Stockholders’ Equity


(a)	Common Stock

On May 14, 2012, the Company sold 20.0 million shares of its common stock at a purchase price of $5.00 per share in an underwritten public offering. The Company received gross proceeds of $100.0 million. After deducting underwriting and other offering expenses, the Company received approximately $97.0 million in net proceeds. The Company used the net proceeds from this offering to fund a portion of the cash consideration paid to the stockholders of CEI in connection with the Company's acquisition thereof on July 2, 2012.

On December 1, 2011, the Company repurchased in the open market from an institutional investor 2.0 million shares of its common stock for $5.45 per share, in a block transaction in compliance with legal requirements.

On July 27, 2011, in connection with the acquisition of Integral, the Company issued approximately 10.4 million shares of its common stock to shareholders of Integral. See Note 3 for a complete description of this transaction.

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

(b) Preferred Stock

On March 8, 2011, all of the 10,000 shares of the previously issued and outstanding shares of Series B Convertible Preferred Stock (“Preferred Stock”) were redeemed for 100,000 shares of common stock. Prior to the redemption, the Preferred Stock had a total liquidation preference of $5.0 million. In accordance with Topic 260, the Preferred Stock was considered a participating security for purposes of computing basic earnings per share prior to redemption.


(c)	Stock Option Plans and Restricted Stock Unit Plans

The Company's board of directors (“Board”) may grant equity-based awards to selected employees, directors and consultants of the Company pursuant to its existing equity incentive plans. In February 2005, the Board approved the 2005 Equity Incentive Plan (“2005 Plan”). The 2005 Plan was subsequently approved by a majority of the Company's stockholders on May 18, 2005. In March 10, 2011, the Board approved the 2011 Equity Incentive Plan (“2011 Plan”). The 2011 Plan was subsequently approved by a majority of the Company's stockholders on May 27, 2011. Each of the 2005 Plan and the 2011 Plan permits the Board to issue a wide-variety of awards, including restricted stock units, restricted stock, stock appreciation rights, stock options and deferred stock units. If any shares covered by an award under the 2005 Plan or 2011 Plan are not purchased or are forfeited, or if an award otherwise is terminated, canceled or retired, such shares are again made available for awards under the 2005 Plan and 2011 Plan. As of December 29, 2013, there are approximately 362,000 and 1.0 million shares reserved for issuance for future grant under the 2005 Plan and 2011 Plan, respectively. The Board may amend or terminate the 2005 Plan or 2011 Plan at any time. Certain amendments, including an increase in the share reserve, require stockholder approval. Generally, options and restricted stock units outstanding vest over periods not exceeding ten years. When the Company grants stock options, they are granted with a per share exercise price not less than the fair market value of the Company's common stock on the date of grant, and generally would be exercisable for up to ten years from the grant date.

Integral Stock Option Plans. All outstanding options to purchase shares of Integral common stock that were not canceled and exchanged for a cash payment upon completion of the Integral merger, were assumed by the Company and converted into options to purchase shares of the Company's common stock (with the number of shares subject to each such option and the exercise price applicable to each such option adjusted based on the applicable exchange ratio) (the “Assumed Options”). The Company assumed each such stock option in accordance with the terms and conditions of the applicable Integral option plan and stock option agreement, subject to the adjustments described in the preceding sentence. On February 20, 2012, the Board confirmed (i) the assumption of Integral's 2008 Stock Incentive Plan (the “2008 Plan”), pursuant to NASDAQ Rule 5635, which provides that shares available under certain plans acquired in mergers and other acquisitions may be used for certain post-transaction grants without further stockholder approval and (ii) an amendment to the 2008 Plan, in order to permit the future grant of awards, including restricted stock unit awards, by the Company pursuant to the plan. The 2008 Plan was approved by Integral's Board of directors in December 2007 and by Integral's stockholders in February 2008. The terms and conditions of specific awards are set at the discretion of the Board. As of December 29, 2013, there are approximately 1.3 million shares of the Company's common stock available for issuance under the 2008 Plan. The shares of common stock available for issuance under the 2008 Plan may be used to grant awards, including stock options, stock appreciation rights, restricted stock and restricted stock units, to any employee, director or consultant who was not an employee, director or consultant of the Company prior to the consummation of the Integral merger. The Board may amend or terminate the 2008 Plan at any time. However, certain amendments, including an increase in the share reserve, would require stockholder approval.

Herley Stock Option Plans. All outstanding options to purchase shares of Herley common stock that were not canceled and exchanged for a cash payment upon completion of the Herley merger, were assumed by the Company and converted into options to purchase shares of the Company's common stock (with the number of shares subject to each such option and the exercise price applicable to each such option adjusted based on the applicable exchange ratio). The Company assumed each such stock option in accordance with the terms and conditions of the applicable Herley option plan and stock option agreement, subject to the adjustments described in the preceding sentence. On December 30, 2012, the Board confirmed (i) the assumption of Herley's 2010 Stock Plan (the “2010 Plan”), pursuant to NASDAQ Rule 5635, and (ii) an amendment to the 2010 Plan, in order to permit the future grant of awards, including restricted stock unit awards, by the Company pursuant to the plan. The 2010 Plan was approved by Herley's Board of Directors in January 2010 and by Herley's stockholders in March 2010. The terms and conditions of specific awards are set at the discretion of the Board. As of December 29, 2013, there are approximately 365,000 shares of the Company's common stock available for issuance under the 2010 Plan. These shares are available to grant awards, including stock options, shares of common stock and restricted stock units, to any employee, director or consultant who was not an employee, director or consultant of the Company prior to the consummation of the Herley merger. The Board of the Company may amend or terminate the 2010 Plan at any time. However, certain amendments, including an increase in the share reserve, would require stockholder approval.

Henry Bros. Electronics Stock Option Plans. HBE's stock option and stock incentive plans acquired in connection with the Company's acquisition of HBE were terminated on December 15, 2010, and no further grants may be made under these plans after such date. Award grants that were outstanding under these plans on December 15, 2010 will continue to be governed by their existing terms and may be exercised for shares of the Company's common stock at any time prior to the expiration of the option term or any earlier termination of those options in connection with the option holder's cessation of service with the Company. Stock options granted under these plans were incentive stock options, may generally be exercised from one to ten years after the date of grant and generally vest ratably over three to five years. Certain of these options had change in control provisions that accelerated the vesting of the options.

Digital Fusion Inc. Stock Option and Stock Incentive Plans. DFI's stock option and stock incentive plans acquired in connection with the Company's acquisition of DFI were terminated on December 24, 2008, and no further grants may be made under these plans after such date. Award grants that were outstanding under these plans on December 24, 2008 will continue to be governed by their existing terms and may be exercised for shares of the Company's common stock at any time prior to the expiration of the ten-year option term or any earlier termination of those options in connection with the option holder's cessation of service with the Company. Stock options granted under these plans included incentive stock options or non-statutory stock options. All non-statutory options vest upon change in control and were 100% vested on December 24, 2008. With respect to incentive stock options, the qualified stock option plans provide that the exercise price of each such option must be at least equal to 100% of the fair market value of its common stock on the date of grant. Stock options granted under these plans may generally be exercised from one to ten years after the date of grant. Certain of these options had change in control provisions that extended the exercise period for grants for two years from the transaction closing date. Awards granted under these plans generally vest equally over three years; however, in connection with the Company's acquisition of DFI the plans were amended to include immediate vesting of all unvested grants upon any future change in control of the Company. DFI also had certain options granted outside of its qualified stock option plans. These non-qualified “out of plan” stock options expire 10 years from grant date.

RSU Agreements. On January 10, 2007, the Compensation Committee of the Board approved a form of Restricted Stock Unit Agreement (an RSU Agreement) to govern the issuance of restricted stock units (“RSUs”) to executive officers under the Company's 2005 Plan. On November 14, 2011, the Compensation Committee of the Board approved a form of RSU Agreement to govern the issuance of RSUs to executive officers under the Company's 2011 Plan. Each RSU represents the right to receive a share of common stock (a “Share”) on the vesting date. Unless and until the RSUs vest, the Employee will have no right to receive Shares under such RSUs. Prior to actual distribution of Shares pursuant to any vested RSUs, such RSUs will represent an unsecured obligation of the Company, payable (if at all) only from the general assets of the Company. The RSUs that may be awarded to executive officers under an RSU Agreement will vest according to vesting schedules specified in the notice of grant accompanying each grant. The Company recognizes compensation expense on a straight-line basis over the vesting periods based on the market price of the Company's stock on the grant date. The awards granted in 2011, 2012, and 2013 had vesting periods ranging from 2 to 10 years; 1 to 10 years, and 1 to 10 years, respectively. Some of the grants for these years have accelerated vesting occurring upon change of control or termination. Upon exercise of the RSU, the Company issues new shares of common stock.

The Company records compensation expense for employee stock options based on the estimated fair value of the options on the date of grant using the Black-Scholes option-pricing model or a trinomial lattice options pricing model with the weighted average assumptions (annualized percentages) included in the following table. Awards with graded vesting are recognized using the straight-line method with the following assumptions:



	2011	2012	2013
Stock Options
Expected life (1)	2.2	10.0	6.25 - 10.0
Risk-free interest rate(2)	0.1% - 3.4%	1.6% - 2.3%	1.1% - 2.9%
Volatility(3)	29.3% - 65.3%	59.0% - 59.7%	56.8% - 61.2%
Forfeiture rate(4)	16.3%	16.3%	10%
Dividend yield(5)	—%	—%	—%

(1) In 2011 and 2012, no unvested options were granted and the expected life was equal to the life of the option.

(2) The risk-free interest rate is based on U.S. Treasury yields in effect at the time of grant with a term equal to the expected term of the options.

(3) In 2011, 2012, and 2013, the Company estimated implied volatility based upon trailing volatility.

(4) Forfeitures are estimated at the time of grant based upon historical information. Forfeitures will be revised, if necessary, in subsequent periods if actual forfeitures differ from estimates.

(5) The Company has no history or expectation of paying dividends on its common stock.

A summary of the status of the Company's stock option plan as of December 29, 2013 and changes in options outstanding under the plan for the year ended December 29, 2013 is as follows:



	Number of Shares Under Option		Weighted-Average Exercise Price per Share		Weighted- Average Remaining Contractual Term (in years)	Aggregate Intrinsic Value
	(000's)					(000's)
Options outstanding at December 30, 2012	1,133		$	27.66	2.8	$	80.0
Granted	1,012		$	5.03	—	—
Exercised	(7	)	$	5.05	—	—
Forfeited or expired	(417	)	$	32.95	—	—
Options outstanding at December 29, 2013	1,721		$	13.16	5.8	$	2,179.0
Options exercisable at December 29, 2013	821		$	22.09	2.4	$	249.0

As of December 29, 2013, there was $2.1 million of total unrecognized stock-based compensation expense related to nonvested options which is expected to be recognized over a remaining weighted-average vesting period of 4.2 years. Upon exercise of an option, the Company issues new shares of common stock.

During the years ended December 25, 2011, December 30, 2012, and December 29, 2013 the following values relate to the grants and exercises under the Company's option plans:



	2011		2012		2013
Weighted average grant date fair value of options granted	$	2.38	$	3.56	$	2.86
Total intrinsic value of options exercised (in thousands)	$	1,832	$	—	$	—

The following table summarizes the Company's Restricted Stock Unit activity:



	Restricted Stock Units (000's)		Weighted-Average Grant Date Fair Value
Nonvested balance at December 30, 2012	3,670		$	7.53
Grants	53		$	12.69
Vested	(132	)	$	12.89
Forfeitures	(243	)	$	9.34
Vested but not released	(3	)	$	12.39
Nonvested balance at December 29, 2013	3,345		$	7.26

As of December 29, 2013, there was $15.8 million of total unrecognized stock-based compensation expense related to nonvested restricted stock units which is expected to be recognized over a remaining weighted-average vesting period of 3.2 years. The fair value of RSU awards that vested in 2011, 2012, and 2013 was $0.8 million, $1.9 million, and $1.7 million, respectively.


(d)	Employee Stock Purchase Plan

In August 1999, the Board approved the 1999 Employee Stock Purchase Plan (“Purchase Plan”). A total of 2,689 thousand shares of Common Stock have been authorized for issuance under the Purchase Plan. The Purchase Plan qualifies as an employee stock purchase plan within the meaning of Section 423 of the Internal Revenue Service Code. Unless otherwise determined by the Compensation Committee of the Board, all employees are eligible to participate in the Purchase Plan so long as they are employed by the Company (or a subsidiary designated by the Board) for at least 20 hours per week and were customarily employed by the Company (or a subsidiary designated by the Board) for at least 5 months per calendar year.

Employees who actively participate in the Purchase Plan are eligible to have up to 15% of their earnings for each purchase period withheld pursuant to the Purchase Plan. The amount that is withheld is used at various purchase dates within the offering period to purchase shares of Common Stock. The price paid for Common Stock at each such purchase date is equal to the lower of 85% of the fair market value of the Common Stock at the commencement date of that offering period or 85% of the fair market value of the Common Stock on the relevant purchase date. Employees are also able to end their participation in the offering at any time during the offering period, and participation ends automatically upon termination of employment. From the Purchase Plan's inception through December 29, 2013, the cumulative number of shares of Common Stock that have been issued under the Purchase Plan is 1,784 thousand and approximately 1,924 thousand shares are available for future issuance. During fiscal 2012, approximately 781 thousand shares were issued under the plan at an average price of $5.19.

The fair value of Kratos' Purchase Plan shares for 2013 was estimated using the Black-Scholes option pricing model. The assumptions and resulting fair values of options granted for 2012 and 2013 were as follows:



	Offering Periods January 1 to December 31, 2011	Offering Periods January 1 to December 31, 2012	Offering Periods January 1 to December 31 2013
Expected term (in years)(1)	0.5	0.5	0.5
Risk-free interest rate(2)	0.10% - 0.19%	0.06% - 0.16%	0.10% - 0.11%
Expected volatility(3)	28.5% - 43.6%	49.70% - 65.73%	36.95% - 43.70%
Expected dividend yield(4)	0%	0%	0%
Weighted average grant-date fair value per share	$3.05	$1.93	$1.50


(1)	The expected term is equivalent to the offering period.


(2)	The risk-free interest rate is based on U.S. Treasury yields in effect at the time of grant with a term equal to the expected term.

(3) The Company estimated implied volatility based upon trailing volatility.

(4) The Company has no history or expectation of paying dividends on its common stock.

As of December 29, 2013, there was no material unrecognized compensation expense related to the Employee Stock Purchase Plan.


(e)	Stockholder Rights Agreement

On December 16, 2004, the Company entered into a Stockholder Rights Agreement (the “Rights Agreement”). Under the terms of the Rights Agreement, initially, the rights (“Rights”) will attach to all certificates representing shares of outstanding Company common stock and no separate rights certificates will be distributed. Subject to the provisions of the Rights Agreement, the Rights will separate from the Company common stock and the distribution date will occur upon the earlier of (i) ten business days following a public announcement that a person or group of affiliated or associated persons has acquired or obtained the right to acquire beneficial ownership of 15% or more of the then-outstanding common stock (an Acquiring Person), or (ii) ten business days (or such later date as may be determined by action of the Board) prior to such time as any person becomes an Acquiring Person following the commencement of a tender offer or exchange offer that would result in a person or group becoming an Acquiring Person. An Acquiring Person does not include certain persons specified in the Rights Agreement. The Rights Agreement was amended on May 14, 2012 to, among other things, redefine the term Acquiring Person to exclude a newly defined term Exempt Person from the definition of Acquiring Person. The term Exempt Person is defined to include: (A) the Company; (B) any subsidiary of the Company; (C) any employee benefit plan maintained by the Company or any of its subsidiaries; (D) any trustee or fiduciary with respect to such employee benefit plan acting in such capacity or trustee or fiduciary holding shares of Company Common Stock for the purpose of funding any such plan or employee benefits; (E) Oak Investment Partners IX, L.P., Oak IX Affiliates Fund, L.P., Oak IX Affiliates Fund-A, L.P., Oak X Affiliates Fund, L.P., Oak Investment Partners X, L.P., Oak Investment Partners XIII, L.P., or their Affiliates and Associates (collectively, the “Oak Parties) as long as the Oak Parties, individually or in the aggregate, are not the beneficial owner of more than 25% of the outstanding shares of Company stock (other than pursuant to a transaction authorized in writing in advance by the Board of Directors) and certain specified criteria are met.

On December 16, 2004, the Board authorized and declared a dividend of one right (a Right) to purchase one one-hundredth of a share of the Company's Series C Preferred Stock (Series C Preferred) for each outstanding share of common stock, par value $0.001, to stockholders of record as of the close of business December 27, 2004. Each Right entitles the registered holder, subject to the terms of the Rights Agreement, to purchase from the Company one one-hundredth of a share of Series C Preferred Stock at a purchase price of $54.00, subject to adjustment.

The Rights are not exercisable until the distribution date and will expire at the close of business on the tenth anniversary of the Rights Agreement unless earlier redeemed or exchanged by the Company.