MERCURY SYSTEMS, INC. FORWARD-LOOKING STATEMENTS From time to time, information provided, statements made by our employees or information included in our filings with theSecurities 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 anyU.S. Federal government shutdown or extended continuing resolution, effects of continued geopolitical unrest and regional conflicts, competition, 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 theU.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, 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. OVERVIEWMercury Systems, Inc. is a leading technology company serving the aerospace and defense industry, positioned at the intersection of high-tech and defense. Headquartered inAndover, Massachusetts , we deliver products and solutions that enable a broad range of aerospace and defense programs, optimized for mission success in some of the most challenging and demanding environments. We envision, create and deliver innovative technology solutions that are open, purpose-built and uncompromised to meet our customers' most-pressing high-tech needs, including those specific to the defense community. As a leading manufacturer of essential components, products, modules and subsystems, we sell to defense prime contractors, theU.S. government and 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, in some cases, 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 companies, coupled with our high level of R&D investments 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 RF to digital, we make mission-critical technologies safe, secure, affordable and relevant for our customers. Our capabilities, technology and R&D investment strategy combine to differentiate Mercury in our industry. Our technologies and capabilities include secure embedded processing modules and subsystems, mission computers, secure and rugged rack-mount servers, safety-critical avionics, components, multi-function assemblies, subsystems and custom microelectronics. We maintain our technological edge by investing in critical capabilities and IP in processing and RF, 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 AI. 32 -------------------------------------------------------------------------------- Table of Contents Our mission critical solutions are deployed by our customers for a variety of applications including C4ISR, electronic intelligence, avionics, 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 ofJuly 2, 2021 , we had 2,384 employees. Our consolidated revenues, acquired revenues, net income, EPS, adjusted EPS, and adjusted EBITDA for fiscal 2021 were$924.0 million ,$88.4 million ,$62.0 million ,$1.12 ,$2.42 and$201.9 million , respectively. Our consolidated revenues, acquired revenues, net income, EPS, adjusted EPS and adjusted EBITDA for fiscal 2020 were$796.6 million ,$0.9 million ,$85.7 million ,$1.56 ,$2.30 and$176.2 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. We remain focused on the four goals we established at the outset of the COVID crisis: to protect the health, safety, and livelihoods of our people; to mitigate or reduce operational and financial risks to the Company; to continue to deliver on our commitments to customers and shareholders; and to continue the mission-critical work Mercury does every day to support the ongoing security of our nation, our brave men and women in uniform, and the communities in which we all live. As we have been designated an "essential business" as a part of the defense industrial base, during the year, our facilities continued to operate while complying with social distancing requirements consistent withCenters for Disease Control and Prevention ("CDC") guidelines and requirements. We implemented numerous preventive measures to maximize the safety of our facilities, including but not limited to, establishing physical segregation areas, implementing environmental cleaning and disinfection protocols in compliance withCDC guidelines and requirements, temperature and COVID testing at our facilities, and limiting non-essential site visits by internal and external visitors. In fiscal 2021, we incurred$9.9 million of direct COVID-related expenses related to these preventative measures as well as certain enhanced compensation programs for our employees. 1MPACT OnAugust 3, 2021 , we announced a companywide effort, called 1MPACT, to lay the foundation for the next phase of our 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 13 acquisitions, deploying$1.2 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 these acquisitions. Now, as we approach the milestone of$1 billion of revenue, we believe there is significant opportunity to realize further scale through consolidating and streamlining our organizational structure which will improve visibility, speed of decision making and accountability. 1MPACT will be led by a new Chief Transformation Officer, and will focus on six major areas: organization efficiency and scalability; procurement and supply chain; facilities optimization; R&D investment; capital and asset efficiency; and scalable common processes and systems. 33 -------------------------------------------------------------------------------- Table of Contents BUSINESS DEVELOPMENTS: FISCAL 2021 OnMay 27, 2021 , we acquiredPentek for a purchase price of$65.0 million , subject to net working capital and net debt adjustments. Based inUpper 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 existing revolving credit facility (the "Revolver"). OnDecember 30, 2020 , we acquired POC for a purchase price of$310.0 million , prior to net working capital and net debt adjustments. Based inTorrance, California , POC more than doubles our global avionics business and expands its collective footprint in the platform and mission management market. We funded the acquisition through a combination of cash on hand and our existing Revolver. FISCAL 2020 During the third quarter endedMarch 27, 2020 , we drew$200.0 million on our$750.0 million Revolver to provide access to capital and flexibility in managing operations during the COVID pandemic. We paid down the$200.0 million draw during our fourth quarter endedJuly 3, 2020 based on reduced turbulence in the capital markets. OnSeptember 23, 2019 , we acquiredAmerican Panel Corporation ("APC") on a cash-free, debt-free basis for a total purchase price of$100.0 million , prior to net working capital and net debt adjustments. Based inAlpharetta, Georgia , APC is a leading innovator in large area display technology for the aerospace and defense market. APC's capabilities are deployed on a wide range of next-generation platforms. The acquisition was funded with cash on hand. EffectiveJuly 1, 2019 , our fiscal year has changed to the 52-week or 53-week period ending on the Friday closest to the last day in June. All references to fiscal 2021 are to the 52-week period fromJuly 4, 2020 toJuly 2, 2021 . All references to fiscal 2020 are to the 53-week period fromJuly 1, 2019 toJuly 3, 2020 . All references to fiscal 2019 is to the 52-week period fromJuly 1, 2018 toJune 30, 2019 . There have been no reclassifications of prior comparable periods due to this change. RESULTS OF OPERATIONS: FISCAL 2021 VS. FISCAL 2020 Results of operations for fiscal 2021 include full period results from the acquisition of APC and only the results from acquisition date for POC andPentek , which were acquired subsequent to fiscal 2020. Results of operations for fiscal 2020 include only results from the acquisition date for APC. Accordingly, the periods presented below are not directly comparable. The Company has applied the FAST Act Modernization and Simplification of Regulation S-K, which limits the discussion to the two most recent fiscal years. Refer to Item 7 of the Company's Form 10-K issued onAugust 18, 2020 for prior year discussion related to fiscal 2019. 34 -------------------------------------------------------------------------------- Table of Contents The following tables set forth, for the periods indicated, financial data from the Consolidated Statements of Operations and Comprehensive Income: As a % of As a % of Total Net Total Net (In thousands) Fiscal 2021 Revenue Fiscal 2020 Revenue Net revenues$ 923,996 100.0 %$ 796,610 100.0 % Cost of revenues 538,808 58.3 439,766 55.2 Gross margin 385,188 41.7 356,844 44.8 Operating expenses: Selling, general and administrative 134,337 14.5 132,253 16.6 Research and development 113,481 12.3 98,485 12.4 Amortization of intangible assets 41,171 4.5 30,560 3.8 Restructuring and other charges 9,222 1.0 1,805 0.2 Acquisition costs and other related expenses 5,976 0.6 2,679 0.4 Total operating expenses 304,187 32.9 265,782 33.4 Income from operations 81,001 8.8 91,062 11.4 Interest income 179 - 2,151 0.3 Interest expense (1,222) (0.1) (1,006) (0.1) Other (expense) income, net (2,785) (0.3) 1,726 0.2 Income before income taxes 77,173 8.4 93,933 11.8 Income tax provision 15,129 1.7 8,221 1.0 Net income$ 62,044 6.7 %$ 85,712 10.8 % REVENUES Total revenues increased$127.4 million , or 16.0%, to$924.0 million during fiscal 2021, as compared to$796.6 million during fiscal 2020 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$87.4 million and$40.0 million of additional acquired revenues and organic revenues, respectively. These increases were driven by higher demand for integrated subsystems and modules and sub-assemblies which increased$153.1 million or 35.0% and$25.4 million or 19.3%, respectively, partially offset by a decrease to components of$51.1 million or 22.5% during fiscal 2021. The increase in total revenue was primarily from the C4I and radar end applications which increased$101.0 million and$55.2 million , respectively, and were partially offset by decreases of$17.5 million and$7.1 million from EW and other sensor and effector end applications. The increase spanned the land, naval and airborne platforms which increased$79.6 million ,$20.3 million and$19.3 million , respectively. The largest program increases were related to a classified radar program, LTAMDS, Abrams, CPS and E2D Hawkeye. Acquired revenue in fiscal 2021 represents activity from the POC andPentek acquired businesses and one fiscal quarter from the APC acquired business. There were no programs comprising 10% or more of our revenues for fiscal 2021 and 2020. See the Non-GAAP Financial Measures section for a reconciliation to our most directly comparable GAAP financial measures. GROSS MARGIN Gross margin was 41.7% for fiscal 2021, a decrease of 310 basis points from the 44.8% gross margin achieved during fiscal 2020. The lower gross margin was primarily driven by the acquisition of POC which contributed to the increasedCustomer Funded Research and Development ("CRAD") of$28.6 million , program mix and incremental COVID related expenses of$7.2 million . These gross margin decreases were partially offset by$0.3 million gross margin benefit from fair value adjustments from purchase accounting in fiscal 2021, as compared to$1.8 million of gross margin impact from fair value adjustments from purchase accounting during fiscal 2020. CRAD primarily represents engineering labor associated with long-term contracts for customized development, production and service activities. Due to the nature of these efforts, they typically carry a lower margin. These products are predominately grouped within integrated subsystems and to a lesser extent modules and sub-assemblies. 35 -------------------------------------------------------------------------------- Table of Contents SELLING, GENERAL AND ADMINISTRATIVE Selling, general and administrative expenses increased$2.0 million , or 1.5%, to$134.3 million during fiscal 2021 as compared to$132.3 million during fiscal 2020. The increase was primarily related to our POC,Pentek and the full period impact of APC driving incremental$7.4 million of expense, partially offset by tighter control over operating expenses including savings from restructuring activities during the period. Selling, general and administrative expenses decreased as a percentage of revenue to 14.5% during fiscal 2021 from 16.6% during fiscal 2020. The acquisitions of POC andPentek resulted in a 30-basis point reduction in selling, general and administrative expenses as a percentage of revenue for fiscal 2021. RESEARCH AND DEVELOPMENT Research and development expenses increased$15.0 million , or 15.0%, to$113.5 million during fiscal 2021, as compared to$98.5 million for fiscal 2020. The increase was primarily related to our recent acquisitions of POC,Pentek and the full period impact of APC driving an incremental$3.9 million of expense. These increases were partially offset by increased CRAD of$28.6 million . Research and development expenses accounted for 12.3% and 12.4% of our revenues during fiscal 2021 and fiscal 2020, respectively. The acquisitions of POC andPentek resulted in an 80-basis point reduction in research and development expenses as a percentage of revenue for fiscal 2021. The increase as a percentage of revenue, excluding acquisitions of POC andPentek , was primarily driven by the continued investment in internal R&D to promote future growth, including new opportunities in avionics missions computers, secure processing, radar modernization and our trusted custom microelectronics business. AMORTIZATION OF INTANGIBLE ASSETS Amortization of intangible assets increased$10.6 million to$41.2 million during fiscal 2021, as compared to$30.6 million for fiscal 2020, primarily due to the acquisitions of POC andPentek as well as the full year impact of amortization from the acquisition of APC. RESTRUCTURING AND OTHER CHARGES During 2021, the Company incurred$9.2 million of restructuring and other charges, as compared to$1.8 million in fiscal 2020. Restructuring and other charges of$4.8 million related to severance costs associated with the elimination of approximately 90 positions throughout the period, predominantly in manufacturing, SG&A and R&D. These charges are related to changing market and business conditions as well as talent shifts and resource redundancy resulting from our internal reorganization that was completed during fiscal 2021. The remaining$4.5 million of restructuring and other charges related to third-party consulting costs associated with 1MPACT, our value creation initiatives. OnAugust 2, 2021 , we initiated a workforce reduction of approximately 90 employees based on changes in the business environment and to align with 1MPACT resulting in expected charges of$9.4 million in the fiscal quarter endingOctober 1, 2021 . These charges include$5.8 million of employee separation costs and$3.6 million of third-party consulting costs. ACQUISITION COSTS AND OTHER RELATED EXPENSES Acquisition costs and other related expenses were$6.0 million during fiscal 2021, as compared to$2.7 million during fiscal 2020. The acquisition costs and other related expenses incurred during fiscal 2021 were related to the acquisitions of POC andPentek , as well as costs associated with our evaluation of other acquisition opportunities. We expect to incur acquisition costs and other related expenses periodically in the future as we continue to seek acquisition opportunities to expand our technological capabilities and especially within the sensor and effector and C4I markets. Transaction costs incurred by the acquiree prior to the consummation of an acquisition would not be reflected in our historical results of operations. INTEREST INCOME Interest income decreased to$0.2 million in fiscal 2021 from$2.2 million in fiscal 2020. This was driven by lower cash on hand and lower interest rates during fiscal 2021 as compared to fiscal 2020. INTEREST EXPENSE Interest expense for fiscal 2021 increased to$1.2 million , as compared to$1.0 million in fiscal 2020. We drew$160.0 million and$40.0 million during the second quarter and fourth quarters of fiscal 2021, respectively, on our Revolver to facilitate the acquisitions of POC andPentek . We drew$200.0 million on the Revolver during the third quarter of fiscal 2020 to provide access to capital and flexibility in managing operations during the COVID pandemic, which was subsequently paid down during the fourth quarter of fiscal 2020. OTHER (EXPENSE) INCOME, NET Other (expense) income, net was$2.8 million of other expense, net during fiscal 2021, as compared to$1.7 million of other income, net in fiscal 2020. Both periods include$2.9 million of financing and registration fees. Fiscal 2021 includes net 36 -------------------------------------------------------------------------------- Table of Contents foreign currency translation gains of$1.2 million , which were partially offset by$0.6 million of litigation and settlement expenses and a$0.3 million loss on sale of investment. Fiscal 2020 included$6.4 million of other investment income partially offset by$0.6 million of litigation and settlement expenses and$0.7 million of net foreign currency translation losses. INCOME TAXES We recorded an income tax provision of$15.1 million and$8.2 million on income before income taxes of$77.2 million and$93.9 million for fiscal years 2021 and 2020, respectively. We recognized a discrete tax benefit of$2.8 million and$7.3 million related to excess tax benefits on stock-based compensation for fiscal years 2021 and 2020, respectively. The effective tax rate for fiscal 2021 and 2020 differed from the Federal statutory rate of 21% primarily due to Federal and state research and development tax credits, excess tax benefits related to stock compensation, non-deductible compensation, and state taxes. Within the calculation of our annual effective tax rate we have used assumptions and estimates that may change as a result of future guidance and interpretation from the Internal Revenue Service. These changes could have a material impact on our futureU.S. tax expense. 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, and restructuring and other expenses associated with our 1MPACT initiative. 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 buildouts inAndover, Massachusetts , andHudson, New Hampshire , along with the ongoing expansion of our trusted custom microelectronics business during fiscal 2022. Based on our current plans, business conditions, including the COVID pandemic, and essential business status, 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. Refer to Item 1A - "Risk Factors" for risk factors concerning the Company, including a risk factor related to health epidemics, pandemics and similar outbreaks. Shelf Registration Statement OnSeptember 14, 2020 , we filed a shelf registration statement on Form S-3ASR with theSEC . The shelf registration statement, which was effective upon filing with theSEC , 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. Additionally, as part of the shelf registration statement, we have entered into an equity distribution agreement which allows us to sell an aggregate of up to$200.0 million of our common stock from time to time through our agents. The actual dollar amount and number of shares of common stock we sell pursuant to the equity distribution agreement will be dependent on, among other things, market conditions and our fund raising requirements. The agents may sell the common stock by any method deemed to be an "at the market offering" as defined in Rule 415 of the Securities Act of 1933, as amended, including without limitation sales made directly on Nasdaq, on any other existing trading market for the common stock or to or through a market maker. In addition, our common stock may be offered and sold by such other methods, including privately negotiated transactions, as we and the agents may agree. As ofJuly 2, 2021 , we have not sold any stock using our at the market offering feature. Revolving Credit Facilities OnSeptember 28, 2018 , we amended the Revolver to increase and extend the borrowing capacity to a$750.0 million , 5-year revolving credit line, with the maturity extended toSeptember 2023 . We drew$160.0 million and$40.0 million during the second and fourth quarters of fiscal 2021, respectively, on the Revolver to facilitate the acquisitions of POC andPentek . As of 37 -------------------------------------------------------------------------------- Table of ContentsJuly 2, 2021 , we had$200.0 million of outstanding borrowings against the Revolver. See Note M in the accompanying consolidated financial statements for further discussion of the Revolver. CASH FLOWS For the Fiscal Years Ended (In thousands) July 2, 2021 July 3, 2020 June 30, 2019 Net cash provided by operating activities$ 97,247 $ 115,184 $ 97,517 Net cash used in investing activities$ (416,887) $ (135,486) $ (153,774) Net cash provided by (used in) financing activities$ 206,229 $ (10,932) $ 247,765 Net (decrease) increase in cash and cash equivalents$ (112,999) $ (31,094) $ 191,411 Cash and cash equivalents at end of year$ 113,839
Our cash and cash equivalents decreased by$113.0 million during fiscal 2021 primarily as the result of investing activities including$372.8 million used in the acquisitions of POC andPentek and$45.6 million invested in purchases of property and equipment. These decreases were partially offset by$200.0 million of borrowings on our Revolver to facilitate the acquisitions of POC andPentek and$97.2 million provided by operating activities. Operating Activities During fiscal 2021, we generated$97.2 million in cash from operating activities, a decrease of$18.0 million , as compared to$115.2 million during fiscal 2020. The decrease in cash generated by operating activities was primarily the result of lower sources of cash from receivables, higher inventory purchases driven by an increase in demand, especially for larger, more complex integrated subsystems and the advanced purchase of inventory intended to mitigate disruptions to the supply chain or unforeseen changes in customer behavior resulting from the COVID pandemic. These decreases were partially offset by higher sources of cash from deferred revenues and customer advances, other non-current assets and income taxes payable. Investing Activities During fiscal 2021, we invested$416.9 million , an increase of$281.4 million , as compared to$135.5 million during fiscal 2020. The increase was primarily driven by$372.8 million used in the acquisitions of POC andPentek , as well as an incremental$2.3 million invested in purchases of property and equipment during fiscal 2021. During fiscal 2020, we invested$96.5 million in the acquisition of APC, which was partially offset by$4.3 million of proceeds from the sale of an investment. Financing Activities During fiscal 2021, we had$206.2 million in cash provided by financing activities, as compared to$10.9 million used in financing activities during fiscal 2020. During fiscal 2021, we borrowed a total of$200.0 million on our Revolver to facilitate the acquisitions of POC andPentek . During fiscal 2020, we drew and repaid$200.0 million on our Revolver to provide access to capital and flexibility in managing operations during the COVID pandemic. Fiscal 2021 had a decrease of$16.2 million in cash used for payments for the retirement of common stock due to a change in our incentive stock plan tax withholding method. COMMITMENTS AND CONTRACTUAL OBLIGATIONS The following is a schedule of our commitments and contractual obligations outstanding atJuly 2, 2021 : Less Than 1-3 3-5 More Than (In thousands) Total 1 Year Years Years 5 Years Operating leases$ 100,030 $ 13,626 $ 25,134 $ 21,253 $ 40,017 Purchase obligations 147,591 147,591 - - -$ 247,621 $ 161,217 $ 25,134 $ 21,253 $ 40,017 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$147.6 million atJuly 2, 2021 . We had a liability atJuly 2, 2021 of$7.5 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$3.4 million primarily due to a tax position previously taken on a tax return of an acquired company during the fiscal year endedJuly 2, 2021 . We do not know the ultimate 38 -------------------------------------------------------------------------------- Table of Contents resolution of these uncertain tax positions 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. OnAugust 2, 2021 , the Company initiated a workforce reduction of approximately 90 employees based on changes in the business environment and to align with 1MPACT, the Company's value creation initiative, resulting in expected charges of$9.4 million in the fiscal quarter endingOctober 1, 2021 . These charges include$5.8 million of employee separation costs and$3.6 million of third-party consulting costs. These costs will be classified as restructuring and other charges within the Company's statement of operations and other comprehensive income for the fiscal quarter endingOctober 1, 2021 . 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 2021 and 2020, 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 toU.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 and financing 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 the 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. 39 -------------------------------------------------------------------------------- Table of Contents The following table reconciles our net income, the most directly comparable GAAP financial measure, to our adjusted EBITDA: For the Fiscal Years Ended (In thousands) July 2, 2021 July 3, 2020 June 30, 2019 Net income$ 62,044 $ 85,712 $ 46,775 Other non-operating adjustments, net (724) (5,636) 364 Interest expense (income), net 1,043 (1,145) 8,177 Income tax provision 15,129 8,221 12,752 Depreciation 25,912 18,770 18,478 Amortization of intangible assets 41,171 30,560 27,914 Restructuring and other charges(1) 9,222 1,805 560 Impairment of long-lived assets - - - Acquisition and financing costs 8,600 5,645 9,628 Fair value adjustments from purchase accounting(2) (290) 1,801 713 Litigation and settlement expense, net 622 944 344 COVID related expenses 9,943 2,593 - Stock-based and other non-cash compensation expense 29,224 26,972 19,621 Adjusted EBITDA$ 201,896 $ 176,242 $ 145,326 (1) Restructuring and other charges for fiscal 2021 are related to changing market and business conditions including talent shifts and resource redundancy resulting from internal reorganization and organization structure evaluation the Company completed, as well as third party consulting costs. 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) 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. Fair value adjustments from purchase accounting for fiscal year 2019 relate to Germane and GECO 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 and financing 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. 40 -------------------------------------------------------------------------------- Table of Contents The following table reconcile net income and diluted earnings per share, the most directly comparable GAAP financial measures, to adjusted income and adjusted EPS: For the Fiscal Years Ended (In thousands, except per share data) July 2, 2021 July 3, 2020 June 30, 2019
Net income and diluted earnings per share
$ 85,712 $ 1.56 $ 46,775 $ 0.96 Other non-operating adjustments, net (724) (5,636) 364 Amortization of intangible assets 41,171 30,560 27,914 Restructuring and other charges(1) 9,222 1,805 560 Impairment of long-lived assets - - - Acquisition and financing costs 8,600 5,645 9,628 Fair value adjustments from purchase accounting(2) (290) 1,801 713 Litigation and settlement expense, net 622 944 344 COVID related expenses 9,943 2,593 - Stock-based and other non-cash compensation expense 29,224 26,972 19,621 Impact to income taxes(3) (25,697) (23,634) (16,630) Adjusted income and adjusted earnings per share$ 134,115 $ 2.42
Diluted weighted-average shares outstanding 55,474 55,115 48,500
(1) Restructuring and other charges for fiscal 2021 are related to changing
market and business conditions including talent shifts and resource redundancy
resulting from internal reorganization and organization structure evaluation the
Company completed, as well as third party consulting costs. 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) 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. Fair value adjustments from purchase accounting for fiscal year
2019 relate to Germane and GECO inventory step-up amortization.
(3) 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:
For the Fiscal Years Ended
(In thousands) July 2, 2021 July 3, 2020 June 30, 2019 Cash provided by operating activities$ 97,247 $ 115,184 $ 97,517 Purchase of property and equipment (45,599) (43,294) (26,691) Free cash flow$ 51,648 $ 71,890 $ 70,826 41
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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:
As a % of As a % of
Total Net Total Net
(In thousands) Fiscal 2021 Revenue Fiscal 2020 Revenue $ Change % Change Organic revenue$ 835,620 90 %$ 795,667 100 %$ 39,953 5 % Acquired revenue(1) 88,376 10 % 943 - % 87,433 9,272 % Total revenues$ 923,996 100 %$ 796,610 100 %$ 127,386 16 % (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 58% and 73% of revenues for the fiscal years endedJuly 2, 2021 andJuly 3, 2020 , respectively. Total revenue recognized under long-term contracts over time was 42% and 27% of revenues for the fiscal years endedJuly 2, 2021 andJuly 3, 2020 , 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 generally 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 long-term 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, due to the fact that: (i) our performance creates or enhances an asset that the customer controls as the asset is created or enhanced; and (ii) our performance creates an asset with no alternative use to us and 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 42 -------------------------------------------------------------------------------- Table of Contents include both 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 ofJuly 2, 2021 , approximately$1.4 million of these costs were in Accrued expenses on our Consolidated Balance Sheet. For long-term 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 long-term 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 long-term 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 long-term 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 long-term 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. 43 -------------------------------------------------------------------------------- Table of ContentsGOODWILL , INTANGIBLE ASSETS AND LONG-LIVED ASSETS We evaluate our goodwill for impairment annually in the fourth quarter and in any interim period in which events or circumstances arise that indicate our goodwill may be impaired. Indicators of impairment include, but are not limited to, a significant deterioration in overall economic conditions, a decline in our market capitalization, the loss of significant business, significant decreases in funding for our contracts, or other significant adverse changes in industry or market conditions. We test goodwill for impairment at the reporting unit level.Goodwill impairment guidance provides entities an option to perform a qualitative assessment (commonly known as "step zero") to determine whether further impairment testing is necessary before performing the two-step test. The qualitative assessment requires significant judgments by management about macro-economic conditions including our operating environment, industry and other market considerations, entity-specific events related to financial performance or loss of key personnel, and other events that could impact the reporting unit. If we conclude that further testing is required, the impairment test involves a two-step process. Step one compares the fair value of the reporting unit with its carrying value, including goodwill. If the carrying amount exceeds the fair value of the reporting unit, step two is required to determine if there is an impairment of the goodwill. Step two compares the implied fair value of the reporting unit's goodwill to the carrying amount of the goodwill. We estimate the fair value of our reporting units 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, expenses, capital expenditures, and working capital, as well as discount factors and income tax rates. In addition, we use the market approach, which compares the reporting unit to publicly-traded companies and transactions involving similar businesses, to support the conclusions of the income approach. During the first quarter of fiscal 2021, the Company reorganized its internal reporting unit structure to align with the Company's market and brand strategy as well as promote scale as the organization continues to grow. The Company evaluated this reorganization under ASC 280 to determine whether this change has impacted the Company's single operating and reportable segment. The Company concluded this change had no effect given the CODM continues to evaluate and manage the Company on the basis of one operating and reportable segment. The Company utilized the management approach for determining its operating segment in accordance with ASC 280. In accordance with FASB ASC 350, Intangibles-Goodwill and Other ("ASC 350"), the Company determines its reporting units based upon whether discrete financial information is available, if management regularly reviews the operating results of the component, the nature of the products offered to customers and the market characteristics of each reporting unit. A reporting unit is considered to be an operating segment or one level below an operating segment also known as a component. Component level financial information is reviewed by management across three divisions: Processing, Microelectronics, and Mission. Accordingly, these were determined to be the Company's new reporting units. As part of our annual goodwill impairment testing, we utilized a discount rate for each of our reporting units, as defined by ASC 350, that we believe represents the risks that our businesses face, considering their sizes, the current economic environment, and other industry data we believe is appropriate. The discount rates for Processing, Microelectronics and Mission were 7.5%, 7.5%, and 7.8%, respectively. The annual testing indicated that the fair values of our Processing, Microelectronics and Mission reporting units significantly exceeded their carrying values, and thus no further testing was required. We also review finite-lived intangible assets and long-lived assets when indications of potential impairment exist, such as a significant reduction in undiscounted cash flows associated with the assets. Should the fair value of our finite-lived intangible assets or long-lived assets decline because of reduced operating performance, market declines, or other indicators of impairment, a charge to operations for impairment may be necessary. 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 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. 44
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Table of Contents 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").
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