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Goodwill and Other Intangible Assets

12 Months Ended

Dec. 25, 2011

Goodwill and Other Intangible Assets

Note 2. Goodwill and Other Intangible Assets

Goodwill

The Company performs its annual impairment test for goodwill in accordance with Topic 350 as of the last day of each fiscal year or when evidence of potential impairment exists.

The Company assesses goodwill for impairment at the reporting unit level, which is defined as an operating segment or one level below an operating segment, referred to as a component. The Company determines its reporting units by first identifying its operating segments, and then assessing whether any components of these segments constitute a business for which discrete financial information is available and where segment management regularly reviews the operating results of that component. The Company aggregates components within an operating segment that have similar economic characteristics. For the annual and, if necessary, interim impairment assessment the Company identified its reporting units to be its operating segments which are Kratos Government Solutions and Public Safety and Security.

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

During the first quarter of 2009, given the significant decline in the stock market in general and specifically the Company's stock price and market capitalization, which declined 39% from an average stock price of $12.90 per share as of December 28, 2008 to $7.80 per share as of February 28, 2009, the Company performed an impairment test for goodwill in accordance with Topic 350 as of February 28, 2009. The test indicated that the book value for the KGS reporting unit exceeded the fair values of these businesses and resulted in the Company recording a charge totaling $41.3 million in the KGS segment in the first quarter of 2009, for the impairment of goodwill. The impairment charge was primarily driven by adverse equity market conditions that caused a decrease in current market multiples and the Company's average stock price as of February 28, 2009, compared with the test performed as of December 28, 2008. The Company's forecasts of growth rates and operating margins had not changed as of February 28, 2009 as compared to the forecasts which were used as of December 28, 2008. The Company reconciled the fair value of its reporting units, which was calculated using the income approach to the Company's market capitalization. As a result of this reconciliation, it was noted that investors were requiring a higher rate of return, and therefore, the discount factor which is based upon an estimated market participant weighted average cost of capital ("WACC") increased 300 basis points from 14% in the Company's year-end impairment test in 2008 as compared to 17% in the Company's 2009 first quarter interim impairment test. This change was the key factor contributing to the $41.3 million goodwill impairment charge that was recorded in the first quarter of 2009.

While the Company's methodology for evaluating goodwill and intangibles for impairment has always used the income and market approach, in the past the market approach was used solely to validate that the fair value derived from the income approach was comparable to its market peers. In December 2011, when the Company performed its annual impairment test for goodwill, the Company used a weighting of the income and market approach to derive the fair value of its reporting units which resulted in a more conservative fair value.

As of December 25, 2011 the fair value of the PSS reporting unit substantially exceeded its carrying value and the fair value of the KGS reporting unit exceeded its carrying value by 3.5%. Considering the relatively small excess of fair value over carrying value for the KGS segment and given the current market conditions and continued economic uncertainty in the U.S. defense industry as a result of the Budget Control Act, the fair value of the KGS reporting unit may deteriorate, resulting in an impairment of the goodwill in that unit. Due to continual changes in market and general business conditions, the Company cannot predict whether, and to what extent, its goodwill and long-lived intangible assets may be impaired in the future periods. Any resulting impairment loss could harm the Company's profitability and financial condition.

The goodwill of the PSS and KGS reporting units are $33.0 million and $540.5 million, respectively.

The changes in the carrying amounts of goodwill for the years ended December 26, 2010 and December 25, 2011, are as follows (in millions):

	Public Safety & Security		Kratos Government Solutions			Total Goodwill

Balance as of December 27, 2009	$	—	$	110.2		$	110.2
Additions due to business combinations		32.4		83.8			116.2

Balance as of December 26, 2010		32.4		194.0			226.4
Retrospective adjustments		0.6		(0.2	)		0.4

Balance as of December 26, 2010 after retrospective adjustments		33.0		193.8			226.8
Additions due to business combinations		—		346.7			346.7

Balance as of December 25, 2011	$	33.0	$	540.5		$	573.5

The accumulated impairment losses as of December 26, 2010 and December 25, 2011 were $165.4 million; $147.1 million associated with the KGS segment and $18.3 million associated with the PSS segment.

If an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value, the Company will evaluate goodwill for impairment between annual tests in accordance with Topic 350.

Purchased Intangible Assets

The value of indefinite-lived intangible assets which are related to trade names was $24.5 million as of December 26, 2010 and December 25, 2011, respectively.

The following tables set forth information for finite-lived intangible assets subject to amortization (in millions):

	As of December 26, 2010							As of December 25, 2011

	Gross Value		Accumulated Amortization			Net Value		Gross Value		Accumulated Amortization			Net Value
Acquired intangible assets:
Customer relationships	$	41.5	$	(10.0	)	$	31.5	$	78.1	$	(19.8	)	$	58.3
Contracts and backlog		24.5		(13.9	)		10.6		60.1		(39.6	)		20.5
Developed technology and technical know-how		22.1		(1.9	)		20.2		22.1		(4.1	)		18.0
Trade names		1.2		(0.6	)		0.6		2.6		(0.8	)		1.8
Favorable lease		1.8		(0.1	)		1.7		1.8		(0.3	)		1.5

Total	$	91.1	$	(26.5	)	$	64.6	$	164.7	$	(64.6	)	$	100.1

The aggregate amortization expense for finite-lived intangible assets was $5.7 million, $9.2 million and $38.0 million for the years ended December 27, 2009, December 26, 2010, and December 25, 2011, respectively. The increase in intangible assets in 2011 was a result of the Company's acquisitions (see Note 3).

Information about estimated amortization expense for intangible assets subject to amortization for the five years succeeding December 25, 2011, is as follows (in millions):

	Amortization Expense

2012	$	34.2
2013		18.3
2014		16.7
2015		11.0
2016		6.3
Thereafter		13.6

	$	100.1

- Definition

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

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