# MERCURY SYSTEMS INC (MRCY) FY 2022 MD&A

Verbatim Item 7 Management's Discussion and Analysis from MERCURY SYSTEMS INC's 10-K for fiscal year 2022.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1049521/000104952122000046/mrcy-20220701.htm
Accession: 0001049521-22-000046
Filing date: 2022-08-16
Report date: 2022-07-01
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary. Published MD&A gate trimmed front/tail over-capture.
Confidence: high

Company profile: /company/MRCY/
All MD&A years: /company/MRCY/mda/
Previous year: /company/MRCY/mda/fy2021/ (FY 2021)
Next year: /company/MRCY/mda/fy2023/ (FY 2023)

ITEM 7.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FORWARD-LOOKING STATEMENTS

From time to time, information provided, statements made by our employees or information included in our filings with the Securities and Exchange Commission (“SEC”) may contain statements that are not historical facts but that are “forward-looking statements,” which involve risks and uncertainties. You can identify these statements by the use of the words “may,” “will,” “could,” “should,” “would,” “plans,” “expects,” “anticipates,” “continue,” “estimate,” “project,” “intend,” “likely,” “forecast,” “probable,” “potential,” and similar expressions. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those projected or anticipated. Such risks and uncertainties include, but are not limited to, continued funding of defense programs, the timing and amounts of such funding, general economic and business conditions, including unforeseen weakness in the Company’s markets, effects of epidemics and pandemics such as COVID, effects of any U.S. Federal government shutdown or extended continuing resolution, effects of continued geopolitical unrest and regional conflicts, competition, inflation, changes in technology and methods of marketing, delays in completing engineering and manufacturing programs, changes in customer order patterns, changes in product mix, continued success in technological advances and delivering technological innovations, changes in, or in the U.S. Government’s interpretation of, federal export control or procurement rules and regulations, changes in, or in the interpretation or enforcement of environmental rules and regulations, market acceptance of the Company's products, shortages in or delays in receiving components, production delays or unanticipated expenses due to performance quality issues with outsourced components, inability to fully realize the expected benefits from acquisitions, restructurings and value creation initiatives such as 1MPACT, or delays in realizing such benefits, challenges in integrating acquired businesses and achieving anticipated synergies, effects of shareholder activism, increases in interest rates, changes to industrial security and cyber-security regulations and requirements, changes in tax rates or tax regulations, changes to interest rate swaps or other cash flow hedging arrangements, changes to generally accepted accounting principles, difficulties in retaining key employees and customers, unanticipated costs under fixed-price service and system integration engagements, and various other factors beyond our control. These risks and uncertainties also include such additional risk factors as set forth under Part I-Item 1A (Risk Factors) in this Annual Report on Form 10-K. We caution readers not to place undue reliance upon any such forward-looking statements, which speak only as of the date made. We undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made.

OVERVIEW

Mercury Systems, Inc. is a technology company that delivers commercial innovation to rapidly transform the global aerospace and defense industry. Headquartered in Andover, Massachusetts, our end-to-end processing platform enables a broad range of aerospace and defense programs, optimized for mission success in some of the most challenging and demanding environments. Processing technologies that comprise our platform include signal solutions, display, software applications, networking, storage and secure processing. Our innovative solutions are mission-ready, trusted and secure, software-defined and open and modular to meet our customers’ most-pressing high-tech needs. Customers access our solutions via the Mercury platform, which encompasses the broad scope of our investments in technologies, companies, products, services and the expertise of our people. Ultimately, we connect our customers to what matters most to them. We connect commercial technology to defense, people to data, partners to opportunities and the present to the future. And, at the most human level, we connect what we do to our customers’ missions; supporting the people for whom safety, security and protecting freedom are of paramount importance.

As a leading manufacturer of essential components, products, modules and subsystems, we sell to defense prime contractors, the U.S. government and original equipment manufacturers (“OEM”) commercial aerospace companies. Mercury has built a trusted, contemporary portfolio of proven product solutions purpose-built for aerospace and defense that it believes meets and exceeds the performance needs of our defense and commercial customers. Customers add their own applications and algorithms to our specialized, secure and innovative products and pre-integrated solutions. This allows them to complete their full system by integrating with their platform, the sensor technology and, increasingly, the processing from Mercury. Our products and solutions are deployed in more than 300 programs with over 25 different defense prime contractors and commercial aviation customers.

Mercury’s transformational business model accelerates the process of making new technology profoundly more accessible to our customers by bridging the gap between commercial technology and aerospace and defense applications. Our long-standing deep relationships with leading high-tech and other commercial companies, coupled with our high level of research and development (“R&D”) investments on a percentage basis and industry-leading trusted and secure design and manufacturing capabilities, are the foundational tenets of this highly successful model. We are leading the development and adaptation of commercial technology for aerospace and defense solutions. From chip-scale to system scale and from data, including radio

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frequency (“RF”) to digital to decision, we make mission-critical technologies safe, secure, affordable and relevant for our customers.

Our capabilities, technology, people and R&D investment strategy combine to differentiate Mercury in our industry. We maintain our technological edge by investing in critical capabilities and intellectual property (“IP” or “building blocks”) in processing, leveraging open standards and open architectures to adapt quickly those building blocks into solutions for highly data-intensive applications, including emerging needs in areas such as artificial intelligence (“AI”).

Our mission critical solutions are deployed by our customers for a variety of applications including command, control, communications, computers, intelligence, surveillance and reconnaissance (“C4ISR”), electronic intelligence, mission computing avionics, electro-optical/infrared (“EO/IR”), electronic warfare, weapons and missile defense, hypersonics and radar.

Since we conduct much of our business with our defense customers via commercial items, requests by customers are a primary driver of revenue fluctuations from quarter to quarter. Customers specify delivery date requirements that coincide with their need for our products. Because these customers may use our products in connection with a variety of defense programs or other projects of different sizes and durations, a customer’s orders for one quarter generally do not indicate a trend for future orders by that customer. Additionally, order patterns do not necessarily correlate amongst customers and, therefore, we generally cannot identify sequential quarterly trends.

As of July 1, 2022, we had 2,386 employees. Our consolidated revenues, acquired revenues, net income, diluted EPS, adjusted EPS and adjusted EBITDA for fiscal 2022 were $988.2 million, $117.8 million, $11.3 million, $0.20, $2.19 and $200.5 million, respectively. Our consolidated revenues, acquired revenues, net income, diluted EPS, adjusted EPS and adjusted EBITDA for fiscal 2021 were $924.0 million, $3.4 million, $62.0 million, $1.12, $2.42 and $201.9 million, respectively. See the Non-GAAP Financial Measures section for a reconciliation to our most directly comparable GAAP financial measures.

OUR RESPONSE TO COVID

We continue to monitor the COVID pandemic and adapt our policies and programs as needed to protect the health, safety and livelihoods of our people. In September 2021, the White House announced that certain contractors would need to create COVID-19 vaccination programs for their employees in order to work on certain U.S. government contracts. We announced our COVID-19 U.S. Vaccination Policy in October 2021 to comply with these federal requirements. In November and December 2021, federal judges temporarily blocked the government from enforcing their vaccine mandate while lawsuits were being resolved. We suspended our vaccine policy pending the resolutions of these lawsuits, similar to other contractors in the aerospace and defense industry.

1MPACT

On August 3, 2021, we announced a companywide effort, called 1MPACT, to lay the foundation for the next phase of the Company’s value creation at scale. The goal of 1MPACT is to achieve our full growth, margin expansion and adjusted EBITDA potential over the next five years. Since fiscal year 2014, we have completed 15 acquisitions, deploying $1.4 billion of capital and, as a result, dramatically scaled and transformed the business. Over this time, we have extracted substantial revenue and cost synergies from each of these individual acquisitions. As we approach the milestone of $1 billion of revenue, we have identified significant opportunity to realize further scale through consolidating and streamlining our internal organizational structure which will improve visibility, speed of decision making and accountability. 1MPACT is led by our Chief Transformation Officer, Thomas Huber, and focuses on the following major areas: organizational efficiency and scalability; procurement and supply chain; facilities optimization; R&D investment; and scalable common processes and systems.

BUSINESS DEVELOPMENTS:

FISCAL 2022

On February 28, 2022, we amended our existing revolving credit facility (the "Revolver") to increase and extend the borrowing capacity to a $1.1 billion, 5-year revolving credit line, with the maturity extended to February 28, 2027. As of July 1, 2022, there was $451.5 million of outstanding borrowings on the Revolver. See Note M in the accompanying consolidated financial statements for further discussion of the Revolver.

On November 29, 2021, we acquired Atlanta Micro, Inc. ("Atlanta Micro") for a purchase price of $90.0 million, subject to net working capital and net debt adjustments. Based in Norcross, Georgia, Atlanta Micro is a leading designer and manufacturer of high-performance RF modules and components, including advanced monolithic microwave integrated circuits

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("MMICs") which are critical for high-speed data acquisition applications including electronic warfare, radar and weapons. We funded the acquisition through our Revolver.

On September 27, 2021, we signed a definitive agreement to acquire Avalex Technologies (“Avalex”) for a purchase price of $155.0 million, subject to net working capital and net debt adjustments. On November 5, 2021, the transaction closed and we acquired Avalex. Based in Gulf Breeze, Florida, Avalex is a provider of mission-critical avionics, including rugged displays, integrated communications management systems, digital video recorders and warning systems. We funded the acquisition with our Revolver.

FISCAL 2021

On May 27, 2021, we acquired Pentek Technologies, LLC and Pentek Systems, Inc. (collectively, "Pentek") for a purchase price of $65.0 million, subject to net working capital and net debt adjustments. Based in Upper Saddle River, New Jersey, Pentek is a leading designer and manufacturer of ruggedized, high-performance, commercial off-the-shelf ("COTS") software-defined radio and data acquisition boards, recording systems and subsystems for high-end commercial and defense applications. The acquisition and associated transaction expenses were funded through a combination of cash on hand and our Revolver.

On December 30, 2020, we acquired Physical Optics Corporation ("POC") for a purchase price of $310.0 million, prior to net working capital and net debt adjustments. Based in Torrance, California, POC more than doubled our global avionics business and expanded its collective footprint in the platform and mission management market. We funded the acquisition through a combination of cash on hand and our Revolver.

RESULTS OF OPERATIONS:

FISCAL 2022 VS. FISCAL 2021

Results of operations for fiscal 2022 include full period results from the acquisitions of POC and Pentek and only results from the acquisition dates for Avalex and Atlanta Micro, which were acquired on November 5, 2021 and November 29, 2021, respectively. Results of operations for fiscal 2021 include only results from the acquisition dates for POC and Pentek. Accordingly, the periods presented below are not directly comparable. The Company has applied the FAST Act Modernization and Simplification of Regulation S-K, which limits the discussion to the two most recent fiscal years. Refer to Item 7 of the Company's Form 10-K issued on August 17, 2021 for prior year discussion related to fiscal 2020.

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The following tables set forth, for the periods indicated, financial data from the Consolidated Statements of Operations and Comprehensive Income:

[[GREPCENT_TABLE]]
[["(In thousands)","Fiscal 2022","","As a % of Total Net Revenue","","Fiscal 2021","","As a % of Total Net Revenue"],["Net revenues","$","988,197","","","100.0","%","","$","923,996","","","100.0","%"],["Cost of revenues","593,241","","","60.0","","","538,808","","","58.3"],["Gross margin","394,956","","","40.0","","","385,188","","","41.7"],["Operating expenses:"],["Selling, general and administrative","157,044","","","15.9","","","134,337","","","14.5"],["Research and development","107,169","","","10.8","","","113,481","","","12.3"],["Amortization of intangible assets","60,267","","","6.1","","","41,171","","","4.5"],["Restructuring and other charges","27,445","","","2.8","","","9,222","","","1.0"],["Acquisition costs and other related expenses","11,421","","","1.2","","","5,976","","","0.6"],["Total operating expenses","363,346","","","36.8","","","304,187","","","32.9"],["Income from operations","31,610","","","3.2","","","81,001","","","8.8"],["Interest income","143","","","\u2014","","","179","","","\u2014"],["Interest expense","(5,806)","","","(0.6)","","","(1,222)","","","(0.1)"],["Other expense, net","(7,552)","","","(0.8)","","","(2,785)","","","(0.3)"],["Income before income taxes","18,395","","","1.9","","","77,173","","","8.4"],["Income tax provision","7,120","","","0.8","","","15,129","","","1.7"],["Net income","$","11,275","","","1.1","%","","$","62,044","","","6.7","%"]]
[[/GREPCENT_TABLE]]

REVENUES

Total revenues increased $64.2 million, or 7.0%, to $988.2 million during fiscal 2022, as compared to $924.0 million during fiscal 2021 including “acquired revenue” which represents net revenue from acquired businesses that have been part of Mercury for completion of four full fiscal quarters or less (and excludes any intercompany transactions). After the completion of four full fiscal quarters, acquired businesses will be treated as organic for current and comparable historical periods. The increase in total revenue was primarily due to $114.4 million of incremental acquired revenues partially offset by a $50.2 million decrease in organic revenues. The increase was driven by higher demand for modules and sub-assemblies and integrated subsystems which increased $49.4 million or 31.5%, and $30.5 million or 5.2%, respectively, and was partially offset by decreases to components of $15.7 million or 8.9% during fiscal 2022. The increase in total revenue was primarily from C4I and EW applications which increased $73.3 million and $18.5 million, respectively, and was partially offset by a decrease of $38.0 million from the radar end application. The increase in revenues spanned the airborne and other platforms which increased $71.2 million and $48.5 million, respectively, and was offset by decreases in the naval and land platforms of $31.6 million and $23.8 million, respectively. The largest program increases were related to a classified C2 program, MH60, P8, Aegis and ALR-56C. Acquired revenue in fiscal 2022 represents activity from the Pentek, Avalex and Atlanta Micro acquired businesses as well as two fiscal quarters from the POC acquired business. There were no programs comprising 10% or more of our revenues for fiscal 2022 and 2021. See the Non-GAAP Financial Measures section for a reconciliation to our most directly comparable GAAP financial measures.

GROSS MARGIN

Gross margin was 40.0% for fiscal 2022, a decrease of 170 basis points from the 41.7% gross margin achieved during fiscal 2021. The lower gross margin was primarily driven by program mix, heavily impacted by industry-wide award delays and supply chain constraints as well as inflation. In addition, the decrease is due to higher engineering content associated with programs in the period evidenced by an increase of $28.5 million in Customer Funded Research and Development ("CRAD") compared to the prior period. CRAD primarily represents engineering labor associated with over time revenue contracts for customized development, production and service activities. The nature of these efforts result in lower margin content, but serve as pre-cursors to higher margin production awards. These products are predominately grouped within integrated subsystems and to a lesser extent modules and sub-assemblies.

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SELLING, GENERAL AND ADMINISTRATIVE

Selling, general and administrative expenses increased $22.7 million, or 16.9%, to $157.0 million during fiscal 2022 as compared to $134.3 million during fiscal 2021. The increase was primarily related to an incremental $8.9 million of expenses related to the acquisitions of Pentek, Avalex and Atlanta Micro as well as an $8.3 million increase to stock compensation expense for a higher volume of equity awards to support the retention of our employees in a challenging labor market. These increases were partially offset by savings from 1MPACT workforce optimization efforts. Selling, general and administrative expenses increased as a percentage of revenue to 15.9% during fiscal 2022 from 14.5% during fiscal 2021.

RESEARCH AND DEVELOPMENT

Research and development expenses decreased $6.3 million, or 5.6%, to $107.2 million during fiscal 2022, as compared to $113.5 million for fiscal 2021. The decrease was primarily related to 1MPACT workforce optimization efforts and employee attrition. The decrease was also impacted by an incremental $28.5 million of CRAD during fiscal 2022. Research and development expenses accounted for 10.8% and 12.3% of our revenues during fiscal 2022 and fiscal 2021, respectively.

AMORTIZATION OF INTANGIBLE ASSETS

Amortization of intangible assets increased $19.1 million to $60.3 million during fiscal 2022, as compared to $41.2 million for fiscal 2021, primarily due to the full period impact from the acquisitions of POC and Pentek, as well as the acquisitions of Avalex and Atlanta Micro during fiscal 2022.

RESTRUCTURING AND OTHER CHARGES

Restructuring and other charges were $27.4 million during fiscal 2022, as compared to $9.2 million during fiscal 2021. Restructuring and other charges during fiscal 2022 primarily related to 1MPACT including $17.4 million of third-party consulting costs, as well as $9.2 million of severance costs associated with the elimination of approximately 135 positions across manufacturing, SG&A and R&D based on ongoing talent and workforce optimization efforts. In addition, fiscal 2022 includes $0.8 million of costs for facilities optimization efforts associated with 1MPACT, including $0.5 million related to lease asset impairment. During fiscal 2021, the Company incurred $9.2 million of restructuring and other charges. Restructuring and other charges primarily related to $4.8 million related to severance costs associated with the elimination of approximately 90 positions throughout the period, across manufacturing, SG&A and R&D. These charges are related to changing market and business conditions as well as talent shifts and resource redundancy from the Company's internal reorganization that was completed during fiscal 2021. The remaining $4.5 million of restructuring and other charges related to third-party consulting costs related to 1MPACT, which was initiated in the fourth quarter of fiscal 2021.

ACQUISITION COSTS AND OTHER RELATED EXPENSES

Acquisition costs and other related expenses were $11.4 million during fiscal 2022, as compared to $6.0 million during fiscal 2021. The acquisition costs and other related expenses incurred during fiscal 2022 were related to the acquisitions of Avalex and Atlanta Micro, as well as $6.8 million for third-party advisory fees and settlement costs in connection with engagements by activist investors. The acquisition costs and other related expenses incurred during fiscal 2021 were related to the acquisitions of POC and Pentek. Both periods include costs associated with our evaluation of potential acquisition opportunities. We expect to continue to incur such acquisition costs and other related expenses in the future as we continue to seek acquisition opportunities to expand our technological capabilities and especially within secure processing, open mission systems, C3 and trusted microelectronics. Transaction costs incurred by the acquiree prior to the consummation of an acquisition would not be reflected in our historical results of operations.

INTEREST EXPENSE

Interest expense for fiscal 2022 increased to $5.8 million, as compared to $1.2 million in fiscal 2021. This increase is primarily related to the $451.5 million of outstanding borrowings on our Revolver used to facilitate the acquisitions of POC and Pentek, Avalex and Atlanta Micro during fiscal 2021 and 2022. This is an increase from $200.0 million of outstanding borrowings on our Revolver for fiscal 2021.

OTHER EXPENSE, NET

Other expense, net increased to $7.6 million during fiscal 2022, as compared to $2.8 million of other expense, net in fiscal 2021. There were $2.4 million of foreign currency translation losses during fiscal 2022 as compared to $1.2 million of foreign currency translation gains during fiscal 2021. In addition, there was $1.3 million of incremental litigation and settlement expenses during fiscal 2022 as compared to the prior comparable period.

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INCOME TAXES

We recorded an income tax provision of $7.1 million and $15.1 million on income before income taxes of $18.4 million and $77.2 million for fiscal years 2022 and 2021, respectively. Within the $7.1 million income tax provision for fiscal year 2022, we recorded a provision to return adjustment of $2.3 million related to an immaterial correction of an error over transfer pricing allocations.

The effective tax rate for fiscal 2022 differed from the Federal statutory rate of 21% primarily due to Federal and state research and development tax credits, non-deductible compensation, provision to return adjustments, state taxes and excess tax provision related to stock compensation.

The effective tax rate for fiscal 2021 differed from the Federal statutory rate of 21% primarily due to Federal and state research and development tax credits, excess benefits related to stock compensation, non-deductible compensation and state taxes.

LIQUIDITY AND CAPITAL RESOURCES

Our primary sources of liquidity come from existing cash and cash generated from operations, our Revolver and our ability to raise capital under our universal shelf registration statement. Our near-term fixed commitments for cash expenditures consist primarily of payments under operating leases and inventory purchase commitments. We plan to continue to invest in improvements to our facilities, continuous evaluation of potential acquisition opportunities and internal R&D to promote future growth, including new opportunities in avionics mission computers, secure processing, radar modernization and trusted custom microelectronics. Our facilities improvements include expansion of our trusted custom microelectronics and mission computing businesses during fiscal 2022.

Based on our current plans and business conditions, we believe that existing cash and cash equivalents, our available Revolver, cash generated from operations and our financing capabilities will be sufficient to satisfy our anticipated cash requirements for at least the next twelve months.

Shelf Registration Statement

On September 14, 2020, we filed a shelf registration statement on Form S-3ASR with the SEC. The shelf registration statement, which was effective upon filing with the SEC, registered each of the following securities: debt securities, preferred stock, common stock, warrants and units. We intend to use the proceeds from financings using the shelf registration statement for general corporate purposes, which may include the following:

•the acquisition of other companies or businesses;

•the repayment and refinancing of debt;

•capital expenditures;

•working capital; and

•other purposes as described in the prospectus supplement.

We have an unlimited amount available under the shelf registration statement.

Revolving Credit Facilities

On February 28, 2022, we amended the Revolver to increase and extend the borrowing capacity to a $1.1 billion, 5-year revolving credit line, with the maturity extended to February 28, 2027. As of July 1, 2022, we had $451.5 million of outstanding borrowings against the Revolver. See Note M in the accompanying consolidated financial statements for further discussion of the Revolver.

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CASH FLOWS

[[GREPCENT_TABLE]]
[["","For the Fiscal Years Ended"],["(In thousands)","July 1, 2022","","July 2, 2021","","July 3, 2020"],["Net cash (used in) provided by operating activities","$","(18,869)","","","$","97,247","","","$","115,184"],["Net cash used in investing activities","$","(274,320)","","","$","(416,887)","","","$","(135,486)"],["Net cash provided by (used in) financing activities","$","245,754","","","$","206,229","","","$","(10,932)"],["Net decrease in cash and cash equivalents","$","(48,185)","","","$","(112,999)","","","$","(31,094)"],["Cash and cash equivalents at end of year","$","65,654","","","$","113,839","","","$","226,838"]]
[[/GREPCENT_TABLE]]

Our cash and cash equivalents decreased by $48.2 million during fiscal 2022 primarily due to $243.5 million of acquisition activity, $27.7 million invested in purchases of property and equipment, $18.9 million used in operating activities and $8.2 million of share repurchase and retirement of common stock used to settle employees' tax liabilities. These decreases were partially offset by $251.5 million of borrowings on our Revolver to facilitate the acquisitions of Avalex and Atlanta Micro.

Operating Activities

During fiscal 2022, we used $18.9 million in cash from operating activities, a decrease of $116.1 million, as compared to $97.2 million provided by operating activities during fiscal 2021. The decrease was primarily due to an increase in unbilled receivables and costs in excess of billings driven by industry-wide award delays and supply chain constraints impacting the timing of billing events and cash conversion as well as higher outflows for inventory during fiscal 2022. Operating activities also included cash outflows for restructuring and other charges associated with 1MPACT as well as acquisition costs and other related expenses related to third-party advisory fees in connection with engagements by activist investors as well as the Avalex and Atlanta Micro acquisitions. These decreases were partially offset by lower cash outflows for accounts payable, accrued expenses and accrued compensation.

Investing Activities

During fiscal 2022, we invested $274.3 million, a decrease of $142.6 million, as compared to $416.9 million during fiscal 2021. During fiscal 2022, we invested $243.5 million in the acquisitions of Avalex and Atlanta Micro, as well as $27.7 million in purchases of property and equipment. During fiscal 2021, we invested $372.8 million in the acquisitions of POC and Pentek as well as $45.6 million in purchases of property and equipment.

Financing Activities

During fiscal 2022, we had $245.8 million in cash provided by financing activities, as compared to $206.2 million during fiscal 2021. The $39.6 million increase was driven by an additional $51.5 million of additional borrowings on our Revolver to facilitate the acquisitions of Avalex and Atlanta Micro, partially offset by $8.1 million of additional payments related to the purchase and retirement of common stock used to settle employees' tax liabilities associated with vesting of restricted stock awards and $2.9 million of payments for deferred financing fees associated with the refinancing of our revolving credit facility as compared to fiscal 2021.

COMMITMENTS AND CONTRACTUAL OBLIGATIONS

The following is a schedule of our commitments and contractual obligations outstanding at July 1, 2022:

[[GREPCENT_TABLE]]
[["(In thousands)","Total","","Less Than 1 Year","","1-3 Years","","3-5 Years","","More Than 5 Years"],["Operating leases","$","97,504","","","$","14,757","","","$","26,838","","","$","21,594","","","$","34,315"],["Purchase obligations","153,729","","","153,729","","","\u2014","","","\u2014","","","\u2014"],["","$","251,233","","","$","168,486","","","$","26,838","","","$","21,594","","","$","34,315"]]
[[/GREPCENT_TABLE]]

See Note B and Note J to the consolidated financial statements for more information regarding our obligations under leases.

Purchase obligations represent open non-cancelable purchase commitments for certain inventory components and services used in normal operations. The purchase commitments covered by these agreements are for less than one year and aggregated $153.7 million at July 1, 2022.

We had a liability at July 1, 2022 of $9.1 million for uncertain tax positions that have been taken or are expected to be taken in various income tax returns. Our liability increased by an additional $1.6 million primarily due to tax positions taken related to a prior period and during the current period. We do not know the ultimate resolution of these uncertain tax positions

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and as such, do not know the ultimate timing of payments related to this liability. Accordingly, these amounts are not included in the above table.

Our standard product sales and license agreements entered into in the ordinary course of business typically contain an indemnification provision pursuant to which we indemnify, hold harmless and agree to reimburse the indemnified party for losses suffered or incurred in connection with certain intellectual property infringement claims by any third party with respect to our products. Such provisions generally survive termination or expiration of the agreements. The potential amount of future payments we could be required to make under these indemnification provisions is, in some instances, unlimited.

As part of our strategy for growth, we continue to explore acquisitions or strategic alliances. The associated acquisition costs incurred in the form of professional fees and services may be material to the future periods in which they occur, regardless of whether the acquisition is ultimately completed.

We may elect from time to time to purchase and subsequently retire shares of common stock in order to settle employees’ tax liabilities associated with vesting of a restricted stock award. These transactions would be treated as a use of cash in financing activities in our Consolidated Statements of Cash Flows.

OFF-BALANCE SHEET ARRANGEMENTS

Other than certain indemnification provisions, we do not have any off-balance sheet financing arrangements or liabilities, guarantee contracts, retained or contingent interests in transferred assets, or any obligation arising out of a material variable interest in an unconsolidated entity. We do not have any majority-owned subsidiaries that are not consolidated in the financial statements. Additionally, we do not have an interest in, or relationships with, any special purpose entities.

RELATED PARTY TRANSACTIONS

During fiscal 2022 and 2021, we did not engage in any related party transactions.

NON-GAAP FINANCIAL MEASURES

In our periodic communications, we discuss certain important measures that are not calculated according to U.S. generally accepted accounting principles (“GAAP”), including adjusted EBITDA, adjusted income, adjusted EPS, free cash flow, organic revenue and acquired revenue.

Adjusted EBITDA is defined as net income before other non-operating adjustments, interest income and expense, income taxes, depreciation, amortization of intangible assets, restructuring and other charges, impairment of long-lived assets, acquisition financing and other third party costs, fair value adjustments from purchase accounting, litigation and settlement income and expense, COVID related expenses and stock-based and other non-cash compensation expense. We use adjusted EBITDA as an important indicator of the operating performance of our business. We use adjusted EBITDA in internal forecasts and models when establishing internal operating budgets, supplementing the financial results and forecasts reported to our board of directors, determining a portion of bonus compensation for executive officers and other key employees based on operating performance, evaluating short-term and long-term operating trends in our operations and allocating resources to various initiatives and operational requirements. We believe that adjusted EBITDA permits a comparative assessment of our operating performance, relative to our performance based on our GAAP results, while isolating the effects of charges that may vary from period to period without any correlation to underlying operating performance. We believe that these non-GAAP financial adjustments are useful to investors because they allow investors to evaluate the effectiveness of the methodology and information used by management in our financial and operational decision-making. We believe that trends in our adjusted EBITDA are valuable indicators of our operating performance.

Adjusted EBITDA is a non-GAAP financial measure and should not be considered in isolation or as a substitute for financial information provided in accordance with GAAP. This non-GAAP financial measure may not be computed in the same manner as similarly titled measures used by other companies. We expect to continue to incur expenses similar to the adjusted EBITDA financial adjustments described above, and investors should not infer from our presentation of this non-GAAP financial measure that these costs are unusual, infrequent or non-recurring.

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The following table reconciles our net income, the most directly comparable GAAP financial measure, to our adjusted EBITDA:

[[GREPCENT_TABLE]]
[["","For the Fiscal Years Ended"],["(In thousands)","July 1, 2022","","July 2, 2021","","July 3, 2020"],["Net income","$","11,275","","","$","62,044","","","$","85,712"],["Other non-operating adjustments, net","2,932","","","(724)","","","(5,636)"],["Interest expense (income), net","5,663","","","1,043","","","(1,145)"],["Income tax provision","7,120","","","15,129","","","8,221"],["Depreciation","33,150","","","25,912","","","18,770"],["Amortization of intangible assets","60,267","","","41,171","","","30,560"],["Restructuring and other charges(1)","27,445","","","9,222","","","1,805"],["Impairment of long-lived assets","\u2014","","","\u2014","","","\u2014"],["Acquisition, financing and other third party costs(2)","13,608","","","8,600","","","5,645"],["Fair value adjustments from purchase accounting(3)","(2,009)","","","(290)","","","1,801"],["Litigation and settlement expense, net","1,908","","","622","","","944"],["COVID related expenses","689","","","9,943","","","2,593"],["Stock-based and other non-cash compensation expense","38,459","","","29,224","","","26,972"],["Adjusted EBITDA","$","200,507","","","$","201,896","","","$","176,242"]]
[[/GREPCENT_TABLE]]

(1) Restructuring and other charges for fiscal 2022 are related to management's decision to undertake certain actions to realign operating expenses through workforce reductions and the closure of certain facilities, businesses and product lines. These charges are typically related to acquisitions and organizational redesign programs initiated as part of discrete post-acquisition integration activities. We believe these items are non-routine and may not be indicative of ongoing operating results.

(2) Acquisition, financing and other third party costs for fiscal 2022 are related to the acquisitions of Avalex and Atlanta Micro, third-party advisory fees in connection with engagements by activist investors and costs associated with our continuous evaluation of potential acquisition opportunities.

(3) Fair value adjustments from purchase accounting for fiscal year 2022 relate to various adjustments arising from the Avalex and Atlanta Micro acquisitions. Fair value adjustments from purchase accounting for fiscal year 2021 relate to various adjustments arising from the POC acquisition. Fair value adjustments from purchase accounting for fiscal year 2020 relate to APC inventory step-up amortization.

Adjusted income and adjusted EPS exclude the impact of certain items and, therefore, have not been calculated in accordance with GAAP. We believe that exclusion of these items assists in providing a more complete understanding of our underlying results and trends and allows for comparability with our peer company index and industry. These non-GAAP financial measures may not be computed in the same manner as similarly titled measures used by other companies. We use these measures along with the corresponding GAAP financial measures to manage our business and to evaluate our performance compared to prior periods and the marketplace. We define adjusted income as net income before other non-operating adjustments, amortization of intangible assets, restructuring and other charges, impairment of long-lived assets, acquisition, financing and other third party costs, fair value adjustments from purchase accounting, litigation and settlement income and expense, COVID related expenses and stock-based and other non-cash compensation expense. The impact to income taxes includes the impact to the effective tax rate, current tax provision and deferred tax provision. Adjusted EPS expresses adjusted income on a per share basis using weighted average diluted shares outstanding.

Adjusted income and adjusted EPS are non-GAAP financial measures and should not be considered in isolation or as a substitute for financial information provided in accordance with GAAP. We expect to continue to incur expenses similar to the adjusted income and adjusted EPS financial adjustments described above, and investors should not infer from our presentation of these non-GAAP financial measures that these costs are unusual, infrequent or non-recurring.

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The following table reconciles net income and diluted earnings per share, the most directly comparable GAAP financial measures, to adjusted income and adjusted EPS:

[[GREPCENT_TABLE]]
[["","For the Fiscal Years Ended"],["(In thousands, except per share data)","July 1, 2022","","July 2, 2021","","July 3, 2020"],["Net income and diluted earnings per share","$","11,275","","","$","0.20","","","$","62,044","","","$","1.12","","","$","85,712","","","$","1.56"],["Other non-operating adjustments, net","2,932","","","","","(724)","","","","","(5,636)"],["Amortization of intangible assets","60,267","","","","","41,171","","","","","30,560"],["Restructuring and other charges(1)","27,445","","","","","9,222","","","","","1,805"],["Impairment of long-lived assets","\u2014","","","","","\u2014","","","","","\u2014"],["Acquisition, financing and other third party costs(2)","13,608","","","","","8,600","","","","","5,645"],["Fair value adjustments from purchase accounting(3)","(2,009)","","","","","(290)","","","","","1,801"],["Litigation and settlement expense, net","1,908","","","","","622","","","","","944"],["COVID related expenses","689","","","","","9,943","","","","","2,593"],["Stock-based and other non-cash compensation expense","38,459","","","","","29,224","","","","","26,972"],["Impact to income taxes(4)","(32,309)","","","","","(25,697)","","","","","(23,634)"],["Adjusted income and adjusted earnings per share","$","122,265","","","$","2.19","","","$","134,115","","","$","2.42","","","$","126,762","","","$","2.30"],["Diluted weighted-average shares outstanding","","","55,901","","","","","55,474","","","","","55,115"]]
[[/GREPCENT_TABLE]]

(1) Restructuring and other charges for fiscal 2022 are related to management's decision to undertake certain actions to realign operating expenses through workforce reductions and the closure of certain facilities, businesses and product lines. These charges are typically related to acquisitions and organizational redesign programs initiated as part of discrete post-acquisition integration activities. We believe these items are non-routine and may not be indicative of ongoing operating results.

(2) Acquisition, financing and other third party costs for fiscal 2022 are related to the acquisitions of Avalex and Atlanta Micro, third-party advisory fees in connection with engagements by activist investors and costs associated with our continuous evaluation of potential acquisition opportunities.

(3) Fair value adjustments from purchase accounting for fiscal year 2022 relate to various adjustments arising from the Avalex and Atlanta Micro acquisitions. Fair value adjustments from purchase accounting for fiscal year 2021 relate to various adjustments arising from the POC acquisition. Fair value adjustments from purchase accounting for fiscal year 2020 relate to APC inventory step-up amortization.

(4) Impact to income taxes is calculated by recasting income before income taxes to include the add-backs involved in determining adjusted income and recalculating the income tax provision using this adjusted income from operations before income taxes. The impact to income taxes includes the impact to the effective tax rate, current tax provision and deferred tax provision.

Free cash flow, a non-GAAP measure for reporting cash flow, is defined as cash provided by operating activities less capital expenditures for property and equipment, which includes capitalized software development costs. We believe free cash flow provides investors with an important perspective on cash available for investments and acquisitions after making capital investments required to support ongoing business operations and long-term value creation. We believe that trends in our free cash flow can be valuable indicators of our operating performance and liquidity.

Free cash flow is a non-GAAP financial measure and should not be considered in isolation or as a substitute for financial information provided in accordance with GAAP. This non-GAAP financial measure may not be computed in the same manner as similarly titled measures used by other companies. We expect to continue to incur expenditures similar to the free cash flow adjustment described above, and investors should not infer from our presentation of this non-GAAP financial measure that these expenditures reflect all of our obligations which require cash.

The following table reconciles cash provided by operating activities, the most directly comparable GAAP financial measure, to free cash flow:

[[GREPCENT_TABLE]]
[["","For the Fiscal Years Ended"],["(In thousands)","July 1, 2022","","July 2, 2021","","July 3, 2020"],["Net cash (used in) provided by operating activities","$","(18,869)","","","$","97,247","","","$","115,184"],["Purchase of property and equipment","(27,656)","","","(45,599)","","","(43,294)"],["Free cash flow","$","(46,525)","","","$","51,648","","","$","71,890"]]
[[/GREPCENT_TABLE]]

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Organic revenue and acquired revenue are non-GAAP measures for reporting financial performance of our business. We believe this information provides investors with insight as to our ongoing business performance. Organic revenue represents total company revenue excluding net revenue from acquired companies for the first four full quarters since the entities’ acquisition date (which excludes intercompany transactions). Acquired revenue represents revenue from acquired companies for the first four full quarters since the entities' acquisition date (which excludes intercompany transactions). After the completion of four full fiscal quarters, acquired revenue is treated as organic for current and comparable historical periods.

The following table reconciles the most directly comparable GAAP financial measure to the non-GAAP financial measure:

[[GREPCENT_TABLE]]
[["(In thousands)","Fiscal 2022","","As a % of Total Net Revenue","","Fiscal 2021","","As a % of Total Net Revenue","","$ Change","","% Change"],["Organic revenue","$","870,435","","","88","%","","$","920,609","","","100","%","","$","(50,174)","","","(5)","%"],["Acquired revenue(1)","117,762","","","12","%","","3,387","","","\u2014","%","","114,375","","","100","%"],["Total revenues","$","988,197","","","100","%","","$","923,996","","","100","%","","$","64,201","","","7","%"]]
[[/GREPCENT_TABLE]]

(1) Acquired revenue for all preceding periods presented has been recast for comparative purposes.

CRITICAL ACCOUNTING POLICIES AND SIGNIFICANT JUDGMENTS AND ESTIMATES

We have identified the policies discussed below as critical to understanding our business and our results of operations. The impact and any associated risks related to these policies on our business operations are discussed throughout Management’s Discussion and Analysis of Financial Condition and Results of Operations where such policies affect our reported and expected financial results. We believe the following critical accounting policies to be those most important to the portrayal of our financial position and results of operations and those that require the most subjective judgment.

REVENUE RECOGNITION

We recognize revenue at a point in time or over time as the performance obligations are met. A performance obligation is a promise in a contract to transfer a distinct good or service to the customer. Contracts with distinct performance obligations recognized at a point in time, with or without an allocation of the transaction price, totaled 45% and 58% of revenues for the fiscal years ended July 1, 2022 and July 2, 2021, respectively. Total revenue recognized under contracts over time was 55% and 42% of revenues for the fiscal years ended July 1, 2022 and July 2, 2021, respectively.

Revenue recognized at a point in time generally relates to contracts that include a combination of components, modules and sub-assemblies, integrated subsystems and related system integration or other services. Revenue is recognized at a point in time for these products and services (versus over time recognition) due to the following: (i) customers are only able to consume the benefits provided by us upon completion of the product or service; (ii) customers do not control the product or service prior to completion; and (iii) we do not have an enforceable right to payment at all times for performance completed to date. Accordingly, there is little judgment in determining when control of the good or service transfers to the customer, and revenue is recognized upon shipment (for goods) or completion (for services).

For contracts with multiple performance obligations, the transaction price is allocated to each performance obligation using the standalone selling price of each distinct good or service in the contract. Standalone selling prices of our goods and services are generally not directly observable. Accordingly, the primary method used to estimate standalone selling price is the expected cost plus a margin approach, under which we forecast the expected costs of satisfying a performance obligation and then add an appropriate margin for that distinct good or service. The objective of the expected cost plus a margin approach is to determine the price at which we would transact if the product or service were sold by us on a standalone basis. Our determination of the expected cost plus a margin approach involves the consideration of several factors based on the specific facts and circumstances of each contract. Specifically, we consider the cost to produce the deliverable, the anticipated margin on that deliverable, the selling price and profit margin for similar parts, our ongoing pricing strategy and policies, often based on the price list established and updated by management on a regular basis, the value of any enhancements that have been built into the deliverable and the characteristics of the varying markets in which the deliverable is sold.

Revenue is recognized over time (versus point in time recognition) for long-term contracts with development, production and service activities where the performance obligations are satisfied over time. These over time contracts involve the design, development, manufacture, or modification of complex modules and sub-assemblies or integrated subsystems and related services. Revenue is recognized over time, given: (i) our performance creates or enhances an asset that the customer controls as the asset is created or enhanced; or (ii) our performance creates an asset with no alternative use to us and (iii) we have an enforceable right to payment for performance completed to date. We consider the nature of these contracts and the types of products and services provided when determining the proper accounting for a particular contract. These contracts include both

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fixed-price and cost reimbursable contracts. Our cost reimbursable contracts typically include cost-plus fixed fee and time and material (“T&M”) contracts. We consider whether contracts should be combined or segmented, and based on this assessment, we combine closely related contracts when all the applicable criteria are met. The combination of two or more contracts requires judgment in determining whether the intent of entering into the contracts was effectively to enter into a single contract, which should be combined to reflect an overall profit rate. Similarly, we may separate an arrangement, which may consist of a single contract or group of contracts, with varying rates of profitability, only if the applicable criteria are met. Judgment also is involved in determining whether a single contract or group of contracts may be segmented based on how the arrangement and the related performance criteria were negotiated. The decision to combine a group of contracts or segment a contract could change the amount of revenue and gross profit recorded in a given period. For all types of contracts, we recognize anticipated contract losses as soon as they become known and estimable. These losses are recognized in advance of contract performance and as of July 1, 2022, approximately $0.3 million of these costs were in Accrued expenses on our Consolidated Balance Sheet.

For over time contracts, we typically leverage the input method, using a cost-to-cost measure of progress. We believe that this method represents the most faithful depiction of our performance because it directly measures value transferred to the customer. Contract estimates and estimates of any variable consideration are based on various assumptions to project the outcome of future events that may span several years. These assumptions include: the amount of time to complete the contract, including the assessment of the nature and complexity of the work to be performed; the cost and availability of materials; the availability of subcontractor services and materials; and the availability and timing of funding from the customer. We bear the risk of changes in estimates to complete on a fixed-price contract which may cause profit levels to vary from period to period. For cost reimbursable contracts, we are reimbursed periodically for allowable costs and are paid a portion of the fee based on contract progress. In the limited instances where we enter into T&M contracts, revenue recognized reflects the number of direct labor hours expended in the performance of a contract multiplied by the contract billing rate, as well as reimbursement of other direct billable costs. For T&M contracts, we elected to use a practical expedient permitted by ASC 606 whereby revenue is recognized in the amount for which we have a right to invoice the customer based on the control transferred to the customer. For over time contracts, we recognize anticipated contract losses as soon as they become known and estimable.

Accounting for over time contracts requires significant judgment relative to estimating total contract revenues and costs, in particular, assumptions relative to the amount of time to complete the contract, including the assessment of the nature and complexity of the work to be performed. Our estimates are based upon the professional knowledge and experience of our engineers, program managers and other personnel, who review each over time contract monthly to assess the contract’s schedule, performance, technical matters and estimated cost at completion. Changes in estimates are applied retrospectively and when adjustments in estimated contract costs are identified, such revisions may result in current period adjustments to earnings applicable to performance in prior periods.

We generally do not provide our customers with rights of product return other than those related to assurance warranty provisions that permit repair or replacement of defective goods over a period of 12 to 36 months. We accrue for anticipated warranty costs upon product shipment. We do not consider activities related to such assurance warranties, if any, to be a separate performance obligation. We offer separately priced extended warranties which generally range from 12 to 36 months that are treated as separate performance obligations. The transaction price allocated to extended warranties is recognized over time in proportion to the costs expected to be incurred in satisfying the obligations under the contract.

On over time contracts, the portion of the payments retained by the customer is not considered a significant financing component because most contracts have a duration of less than one year and payment is received as progress is made. Many of our over time contracts have milestone payments, which align the payment schedule with the progress towards completion on the performance obligation. On some contracts, we may be entitled to receive an advance payment, which is not considered a significant financing component because it is used to facilitate inventory demands at the onset of a contract and to safeguard us from the failure of the other party to abide by some or all of their obligations under the contract.

We define service revenues as revenue from activities that are not associated with the design, development, production, or delivery of tangible assets, software or specific capabilities sold by us. Examples of our service revenues include: analyst services and systems engineering support, consulting, maintenance and other support, testing and installation. We combine our product and service revenues into a single class as services revenues are less than 10 percent of total revenues.

INVENTORY VALUATION

We value our inventory at the lower of cost (first-in, first-out) or its net realizable value. We write down inventory for excess and obsolescence based upon assumptions about future demand, product mix and possible alternative uses. Actual demand, product mix and alternative usage may be higher or lower resulting in variations in on our gross margin.

INCOME TAXES

The determination of income tax expense requires us to make certain estimates and judgments concerning the calculation of deferred tax assets and liabilities, as well as the deductions and credits that are available to reduce taxable income. We

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recognize deferred tax assets and liabilities for the expected future tax consequences of events that have been included in our consolidated financial statements. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates for the year in which the differences are expected to reverse.

In evaluating our ability to recover deferred tax assets, we consider all available positive and negative evidence, including our past operating results, our forecast of future earnings, future taxable income and tax planning strategies. The assumptions utilized in determining future taxable income require significant judgment. We record a valuation allowance against deferred tax assets if, based upon the available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. If it becomes more likely than not that a tax asset will be used for which a reserve has been provided, we reverse the related valuation allowance. If our actual future taxable income by tax jurisdiction differs from estimates, additional allowances or reversals of reserves may be necessary.

We use a two-step approach to recognize and measure uncertain tax positions. First, the tax position must be evaluated to determine the likelihood that it will be sustained upon external examination. If the tax position is deemed more-likely-than-not to be sustained, the tax position is then assessed to determine the amount of benefit to recognize in the financial statements. The amount of the benefit that may be recognized is the largest amount that has a greater than 50% likelihood of being realized upon ultimate settlement. We reevaluate our uncertain tax positions on a quarterly basis and any changes to these positions as a result of tax audits, tax laws or other facts and circumstances could result in additional charges to operations.

BUSINESS COMBINATIONS

We utilize the acquisition method of accounting for business combinations and allocate the purchase price of an acquisition to the various tangible and intangible assets acquired and liabilities assumed based on their estimated fair values. We primarily establish fair value using the income approach based upon a discounted cash flow model. The income approach requires the use of many assumptions and estimates including future revenues and expenses, as well as discount factors and income tax rates. Other estimates include:

•estimated step-ups for the overt-time contracts fixed assets, leasehold interests and inventory;

•estimated fair values of intangible assets; and

•estimated income tax assets and liabilities assumed from the acquiree.

While we use our best estimates and assumptions as part of the purchase price allocation process to accurately value assets acquired and liabilities assumed at the business acquisition date, our estimates and assumptions are inherently uncertain and subject to refinement. As a result, during the purchase price allocation period, which is generally one year from the business acquisition date, we record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. For changes in the valuation of intangible assets between preliminary and final purchase price allocation, the related amortization is adjusted in the period it occurs. Subsequent to the purchase price allocation period any adjustment to assets acquired or liabilities assumed is included in operating results in the period in which the adjustment is determined.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

See Note B to consolidated financial statements (under the caption “Recently Issued Accounting Pronouncements”).

RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS

See Note B to consolidated financial statements (under the caption “Recently Adopted Accounting Pronouncements”).