10-Q 1 ktos-20220327.htm 10-Q ktos-20220327
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
 
      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the Quarterly Period Ended March 27, 2022
or 
        TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________ 
Commission file number 001-34460
 
KRATOS DEFENSE & SECURITY SOLUTIONS, INC.
(Exact name of registrant as specified in its charter)
Delaware13-3818604
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer Identification No.)
1 Chisholm Trail, Suite 3200
Round Rock, TX 78681
(512238-9840
(Address, including zip code, and telephone number, including
area code, of registrant’s principal executive offices)

Securities registered pursuant to Section 12(b) of the Act:
Title of each classTrading Symbol(s)Name of each exchange on which registered
Common Stock, $0.001 par valueKTOSThe NASDAQ Global Select Market
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes ý  No o
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).   Yes ý  No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
ý
Accelerated filer
 
Non-accelerated filer
Smaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes   No 
As of April 29, 2022, 124,997,920 shares of the registrant’s common stock were outstanding.


KRATOS DEFENSE & SECURITY SOLUTIONS, INC.
 
FORM 10-Q
 
FOR THE QUARTERLY PERIOD ENDED MARCH 27, 2022
 
INDEX
  Page
  
   
  
 
  
 
 
 
  
  
  
  
 
  
  
  
  
  
  
  
2

PART I. FINANCIAL INFORMATION
Item 1.  Financial Statements.
KRATOS DEFENSE & SECURITY SOLUTIONS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
 (in millions, except par value and number of shares)
 March 27, 2022
(Unaudited)December 26, 2021
Assets  
Current assets:  
Cash and cash equivalents$254.4 $349.4 
Accounts receivable, net65.9 93.9 
Unbilled receivables, net214.8 190.8 
Inventoried costs107.1 91.7 
Prepaid expenses11.1 9.8 
Other current assets34.6 22.5 
Total current assets687.9 758.1 
Property, plant and equipment, net173.5 168.3 
Operating lease right-of-use assets39.6 38.5 
Goodwill522.9 493.9 
Intangible assets, net51.5 43.2 
Other assets90.1 87.5 
Total assets$1,565.5 $1,589.5 
Liabilities and Stockholders Equity
  
Current liabilities:  
Accounts payable$51.7 $50.4 
Accrued expenses34.2 27.2 
Accrued compensation56.7 47.3 
Accrued interest0.2 1.5 
Billings in excess of costs and earnings on uncompleted contracts49.7 58.1 
Current portion of operating lease liabilities10.5 10.1 
Other current liabilities9.2 25.7 
Current liabilities of discontinued operations1.1 0.8 
Total current liabilities213.3 221.1 
Long-term debt, net of current portion295.0 296.7 
Operating lease liabilities, net of current portion33.3 32.7 
Other long-term liabilities73.9 76.2 
Long-term liabilities of discontinued operations2.5 2.5 
Total liabilities618.0 629.2 
Commitments and contingencies (Note 14)
Redeemable noncontrolling interest15.2 15.2 
Stockholders equity:
  
Preferred stock, $0.001 par value, 5,000,000 shares authorized, 0 shares outstanding at March 27, 2022 and December 26, 2021
  
Common stock, $0.001 par value, 195,000,000 shares authorized; 124,825,355 and 123,987,424 shares issued and outstanding at March 27, 2022 and December 26, 2021, respectively
  
Additional paid-in capital1,582.0 1,578.9 
Accumulated other comprehensive income0.6 0.6 
Accumulated deficit(650.3)(634.4)
Total stockholders equity
932.3 945.1 
Total liabilities and stockholders equity
$1,565.5 $1,589.5 

The accompanying notes are an integral part of these condensed consolidated financial statements.
3

KRATOS DEFENSE & SECURITY SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in millions, except per share amounts)
 (Unaudited)
 Three Months Ended
 March 27, 2022March 28, 2021
Service revenues$67.9 $57.3 
Product sales128.3 136.9 
Total revenues196.2 194.2 
Cost of service revenues49.9 42.5 
Cost of product sales94.4 100.7 
Total costs144.3 143.2 
Gross profit51.9 51.0 
Selling, general and administrative expenses43.3 37.9 
Merger and acquisition expenses0.3 0.2 
Research and development expenses9.2 8.0 
Restructuring expenses and other0.3  
Operating income (loss)(1.2)4.9 
Other expense:  
Interest expense, net(5.9)(5.9)
Loss on extinguishment of debt(13.0) 
Other income, net0.1 0.2 
Total other expense, net(18.8)(5.7)
Loss from continuing operations before income taxes(20.0)(0.8)
Benefit for income taxes from continuing operations(4.3)(2.7)
Income (loss) from continuing operations(15.7)1.9 
Discontinued operations:
Loss from discontinued operations before income taxes (0.3) 
Income tax benefit0.1  
Loss from discontinued operations(0.2) 
Net income (loss)(15.9)1.9 
Less: Net income attributable to noncontrolling interest  
Net income (loss) attributable to Kratos$(15.9)$1.9 
Basic income (loss) per common share attributable to Kratos:  
Income (loss) from continuing operations$(0.12)$0.02 
Loss from discontinued operations  
Net income (loss) per common share$(0.12)$0.02 
Diluted income (loss) per common share attributable to Kratos:
Income (loss) from continuing operations$(0.12)$0.01 
Loss from discontinued operations  
Net income (loss) per common share$(0.12)$0.01 
Weighted average common shares outstanding:
Basic125.9 124.1 
Diluted125.9 127.7 
 
The accompanying notes are an integral part of these consolidated financial statements.

4

KRATOS DEFENSE & SECURITY SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in millions, except per share amounts)
 (Unaudited)

Three Months Ended
March 27, 2022March 28, 2021
Net income (loss)$(15.9)$1.9 
Change in cumulative translation adjustment 0.2 
Comprehensive income (loss)(15.9)2.1 
Less: Comprehensive income attributable to noncontrolling interest  
Comprehensive income (loss) attributable to Kratos$(15.9)$2.1 

The accompanying notes are an integral part of these consolidated financial statements.
5

KRATOS DEFENSE & SECURITY SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
For the three months ended March 27, 2022 and March 28, 2021
(in millions)
(Unaudited)
Redeemable Noncontrolling InterestCommon StockAdditional Paid-In CapitalAccumulated Other Comprehensive IncomeAccumulated DeficitTotal Stockholders’ Equity
SharesAmounts
Balance, December 27, 2020$14.8 123.0 $ $1,556.3 $1.4 $(632.4)$925.3 
Stock-based compensation— — — 6.2 — — 6.2 
Issuance of common stock for employee stock purchase plan and stock options— 0.2 — 2.5 — — 2.5 
Restricted stock issued and related taxes
— 0.5 — (7.1)— — (7.1)
Net income— — — — — 1.9 1.9 
Other comprehensive income, net of tax— — — — 0.2 — 0.2 
Balance, March 28, 2021$14.8 123.7 $ $1,557.9 $1.6 $(630.5)$929.0 

Redeemable Noncontrolling InterestCommon StockAdditional Paid-In CapitalAccumulated Other Comprehensive IncomeAccumulated DeficitTotal Stockholders’ Equity
SharesAmounts
Balance, December 26, 2021$15.2 124.0 $ $1,578.9 $0.6 $(634.4)$945.1 
Stock-based compensation— — — 7.0 — — 7.0 
Issuance of common stock for employee stock purchase plan and stock options— 0.2 — 2.9 — — 2.9 
Restricted stock issued and related taxes
— 0.6 — (6.8)— — (6.8)
Net loss— — — — — (15.9)(15.9)
Balance, March 27, 2022$15.2 124.8 $ $1,582.0 $0.6 $(650.3)$932.3 



























6

KRATOS DEFENSE & SECURITY SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions)
(Unaudited)
Three Months Ended
March 27, 2022March 28, 2021
Operating activities: 
Net income (loss)$(15.9)$1.9 
Loss from discontinued operations(0.2) 
Income (loss) from continuing operations(15.7)1.9 
Adjustments to reconcile income (loss) from continuing operations to net cash provided by (used in) operating activities from continuing operations:  
Depreciation and amortization7.0 6.3 
Deferred income taxes 0.1 
Amortization of lease right-of-use assets2.6 2.2 
Stock-based compensation7.0 6.2 
Amortization of deferred financing costs0.3 0.2 
Loss on extinguishment of debt13.0  
Recovery of doubtful accounts (0.1)
Changes in assets and liabilities, net of acquisitions:  
Accounts receivable31.9 9.8 
Unbilled receivables(19.8)(1.8)
Inventoried costs(15.3)(4.2)
Prepaid expenses and other assets(9.5)(2.0)
Operating lease liabilities(2.7)(2.2)
Accounts payable1.3 (2.0)
Accrued expenses6.1 (2.7)
Accrued compensation5.6 6.2 
Accrued interest(1.3)4.9 
Billings in excess of costs and earnings on uncompleted contracts(8.3)7.1 
Income tax receivable and payable(4.9)(2.2)
Other liabilities(5.2)(5.0)
Net cash provided by (used in) operating activities from continuing operations(7.9)22.7 
Investing activities:  
Cash paid for acquisitions, net of cash acquired(58.5)(5.1)
Capital expenditures(10.8)(9.6)
Net cash used in investing activities from continuing operations(69.3)(14.7)
Financing activities: 
Proceeds from the issuance of long-term debt200.0  
Debt issuance costs(3.2) 
Credit agreement borrowings100.0  
Repayment of debt(309.8) 
Payments under finance leases(0.3)(0.2)
Payments of employee taxes withheld from share-based awards(6.8)(7.1)
Proceeds from shares issued under equity plans2.9 2.5 
Net cash used in financing activities from continuing operations(17.2)(4.8)
Net cash provided by (used in) continuing operations(94.4)3.2 
Net operating cash flows of discontinued operations0.1 (0.5)
Effect of exchange rate changes on cash, cash equivalents and restricted cash(0.7)(0.6)
Net increase (decrease) in cash, cash equivalents and restricted cash(95.0)2.1 
Cash, cash equivalents and restricted cash at beginning of period349.4 381.5 
Cash, cash equivalents and restricted cash at end of period$254.4 $383.6 

The accompanying notes are an integral part of these condensed consolidated financial statements.
7

KRATOS DEFENSE & SECURITY SOLUTIONS, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
(Unaudited)
 
Note 1. Summary of Significant Accounting Policies
 
All references to the “Company” and “Kratos” refer to Kratos Defense & Security Solutions, Inc., a Delaware corporation, and its subsidiaries.
 
(a)    Basis of Presentation

 The information as of March 27, 2022 and for the three months ended March 27, 2022 and March 28, 2021 is unaudited. The condensed consolidated balance sheet as of December 26, 2021 was derived from the Company’s audited consolidated financial statements at that date. In the opinion of management, these unaudited condensed consolidated financial statements include all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of the Company’s financial position, results of operations and cash flows for the interim periods presented. The results have been prepared in accordance with the instructions to Form 10-Q and do not necessarily include all information and footnotes necessary for presentation in accordance with accounting principles generally accepted in the U.S. (“GAAP”). These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the related notes included in the Company’s audited annual consolidated financial statements for the fiscal year ended December 26, 2021, included in the Company’s Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission (the “SEC”) on February 22, 2022 (the “Form 10-K”). Interim operating results are not necessarily indicative of operating results expected in subsequent periods or for the year as a whole.

(b)    Principles of Consolidation
 
The condensed consolidated financial statements include the accounts of the Company, its 100% owned subsidiaries and its majority owned subsidiary, KTT Core, which is 80.1% owned by the Company. All inter-company transactions have been eliminated in consolidation. Noncontrolling interest consists of the remaining 19.9% interest in KTT Core. See Note 12 for further information related to the redeemable noncontrolling interest.
 
(c)    Fiscal Year
 
The Company has a 52/53 week fiscal year ending on the last Sunday of the calendar year. The three month periods ended March 27, 2022 and March 28, 2021 consisted of 13-week periods. There are 52 calendar weeks in the fiscal years ending on December 25, 2022 and December 26, 2021.
 
(d)    Accounting Estimates

There have been no significant changes in the Company’s accounting estimates for the three months ended March 27, 2022 as compared to the accounting estimates described in the Annual Report on Form 10-K.

(e)    Accounting Standards Updates

In October 2021, the FASB issued ASU 2021-08 (“ASU 2021-08”), Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers, which requires entities to recognize and measure contract assets and contract liabilities acquired in a business combination in accordance with ASC 2014-09, Revenue from Contracts with Customers (Topic 606). The update will generally result in an entity recognizing contract assets and contract liabilities at amounts consistent with those recorded by the acquiree immediately before the acquisition date rather than at fair value. The new standard is effective on a prospective basis for fiscal years beginning after December 15, 2022, with early adoption permitted. The Company has adopted the new standard effective December 26, 2021. The adoption of the new standard did not have an impact on the Company’s consolidated financial statements.

(f)    Fair Value of Financial Instruments
 
The carrying amounts and the related estimated fair values of the Company’s long-term debt financial instruments not measured at fair value on a recurring basis at March 27, 2022 and December 26, 2021 are presented in Note 10. The carrying
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value of all other financial instruments, including cash equivalents, accounts receivable, unbilled receivables, accounts payable, accrued expenses, billings in excess of cost and earnings on uncompleted contracts, income taxes payable and short-term debt, approximated their estimated fair values at March 27, 2022 and December 26, 2021 due to the short-term nature of these instruments.

Note 2. Acquisitions

CTT Inc.

On December 10, 2021, the Company acquired CTT Inc. (“CTT”), a company that designs, develops, and manufactures microwave application components and equipment primarily for customers in the defense industry. The purchase price was $22.0 million in cash, subject to adjustments for transaction expenses, indebtedness, cash on hand, and post-closing working capital adjustments. Approximately $6.3 million of the purchase price was paid on December 10, 2021, with the remaining $15.2 million of the purchase price paid on December 30, 2021. The allocation of the total consideration for this acquisition to the tangible and identifiable intangible assets acquired and liabilities assumed is preliminary until the Company obtains final information regarding their fair values. However, the Company does not expect any adjustment to such allocations to be material to the Company's consolidated financial statements. The operating results of the acquisition have been included in the Company’s results of operations from the effective acquisition date. The amount of net sales and earnings of CTT included in the condensed consolidated statement of operations for the year ended December 26, 2021 are not material. Had the acquisition occurred as of December 28, 2020, net sales, net income from consolidated operations, net income attributable to Kratos, and basic and diluted net income per share attributable to Kratos on a pro forma basis for the year ended December 26, 2021 would not have been materially different than the reported amounts. CTT is included in the Kratos Government Solutions (KGS) segment.

Cosmic Advanced Engineered Solutions, Inc.

On December 27, 2021, Kratos Integral Holdings, LLC entered into a Stock Purchase Agreement to acquire Cosmic Advanced Engineered Solutions, Inc. (“Cosmic”) from the Carol L. Zanmiller Living Trust and the John G. Hutchens Living Trust for $37.5 million in cash, subject to adjustments for transaction expenses, indebtedness, cash on hand, and working capital adjustments. Cosmic focuses on radio frequency, terrestrial, and space-based communication solutions, including digital signals processing and geolocation analysis. In addition, Cosmic provides overhead persistent infrared for missile defense systems and embedded cyber solutions to U.S. government agencies. On December 27, 2021, the acquisition was completed following the satisfaction of all closing conditions, including receipt of regulatory approval from all required government authorities. The allocation of the total consideration for this acquisition to the tangible and identifiable intangible assets acquired and liabilities assumed is preliminary until the Company obtains final information regarding their fair values. However, the Company does not expect any adjustment to such allocations to be material to the Company's consolidated financial statements. The operating results of the acquisition have been included in the Company’s results of operations from the effective acquisition date. Cosmic is included in the KGS segment.

The excess of the purchase price over the fair value of the tangible and identifiable intangible assets acquired and liabilities assumed in the acquisition was allocated to goodwill. The goodwill represents the value the Company expects to be created by integrating Cosmic’s existing business with Kratos’ related products and customers.

The transaction has been accounted for using the acquisition method of accounting, which requires, among other things, that the identifiable assets acquired and the liabilities assumed be recognized at their fair values as of the acquisition date. The fair value measurements are based primarily on significant inputs not observable in the marketplace and thus represent Level 3 measurements.

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The following table summarizes the allocation of the purchase price over the estimated fair values of the major assets acquired and liabilities assumed (in millions):

Accounts receivable $3.8 
Unbilled receivables4.0 
Other current assets0.1 
Property and equipment1.3 
Intangible assets10.0 
  Total identifiable net assets acquired19.2 
Total identifiable net liabilities assumed(9.6)
Goodwill28.6 
Net assets acquired, excluding cash$38.2 

Based on the Company’s estimate of fair value, as of December 27, 2021, net liabilities included $6.7 million of current liabilities. The identifiable intangible assets include trade names of $1.5 million with a remaining useful life of 5 years, backlog of $3.0 million with an estimated useful life of 2 years, customer relationships of $2.5 million with remaining useful lives of 10 years, and developed technology of $3.0 million with a remaining useful life of 10 years. The Company also established a deferred tax liability of $2.9 million for the difference between the financial statement basis and tax basis of the acquired assets of Cosmic and a corresponding increase in goodwill. The goodwill recorded in this transaction is not expected to be tax-deductible.

The amounts of revenue and operating loss of Cosmic included in the Company’s condensed consolidated statement of operations for the three months ended March 27, 2022 were $12.7 million and $0.2 million, respectively.

A summary of the consideration paid for the acquired ownership in Cosmic is as follows:

Cash paid$39.5 
Less: Cash acquired(1.3)
Total consideration$38.2 

Southern Research Engineering Division

On March 9, 2022, the Company executed an Asset Purchase Agreement to acquire the assets of the Engineering Division of Southern Research Institute (SRI), an Alabama non-profit corporation, for a purchase price of approximately $80.0 million, comprised of $75.0 million in cash, subject to any working capital adjustments, and $5.0 million in Kratos common stock. Southern Research’s Engineering Division (SRE) is the market leader in assisting customers in the development, modeling, and deployment of advanced materials for extreme environments, including hypersonic, space, missile, missile defense, strategic deterrence, propulsion systems, and energy applications. SRE also specializes in Intelligence Surveillance and Reconnaissance (ISR) sensor development, electromechanical systems design and integration, aerospace engineering, materials engineering, artificial intelligence and machine learning, directed energy, RF systems design and integration, advanced manufacturing, and computational sciences. The acquisition will establish Kratos SRE, a new business unit within Kratos’ Defense and Rocket Support Services Division. Closing is subject to certain conditions, which are expected to be satisfied during the second quarter of 2022.

Note 3. Revenue Recognition

Effective January 1, 2018, the Company 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 the Company determines are within the scope of ASC 606, the Company performs the following five steps: (i) identify the contract(s) with a customer; (ii) identify the performance obligations in each contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when (or as) the entity satisfies a performance obligation. Once the
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contract is identified and determined to be within the scope of ASC 606, the Company assesses the goods or services promised within each contract, determines those that are performance obligations, and assesses whether each promised good or service is distinct. The Company then recognizes 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 in ASC 606. The majority of the Company’s 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, the Company allocates the contract’s transaction price to each performance obligation based on the relative 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 the Company forecasts the expected costs of satisfying a performance obligation and then adds an appropriate margin for that distinct good or service.

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

Remaining Performance Obligations

The Company calculates revenues from remaining performance obligations as the dollar value of the remaining performance obligations on executed contracts. On March 27, 2022, the Company had approximately $982.1 million of remaining performance obligations. The Company expects to recognize approximately 50% of the remaining performance obligations as revenue in fiscal year 2022, an additional 20% in fiscal year 2023, and the balance thereafter.

Contract Estimates

Due to the nature of the work required to be performed on many performance obligations, the estimation of total revenue and cost at completion is complex, subject to many variables, and requires significant judgment. On a quarterly basis, the Company conducts its contract cost Estimate at Completion (“EAC”) process by reviewing the progress and execution of outstanding performance obligations within its contracts. As part of this process, management reviews information including, but not limited to, any outstanding key contract matters, progress towards completion and the related program schedule, identified risks and opportunities and the related changes in estimates of revenues and costs. The risks and opportunities include management’s judgment about the ability and cost to achieve the schedule (e.g., the number and type of milestone events), technical requirements (e.g., a newly-developed product versus a mature product) and other contract requirements. Management must make assumptions and estimates regarding labor productivity and availability, the complexity of the work to be performed, the availability of materials, the length of time to complete the performance obligation (e.g., to estimate increases in wages and prices for materials and related support cost allocations), execution by subcontractors, the availability and timing of funding from customers and overhead cost rates, among other variables.

In addition, certain of the Company’s long-term contracts contain award fees, incentive fees, or other provisions that can either increase or decrease the transaction price. These variable amounts generally are awarded upon achievement of certain performance metrics, program milestones, or cost targets and can be based upon customer discretion. Variable consideration is estimated at the most likely amount to which the Company is expected to be entitled. Estimated amounts are included in the transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is resolved. Estimates of variable consideration and determination of whether to include estimated amounts in the transaction price are based largely on an assessment of the Company’s anticipated performance and all information (historical, current, and forecasted) that is reasonably available.

Contracts are often modified to account for changes in contract specifications and requirements. Contract modifications are considered to exist when the modification either creates new or changes the existing enforceable rights and
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obligations. Most of the Company’s contract modifications are for goods or services that are not distinct from the existing contract due to the significant integration service provided in the context of the contract and are accounted for as if they were part of that existing contract. The effect of a contract modification on the transaction price, and the measure of progress for the performance obligation to which it relates, is recognized as an adjustment to revenue (either as an increase in or a reduction of revenue) on a cumulative catch-up basis.

As a result of the EAC process, any quarterly adjustments to revenues, cost of sales, and the related impact to operating income are recognized as necessary in the period they become known. These adjustments may result from positive program performance, and may result in an increase in operating income during the performance of individual performance obligations, if it is determined the Company will be successful in mitigating risks surrounding the technical, schedule and cost aspects of those performance obligations or realizing related opportunities. Likewise, these adjustments may result in a decrease in operating income if it is determined the Company will not be successful in mitigating these risks or realizing related opportunities. Changes in estimates of net sales, cost of sales, and the related impact to operating income are recognized quarterly on a cumulative catch-up basis, which recognizes in the current period the cumulative effect of the changes on current and prior periods. A significant change in one or more of these estimates could affect the profitability of one or more of the Company’s contracts. When estimates of total costs to be incurred on a performance obligation exceed total estimates of revenue to be earned, a provision for the entire loss on the performance obligation is recognized in the period the loss is determined. No cumulative catch-up adjustment on any one contract was material to the Company’s unaudited condensed consolidated financial statements for the three-month periods ended March 27, 2022, and March 28, 2021. Likewise, total cumulative catch-up adjustments were not material for the three-month periods ended March 27, 2022, and March 28, 2021.

Contract Assets and Liabilities

For each of the Company’s contracts, the timing of revenue recognition, customer billings, and cash collections results in a net contract asset or liability at the end of each reporting period. Fixed-price contracts are typically billed to the customer either using progress payments, whereby amounts are billed monthly as costs are incurred or work is completed, or performance based payments, which are based upon the achievement of specific, measurable events or accomplishments defined and valued at contract inception. Cost-type contracts are typically billed to the customer on a monthly or semi-monthly basis.

Contract assets consist of unbilled receivables, primarily related to long-term contracts where revenue recognized under the cost-to-cost method exceeds amounts billed to customers. Unbilled receivables are classified as current assets and, in accordance with industry practice, include amounts that may be billed and collected beyond one year due to the long-term nature of many of the Company’s contracts. Accumulated contract costs in unbilled receivables include direct production costs, factory and engineering overhead, production tooling costs, and, for government contracts, recovery of allowable general and administrative expenses. Unbilled receivables also include certain estimates of variable consideration described above. The Company’s contracts that give rise to contract assets are not considered to include a significant financing component as the payment terms are intended to protect the customer in the event the Company does not perform on its obligations under the contract.

Contract liabilities include advance payments and billings in excess of revenue recognized. Certain customers make advance payments prior to the satisfaction of the Company’s performance obligations on the contract. These amounts are recorded as contract liabilities until such performance obligations are satisfied, either over time as costs are incurred or at a point in time when deliveries are made. The Company’s contracts that give rise to contract liabilities do not include a significant financing component as the underlying advance payments received are generally utilized to pay for contract costs within a one-year period or are used to ensure the customer meets contractual requirements.

Net contract assets and liabilities are as follows (in millions):
March 27, 2022December 26, 2021Net Change
Contract assets$214.8 $190.8 $24.0 
Contract liabilities$49.7 $58.1 $(8.4)
Net contract assets$165.1 $132.7 $32.4 

Contract assets increased $24.0 million during the three months ended March 27, 2022, primarily due to the recognition of revenue related to the satisfaction or partial satisfaction of performance obligations for which the Company has not yet billed the customers. There were no significant impairment losses related to any receivables or contract assets arising from the Company’s contracts with customers during the three months ended March 27, 2022. Contract liabilities decreased $8.4 million during the three months ended March 27, 2022, primarily due to revenue recognized in excess of payments
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received on these performance obligations. For the three months ended March 27, 2022 the Company recognized revenue of $21.2 million that was previously included in the contract liabilities that existed at December 26, 2021. For the three months ended March 28, 2021 the Company recognized revenue of $17.0 million that was previously included in the contract liabilities that existed at December 27, 2020.

In November 2019, a large training solutions program was terminated for convenience (“T for C”) by the customer. Under a T for C, a contractor is entitled to seek specified costs through a termination settlement process including (1) the contract price for completed supplies and services accepted by the government but not previously paid for; (2) the cost incurred in the performance of work terminated plus a reasonable profit on those costs; and (3) its costs incurred in settling with subcontractors and preparing and settling the termination proposal. Under a T for C, the Company would not be able to collect the total withheld amounts until the settlement terms of the T for C have been negotiated and agreed to with the customer. At March 27, 2022, approximately $10.8 million in unbilled receivables remained outstanding on this project. In March 2022, the Company and the customer agreed to a settlement of $6.0 million for a portion of the amounts outstanding on this project, which is expected to be collected in the third quarter of 2022. The remaining unbilled balance of $4.8 million is subject to negotiation and settlement with the customer. In addition, the Company is currently in dispute with an international customer in the Unmanned Systems (US) segment over approximately $10.0 million in unbilled receivables outstanding as of March 27, 2022. The dispute with the international customer concerns the completion of certain system requirements and certain 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. Management has evaluated the present facts of the matters and performed a reassessment of the contractual amounts due and has determined that no adjustment to previously recognized revenue, or the corresponding unbilled receivables, is necessary at March 27, 2022.

Disaggregation of Revenue

The following series of tables presents the Company’s revenue disaggregated by several categories. For the majority of contracts, revenue is recognized over time as work is performed on the contract. Revenue by contract type was as follows (in millions):
Three Months Ended
March 27, 2022March 28, 2021
Kratos Government Solutions
Fixed price$101.3 $99.5 
Cost plus fee32.3 28.6 
Time and materials10.0 10.2 
Total Kratos Government Solutions143.6 138.3 
Unmanned Systems
Fixed price31.5 37.2 
Cost plus fee20.4 17.9 
Time and materials0.7 0.8 
Total Unmanned Systems52.6 55.9 
Total Revenues$196.2 $194.2 

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Revenue by customer was as follows (in millions):
Three Months Ended
March 27, 2022March 28, 2021
Kratos Government Solutions
U.S. Government (1)
$89.5 $92.6 
International (2)
34.7 31.7 
U.S. Commercial and other customers19.4 14.0 
Total Kratos Government Solutions143.6 138.3 
Unmanned Systems
U.S. Government (1)
50.1 49.6 
International (2)
1.8 6.3 
U.S. Commercial and other customers0.7  
Total Unmanned Systems52.6 55.9 
Total Revenues$196.2 $194.2 
(1) Sales to the U.S. Government include sales from contracts for which the Company is the prime contractor, as well as those for which the
Company is a subcontractor and the ultimate customer is the U.S. Government. Each of the Company’s segments derives substantial revenue
from the U.S. Government. These sales include foreign military sales contracted through the U.S. Government.

(2) International sales include sales from contracts for which the Company is the prime contractor, as well as those for which the Company is a
subcontractor and the ultimate customer is an international customer. These sales include direct sales with governments outside the U.S. and
commercial sales with customers outside the U.S.

Note 4. Discontinued Operations

On February 28, 2018, the Company entered into a Stock Purchase Agreement to sell the operations of Kratos Public Safety & Security Solutions, Inc., a Delaware corporation and wholly owned subsidiary of the Company (“PSS”), to Securitas Electronic Security, Inc., a Delaware corporation (“Buyer”). On June 11, 2018, the Company 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, the Company has received approximately $68.7 million of aggregate net cash proceeds from the Transaction, after taking into account amounts that were paid by the Company pursuant to a negotiated transaction services agreement between the Company and the Buyer, receipt of approximately $7.3 million in net working capital retained by the Company, and associated transaction fees and expenses, including the impact of the final settlement and determination of the closing net working capital adjustment and litigation which was settled with the Buyer in the fourth quarter of 2021 and first quarter of 2022, respectively.

Note 5. Goodwill and Intangible Assets
 
(a)    Goodwill
 
    The carrying amounts of goodwill as of March 27, 2022 and December 26, 2021 by reportable segment are as follows (in millions):
As of March 27, 2022
KGSUSTotal
Gross value$648.3 $127.9 $776.2 
Less accumulated impairment239.5 13.8 253.3 
Net$408.8 $114.1 $522.9 

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As of December 26, 2021
KGSUSTotal
Gross value$619.3 $127.9 $747.2 
Less accumulated impairment239.5 13.8 253.3 
Net$379.8 $114.1 $493.9 

(b)    Purchased Intangible Assets
 
The following table sets forth information for finite-lived and indefinite-lived intangible assets (in millions): 
 As of March 27, 2022As of December 26, 2021
 Gross
Value
Accumulated
Amortization
Net
Value
Gross
Value
Accumulated
Amortization
Net
Value
Acquired finite-lived intangible assets:    
Customer relationships$79.0 $(58.2)$20.8 $76.5 $(57.6)$18.9 
Contracts and backlog37.9 (33.8)4.1 34.9 (33.1)1.8 
Developed technology and technical know-how34.4 (26.1)8.3 31.4 (25.8)5.6 
Trade names4.2 (2.1)2.1 2.7 (2.0)0.7 
In-process research and development9.5 (0.2)9.3 9.5 (0.2)9.3 
Total finite-lived intangible assets165.0 (120.4)44.6 155.0 (118.7)36.3 
Indefinite-lived trade names6.9 — 6.9 6.9 — 6.9 
Total intangible assets$171.9 $(120.4)$51.5 $161.9 $(118.7)$43.2 

Consolidated amortization expense related to intangible assets subject to amortization was $1.7 million and $1.4 million for the three months ended March 27, 2022 and March 28, 2021, respectively.

Note 6. Inventoried Costs
 
Inventoried costs, consisted of the following components (in millions):
 
 March 27, 2022December 26, 2021
Raw materials$66.6 $58.5 
Work in process34.9 28.5 
Finished goods5.6 4.7 
Total inventoried costs$107.1 $91.7 
 
Note 7. Net Income (Loss) per Common Share
 
The Company calculates net income (loss) per share in accordance with FASB ASC Topic 260, Earnings per Share (Topic 260). Under Topic 260, basic net income (loss) per common share attributable to the Kratos shareholders is calculated by dividing net income (loss) attributable to Kratos by the weighted-average number of common shares outstanding during the reporting period. Diluted net income (loss) per common share reflects the effects of potentially dilutive securities.

Shares from stock options and awards, excluded from the calculation of diluted net loss per share because their inclusion would have been anti-dilutive, were 1.2 million for the three months ended March 27, 2022.
 
Note 8. Leases

The Company leases certain facilities, office space, vehicles and equipment. Lease assets and lease liabilities are recognized at the commencement of an arrangement where it is determined at inception that a lease exists. Lease assets represent the right to use an underlying asset for the lease term, and lease liabilities represent the obligation to make lease payments arising from the lease. These assets and liabilities are initially recognized based on the present value of lease
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payments over the lease term calculated using an incremental borrowing rate generally applicable to the location of the lease asset, unless the implicit rate is readily determinable. Lease assets also include any upfront lease payments made and exclude lease incentives. Lease terms include options to extend or terminate the lease when it is reasonably certain that those options will be exercised. The Company has operating lease arrangements with lease and non-lease components. The non-lease components in these arrangements are not significant when compared to the lease components. For all operating leases, the Company accounts for the lease and non-lease components as a single component.

Variable lease payments are generally expensed as incurred. Leases with an initial term of 12 months or less are not recorded on the balance sheet, and the expense for these short-term leases is recognized on a straight-line basis over the lease term.

The depreciable life of lease assets and leasehold improvements is limited by the expected lease term, unless there is a transfer of title or purchase option reasonably certain of exercise.

    The components of lease expense were as follows (in millions):
Three Months Ended
March 27, 2022March 28, 2021
Amortization of right of use assets - finance leases$0.7 $0.5 
Interest on lease liabilities - finance leases0.7 0.6 
Operating lease cost 3.3 2.9 
Short-term lease cost0.2 0.2 
Variable lease cost (cost excluded from lease payments)  
Sublease income  
Total lease cost
$4.9 $4.2 

The components of leases on the balance sheet were as follows (in millions):
March 27, 2022December 26, 2021
Operating Leases:
Operating lease right-of-use assets
$39.6 $38.5 
Current portion of operating lease liabilities
$10.5 $10.1 
Operating lease liabilities, net of current portion
$33.3 $32.7 
Finance leases:
Property, plant and equipment, net
$38.3 $39.0 
Other current liabilities
$1.2 $1.2 
Other long-term liabilities
$42.9 $43.2 

Cash paid for amounts included in the measurement of lease liabilities was as follows (in millions):
Three Months Ended
March 27, 2022March 28, 2021
Finance lease - cash paid for interest$0.7 $0.6 
Finance lease - financing cash flows$0.3 $0.2 
Operating lease - operating cash flows (fixed payments)$3.4 $2.8 
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Other supplemental noncash information (in millions):
Three Months Ended
March 27, 2022March 28, 2021
Operating lease liabilities arising from obtaining right-of-use assets$3.7 $0.2 
Finance lease liabilities arising from obtaining right-of-use assets$ $ 
March 27, 2022March 28, 2021
Weighted-average remaining lease term (in years):
Operating leases
4.505.28
Finance leases
15.9117.44
Weighted-average discount rate:
Operating leases
6.48 %6.50 %
Finance leases
6.51 %6.52 %

The maturity of lease liabilities is (in millions):
Operating LeasesFinance Leases
2022 (1)
$9.8 $3.0 
202312.4 4.1 
20249.8 4.2 
20258.3 4.2 
20264.9 4.3 
Thereafter5.3 52.8 
Total lease payments50.5 72.6 
Less: imputed interest(6.7)(28.5)
Total present value of lease liabilities$43.8 $44.1 
(1) Excludes the three months ended March 27, 2022.

Note 9. Income Taxes

A reconciliation of the total income tax provision (benefit) to the amount computed by applying the statutory federal income tax rate of 21% to income from continuing operations before income taxes for the three months ended March 27, 2022 and March 28, 2021 is as follows (in millions):
 For the Three Months Ended
 March 27,
2022
March 28,
2021
Income tax benefit at federal statutory rate$(4.2)$(0.2)
Nondeductible expenses and other1.0 (0.2)
Stock compensation - excess tax benefits(0.9)(2.4)
Federal impact of research & development tax credits(0.2)0.1 
Benefit for income taxes from continuing operations$(4.3)$(2.7)

The Company calculates its interim income tax provision in accordance with ASC Topic 270, “Interim Reporting,” and ASC Topic 740, “Accounting for Income Taxes.” Historically, the Company calculated the provision for income taxes during the interim reporting periods by applying an estimate of the annual effective tax rate for the full fiscal year to “ordinary” income or loss (pretax income or loss excluding unusual or infrequently occurring discrete items) for the reporting period. The Company determined that since small changes in estimated “ordinary” income would result in significant changes in the
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estimated annual effective tax rate, the historical method would not provide a reliable estimate for the three ended March 27, 2022. Therefore, a discrete effective tax rate method was used to calculate taxes for the three months ended March 27, 2022.
As of December 26, 2021, the Company had $25.9 million of unrecognized tax benefits that, if recognized, would impact the Company’s effective income tax rate. During the three months ended March 27, 2022 unrecognized tax benefits increased by $0.1 million relating to various current year tax positions.

The Company recognizes interest and penalties related to unrecognized tax benefits in its provision for income taxes. For each of the three months ended March 27, 2022 and March 28, 2021, the Company recorded an expense for interest and penalties of $0.1 million. For the three months ended March 27, 2022 and March 28, 2021, there was no material benefit recorded related to the removal of interest and penalties. The Company believes that it is reasonably possible that as much as $0.5 million of the liabilities for uncertain tax positions will expire within the next twelve months due to the expiration of various applicable statutes of limitations.

Note 10. Debt
 
(a) New Credit Facility

    On February 18, 2022, the Company completed the refinancing of its outstanding $90 million revolving credit facility and $300 million 6.5% Senior Secured Notes (the “Senior Secured Notes”), with a new 5-year $200 million Revolving Credit Facility and 5-year $200 million Term Loan A (collectively, the “New Credit Facility”). The Company incurred debt issuance costs of $3.2 million associated with the New Credit Facility. The Company has drawn approximately $200 million under the Term Loan A and $100 million on the new Revolving Credit Facility, with $100 million remaining in borrowing capacity, less approximately $13.2 million of letters of credit outstanding.

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

The New Credit Facility is governed by a Credit Agreement (the “Credit Agreement”), which establishes the 5-year senior secured credit facility which is comprised of the $200 million Revolving Credit Facility (which includes sub-facilities for the incurrence of up to $10.0 million of swingline loans and the issuance of up to $50.0 million of Letters of Credit) and the $200 million Term Loan A. The Credit Agreement contemplates uncommitted incremental credit facilities of up to $200 million (which amount would be reduced by the aggregate amount of any and all incremental credit facilities actually established under the Credit Agreement) plus additional uncommitted incremental capacity subject to a limitation based on the Company’s pro forma total net leverage ratio (including any such additional uncommitted incremental capacity).

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

Mandatory amortization on the Term Loan A is 2.5% in each of the first and second years and 5.0% in each of the third, fourth and fifth years, with the remaining outstanding balance due at maturity. The Credit Agreement contains certain covenants, which include, but are not limited to, restrictions on indebtedness, liens, fundamental changes, restricted payments, asset sales, and investments, and places limits on various other payments. The Company was in compliance with the covenants contained in the Credit Agreement as of March 27, 2022.
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(b) 6.5% Senior Secured Notes due 2025

In November 2017, the Company issued and sold $300 million aggregate principal amount of 6.5% Senior Secured Notes due 2025, or the Senior Secured Notes, in a private placement conducted pursuant to Rule 144A and Regulation S under the Securities Act of 1933, as amended. The Company incurred debt issuance costs of $6.6 million associated with the Senior Secured Notes. The Senior Secured Notes were redeemed on March 14, 2022.

(c)    Other Indebtedness

Credit and Security Agreement

On November 20, 2017, the Company entered into an amended and restated credit and security agreement (the “Credit and Security Agreement”), which established 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 the agent’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. The Credit and Security Agreement was replaced by the New Credit Facility on February 18, 2022.

Fair Value of Long-term Debt
 
Carrying amounts and the related estimated fair values of the Company’s Senior Secured Notes not measured at fair value on a recurring basis at December 26, 2021 are presented in the following table:
 
 As of December 26, 2021
$ in millionsPrincipalCarrying
Amount
Fair Value
Total long-term debt including current portion$300.0 $296.7 $308.3 

The fair value of the Company’s Senior Secured Notes was based upon actual trading activity (Level 1, Observable inputs -quoted prices in active markets).

 As of December 26, 2021, the difference between the carrying amount of $296.7 million and the principal amount of $300.0 million presented in the above table is the unamortized debt issuance costs of $3.3 million, which were being accreted to interest expense over the term of the related debt. The Senior Secured Notes were redeemed on March 14, 2022.

Term Loan and Revolving Credit Debt

Long-term debt and the current period interest rates were as follows (in millions):
Three Months Ended
March 27, 2022
Term Loan A$200.0
Revolving credit facility100.0
Total debt300.0
Less current portion(3.7)
Total long-term debt, less current portion296.3
Less long-term unamortized debt issuance costs - term loans(1.3)
Total long-term debt, net of unamortized debt issuance costs - term loans$295.0
Unamortized debt issuance costs - revolving credit facility$1.5
Current period interest rate2.2 %

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Future long-term debt principal payments at March 27, 2022 were as follows (in millions):

2022$3.7 
20235.0 
20248.8 
202510.0 
202610.0 
2027162.5 
$200.0 

Note 11. Segment Information
 
The Company operates in two reportable segments. The KGS reportable segment is comprised of an aggregation of KGS operating business units, including the Company’s microwave electronic products, space and satellite communications, training and cybersecurity, C5ISR/modular systems, turbine technologies and defense and rocket support services operating segments. The US reportable segment consists of the Company’s unmanned aerial, unmanned ground, unmanned seaborne and command, control and communications system business. The KGS and US segments provide products, solutions and services for mission critical national security programs. KGS and US customers primarily include national security related agencies, the U.S. Department of Defense (the “DoD”), intelligence agencies and classified agencies, and to a lesser degree, international government agencies and domestic and international commercial customers.

The Company organizes its reportable segments based on the nature of the products, solutions and services offered. Transactions between segments are generally negotiated and accounted for under terms and conditions similar to other government and commercial contracts. In the following table, total operating income from continuing operations of the reportable business segments is reconciled to the corresponding consolidated amount. The reconciling item Corporate activities includes costs for certain stock-based compensation programs (including stock-based compensation costs for stock options, employee stock purchase plan and restricted stock units), the effects of items not considered part of management’s evaluation of segment operating performance, merger and acquisition expenses, corporate costs not allocated to the segments, and other miscellaneous corporate activities.

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 Revenues, depreciation and amortization, and operating income generated by the Company’s reportable segments for the three month periods ended March 27, 2022 and March 28, 2021 are as follows (in millions): 
 Three Months Ended
 March 27, 2022March 28, 2021
Revenues: