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KRATOS DEFENSE & SECURITY SOLUTIONS, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.(Edgar Glimpses Via Acquire Media NewsEdge) This Quarterly Report on Form 10-Q (this "Quarterly Report") contains "forward-looking statements" relating to our future financial performance, the market for our services and our expansion plans and opportunities. In some cases, you can identify forward-looking statements by terminology such as "may," "will," "should," "expect," "plan," "anticipate," "believe," "estimate," "predict," "potential," or "continue," the negative of such terms or other comparable terminology. These forward-looking statements reflect our current beliefs, expectations and projections, are based on assumptions, and are subject to known and unknown risks and uncertainties that could cause our actual results or achievements to differ materially from any future results or achievements expressed in or implied by our forward-looking statements. Many of these factors are beyond our ability to control or predict. As a result, you should not place undue reliance on forward-looking statements. The most important risks and uncertainties that could cause our actual results or achievements to differ materially from the results or achievements reflected in our forward-looking statements, include, but are not limited to: changes or cutbacks in spending or the appropriation of funding by the federal government, including the U.S. Department of Defense, which could cause delays, cancellations or reductions of key government contracts; changes in the scope or timing of our projects; the timing, rescheduling or cancellation of significant customer contracts and agreements, or consolidation by or the loss of key customers; risks of adverse regulatory action or litigation; risks associated with debt leverage; failure to successfully consummate acquisitions or integrate acquired operations; risks related to security breaches, cybersecurity attacks or other significant disruptions of our information systems; and competition in the marketplace, which could reduce revenues and profit margins, as well as the additional risks and uncertainties described in this Quarterly Report on Form 10-Q and in "Item 1A-Risk Factors" of our Annual Report on Form 10-K for the fiscal year ended December 29, 2013 filed with the Securities and Exchange Commission on March 12, 2014. These forward-looking statements reflect our views and assumptions only as of the date such forward-looking statements are made. Except as required by law, we assume no responsibility for updating any forward-looking statements, whether as a result of new information, future events or otherwise. All references to "us," "we," "our," the "Company" and "Kratos" refer to Kratos Defense & Security Solutions, Inc., a Delaware corporation, and its subsidiaries. Overview We are a specialized security technology business providing mission critical products, technology solutions and services for domestic and international customers, with our principal customers being national security related agencies of the U.S. Government. Our core capabilities are sophisticated engineering, manufacturing, system integration, test and evaluation offerings for national security platforms and programs. Our principal products and services are related to Command, Control, Communications, Computing, Combat Systems, Intelligence, Surveillance and Reconnaissance ("C5ISR"). We offer our customers products, solutions, services and expertise to support their mission-critical needs by leveraging our skills across our core offering areas in C5ISR. We design, engineer and manufacture specialized electronic components, subsystems and systems for electronic attack, electronic warfare, radar, and missile system platforms; integrated product, software and technology solutions for satellite communications; products and solutions for unmanned systems; products and services related to cybersecurity and cyberwarfare; products and solutions for ballistic missile defense; weapons systems trainers; advanced network engineering and information technology services; weapons systems lifecycle support and sustainment; military weapon range operations and technical services; and public safety, critical infrastructure security and surveillance systems. We believe our stable customer base, strong customer relationships, intellectual property, broad array of contract vehicles, "designed in" positions on strategic national security platforms, large employee base possessing specialized skills, specialized manufacturing facilities and equipment, extensive list of past performance qualifications, and significant management and operational capabilities position us for success. We were incorporated in the state of New York on December 19, 1994 and began operations in March 1995. We reincorporated in the state of Delaware in 1998. We completed our exit of the commercial wireless industry, began building a national security focused business and changed the Company's name to Kratos Defense & Security Solutions, Inc. in September 2007. Industry Update On February 15, 2014, legislation was signed that raises the U.S. debt limit through March 2015. In addition, in January 2014, appropriators passed legislation that offsets a portion of the sequester cuts for fiscal 2014 and 2015. This 26-------------------------------------------------------------------------------- Table of Contents translates to a somewhat better outlook for the defense industry than what was generally expected for both this year and next. However, we still expect lower or delayed awards on some of our programs, increased competition for a reduced defense outlay, and increased protest activity with a related negative impact on our revenues, earnings and cash flows. In March 2014, the Pentagon submitted its FY 2015 Budget Request of approximately $496 billion, which is consistent with the Bipartisan Budget Spending Authorization. Also in March 2014, the Pentagon published the Quadrennial Defense Review ("QDR"). Both the Pentagon's FY 2015 Budget Request and the QDR provide important insight for future national security funding priorities and related programs, which include cyber security and warfare, unmanned systems, satellite communications, missile defense and electronic warfare. In September 2014, the President signed a FY2015 Continuing Resolution ("CR") that will fund the government through December 11, 2014. The bill sets the discretionary funding level for the federal government during CR period at an annual rate of $1.012 trillion. The House has passed seven of the twelve FY2015 appropriations bills while the Senate has passed none to date. As a result, Congress will have less than one month to reach agreement on the details of all 12 appropriations bills, put them together into an omnibus bill, and get the omnibus bill to the president by December 11th. If Congress does not meet this deadline it will need to pass another CR to avert a government shutdown. Reportable Segments We operate in two principal reportable business segments: Kratos Government Solutions ("KGS") and Public Safety & Security ("PSS"). We organize our reportable business 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, and these intercompany transactions are eliminated in consolidation. The condensed consolidated financial statements in this Form 10-Q are presented in a manner consistent with our operating structure. For additional information regarding our reportable business segments, see Note 9 of the notes to the condensed consolidated financial statements. From a customer and solutions perspective, we view our business as an integrated whole, leveraging skills and assets wherever possible. Strategic Acquisitions We have historically supplemented our organic growth by identifying, acquiring and integrating businesses that meet our primary objective of providing us with the technology, intellectual property, manufacturing facilities and production equipment to address strategic national security programs and platforms, primarily in the unmanned systems, electronic warfare, satellite communications and missile system and radar areas of the DoD. We have also made certain acquisitions in the critical infrastructure security, strategic asset protection and public safety areas to expand our capabilities, scope, national depth, breadth and overall service offering. Key Financial Statement Concepts For a complete description of our business and a discussion of our critical accounting matters, please refer to Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," in the Form 10-K. As of September 28, 2014, we consider the following factors to be important in understanding our financial statements. KGS' business with the U.S. Government and prime contractors is generally performed under fixed price, time and material and cost reimbursable contracts. In accounting for our long-term contracts for production of products and services provided to the U.S. Government and provided to our PSS segment customers under fixed price contracts, we utilize both cost-to-cost and units delivered measures under the percentage-of-completion method of accounting under the provisions of ASC Topic 605, Revenue Recognition. Under the units delivered measure of the percentage-of-completion method of accounting, sales are recognized as the units are accepted by the customer generally using sales values for units in accordance with the contract terms. We estimate profit as the difference between total estimated revenue and total estimated cost of a contract and recognize that profit over the life of the contract based on deliveries or as computed on the basis of the estimated final average unit costs plus profit. We classify contract revenues as product sales or service revenues depending upon the predominant attributes of the relevant underlying contracts. Cost reimbursable contracts for the U.S. Government provide for reimbursement of costs plus the payment of a fee. Some cost reimbursable contracts include incentive fees that are awarded based on performance on the contract. Under time and materials contracts, we are reimbursed for labor hours at negotiated 27-------------------------------------------------------------------------------- Table of Contents hourly billing rates and reimbursed for travel and other direct expenses at actual costs plus applied general and administrative expenses. We consider the following factors when determining if collection of a receivable is reasonably assured: comprehensive collection history; results of our communications with customers; the current financial position of the customer; and the relevant economic conditions in the customer's country. If we have had no prior experience with the customer, we review reports from various credit organizations to ensure that the customer has a history of paying its creditors in a reliable and effective manner. If the financial condition of our customers were to deteriorate and adversely affect their financial ability to make payments, additional allowances would be required. Additionally, on certain contracts whereby we perform services for a prime/general contractor, a specified percentage of the invoiced trade accounts receivable may be retained by the customer until we complete the project. We periodically review all retainages for collectability and record allowances for doubtful accounts when deemed appropriate, based on our assessment of the associated risks. We monitor our policies and procedures with respect to our contracts on a regular basis to ensure consistent application under similar terms and conditions as well as compliance with all applicable government regulations. In addition, costs incurred and allocated to contracts with the U.S. Government are routinely audited by the Defense Contract Audit Agency. We manage and assess the performance of our businesses based on our performance on individual programs and contracts and programs obtained generally from government organizations with consideration given to the "Critical Accounting Principles and Estimates" as described in the Form 10-K. Due to the Federal Acquisition Regulation rules that govern our business, most types of costs are allowable, and we do not focus on individual cost groupings (such as cost of sales or general and administrative costs) as much as we do on total contract costs, which are a key factor in determining contract operating income. As a result, in evaluating our operating performance, we look primarily at changes in sales and service revenue and at operating income, including the effects of significant changes in operating income. Changes in contract estimates are reviewed on a contract-by-contract basis and are revised periodically throughout the life of the contract such that adjustments to profit resulting from revisions are made cumulative to the date of the revision in accordance with GAAP. Significant management judgments and estimates, including the estimated costs to complete the project, which determine the project's percent complete, must be made and used in connection with the revenue recognized in any accounting period. Material differences may result in the amount and timing of our revenue for any period if management makes different judgments or utilizes different estimates. Comparison of Results for the Three Months Ended September 29, 2013 to the Three Months Ended September 28, 2014 Revenues. Revenues by operating segment for the three months ended September 29, 2013 and September 28, 2014 are as follows (dollars in millions): September 29, 2013 September 28, 2014 $ change % change Kratos Government Solutions Service revenues $ 57.0 $ 54.3 $ (2.7 ) (4.7 )% Product sales 117.6 120.0 2.4 2.0 % Total Kratos Government Solutions 174.6 174.3 (0.3 ) (0.2 )% Public Safety & Security Service revenues 51.8 42.8 (9.0 ) (17.4 )% Product sales - - - N/A Total Public Safety & Security 51.8 42.8 (9.0 ) (17.4 )% Total revenues $ 226.4 $ 217.1 $ (9.3 ) (4.1 )% Revenues decreased $9.3 million from $226.4 million for the three months ended September 29, 2013 to $217.1 million for the three months ended September 28, 2014. PSS segment revenue decreased by $9.0 million, primarily driven by the completion or wind-down of certain security installation projects which occurred in the third quarter of 2014, coupled with the delay in awards of new security installation projects, competitor protests, reprocurement of awards, delays in contract negotiation processes and general contract award delays. KGS segment revenue decreased by $0.3 million. This net decrease was primarily due to the continued contraction and commoditization of the Company's legacy government services business of approximately $8.6 million, the expected reduction in two sizable satellite communications projects as the scope of work 28-------------------------------------------------------------------------------- Table of Contents completed its natural contract life cycle transitioning from production to sustainment, resulting in net aggregate reduced revenues of $3.8 million, the reduction of shipments of certain of our aerial target products of $6.5 million, and delays in contract awards and competitor protests of new contracts awarded to the Company. These reductions were substantially offset by increased shipments in our specialized modular systems business of $6.5 million, increased work performed in our specialized air crew trainer business of $6.1 million, increased specialized work performed on government weapons ranges of $5.1 million, and increased shipments of our electronic warfare products of $1.5 million. Product sales increased $2.4 million from $117.6 million for the three months ended September 29, 2013 to $120.0 million for the three months ended September 28, 2014, primarily as a result of increased production of our specialized modular systems and electronic warfare products, offset in part by the reduction of shipments of certain of our aerial target products. As a percentage of total revenue, product sales were 51.9% for the three months ended September 29, 2013 as compared to 55.3% for the three months ended September 28, 2014. Service revenues decreased by $11.7 million from $108.8 million for the three months ended September 29, 2013 to $97.1 million for the three months ended September 28, 2014. The decrease was primarily related to reductions in the legacy government service revenues and other service contracts in the KGS segment noted previously, which reductions are being experienced industry wide as a result of declining DoD budgets, changes in certain DoD procurement rules and other factors, and the reductions in our PSS business. Cost of Revenues. Cost of revenues decreased $10.0 million from $174.1 million for the three months ended September 29, 2013 to $164.1 million for the three months ended September 28, 2014. The decrease in cost of revenues was primarily a result of the changes discussed above. Gross margin increased from 23.1% for the three months ended September 29, 2013 to 24.4% for the three months ended September 28, 2014. Margins on services decreased from the three months ended September 29, 2013 to September 28, 2014, from 24.3% to 20.0%, respectively, due primarily to an unfavorable mix of revenues and decreased margins in our PSS segment. Margins on products increased from the three months ended September 29, 2013 to September 28, 2014 from 22.0% to 28.0%, respectively, primarily due to the mix of products shipped. Margins in the KGS segment increased from 22.6% for the three months ended September 29, 2013 to 26.6% for the three months ended September 28, 2014, primarily as a result of a favorable mix of revenues. In addition, margins on products in the three months ended September 29, 2013 were impacted by increased costs recorded of approximately $5.4 million on certain aerial target contracts to reflect retrofits necessary to address design changes. Similarly, margins in the three months ended September 28, 2014 were impacted by net increased costs recorded of $3.2 million for retrofit related matters and a contract conversion adjustment. Margins in the PSS segment declined from 24.7% for the three months ended September 29, 2013 to 15.7% for the three months ended September 28, 2014 due primarily to a less favorable mix of revenues, and due to costs incurred on two sizable projects which have been completed in the third quarter of 2014 or are near-completion, under which we are in the process of submitting or have submitted changes orders to these customers to reimburse us for the work we have performed at our customers request. We have not reflected the potential value of these customer change orders in our revenues, which has resulted in a reduction to our gross margins during the current quarter. Selling, General and Administrative Expenses. Selling, general and administrative expenses ("SG&A") decreased $2.0 million from $47.8 million for the three months ended September 29, 2013 to $45.8 million for the three months ended September 28, 2014, primarily as a result of a $3.3 million reduction of amortization of intangibles in 2014. As a percentage of revenues, SG&A remained flat at 21.1%. Excluding amortization of intangibles of $9.0 million for the three months ended September 29, 2013 and amortization of intangibles of $5.7 million for the three months ended September 28, 2014, SG&A increased as a percentage of revenues from 17.1% to 18.5%, or from $38.8 million to $40.1 million for the three months ended September 29, 2013 and September 28, 2014, respectively, due to an increase in non-cash stock compensation expense of $0.8 million, and due to increased infrastructure and business development investments made in our unmanned aerial drones and targets and combat aircraft business. Merger and Acquisition Expenses. The expense of $0.2 million for the three months ended September 29, 2013 were related to legal costs associated with an acquired entity. Internal Research and Development ("IR&D") Expenses. IR&D expenses were $4.8 million for the three months ended September 29, 2013 and $5.9 million for the three months ended September 28, 2014. As a percentage of revenues, IR&D increased from 2.1% of revenues in the three months ended September 29, 2013 to 2.7% of revenues in the three months ended September 28, 2014 as a result of certain investments the Company is making related to new programs and platforms in the electronic products business, the unmanned systems area, and the satellite communications business. We are making certain of these investments in conjunction with our customers, with the objectives of the Company's products being "designed in" to these new long term program opportunities and the Company owning certain intellectual property rights for products that support these programs. 29-------------------------------------------------------------------------------- Table of Contents Unused office space and other restructuring. The benefit of $6.6 million for the three months ended September 29, 2013 was primarily due to a change in the estimated excess facility accrual of office space at our Colombia, Maryland administrative facilities partially offset by expenses related to workforce reductions as a result of cost reduction initiatives we have implemented across the Company. The expense of $0.1 million for the three months ended September 28, 2014 was primarily due to employee termination costs related to personnel reduction actions taken during the third quarter of 2014. Other Expense, Net. Other expense, net decreased from $15.4 million to $12.5 million for the three months ended September 29, 2013 and September 28, 2014, respectively. The decrease in expense of $2.9 million is primarily related to a reduction in interest expense. Provision for Income Taxes. Income tax expense (benefit) for the three months ended September 29, 2013 and September 28, 2014 was $0.2 million and $(0.2) million, respectively. These amounts were primarily a function of the estimated effective tax rate for the respective years. The estimated effective tax rate for any given year is driven by estimated foreign taxes, estimated state taxes, permanent book/tax differences, tax amortization of intangible assets that have an indefinite life under GAAP and the projected income or loss for the year. Income (loss) from Discontinued Operations. Revenue from discontinued operations was $0.0 million and $0.0 million and (loss) income from discontinued operations was $(0.4) million and $0.2 million for the three months ended September 29, 2013 and September 28, 2014, respectively. The loss from discontinued operations for the three months ended September 29, 2013 and September 28, 2014 were primarily related to operations of the non-core businesses from the Integral acquisition that were classified as held for sale and subsequently sold. See Note 7 of the Notes to the Condensed Consolidated Financial Statements for a further discussion of our discontinued operations. Comparison of Results for the Nine Months Ended September 29, 2013 to the Nine Months Ended September 28, 2014 Revenues. Revenues by operating segment for the nine months ended September 29, 2013 and September 28, 2014 are as follows (dollars in millions): September 29, 2013 September 28, 2014 $ change % change Kratos Government Solutions Service revenues $ 180.9 $ 157.2 $ (23.7 ) (13.1 )% Product sales 379.9 334.0 (45.9 ) (12.1 )% Total Kratos Government Solutions 560.8 491.2 (69.6 ) (12.4 )% Public Safety & Security Service revenues 154.1 142.3 (11.8 ) (7.7 )% Product sales - 13.0 13.0 N/A Total Public Safety & Security 154.1 155.3 1.2 0.8 % Total revenues $ 714.9 $ 646.5 $ (68.4 ) (9.6 )% Revenues decreased $68.4 million from $714.9 million for the nine months ended September 29, 2013 to $646.5 million for the nine months ended September 28, 2014. KGS segment revenue decreased by $69.6 million. The decrease in revenues were primarily due to competitor protests on awards made to Kratos, a decline in shipments of our defense products, delays in orders and awards as a result of the challenging federal government and DoD funding environment, all of which adversely impacted the timing of new contract awards, bookings and the Company's revenues. Additionally, revenue was also adversely impacted by the decrease resulting from the expected completion of two sizable satellite communications projects as the scope of work completed its natural contract life cycle transitioning from production to sustainment, which impacted revenues by approximately $13.3 million, continued ongoing weakness and increased competition and commoditization in our legacy government services businesses of approximately $20.2 million, and the reduction of shipments of certain of our aerial target products of $32.1 million. PSS segment revenue increased by $1.2 million, primarily due to the delivery of security related communication equipment of $13 million, offset by the delay in contract awards and project starts in 2014. Product sales decreased $32.9 million from $379.9 million for the nine months ended September 29, 2013 to $347.0 million for the nine months ended September 28, 2014, primarily as a result of the decline in product shipments due to the factors discussed above. As a percentage of total revenue, product sales were 53.1% for the nine months ended September 29, 30-------------------------------------------------------------------------------- Table of Contents 2013 as compared to 53.7% for the nine months ended September 28, 2014. Service revenues decreased by $35.5 million from $335.0 million for the nine months ended September 29, 2013 to $299.5 million for the nine months ended September 28, 2014. The decrease was primarily related to reductions in the legacy government service revenues and other service contracts in the KGS segment, which reductions are being experienced industry wide as a result of declining DoD budgets, changes in certain DoD procurement rules and other factors, as well as due to the expected completion of two sizable satellite communications projects. Cost of Revenues. Cost of revenues decreased $51.9 million from $536.4 million for the nine months ended September 29, 2013 to $484.5 million for the nine months ended September 28, 2014. The decrease in cost of revenues was primarily a result of the changes discussed above. Gross margin increased from 25.0% for the nine months ended September 29, 2013 to 25.1% for the nine months ended September 28, 2014. Margins on services decreased from the nine months ended September 29, 2013 to September 28, 2014, from 24.1% to 23.3%, respectively, due primarily to a unfavorable mix of revenues and decreased margins in our PSS segment. Margins on products increased for the nine months ended September 29, 2013 to September 28, 2014 from 25.7% to 26.6%, respectively, primarily as a result of a mix of products shipped. Margins in the KGS segment increased from 24.8% for the nine months ended September 29, 2013 to 26.3% for the nine months ended September 28, 2014, primarily as a result of a favorable mix of revenues. In addition, margins on products in the nine months ended September 29, 2013 were impacted by increased costs recorded of approximately $5.4 million on certain aerial target contracts to reflect retrofits necessary to address design changes. Similarly, margins in the nine months ended September 28, 2014 were impacted by net increased costs recorded of $3.2 million for retrofit related matters and a contract conversion adjustment. Margins in the PSS segment decreased from 25.8% for the nine months ended September 29, 2013 and 21.0% for the nine months ended September 28, 2014, primarily due to decreased service margins and due to costs incurred on two sizable projects which have been completed in the third quarter of 2014 or are near-completion, under which we are in the process of submitting or have submitted changes orders to these customers to reimburse us for the work we have performed at our customers request. We have not reflected the potential value of these customer change orders in our revenues, which has resulted in a reduction to our gross margins during the current quarter. Selling, General and Administrative Expenses. Selling, general and administrative expenses decreased $10.8 million from $144.9 million for the nine months ended September 29, 2013 to $134.1 million for the nine months ended September 28, 2014, primarily as a result a $10.3 million reduction of amortization of intangibles in 2014, as well as cost reduction actions taken by the Company. As a percentage of revenues, SG&A increased from 20.3% to 20.7%. Excluding amortization of intangibles of $27.3 million for the nine months ended September 29, 2013 and amortization of intangibles of $17.0 million for the nine months ended September 28, 2014, SG&A increased as a percentage of revenues from 16.4% to 18.1%, or from $117.6 million to $117.1 million for the nine months ended September 29, 2013 and September 28, 2014, respectively, primarily as a result of the decline in revenues discussed previously, offset in part by increased compliance costs including internal cyber security costs incurred to protect the Company's assets, Sarbanes Oxley and audit compliance costs including internal audit and external audit costs of $0.9 million. Merger and Acquisition Expenses. The benefit of $2.3 million for the nine months ended September 29, 2013 was due to the reduction in a $3.1 million liability as a result of the final settlement of our indemnity obligations related to former directors and officers of Integral, partially offset by other merger expenses and legal fees related to prior acquisitions. Internal Research and Development ("IR&D") Expenses. IR&D expenses were $14.5 million for the nine months ended September 29, 2013 and $17.0 million for the nine months ended September 28, 2014. As a percentage of revenues, IR&D increased from 2.0% of revenues in the nine months ended September 29, 2013 to 2.6% of revenues in the nine months ended September 28, 2014 as a result of certain investments the Company is making primarily related to new programs and platforms in the electronic products business, the unmanned systems area, and the satellite communications business. We are making certain of these investments in conjunction with our customers, with the objectives of the Company's products being "designed in" to these new long term program opportunities and the Company owning certain intellectual property rights for products that support these programs. Unused office space and other restructuring. The credit of $5.0 million for the nine months ended September 29, 2013 was due to a reduction in the excess facility accrual of office space at the Columbia, Maryland administrative facilities, partially offset by expenses related to workforce reductions as a result of cost reduction initiatives we have implemented across the Company. The expense of $1.7 million for the nine months ended September 28, 2014 was primarily due to an estimated excess facility accrual of office space at our Sacramento, California administrative facilities, as well as due to employee termination costs related to personnel reduction actions taken during the nine-month period ended September 28, 2014. 31-------------------------------------------------------------------------------- Table of Contents Other Expense, Net. Other expense, net increased from $48.5 million to $81.3 million for the nine months ended September 29, 2013 and September 28, 2014, respectively. The increase in expense of $32.8 million is primarily related to $39.1 million loss on the extinguishment of the Company's 10% Senior Secured Notes due 2017. Provision for Income Taxes. Income tax expense (benefit) for the nine months ended September 29, 2013 and September 28, 2014 was $2.9 million and $3.7 million, respectively. These amounts were primarily a function of the estimated effective tax rate for the respective years. The estimated effective tax rate for any given year is driven by estimated foreign taxes, estimated state taxes, permanent book/tax differences, tax amortization of intangible assets that have an indefinite life under GAAP and the projected income or loss for the year. Income (loss) from Discontinued Operations. Revenue from discontinued operations was $3.6 million and $0 million and loss from discontinued operations was $4.8 million and $0.0 million for the nine months ended September 29, 2013 and September 28, 2014, respectively. The revenue and loss from discontinued operations for the nine months ended September 29, 2013 were primarily related to operations of the non-core businesses from the Integral acquisition that have been classified as held for sale. See Note 7 of the Notes to the Condensed Consolidated Financial Statements for a further discussion of our discontinued operations. Backlog At both September 29, 2013 and September 28, 2014, our backlog was approximately $1.0 billion of which $543.0 million was funded in 2013 and $533.0 million was funded in 2014. Backlog is our estimate of the amount of revenue we expect to realize over the remaining life of awarded contracts and task orders that we have in hand as of the measurement date. Our total backlog consists of funded and unfunded backlog. We define funded backlog as estimated future revenue under government contracts and task orders for which funding has been appropriated by Congress and authorized for expenditure by the applicable agency, plus our estimate of the future revenue we expect to realize from our commercial contracts that are under firm orders. Our funded backlog does not include the full potential value of our contracts because Congress often appropriates funds to be used by an agency for a particular program of a contract on a yearly or quarterly basis even though the contract may call for performance over a number of years. As a result, contracts typically are only partially funded at any point during their term, and all or some of the work to be performed under the contracts may remain unfunded unless and until Congress makes subsequent appropriation and the procuring agency allocates funding to the contract. Unfunded backlog reflects our estimate of future revenue under awarded government contracts and task orders for which either funding has not yet been appropriated or expenditure has not yet been authorized. Our total backlog does not include estimates of revenue from government-wide acquisition contracts or General Services Administration schedules beyond awarded or funded task orders, but our unfunded backlog does include estimates of revenue beyond awarded or funded task orders for other types of indefinite delivery, indefinite quantity contracts based on our experience under such contracts and similar contracts. Unfunded backlog also includes priced options, which consist of the aggregate contract revenues expected to be earned as a result of a customer exercising an option period that has been specifically defined in the original contract award. Contracts undertaken by us may extend beyond one year. Accordingly, portions are carried forward from one year to the next as part of backlog. Because many factors affect the scheduling of projects, no assurance can be given as to when revenue will be realized on projects included in our backlog. Although funded backlog represents only business that is considered to be firm, we cannot guarantee that cancellations or scope adjustments will not occur. The majority of funded backlog represents contracts with terms that would entitle us to all or a portion of our costs incurred and potential fees upon cancellation by the customer. Management believes that year-to-year comparisons of backlog are not necessarily indicative of future revenues. The actual timing of receipt of revenues, if any, on projects included in backlog could change because many factors affect the scheduling of projects. In addition, cancellation or adjustments to contracts may occur. Backlog is typically subject to large variations from quarter to quarter as existing contracts are renewed or new contracts are awarded. Additionally, all U.S. Government contracts included in backlog, whether or not funded, may be terminated at the convenience of the U.S. Government. Liquidity and Capital Resources As of September 28, 2014, we had cash and cash equivalents of $16.2 million compared with cash and cash equivalents of $55.7 million as of December 29, 2013, which includes $8.4 million and $16.0 million, respectively, of cash and cash equivalents held by our foreign subsidiaries. We are not presently aware of any restrictions on the repatriation of these funds; however, they are considered permanently invested in these foreign subsidiaries. If these funds were needed to fund our 32-------------------------------------------------------------------------------- Table of Contents operations or satisfy obligations in the U.S. they could be repatriated, and their repatriation into the U.S. may cause us to incur additional U.S. income taxes or foreign withholding taxes. Any additional U.S. income taxes could be offset, in part or in whole, by foreign tax credits. The amount of such taxes and application of tax credits would be dependent on the income tax laws and other circumstances at the time these amounts are repatriated. Based on these variables, it is not practicable to determine the income tax liability that might be incurred if these earnings were to be repatriated. We do not currently intend to repatriate these earnings. Our total debt, including capital lease obligations, principal due on Senior Secured Notes, and other term debt increased by $19.3 million from $644.7 million on December 29, 2013 to $664.0 million on September 28, 2014. The increase in debt was primarily due to an offering of $625.0 million aggregate principal amount of 7.00% Senior Secured Notes due 2019 in a private placement conducted pursuant to Rule 144A and Regulation S under the Securities Act of 1933, as amended. The proceeds from the offering, as well as borrowings of $41.0 million from our new credit facility and cash from operations were used to extinguish the Company's existing 10% Senior Secured Notes due 2017 and to pay all fees and expenses related thereto. Our operating cash flow is used to finance trade accounts receivable, inventory, capital expenditures, support ongoing operations, service our debt and make strategic acquisitions. Cash from continuing operations is primarily derived from our customer contracts in progress and associated changes in working capital components. Our Days Sales Outstanding (DSOs) have increased from 103 days at December 29, 2013 to 107 days as of September 28, 2014, primarily as a result of certain contractual milestones that have not yet been attained, such as equipment deliveries on a missile system program that has been delayed due to a subcontractor issue, and for certain flight requirements that must be fulfilled on certain aerial target programs, and therefore we are unable to bill for amounts outstanding related to those milestones. The challenging DoD budgetary environment described above, which has in certain instances caused delays in obtaining funding necessary to proceed with payments, has impacted our DSOs as well. Our accounts receivable balance of $255.1 million at September 28, 2014 includes $1.6 million of receivables due from a Greek customer under a subcontract arrangement Gichner Holdings, Inc. ("Gichner") entered into with the Greek Ministry of Defense ("GMoD") in 2004 prior to our acquisition of Gichner in 2010. We do not have any significant direct exposure to European government receivables, and our customers do not rely heavily on European government subsidies or other European government support. We will continue to monitor our exposure to risks related to European sovereign debt. A summary of our net cash provided by operating activities from continuing operations, investing activities, and financing activities from our condensed consolidated statements of cash flows is as follows (in millions): |