MERCURY SYSTEMS INC 10-Q

ITEM 2. 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, 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, market acceptance of the Company's products, shortages in components, production delays or unanticipated expenses due to performance quality issues with outsourced components, inability to fully realize the expected benefits from acquisitions and restructurings, or delays in realizing such benefits, challenges in integrating acquired businesses and achieving anticipated synergies, increases in interest rates, changes to interest rate swaps or other cash flow hedging arrangements, changes to industrial security and cyber-security regulations and requirements, changes in tax rates or tax regulations, 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 the Company's Annual Report on Form 10-K for the fiscal year ended July 3, 2020. 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 leading technology company serving the aerospace and defense industry, positioned at the intersection of high-tech and defense. Headquartered in Andover, Massachusetts, we deliver solutions that power 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 purpose-built to meet our customers’ most-pressing high-tech needs, including those specific to the defense community. As a leading manufacturer of essential components, modules and subsystems, we sell to defense prime contractors, the U.S. government and OEM commercial aerospace companies. We have built a trusted, contemporary portfolio of proven product solutions purpose-built for aerospace and defense that we believe 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 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. 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, RF 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. 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 21 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 January 1, 2021, we had 2,376 employees. We employ hardware and software architects and design engineers, primarily engaged in engineering and research and product development activities to achieve our objectives to fully capitalize upon and maintain our technological leads in the high-performance, real-time sensor processing industry and in mission computing, platform management and other safety-critical applications. Our talent attraction, engagement and retention is critical to execute on our long-term strategy. We invest in our culture and values to drive employee engagement that turns ideas into action, delivering trusted and secure solutions at the speed of innovation. We believe that our success depends on our ability to embrace diversity company-wide and realize the benefits of a diverse workforce that includes a greater variety of solutions to problems, a broader collection of skills and experiences and an array of viewpoints to consider. Mercury is committed to providing an inclusive environment that respects the diversity of the world. We believe that the workforce required to grow our business and deliver creative solutions must be rich in diversity of thought, experience and culture. Our diversity and inclusion initiatives focus on building and maintaining the talent that will create cohesive and collaborative teams that drive innovation. These values will help our employees realize their full potentials at work to provide Innovation That Matters®. Our consolidated revenues, acquired revenues, net income, diluted net earnings per share, adjusted earnings per share (“adjusted EPS”), and adjusted EBITDA for the second quarter ended January 1, 2021 were $210.7 million, $0.2 million, $12.7 million, $0.23, $0.54, and $45.3 million, respectively. Our consolidated revenues, acquired revenues, net income, diluted net earnings per share, adjusted EPS, and adjusted EBITDA for the six months ended January 1, 2021 were $416.3 million, $9.1 million, $28.5 million, $0.51, $1.05, and $88.1 million, respectively. See the Non-GAAP Financial Measures section for a reconciliation to our most directly comparable GAAP financial measures. OUR RESPONSE TO COVID The COVID pandemic continues to impact people and countries around the world. This is a time of extraordinary uncertainty. It is also a time when the work we do in support of strategic national priorities is recognized as critical. At Mercury, 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. To protect the health, safety, and livelihoods of our employees, we took immediate action on several fronts, instituting a variety of new policies and programs including, but not limited to, additional sick leave for COVID-related circumstances, a work-from-home policy for all employees who can perform their duties remotely as well as increasing overtime pay for eligible employees. We also established a relief fund, with an initial $1 million budget, to assist eligible Mercury employees, including temporary agency employees, experiencing unexpected financial burdens as a result of the COVID crisis. The intent of the Mercury COVID Relief Fund is to provide financial assistance to employees who may otherwise be unable to pay for basic necessities, unexpected care for immediate family members, or other urgent needs that promote their health and safety during the current COVID crisis. 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 with Centers 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 with CDC guidelines and requirements, temperature and COVID testing at our facilities, and limiting non-essential site visits by internal and external visitors. We will continue to monitor and assess our response to protect the health, safety and livelihoods of our people. RESULTS OF OPERATIONS: Results of operations for the second quarter ended January 1, 2021 includes only results from the December 30, 2020 acquisition date for Physical Optics Corporation ("POC"). Results of operations for the six months ended January 1, 2021 include full period results from the acquisition of American Panel Corporation ("APC") and only results from the acquisition date for POC which was acquired subsequent to July 3, 2020. Results of operations for the six months ended December 27, 2019 include only partial period results from the acquisition date for APC. Accordingly, the periods presented below are not directly comparable. 22 The second quarter ended January 1, 2021 compared to t he second quarter ended December 27, 2019 The following table sets forth, for the second quarter ended indicated, financial data from the Consolidated Statements of Operations and Comprehensive Income: (In thousands) January 1, 2021 As a % of Total Net Revenue December 27, 2019 As a % of Total Net Revenue Net revenues $ 210,676 100.0 % $ 193,913 100.0 % Cost of revenues 122,009 57.9 105,407 54.4 Gross margin 88,667 42.1 88,506 45.6 Operating expenses: Selling, general and administrative 31,596 15.0 32,804 16.9 Research and development 28,128 13.4 24,660 12.7 Amortization of intangible assets 7,643 3.6 7,992 4.1 Restructuring and other charges 951 0.5 1,101 0.6 Acquisition costs and other related expenses 2,236 1.0 1,124 0.6 Total operating expenses 70,554 33.5 67,681 34.9 Income from operations 18,113 8.6 20,825 10.7 Interest income 60 — 312 0.2 Interest expense (73) — — — Other expense, net (981) (0.5) (351) (0.2) Income before income taxes 17,119 8.1 20,786 10.7 Income tax provision 4,433 2.1 5,110 2.6 Net income $ 12,686 6.0 % $ 15,676 8.1 % R EVENUES Total revenues increased $16.8 million, or 8.6%, to $210.7 million during the second quarter ended January 1, 2021, as compared to $193.9 million during the second quarter ended December 27, 2019, including “acquired revenue” which represents net revenue from acquired businesses that have been part of Mercury for completion of four full quarters or less (and excludes any intercompany transactions). After the completion of four fiscal quarters, acquired businesses will be treated as organic for current and comparable historical periods. The increase was primarily due to $16.5 million of additional organic revenues which were predominantly driven by increased demand for integrated subsystems, across radar applications, and within land and naval platforms. These increases were partially offset by decreases to components across electronic warfare and other applications across airborne and other platforms. The organic revenues increase was driven by the LTAMDS program, a ground radar program, an airborne program and the Filthy Buzzard program, which were partially offset by decreases in a classified missile program, P8 and the Filthy Badger program. See the Non-GAAP Financial Measures section for a reconciliation to our most directly comparable GAAP financial measures. G ROSS M ARGIN Gross margin was 42.1% for the second quarter ended January 1, 2021, a decrease of 350 basis points from the 45.6% gross margin achieved during the second quarter ended December 27, 2019. The lower gross margin was primarily driven by $3.1 million of direct COVID related expenses, as well as program mix and higher Customer Funded Research and Development (“CRAD”). These costs were partially offset by operational efficiencies and lower inventory step-up amortization. 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. S ELLING , G ENERAL AND A DMINISTRATIVE Selling, general and administrative expenses decreased $1.2 million, or 3.7%, to $31.6 million during the second quarter ended January 1, 2021, as compared to $32.8 million in the second quarter ended December 27, 2019. The decrease was primarily related to improved operating leverage, partially offset by additional headcount from organic growth and direct COVID related expenses. Selling, general and administrative expenses decreased as a percentage of revenue to 15.0% for the second quarter ended January 1, 2021 from 16.9% for the second quarter ended December 27, 2019. 23 R ESEARCH AND D EVELOPMENT Research and development expenses increased $3.4 million, or 14.1%, to $28.1 million during the second quarter ended January 1, 2021, as compared to $24.7 million during the second quarter ended December 27, 2019. Research and development expenses accounted for 13.4% and 12.7% of our revenues for the second quarters ended January 1, 2021 and December 27, 2019, respectively. The increase during the second quarter ended January 1, 2021 was primarily driven by the continued investment in internal R&D to promote future growth, including new opportunities in avionics mission computers, secure processing, radar modernization and our trusted custom microelectronics business. R ESTRUCTURING AND O THER C HARGES Restructuring and other charges were $1.0 million during the second quarter ended January 1, 2021, as compared to $1.1 million during the second quarter ended December 27, 2019. Restructuring and other charges during the second quarter ended January 1, 2021 primarily related to severance costs associated with the elimination of 23 positions, predominantly in the manufacturing, SG&A and R&D functions. Restructuring and other charges are typically related to acquisitions and organizational redesign programs initiated as part of discrete post-acquisition integration activities. These charges related to changing market and business conditions including talent shifts and resource redundancy resulting from the internal reorganization the Company completed in the first quarter. A CQUISITION C OSTS AND O THER R ELATED E XPENSES Acquisition costs and other related expenses were $2.2 million during the second quarter ended January 1, 2021, as compared to $1.1 million during the second quarter ended December 27, 2019. The second quarter ended January 1, 2021 included expenses related to the acquisition of POC which was completed on December 30, 2020. 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, 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. I NTEREST I NCOME Interest income decreased to $0.1 million during the second quarter ended January 1, 2021, as compared to $0.3 million for the second quarter ended December 27, 2019. This was driven by the lower rate earned on cash on hand during the second quarter ended January 1, 2021, as compared to the prior year. I NTEREST E XPENSE We incurred $0.1 million of interest expense during the second quarter ended January 1, 2021, related to the $160.0 million draw on our Revolver to support the POC acquisition, compared to no interest expense during the second quarter ended December 27, 2019. O THER E XPENSE , N ET Other expense, net increased to $1.0 million during the second quarter ended January 1, 2021, as compared to $0.4 million for the second quarter ended December 27, 2019. The increase was primarily driven by a $0.4 million loss on the sale of a cost-method investment, offset by net foreign currency translation gains of $0.4 million during the second quarter ended January 1, 2021. The second quarter ended December 27, 2019 included net foreign currency translation gains of $0.5 million. Both periods include $0.7 million of financing and registration fees. I NCOME T AXES We recorded an income tax provision of $4.4 million and $5.1 million on income before income taxes of $17.1 million and $20.8 million for the second quarters ended January 1, 2021 and December 27, 2019, respectively. During the second quarters ended January 1, 2021 and December 27, 2019, we recognized a discrete tax benefit of $0.1 million and $0.4 million, respectively, related to excess tax benefits on stock-based compensation. The effective tax rate for the second quarters ended January 1, 2021 and December 27, 2019 differed from the Federal statutory rate primarily due to Federal and State research and development credits, excess tax benefits related to stock-based 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 (“IRS”). 24 Six months ended January 1, 2021 compared to the six months ended December 27, 2019 The following tables set forth, for the six month periods indicated, financial data from the Consolidated Statements of Operations and Comprehensive Income: (In thousands) January 1, 2021 As a % of Total Net Revenue December 27, 2019 As a % of Total Net Revenue Net revenues $ 416,297 100.0 % $ 371,217 100.0 % Cost of revenues 239,511 57.5 204,311 55.0 Gross margin 176,786 42.5 166,906 45.0 Operating expenses: Selling, general and administrative 64,500 15.5 62,774 16.9 Research and development 55,545 13.3 46,530 12.5 Amortization of intangible assets 15,374 3.7 15,011 4.0 Restructuring and other charges 2,248 0.6 1,749 0.5 Acquisition costs and other related expenses 2,236 0.5 2,541 0.8 Total operating expenses 139,903 33.6 128,605 34.7 Income from operations 36,883 8.9 38,301 10.3 Interest income 132 — 1,499 0.4 Interest expense (73) — — — Other expense, net (1,827) (0.5) (1,785) (0.5) Income before income taxes 35,115 8.4 38,015 10.2 Income tax provision 6,631 1.6 3,092 0.8 Net income $ 28,484 6.8 % $ 34,923 9.4 % R EVENUES Total revenues increased $45.1 million, or 12.1%, to $416.3 million during the six months ended January 1, 2021, as compared to $371.2 million during the six months ended December 27, 2019. The increase is primarily due to $37.0 million of additional organic revenues primarily related to integrated subsystems across radar and C4I applications, within land and naval platforms. The increases in organic revenues were primarily driven by a ground radar program, LTAMDS, an airborne program and the Patriot program, which were partially offset by decreases in a classified missile program, AIDEWS and F16/SABR programs. Total revenues also increased due to $8.1 million of additional acquired revenues from the APC and POC acquisitions. See the Non-GAAP Financial Measures section for a reconciliation to our most directly comparable GAAP financial measures. G ROSS M ARGIN Gross margin was 42.5% for the six months ended January 1, 2021, a decrease of 250 basis points from the 45.0% gross margin achieved during the six months ended December 27, 2019. The lower gross margin was primarily driven by $5.0 million of direct COVID expenses, as well as additional CRAD and program mix. These costs were partially offset by operational efficiencies and lower inventory step-up amortization. S ELLING , G ENERAL AND A DMINISTRATIVE Selling, general and administrative expenses increased $1.7 million, or 2.7%, to $64.5 million during the six months ended January 1, 2021, as compared to $62.8 million during the six months ended December 27, 2019. The increase was primarily related to $0.6 million of direct COVID related expenses, additional headcount from organic growth and our recent acquisitions. Selling, general and administrative expenses as a percentage of revenues decreased to 15.5% for the six months ended January 1, 2021 from 16.9% for the six months ended December 27, 2019 due to improved operating leverage. 25 R ESEARCH AND D EVELOPMENT Research and development expenses increased $9.0 million, or 19.3%, to $55.5 million during the six months ended January 1, 2021, as compared to $46.5 million during the six months ended December 27, 2019. Research and development expenses accounted for 13.3% and 12.5% of our revenues for the six months ended January 1, 2021 and December 27, 2019, respectively. The increase was primarily driven by the continued investment in internal R&D to promote future growth, including new opportunities in avionics mission computers, secure processing, radar modernization and our trusted custom microelectronics business. R ESTRUCTURING A ND O THER C HARGES Restructuring and other charges were $2.2 million during the six months ended January 1, 2021, as compared to $1.7 million during the six months ended December 27, 2019. Restructuring and other charges are typically related to acquisitions and organizational redesign programs initiated as part of discrete post-acquisition integration activities. These charges related to changing market and business conditions including talent shifts and resource redundancy resulting from the internal reorganization the Company completed in the first quarter. A CQUISITION C OSTS AND O THER R ELATED E XPENSES Acquisition costs and other related expenses were $2.2 million during the six months ended January 1, 2021, as compared to $2.5 million during the six months ended December 27, 2019. The expenses we incurred during the six months ended January 1, 2021 were related to the acquisition of POC which was completed on December 30, 2020. The acquisition costs and other related expenses we incurred during the six months ended December 27, 2019 were related to the acquisition of APC 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, 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. I NTEREST I NCOME Interest income decreased to $0.1 million during the six months ended January 1, 2021, as compared to $1.5 million during the six months ended December 27, 2019. This was driven by a lower rate of interest earned on cash on hand during the six months ended January 1, 2021 compared to the prior period. I NTEREST E XPENSE We incurred $0.1 million of interest expense during the six months ended January 1, 2021, related to the $160.0 million draw on our Revolver to support the POC acquisition, compared to no interest expense during the six months ended December 27, 2019. O THER E XPENSE , N ET Other expense, net of $1.8 million was consistent during the six months ended January 1, 2021 and December 27, 2019. The six months ended January 1, 2021 included a $0.4 million loss on the sale of a cost-method investment and litigation and settlement expenses, partially offset by net foreign currency translation gains of $0.6 million. The six months ended December 27, 2019 included net foreign currency translation losses of $0.2 million. Both periods included $1.6 million of financing and registration fees. I NCOME T AXES We recorded an income tax provision of $6.6 million and $3.1 million on income before income taxes of $35.1 million and $38.0 million for the six months ended January 1, 2021 and December 27, 2019, respectively. During the six months ended January 1, 2021 and December 27, 2019, we recognized a discrete tax benefit of $2.6 million and $6.5 million, respectively, related to excess tax benefits on stock-based compensation. The effective tax rate for the six months ended January 1, 2021 and December 27, 2019 differed from the Federal statutory rate primarily due to Federal and State research and development credits, excess tax benefits related to stock-based 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 IRS. 26 L IQUIDITY AND C APITAL R ESOURCES 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, inventory purchase commitments and purchase price payout to the employee shareholders of POC . We plan to continue to invest in improvements to our facilities 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 in Andover, Massachusetts, Cypress, California and Hudson, New Hampshire, along with the ongoing expansion of our trusted custom microelectronics business during fiscal 2021. 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. 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 under 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. Revolving Credit Facility On September 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 to September 2023. As of January 1, 2021, we had $160.0 million of outstanding borrowings on the Revolver. See Note I in the accompanying consolidated financial statements for further discussion of the Revolver. C ASH F LOWS As of and For the Six Months Ended, (In thousands) January 1, 2021 December 27, 2019 Net cash provided by operating activities $ 46,868 $ 56,376 Net cash used in investing activities $ (266,852) $ (117,421) Net cash provided by (used in) financing activities $ 163,122 $ (14,934) Net decrease in cash, cash equivalents and restricted cash $ (56,099) $ (75,895) Cash, cash equivalents and restricted cash at end of period $ 170,739 $ 182,037 Our cash, cash equivalents and restricted cash decreased by $56.1 million from July 3, 2020 to January 1, 2021, primarily as the result of $243.6 million used for the acquisition of POC and $24.8 million invested in purchases of property and equipment, partially offset by $160.0 million of borrowings on our Revolver to facilitate the acquisition of POC and $46.9 million provided by operating activities. 27 Operating Activities During the six months ended January 1, 2021, we generated $46.9 million in cash from operating activities, a decrease of $9.5 million, as compared to the six months ended December 27, 2019. The decrease was primarily the result of higher inventory purchases intended to mitigate potential disruptions to the supply chain or unforeseen changes in customer behavior resulting from the COVID pandemic and to support growth of the business and lower comparable net income. This decrease was partially offset by higher deferred revenues and customer advances, and lower prepaid income taxes. Investing Activities During the six months ended January 1, 2021, we invested $266.9 million, an increase of $149.4 million, as compared to the six months ended December 27, 2019. The increase was driven by $243.6 million in cash used for the acquisition of POC and an additional $3.8 million invested in purchases of property and equipment, primarily related to our facilities, during the six months ended January 1, 2021. Financing Activities During the six months ended January 1, 2021, we had $163.1 million in cash provided by financing activities as compared to $14.9 million used in financing activities during the six months ended December 27, 2019. The $178.0 million increase was primarily due to $160.0 million of borrowings on our Revolver to facilitate the acquisition of POC and $14.9 million of fewer payments related to the purchase and retirement of common stock used to settle individual employees’ tax liabilities associated with vesting of restricted stock awards, as compared to the six months ended December 27, 2019. The decrease in the payments related to the purchase and retirement of common stock used to settle individual employees’ tax liabilities associated with vesting of restricted stock awards is due to a change in our incentive stock plan tax withholding methods. C OMMITMENTS, C ONTRACTUAL O BLIGATIONS AND C ONTINGENCIES The following is a schedule of our commitments and contractual obligations outstanding at January 1, 2021: (In thousands) Total Less Than 1 Year 1-3 Years 3-5 Years More Than 5 Years Purchase obligations $ 132,021 $ 132,021 $ — $ — $ — Operating leases 114,008 12,291 25,272 22,858 53,587 Deferred consideration 61,626 61,626 — — — $ 307,655 $ 205,938 $ 25,272 $ 22,858 $ 53,587 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 approximately $132.0 million at January 1, 2021. As of January 1, 2021, we held $61.6 million of Restricted cash and recorded a Deferred consideration liability for a purchase price payout to the employee shareholders of POC. This payout was made during the third quarter of fiscal 2021. We have a liability at January 1, 2021 of $4.1 million for uncertain tax positions that have been taken or are expected to be taken in various income tax returns. We do not know the ultimate resolution on these uncertain tax positions and as such, do not know the ultimate timing of payments or amount, if any, 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. 28 O FF - BALANCE S HEET A RRANGEMENTS Other than certain indemnification provisions in the normal course of business, 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. N ON -G AAP F INANCIAL M EASURES 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 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. The following table reconciles our net income, the most directly comparable GAAP financial measure, to our adjusted EBITDA: Second Quarters Ended Six Months Ended (In thousands) January 1, 2021 December 27, 2019 January 1, 2021 December 27, 2019 Net income $ 12,686 $ 15,676 $ 28,484 $ 34,923 Other non-operating adjustments, net (3) (549) (185) (248) Interest expense (income), net 13 (312) (59) (1,499) Income tax provision 4,433 5,110 6,631 3,092 Depreciation 5,641 4,555 10,907 8,917 Amortization of intangible assets 7,643 7,992 15,374 15,011 Restructuring and other charges 951 1,101 2,248 1,749 Impairment of long-lived assets — — — — Acquisition and financing costs 2,969 1,882 3,810 4,118 Fair value adjustments from purchase accounting — 600 — 600 Litigation and settlement expense, net 251 142 438 455 COVID related expenses 3,309 — 5,628 — Stock-based and other non-cash compensation expense 7,439 6,639 14,806 12,415 Adjusted EBITDA $ 45,332 $ 42,836 $ 88,082 $ 79,533 29 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. The following tables reconcile net income and diluted earnings per share, the most directly comparable GAAP measures, to adjusted income and adjusted EPS: Second Quarters Ended (In thousands, except per share data) January 1, 2021 December 27, 2019 Net income and diluted earnings per share $ 12,686 $ 0.23 $ 15,676 $ 0.29 Other non-operating adjustments, net (1) (3) (549) Amortization of intangible assets 7,643 7,992 Restructuring and other charges 951 1,101 Impairment of long-lived assets — — Acquisition and financing costs 2,969 1,882 Fair value adjustments from purchase accounting — 600 Litigation and settlement expense, net 251 142 COVID related expenses 3,309 — Stock-based and other non-cash compensation expense 7,439 6,639 Impact to income taxes (2) (5,275) (4,368) Adjusted income and adjusted earnings per share $ 29,970 $ 0.54 $ 29,115 $ 0.53 Diluted weighted-average shares outstanding 55,434 55,001 (1) Effective as of the third quarter of fiscal 2020, the Company has revised its definition of adjusted income and adjusted earnings per share to incorporate other non-operating adjustments, which includes gains or losses on foreign currency remeasurement, investments and fixed assets sales or disposals among other adjustments. Adjusted EPS for prior periods has been recast for comparative purposes. (2) 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. 30 Six Months Ended (In thousands, except per share data) January 1, 2021 December 27, 2019 Net income and earnings per share $ 28,484 $ 0.51 $ 34,923 $ 0.63 Other non-operating adjustments, net (1) (185) (248) Amortization of intangible assets 15,374 15,011 Restructuring and other charges 2,248 1,749 Impairment of long-lived assets — — Acquisition and financing costs 3,810 4,118 Fair value adjustments from purchase accounting — 600 Litigation and settlement expense, net 438 455 COVID related expenses 5,628 — Stock-based and other non-cash compensation expense 14,806 12,415 Impact to income taxes (2) (12,299) (15,293) Adjusted income and adjusted earnings per share $ 58,304 $ 1.05 $ 53,730 $ 0.98 Diluted weighted-average shares outstanding 55,385 55,037 (1) Effective as of the third quarter of fiscal 2020, the Company has revised its definition of adjusted income and adjusted earnings per share to incorporate other non-operating adjustments, which includes gains or losses on foreign currency remeasurement, investments and fixed assets sales or disposals among other adjustments. Adjusted EPS for prior periods has been recast for comparative purposes. (2) 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: Second Quarters Ended Six Months Ended (In thousands) January 1, 2021 December 27, 2019 January 1, 2021 December 27, 2019 Cash provided by operating activities $ 23,939 $ 32,066 $ 46,868 $ 56,376 Purchase of property and equipment (13,775) (11,324) (24,753) (20,919) Free cash flow $ 10,164 $ 20,742 $ 22,115 $ 35,457 31 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 tables reconcile the most directly comparable GAAP financial measure to the non-GAAP financial measure for the second quarters and six months ended January 1, 2021 and December 27, 2019, respectively: (In thousands) January 1, 2021 As a % of Total Net Revenue December 27, 2019 As a % of Total Net Revenue $ Change % Change Organic revenue $ 210,459 100 % $ 193,913 100 % $ 16,546 9 % Acquired revenue 217 — % — — % 217 100 % Total revenues $ 210,676 100 % $ 193,913 100 % $ 16,763 9 % (In thousands) January 1, 2021 As a % of Total Net Revenue December 27, 2019 As a % of Total Net Revenue $ Change % Change Organic revenue $ 407,244 98 % $ 370,274 100 % $ 36,970 10 % Acquired revenue 9,053 2 % 943 — % 8,110 860 % Total revenues $ 416,297 100 % $ 371,217 100 % $ 45,080 12 % R ECENTLY I SSUED A CCOUNTING P RONOUNCEMENTS See Note B to our consolidated financial statements (under the caption "Recently Issued Accounting Pronouncements"). R ECENTLY A DOPTED A CCOUNTING P RONOUNCEMENTS See Note B to our consolidated financial statements (under the caption "Recently Adopted Accounting Pronouncements"). 32 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK There were no material changes in our exposure to market risk from July 3, 2020 to January 1, 2021.