Goodwill and Other Intangible Assets


(a)	Goodwill

The Company historically performed 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. In the third quarter of fiscal year 2014, the Company prospectively changed its goodwill testing date from the last day of its fiscal year to the last day of its fiscal October. The change was to better align its impairment testing procedures with the completion of its annual financial and strategic planning process. This change was applied prospectively beginning on November 2, 2014; retrospective application to prior periods is impracticable as the Company is unable to objectively determine, without the use of hindsight, the assumptions that would have been used in those earlier periods to estimate fair value.

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.

The Company concluded that goodwill was not impaired at November 2, 2014. In determining the fair value for the reporting units, there are key assumptions relating to our future operating performance and revenue growth. If the actual operating performance and financial results are not consistent with our assumptions, an impairment in our $596.4 million goodwill and $52.3 million long-lived intangibles could occur in future periods. Market factors that could impact our ability to successfully develop new products include the successful completion of certain unmanned system platforms, the successful acceptance of new unmanned system platforms, including from a political and budgetary standpoint. For example, 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 the UCAS product. Additionally, the US reporting unit fair value assumes that we will receive follow on orders for the Sub-Sonic Aerial Target ("SSAT"), which is currently under contract with the US Navy.

As a result of an internal organizational realignment in August 2013 the Company reorganized its KGS operating segment. As a result of this reorganization, the KGS reporting segment had five operating segments: Defense Rocket Support Services ("DRSS"), Electronic Products ("EP"), Technical and Training Solutions ("TTS"), Modular Systems ("MS"), and Unmanned Systems ("US"). All of the KGS operating segments provide technology based defense solutions, involving products and services, primarily for mission critical United States National Security priorities, with the primary focus relating to the nation’s C5ISR requirements. The PSS reportable business segment provides integrated solutions for advanced homeland security, public safety, critical infrastructure security, and security and surveillance systems for government, industrial and commercial customers. In the fourth quarter of 2014, we expanded the number of reportable segments to three as we separated the KGS segment into two reportable segments: KGS and Unmanned Systems (“US”). As a result, the KGS reportable segment is comprised of an aggregation of Kratos’ Government Solutions operating segments, including our electronic products, satellite communications, modular systems and rocket support operating segments. The Company has identified its reporting units to be the DRSS, EP, TTS, MS, US divisions and PSS, to be tested for potential impairment in its fiscal year 2014 annual test.

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 method and the market approach, which estimates the fair value of the Company's 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, a Level 3 measurement (See Note 10). 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.

As a result of the Company's decision in June 2012 to dispose of certain non-core businesses acquired in the Integral acquisition in July 2011, the Company allocated $1.5 million of goodwill to discontinued operations, which resulted in an impairment charge (see Note 9). The Company then tested the goodwill remaining in the KGS reporting unit. The fair value of the KGS reporting unit exceeded its carrying value by 7.4% at that time.

During the fourth quarter of 2012, the KGS reporting unit was impacted by continued declining market valuations and the economic uncertainty in the U.S. defense industry. Congress was unable to agree on a budget that conformed with the Budget Control Act of 2011 requirements, which called for additional substantial defense spending reductions through sequestration. Congress and the President could not agree on budgetary, tax and spending issues, and as a result a FY 2013 budget was not passed and a six-month continuing resolution that funded the U.S. Government through March 27, 2013 was passed. These events significantly increased the likelihood of the sequester occurring which had negative consequences for the defense industry. In addition, as Congress and the Administration could not come to an agreement on terms of a possible national fiscal approach, they also failed to address other fiscal matters such as the debt ceiling. These events negatively impacted the Company's 2012 annual estimate of the fair value of the KGS reporting unit resulting in the book value of the KGS reporting unit exceeding its fair value in step one of the impairment test.

The Company performed the second step of the goodwill impairment test to measure the amount of the impairment loss, if any, of the KGS reporting unit. The second step of the test requires the allocation of the reporting unit's fair value to its assets and liabilities, including any unrecognized intangible assets, in a hypothetical analysis that calculates the implied fair value of goodwill as if the reporting unit was being acquired in a business combination. If the implied fair value of goodwill is less than the carrying value, the difference is recorded as an impairment loss. Based on the results of the step two analysis, the Company recorded an $82.0 million goodwill impairment in 2012 related to our KGS reporting unit.

As of December 28, 2014, the goodwill of the PSS, US and KGS reportable segments were $35.6 million, $97.3 million and $463.5 million, respectively.

The changes in the carrying amount of goodwill for the years ended December 29, 2013 and December 28, 2014 are as follows (in millions):



	Public Safety & Security		US		KGS			Total
Balance as of December 30, 2012	$	35.6	$	—	$	560.9		$	596.5
Retrospective adjustments	—				(0.1		)	(0.1		)
Balance as of December 30, 2012 after retrospective adjustments	35.6		—		560.8			596.4
2013 reorganization	—		97.3		(97.3		)	—
Balance as of December 29, 2013	35.6		97.3		463.5			596.4
2014 transactions	—		—		—			—
Balance as of December 28, 2014	$	35.6	$	97.3	$	463.5		$	596.4

The accumulated impairment losses as of December 28, 2014 were $247.4 million, of which $215.3 million was associated with the KGS reportable segment, $13.8 million was associated with the US reportable segment, and $18.3 million was associated with the PSS reportable segment.


(b)	Purchased Intangible Assets

The following table sets forth information for acquired finite-lived and indefinite-lived intangible assets (in millions):



	As of December 29, 2013							As of December 28, 2014
	Gross Value		Accumulated Amortization			Net Value		Gross Value		Accumulated Amortization			Net Value
Acquired finite-lived intangible assets:
Customer relationships	$	97.7	$	(53.7	)	$	44.0	$	99.0	$	(70.6	)	$	28.4
Contracts and backlog	80.0		(78.7		)	1.3		82.7		(80.0		)	2.7
Developed technology and technical know-how	22.1		(8.6		)	13.5		23.1		(10.9		)	12.2
Trade names	6.1		(3.1		)	3.0		6.0		(5.0		)	1.0
Favorable operating lease	1.8		(0.6		)	1.2		1.8		(0.7		)	1.1
Total finite-lived intangible assets	207.7		(144.7		)	63.0		212.6		(167.2		)	45.4
Acquired indefinite-lived intangible assets
Trade names	6.9		—			6.9		6.9		—			6.9
Total indefinite-lived intangible assets	6.9		—			6.9		6.9		—			6.9
Total intangible assets	$	214.6	$	(144.7	)	$	69.9	$	219.5	$	(167.2	)	$	52.3

The Company reviews intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. Impairment losses, where identified, are determined as the excess of the carrying value over the estimated fair value of the long-lived asset. The recoverability of the carrying value of assets held for use is assessed based on a review of projected undiscounted cash flows. Prior to conducting step one of the 2012 goodwill impairment test, certain of the long-lived assets were assessed for recoverability. During 2012 the Company made the decision to minimize the use of the CMCI and HBE trade names as part of its overall branding strategy which resulted in a revised fair value of $6.9 million for such trade names, with a remaining useful life of two years. This resulted in an impairment of $14.6 million in 2012. The impairment related to the KGS and PSS reportable segments were $1.7 million and $12.9 million, respectively.

The aggregate amortization expense for finite-lived intangible assets was $43.9 million, $36.2 million and $22.5 million for the years ended December 30, 2012, December 29, 2013, and December 28, 2014, respectively. The Company records all amortization expense in selling, general and administrative expenses in the Consolidated Statements of Operations and Comprehensive Loss.

The estimated future amortization expense of acquired intangible assets with finite lives as of December 28, 2014 is as follows (in millions):



Fiscal Year	Amount
2015	$	15.6
2016	10.9
2017	9.4
2018	4.3
2019	3.5
Thereafter	1.7
Total	$	45.4