primarily of investments in machinery, computer hardware and software
and improvement of our physical properties in order to maintain suitable
conditions in which to conduct our business. During the year ended December 27,
2020 , capital expenditures of approximately $18.1 million were incurred in our
US business, primarily related to our unmanned combat target initiative,
including capital expenditures for Valkyries we are building in advance of
contract award.
Our net cash provided by financing activities from continuing operations is summarized as follows (in millions):
Year Ended
December 27, 2020 December 29, 2019
Financing activities:
Proceeds from the issuance of long-term debt $ 5.1 $ -
Proceeds from the issuance of common stock $ 240.4 $ -
Repayment under credit facility and debt (0.6) -
Payments under finance leases (0.6) (0.5)
Proceeds from exercise of restricted stock units, employee stock options, and employee stock purchase plan
3.4 4.0
Net cash provided by financing activities from continuing operations $
247.7 $ 3.5
Net cash provided by financing activities from continuing operations was $247.7
million for the year ended December 27, 2020 and consisted primarily of net
proceeds of $240.4 million from our recently completed equity offering of
approximately 15.5 million shares of common stock. Net cash provided by
financing activities from continuing operations was $3.5 million for the year
ended December 29, 2019 .
The net operating cash flows of discontinued operations is summarized as follows
(in millions):
Year Ended
December 27, 2020 December 29, 2019
Net operating cash flows of discontinued operations $ 1.9 $ 1.1
The net operating cash flow of discontinued operations for the year ended
December 27, 2020 is substantially related to the approximately $3.1 million
collected on amounts due related to the legacy projects retained by us following
the sale of our PSS business unit, partially offset by the loss from operations
from our discontinued PSS business unit of $0.9 million . The net operating cash
flow of discontinued operations for the year ended December 29, 2019 is
substantially related to the approximately $3.7 million collected on amounts due
related to the legacy projects retained by us, less costs incurred to complete
the legacy projects, partially offset by a reduction in other current
liabilities of $1.8 million .
6.5% Senior Secured Notes due 2025
InNovember 2017 , we issued and sold$300 million aggregate principal amount of 6.5% Senior Secured Notes due 2025 (the "6.5% Notes") in a private placement conducted pursuant to Rule 144A and Regulation S under the Securities Act of 1933, as amended (the "Act"). The net proceeds from the issuance of the 6.5% Notes were$295.5 million after expenses of$4.5 million . We utilized the net proceeds from the sale of the 6.5% Notes, as well as cash from an equity offering to extinguish our previously outstanding 7% Notes. The total reacquisition price of the 7% Notes was$385.2 million , including a$12.0 million call premium, and$0.3 million of accrued interest. The 6.5% Notes are governed by the Indenture, dated as ofNovember 20, 2017 (the "Indenture"), among the Company, our existing and future domestic subsidiaries parties thereto (the "Subsidiary Guarantors") andWilmington Trust, National Association , as trustee and collateral agent (in such capacity, the "2017 Trustee and Collateral Agent"). A Subsidiary Guarantor can be released from its guarantee if (a) all of the capital stock issued by such Subsidiary Guarantor or all or substantially all of the assets of such Subsidiary Guarantor are sold or otherwise disposed of; (b) we designate such Subsidiary Guarantor as an Unrestricted Subsidiary; (c) we exercise our legal defeasance option or our covenant defeasance option; or (d) upon satisfaction and discharge of the Indenture or payment in full in cash of the principal of, premium, if any, and accrued and unpaid interest on the 6.5% Notes. 52 -------------------------------------------------------------------------------- The 6.5% Notes bear interest at a rate of 6.5% per year from the date of original issuance or from the most recent payment date on which interest has been paid or provided for. Interest on the 6.5% Notes is payable in arrears onMay 30 andNovember 30 of each year, beginning onMay 30, 2018 . The 6.5% Notes are fully and unconditionally guaranteed by the Subsidiary Guarantors. The 6.5% Notes and the guarantees (as set forth in the Indenture, the "Guarantees") are our senior secured obligations and are equal in right of payment with all other senior obligations of the Subsidiary Guarantors' existing and future secured debt to the extent of the assets securing that secured debt. Our obligations under the 6.5% Notes are secured by a first priority lien on substantially all of our assets and the assets of the Subsidiary Guarantors, except with respect to accounts receivable, inventory, deposit accounts, securities accounts, cash, securities and general intangibles (other than intellectual property), on which the holders of the 6.5% Notes have a second priority lien, junior to the lien securing our obligations under the Credit Agreement. The 6.5% Notes are redeemable by the Company, in whole or in part, at the respective redemption prices specified in the Indenture. We may also be required to make an offer to purchase the 6.5% Notes upon a change of control and certain sales of our assets. The Indenture contains covenants limiting, among other things, our ability and the Subsidiary Guarantors' ability to: (a) pay dividends on or make distributions or repurchase or redeem the Company's capital stock or make other restricted payments; (b) incur additional debt and guarantee debt; (c) prepay, redeem or repurchase certain debt; (d) issue certain preferred stock or similar equity securities; (e) make loans and investments; (f) sell assets; (g) incur liens; (h) consolidate, merge, sell or otherwise dispose of all or substantially all of our assets; (i) enter into transactions with affiliates; and (j) enter into agreements restricting our ability and certain of our subsidiaries' ability to pay dividends. These covenants are subject to a number of exceptions. As ofDecember 27, 2020 , we were in compliance with the covenants contained in the Indenture governing the 6.5% Notes. The terms of the Indenture require that the net cash proceeds from asset dispositions be either utilized to (i) repay or prepay amounts outstanding under the Credit Agreement unless such amounts are reinvested in similar collateral, (ii) permanently reduce other indebtedness, (iii) make an investment in assets that replace the collateral of the 6.5% Notes or (iii) a combination of (i), (ii) and (iii). To the extent there are any remaining net proceeds from the asset disposition after application of (i), (ii) and (iii), such amounts are required to be utilized to repurchase 6.5% Notes at par. The Indenture also provides for events of default which, if any of them occurs, would permit or require the principal, premium, if any, interest, if any, and any other monetary obligations on all the then-outstanding 6.5% Notes to become or to be declared due and payable immediately.
Other Indebtedness
Credit and Security Agreement
OnNovember 20, 2017 , we entered into an amended and restated Credit Agreement with the lenders from time to time party thereto, the Agent, andSunTrust Robinson Humphrey, Inc. , as Joint Lead Arranger and Sole Book Runner. As amended and restated, the Credit Agreement establishes a five year senior secured revolving credit facility in the aggregate principal amount of$90.0 million (subject to a potential increase of the aggregate principal amount to$115.0 million , subject to SunTrust's and applicable lenders' approval), consisting of a subline for letters of credit in an amount not to exceed$50.0 million , as well as a swingline loan in an aggregate principal amount at any time outstanding not to exceed$10.0 million . Borrowings under the revolving credit facility may take the form of a base rate revolving loan, Eurodollar revolving loan or swing line loan. Base rate revolving loans and swing line loans will bear interest at a rate per annum equal to the sum of the Applicable Margin (as defined in the Credit Agreement) from time to time in effect plus the highest of (i) the Agent's prime lending rate, as in effect at such time, (ii) the federal funds rate, as in effect at such time, plus 0.50% per annum and (iii) the Adjusted LIBOR Rate (as defined in the Credit Agreement) determined at such time for an interest period of one month, plus 1.00% per annum. Eurodollar revolving loans will bear interest a rate per annum equal to the sum of the Applicable Margin from time to time in effect plus the Adjusted LIBOR Rate. The Applicable Margin varies between 1.00%-1.50% for base rate revolving loans and swing line loans and 2.00%-2.50% for Eurodollar loans, and is based on several factors including our then-existing borrowing base and the lenders' total commitment amount and revolving credit exposure. The calculation of our borrowing base takes into account several items relating to us and our subsidiaries, including amounts due and owing under 53 --------------------------------------------------------------------------------
billed and unbilled accounts receivables, then held eligible raw materials inventory, work-in-process inventory, and applicable reserves.
As ofDecember 27, 2020 , there were no borrowings outstanding on the Credit Agreement and$5.9 million was outstanding on letters of credit, resulting in net borrowing base availability of$71.9 million . We were in compliance with the financial covenants of the Credit Agreement as ofDecember 27, 2020 .
Israel Debt
DuringAugust 2020 , we entered into two five-year term loans with two banks inIsrael representing an aggregate principal amount of approximately$5.1 million . These loans were subsidized by theState of Israel as part of a COVID-19 relief package with interest at Israeli NIS prime interest, plus a margin of 1.5%. The first year of interest is paid by theState of Israel with subsequent interest and principal payments due monthly commencing inAugust 2021 .
5-D Systems Loan
In connection with the acquisition of 5-D Systems, we assumed a loan in the amount of approximately$0.5 million that had been obtained under the Small Business Administration Paycheck Protection Program as part of a COVID-19 relief package. The sellers of 5-D Systems have applied for forgiveness of this loan and as part of the purchase have agreed to indemnify Kratos in the event the application for forgiveness of the loan is not accepted.
Off Balance Sheet Arrangements
We have no off-balance sheet arrangements as defined in Regulation S-K, Item 303(a)(4)(ii).
Contractual Obligations and Commitments
The following table summarizes our contractual obligations and other commitments
at
Payments Due/Forecast by Period
Total 2021 2022 - 2023 2024 - 2025 2026 and After
Debt, net of interest(1)
2.7 $ 302.1 $ -
Estimated interest on debt(2) 97.8 19.5 39.2 39.1 -
Purchase orders(3) 159.4 138.0 21.4 - -
Operating leases(4) 56.6 11.7 20.9 15.2 8.8
Finance leases(4) 68.8 3.4 7.0 7.1 51.3
Unrecognized tax benefits,
including interest and
penalties(5) - - - - -
Total commitments and recorded
liabilities $ 688.2 $ 173.4 $ 91.2 $ 363.5 $ 60.1
(1) The 6.5% Notes in the aggregate outstanding principal amount of
(2) Includes interest payments on the 6.5% Notes. See Note 5 in the Notes to
Consolidated Financial Statements contained within in this Annual Report for
further details.
(3) Purchase orders include commitments in which a written purchase order has
been issued to a vendor, but the goods have not been received or services have
not been performed.
(4) We have entered into or acquired various non-cancelable operating and
finance lease agreements that expire on various dates through 2038. See Note 6
in the Notes to Consolidated Financial Statements contained within this Annual
Report for further details.
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(5) As of December 27, 2020 , we have an $18.5 million noncurrent liability for
uncertain tax positions and a $2.5 million guarantor liability, all of which may
result in cash payments. The future payments related to uncertain tax positions
have not been presented in the table above due to the uncertainty of the amounts
and timing of cash settlements with the taxing authorities.
As of December 27, 2020 , we have $5.9 million of standby letters of credit
outstanding. Our letters of credit are primarily related to milestone payments
received from foreign customers for which the customer has not yet received the
product. Additional information regarding our financial commitments at
December 27, 2020 is provided in the Notes to Consolidated Financial Statements
contained in this Annual Report, specifically Note 15.
Other Liquidity Matters
We believe our cash on hand, together with funds available under the Credit Agreement and cash expected to be generated from operating activities will be sufficient to fund our anticipated working capital and other cash needs for at least the next 12 months. As discussed in Item 1A "Risk Factors" contained within this Annual Report, our quarterly and annual operating results have fluctuated in the past and may vary in the future due to a variety of factors, many of which are external to our control. If the conditions in our industry deteriorate, our customers cancel or postpone projects or if we are unable to sufficiently increase our revenues or further reduce our expenses, we may experience, in the future, a significant long-term 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. EffectiveJanuary 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 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. As a result, under ASC 606 revenue is recognized over a period of time utilizing the percentage-of-completion cost-to-cost method. 55 -------------------------------------------------------------------------------- For our federal contracts, we applyU.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 theU.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 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 Rocket Support Services ("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 criticalU.S. national security priorities, with the primary focus relating to the nation's Command, Control, Communications, Computing, Combat Systems, Intelligence, Surveillance ("C5ISR") and Reconnaissance requirements. The US reportable segment provides unmanned aerial systems, unmanned ground, and unmanned seaborne systems. We have identified our reporting units to be the DRSS, ME, ST&C, MS, and KTT operating segments, within the KGS reportable segment, and the US reportable segment, each of which has been assessed and evaluated for potential impairment in our fiscal year 2020 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
56
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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
In determining the fair value of our reporting units, there are key assumptions related to our future operating performance and revenue growth. If the actual operating performance and financial results are not consistent with our assumptions, a further impairment in our$483.9 million goodwill and$43.0 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 theU.S. Navy will continue to award full rate production contracts for the Sub-Sonic Aerial Target . Our goodwill impairment assessment includes assumptions of the entry to new international markets for which we have not yet penetrated. Additional risks for goodwill across all reporting units include, but are not limited to, the risks discussed in Item 1A "Risk Factors" contained within this Annual Report and: •a decline in our stock price and resulting market capitalization, if we determine the decline is sustained and is indicative of a reduction in the fair value below the carrying value of our reporting units; •a decrease in available government funding, including budgetary constraints affectingU.S. Government spending generally, or specific departments or agencies; •changes inU.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; and •continued impact to our businesses and the industry resulting from COVID-19. 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. 57 -------------------------------------------------------------------------------- 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 2020 effective tax rate at
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.
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