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 our markets, effects of any U.S. federal government shutdown or extended continuing resolution, effects of geopolitical unrest and regional conflicts, competition, changes in technology and methods of marketing, delays in or cost increases related to completing development, engineering and manufacturing programs, changes in customer order patterns, changes in product mix, continued success in technological advances and delivering technological innovations, changes in, or in the U.S. government’s interpretation of, federal export control or procurement rules and regulations, changes in, or in the interpretation or enforcement of, environmental rules and regulations, market acceptance of our products, shortages in or delays in receiving components, supply chain delays or volatility for critical components such as semiconductors, production delays or unanticipated expenses including due to quality issues or manufacturing execution issues, capacity underutilization, increases in scrap or inventory write-offs, failure to achieve or maintain manufacturing quality certifications, such as AS9100, the impact of supply chain disruption, inflation and labor shortages, among other things, on program execution and the resulting effect on customer satisfaction, inability to fully realize the expected benefits from acquisitions, restructurings, and operational efficiency initiatives or delays in realizing such benefits, challenges in integrating acquired businesses and achieving anticipated synergies, effects of shareholder activism, increases in interest rates, changes to industrial security and cyber-security regulations and requirements and impacts from any cyber or insider threat events, changes in tax rates or tax regulations, such as the deductibility of internal research and development, changes to interest rate swaps or other cash flow hedging arrangements, changes to generally accepted accounting principles, difficulties in retaining key employees and customers, litigation, including the dispute arising with the former CEO over his resignation, 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 are discussed in our filings with the U.S. Securities and Exchange Commission, including our Annual Report on Form 10-K for the fiscal year ended June 30, 2023 and subsequent Quarterly Reports on Form 10-Q and Current Reports on Form 8-K. We caution readers not to place undue reliance upon any such forward-looking statements, which speak only as of the date made. We undertake no obligation to update any forward looking statement to reflect events or circumstances after the date on which such statement is made. OVERVIEW Mercury Systems, Inc. is a technology company that delivers processing power for the most demanding aerospace and defense missions. Headquartered in Andover, Massachusetts, our end-to-end processing platform enables a broad range of aerospace and defense programs, optimized for mission success in some of the most challenging and demanding environments. Processing technologies that comprise our platform include signal solutions, display, software applications, networking, storage and secure processing. Our innovative solutions are mission-ready, trusted and secure, software-defined and open and modular meeting our customers’ cost and schedule needs today by allowing them to use or modify our products to suit their mission. Customers access our solutions via the Mercury Processing Platform, which encompasses the broad scope of our investments in technologies, companies, products, services and the expertise of our people. Ultimately, we connect our customers to what matters most to them. We connect commercial technology to defense, people to data and partners to opportunities. And, at the most human level, we connect what we do to our customers’ missions; supporting the people for whom safety, security and protecting freedom are of paramount importance. As a leading manufacturer of essential components, products, modules and subsystems, we sell to defense prime contractors, the U.S. government and original equipment manufacturers (“OEM”) commercial aerospace companies. Mercury has built a trusted, robust portfolio of proven product solutions, leveraging the most advanced commercial silicon technologies and purpose-built to exceed the performance needs of our defense and commercial customers. Customers add their own applications and algorithms to our specialized, secure and innovative products and pre-integrated solutions. This allows them to complete their full system by integrating with their platform, the sensor technology and, increasingly, the processing from Mercury. Our products and solutions are deployed in more than 300 programs with over 25 different defense prime contractors and commercial aviation customers. Mercury’s 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 on time constraints that matter. 22 Our long-standing deep relationships with leading high-tech and other commercial companies, coupled with our high level of research and development (“R&D”) investments on a percentage basis and industry-leading trusted and secure design and manufacturing capabilities, are the foundational tenets of this model. We are leading the development and adaptation of commercial technology for aerospace and defense solutions. From chip-scale to system scale and from data, including radio frequency (“RF”) to digital to decision, we make mission-critical technologies safe, secure, affordable and relevant for our customers. Our capabilities, technology, people and R&D investment strategy combine to differentiate Mercury in our industry. We maintain our technological edge by investing in critical capabilities and intellectual property (“IP” or “building blocks”) in processing, leveraging open standards and open architectures to adapt quickly those building blocks into solutions for highly data-intensive applications, including emerging needs in areas such as artificial intelligence (“AI”). Our mission critical solutions are deployed by our customers for a variety of applications including command, control, communications, computers, intelligence, surveillance and reconnaissance (“C4ISR”), electronic intelligence, mission computing avionics, electro-optical/infrared (“EO/IR”), electronic warfare, weapons and missile defense, hypersonics and radar. Since we conduct much of our business with our defense customers via commercial items, requests by customers are a primary driver of revenue fluctuations from quarter to quarter. Customers specify delivery date requirements that coincide with their need for our products. Because these customers may use our products in connection with a variety of defense programs or other projects of different sizes and durations, a customer’s orders for one quarter generally do not indicate a trend for future orders by that customer. Additionally, order patterns do not necessarily correlate amongst customers and, therefore, we generally cannot identify sequential quarterly trends. As of December 29, 2023, we had 2,550 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. We are strongly focused on 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. We believe that these values will help our employees realize their full potentials at work to provide Innovation That Matters®. Our consolidated revenues, net loss, diluted net loss per share, adjusted loss per share (“adjusted EPS”), and adjusted EBITDA for the second quarter ended December 29, 2023 were $197.5 million, ($45.6) million, ($0.79), ($0.42), and ($21.3) million, respectively. Our consolidated revenues, net loss, diluted net loss per share, adjusted EPS, and adjusted EBITDA for the six months ended December 29, 2023 were $378.5 million, ($82.3) million, ($1.44), ($0.66), and ($19.4) million, respectively. See the Non-GAAP Financial Measures section for a reconciliation to our most directly comparable GAAP financial measures. 23 RESULTS OF OPERATIONS: There were 13 weeks included in the results of operations for the second quarters ended December 29, 2023 and December 30, 2022, respectively. There were 26 weeks during the six months ended December 29, 2023 and December 30, 2022, respectively. The results for the second quarter and six months ended December 29, 2023 are not necessarily indicative of the results to be expected for the full fiscal year. The second quarter ended December 29, 2023 compared to the second quarter ended December 30, 2022 The following table sets forth, for the second quarter ended indicated, financial data from the Consolidated Statements of Operations and Comprehensive Loss: (In thousands) December 29, 2023 As a % of Total Net Revenue December 30, 2022 As a % of Total Net Revenue Net revenues $ 197,463 100.0 % $ 229,588 100.0 % Cost of revenues 165,943 84.0 148,628 64.7 Gross margin 31,520 16.0 80,960 35.3 Operating expenses: Selling, general and administrative 44,470 22.5 45,057 19.6 Research and development 28,476 14.4 26,906 11.7 Amortization of intangible assets 12,270 6.3 13,536 5.9 Restructuring and other charges 2 — 2,069 1.0 Acquisition costs and other related expenses 231 0.1 939 0.4 Total operating expenses 85,449 43.3 88,507 38.6 Loss from operations (53,929) (27.3) (7,547) (3.3) Interest income 29 — 220 0.1 Interest expense (8,674) (4.4) (6,590) (2.9) Other (expense) income, net (1,148) (0.5) 846 0.4 Loss before income tax benefit (63,722) (32.3) (13,071) (5.7) Income tax benefit (18,141) (9.2) (2,151) (0.9) Net loss $ (45,581) (23.1) % $ (10,920) (4.8) % R EVENUES Total revenues decreased $32.1 million, or 14.0%, to $197.5 million during the second quarter ended December 29, 2023, as compared to $229.6 million during the second quarter ended December 30, 2022. Revenues decreased year over year as we continue to prioritize resources to execute our challenged programs, transition from our higher mix of development programs and aim to better align our operating cadence with prudent working capital management. As a result, we are experiencing a temporary volume shift in our total revenue, especially our over time revenue which decreased by approximately $25.1 million. We expect this trend to continue through the remainder of fiscal 2024. Over time revenue represented 53% of total revenues during the second quarter ended December 29, 2023, as compared to 56% of total revenues during the second quarter ended December 30, 2022. Specifically, with regard to our challenged programs which are recognized over time, we have recognized a majority of the revenue and related cost as we acquired material and applied labor over the period of performance to progress these programs in prior periods. As we continue to resolve technical challenges and complete these programs, which consumes a significant amount of operational capacity, the remaining revenues on these challenged programs are recognized, however these revenues represent a very small proportion of the total contract value. In addition, we adjusted our estimates at completion for incremental technical and execution costs in the quarter, especially as related to one of our challenged programs as well as certain other development and production programs resulting in a cumulative adjustment to reduce revenues in the second quarter. In addition, as we transition our operating cadence with a goal of more properly balancing our material purchases with contract awards and resource availability to drive better working capital results, we are experiencing a near-term revenue timing dynamic. We experienced decreases across each product grouping during the second quarter ended December 29, 2023 when compared to the prior period; modules and sub-assemblies, components, and integrated subsystems, decreased $26.5 million, $3.7 million, and $1.9 million, respectively. The decrease in total revenue was primarily driven by the radar, other sensor and 24 effector and electronic warfare end applications decreases of $30.5 million, $6.7 million, and $5.3 million, respectively, partially offset by increases to C4I end applications of $11.7 million. The decrease in total revenue was also driven by lower Naval and Other platforms of $18.3 million and $17.9 million, respectively, partially offset by increases to airborne platforms of $4.9 million. The largest program decreases were related to the AEGIS program, a secure processing program, and the THAAD program, partially offset by increases to a large C4I program and the F/A-18 program when compared to the prior period. There were no programs comprising 10% or more of our revenues for the second quarters ended December 29, 2023 or December 30, 2022. G ROSS M ARGIN Gross margin was 16.0% for the second quarter ended December 29, 2023, a decrease of 1930 basis points from the 35.3% gross margin realized during the second quarter ended December 30, 2022. The lower gross margin was driven by cost growth impacts and higher manufacturing adjustments, primarily related to inventory reserves and scrap. The growth in estimated costs to complete during fiscal 2024 has significantly reduced the overall margins recognized on the affected programs through completion. Program cost growth of approximately $30.6 million was recorded in the quarter resulting in an incremental impact of approximately $23.3 million to gross margin, or 1230 basis points, when compared to the prior period. Approximately $13.7 million of total cost growth impact in the quarter was attributable to the approximately 20 challenged programs, of which $12.6 million related to one program. The remaining $16.9 million was incurred across certain other development and production programs based on facts and circumstances in the quarter. The decrease in gross margin was also attributable to higher manufacturing adjustments of approximately $13.3 million related to inventory reserves and scrap. The increase in inventory reserves was related to specifically identified excess and obsolete inventory primarily resulting from a shift in customer demand for our next generation product offering. In addition, we are actively marketing and selling certain of our slow moving inventory with certain parts expected to be at a discount. The increase in scrap was primarily a result of higher levels of discrepant material especially as related to the common processing architecture across several of our remaining challenged programs. We have several initiatives underway to address more efficient and cost-effective producibility of these subsystems. S ELLING , G ENERAL AND A DMINISTRATIVE Selling, general and administrative expenses decreased $0.6 million, or 1.3%, to $44.5 million during the second quarter ended December 29, 2023, as compared to $45.1 million in the second quarter ended December 30, 2022. The decrease was primarily driven by the reduction in force initiated on August 9, 2023, resulting in lower compensation costs including $2.5 million of stock compensation expense, $1.3 million of bonus expense, as well as a reduction in controllable spend. These decreases were partially offset by contract asset write-offs of $4.8 million as a result of negotiating settlement terms with our customers to reduce scope, or otherwise exit contracts, especially as related to certain challenged programs. R ESEARCH AND D EVELOPMENT Research and development expenses increased $1.6 million, or 5.8%, to $28.5 million during the second quarter ended December 29, 2023, as compared to $26.9 million during the second quarter ended December 30, 2022. The increase during the second quarter ended December 29, 2023 was driven by higher compensation costs of $1.3 million and $1.2 million of incremental R&D spend on equipment and supplies and outside services, partially offset by lower bonus expense of $0.8 million as compared to the second quarter ended December 30, 2022. A MORTIZATION OF I NTANGIBLE A SSETS Amortization of intangible assets decreased $1.3 million to $12.3 million during the second quarter ended December 29, 2023, as compared to $13.5 million during the second quarter ended December 30, 2022, primarily due to the backlog intangible from our Avalex acquisition being fully amortized in fiscal 2023. R ESTRUCTURING AND O THER C HARGES There was an immaterial amount of restructuring and other charges during the second quarter ended December 29, 2023. Restructuring and other charges during the second quarter ended December 30, 2022 included $1.0 million of costs related to facility optimization efforts associated with 1MPACT, including $0.8 million related to lease asset impairment, as well as $0.6 million related to severance costs and the remaining $0.4 million related to third party consulting costs associated with 1MPACT. 25 On January 12, 2024, we initiated and approved a workforce reduction that will eliminate approximately 100 positions, resulting in expected restructuring charges of approximately $10 - 12 million. All of the restructuring and other charges will be classified as Operating expenses in the Consolidated Statements of Operations and Comprehensive Loss and any remaining restructuring obligations are expected to be paid within the next twelve months. A CQUISITION C OSTS AND O THER R ELATED E XPENSES There was an immaterial amount of acquisition costs and other related expenses during the second quarter ended December 29, 2023. The acquisition costs and other related expenses during the second quarter ended December 30, 2022 were primarily related to $0.6 million for third-party advisory fees in connection with engagements by activist investors and other acquisition related costs. I NTEREST E XPENSE We incurred $8.7 million of interest expense during the second quarter ended December 29, 2023, as compared to $6.6 million during the second quarter ended December 30, 2022. The increase was driven by a higher interest rate and higher average outstanding borrowings during the period on our existing credit facility (the "Revolver"). O THER (E XPENSE ) I NCOME, N ET Other expense, net was $1.1 million during the second quarter ended December 29, 2023, as compared to other income, net of $0.8 million during the second quarter ended December 30, 2022. The second quarter ended December 29, 2023 includes litigation and settlement expenses of $1.4 million and $0.8 million of financing costs, partially offset by net foreign currency translation gains of $0.7 million and $0.4 million of other income. The second quarter ended December 30, 2022 includes net foreign currency translation gains of $1.4 million offset by $0.5 million of financing costs. I NCOME T AXES We recorded an income tax benefit of $18.1 million and $2.2 million on a loss before income taxes of $63.7 million and $13.1 million for the second quarters ended December 29, 2023 and December 30, 2022, respectively. During the second quarters ended December 29, 2023 and December 30, 2022, we recognized a tax provision of $0.4 million and $0.1 million related to stock compensation shortfalls, respectively. During the second quarter ended December 30, 2022, we recognized a tax benefit of $2.3 million related to a release of income tax reserves for unrecognized income tax benefits due to the expiration of the statute of limitations. The effective tax rate for the second quarters ended December 29, 2023 and December 30, 2022 differed from the federal statutory rate primarily due to federal and state research and development credits, non-deductible compensation, stock compensation shortfalls and state taxes. The effective tax rate for the second quarter ended December 30, 2022 also differed from the federal statutory rate due to the release of previously unrecognized income tax benefits. The Tax Cuts and Jobs Act of 2017 requires companies to capitalize and amortize domestic research and development expenditures over five years for tax purposes, and foreign research and development expenditures over fifteen years for tax purposes, effective for us beginning in the fiscal year ended June 30, 2023. As a result, we have recorded a deferred tax asset through the second quarter ended December 29, 2023 of $88.9 million. During the second quarter ended December 29, 2023, we have made $0.3 million of tax payments related to this requirement. We will continue to monitor guidance and any proposed regulations and adjust the estimates as necessary. 26 Six months ended December 29, 2023 compared to the six months ended December 30, 2022 The following table sets forth, for the six month periods indicated, financial data from the Consolidated Statements of Operations and Comprehensive Loss: (In thousands) December 29, 2023 As a % of Total Net Revenue December 30, 2022 As a % of Total Net Revenue Net revenues $ 378,454 100.0 % $ 457,167 100.0 % Cost of revenues 296,407 78.3 298,112 65.2 Gross margin 82,047 21.7 159,055 34.8 Operating expenses: Selling, general and administrative 80,264 21.2 84,000 18.4 Research and development 60,348 15.9 54,672 12.0 Amortization of intangible assets 24,817 6.6 28,110 6.1 Restructuring and other charges 9,548 2.5 3,577 0.8 Acquisition costs and other related expenses 1,200 0.4 3,437 0.8 Total operating expenses 176,177 46.6 173,796 38.1 Loss from operations (94,130) (24.9) (14,741) (3.3) Interest income 132 — 249 0.1 Interest expense (16,537) (4.4) (11,137) (2.4) Other expense, net (2,922) (0.7) (2,799) (0.6) Loss before income tax benefit (113,457) (30.0) (28,428) (6.2) Income tax benefit (31,168) (8.2) (3,173) (0.7) Net loss $ (82,289) (21.8) % $ (25,255) (5.5) % R EVENUES Total revenues decreased $78.7 million, or 17.2%, to $378.5 million during the six months ended December 29, 2023, as compared to $457.2 million during the six months ended December 30, 2022. Revenues decreased year over year as we continue to prioritize resources to execute our challenged programs, transition from our higher mix of development programs and aim to better align our operating cadence with prudent working capital management. As a result, we are observing a temporary volume shift in our total revenue, especially our over time revenue which decreased by approximately $63.8 million. We expect this trend to continue through the remainder of fiscal 2024. Over time revenue represented 55% of total revenues during the six months ended December 29, 2023, as compared to 60% of total revenues during the six months ended December 30, 2022. Specifically, with regard to our challenged programs which are recognized over time, we have recognized a majority of the revenue and related cost as we acquired material and applied labor over the period of performance to progress these programs in prior periods. As we continue to resolve technical challenges and complete these programs, which consumes a significant amount of operational capacity, the remaining revenues on these challenged programs are recognized, however these revenues represent a very small proportion of the total contract value. In addition, we adjusted our estimates at completion for incremental technical and execution costs in the quarter, especially as related to one of our challenged programs as well as certain other development and production programs resulting in a cumulative adjustment to reduce revenues in the six months ended. In addition, as we transition our operating cadence with a goal of more properly balancing our material purchases with contract awards and resource availability to drive better working capital results, we are experiencing a near-term revenue timing dynamic. We experienced product grouping decreases driven by modules and sub-assemblies and integrated subsystems, which decreased $44.7 million and $35.9 million, respectively, partially offset by an increase in the components product grouping of $1.9 million. The decrease in total revenue was primarily driven by the radar, electronic warfare and other end applications decreases of $55.3 million, $12.3 million, and $12.2 million, respectively, partially offset by increases to C4I end applications of $7.8 million. We experienced decreases across each platform during the six months ended December 29, 2023 when compared to the prior period; Other, Naval, Land and Airborne platforms decreased $36.6 million, $25.4 million, $11.0 million and $5.7 million, respectively. The largest program decreases were related to the LTAMDS, AEGIS and P8 programs, partially offset by increases to a large C4I program and the F/A-18 program when compared to the prior period. There were no programs comprising 10% or more of our revenues for the six months quarters ended December 29, 2023 or December 30, 2022. 27 G ROSS M ARGIN Gross margin was 21.7% for the six months ended December 29, 2023, a decrease of 1310 basis points from the 34.8% gross margin realized during the six months ended December 30, 2022. The lower gross margin was driven by cost growth impacts and higher manufacturing adjustments, primarily related to inventory reserves, scrap and certain other non-recurring cost adjustments. The growth in estimated costs to complete during fiscal 2024 has significantly reduced the overall margins recognized on the affected programs through completion. Program cost growth of approximately $48.0 million was recorded in the six months resulting in an incremental impact of approximately $27.9 million to gross margin, or 840 basis points, when compared to the prior period. Approximately, $19.3 million of total cost growth impact in the six months was attributable to the approximately 20 challenged programs, of which a total of $17.7 million related to two programs. The remaining $28.7 million was incurred across certain other development and production programs based on facts and circumstances in the quarter. The decrease in gross margin was also attributable to higher manufacturing adjustments of approximately $18.1 million related to inventory reserves and scrap. The increase in inventory reserves was related to specifically identified excess and obsolete inventory primarily resulting from a shift in customer demand for our next generation product offering. In addition, we are actively marketing and selling certain of our slow moving inventory with certain parts expected to be at a discount. The increase in scrap was primarily a result of higher levels of discrepant material especially as related to the common processing architecture across several of our remaining challenged programs. We have several initiatives underway to address more efficient and cost-effective producibility of these subsystems. S ELLING , G ENERAL AND A DMINISTRATIVE Selling, general and administrative expenses decreased $3.7 million, or 4.4%, to $80.3 million during the six months ended December 29, 2023, as compared to $84.0 million during the six months ended December 30, 2022. The decrease was primarily driven by the reduction in force initiated on August 9, 2023, resulting in lower compensation costs including $5.7 million of lower stock compensation and $4.1 million of lower bonus expense. These decreases were partially offset by contract asset write-offs of $4.8 million as a result of negotiating settlement terms with our customers to reduce scope, or otherwise exit contracts, especially as related to certain challenged programs. R ESEARCH A ND D EVELOPMENT Research and development expenses increased $5.7 million, or 10.4%, to $60.3 million during the six months ended December 29, 2023, as compared to $54.7 million during the six months ended December 30, 2022. The increase was primarily due to an increase in compensation costs of $4.8 million, incremental R&D spend on equipment, supplies and outside services totaling $2.9 million, partially offset by lower bonus expense of $2.3 million as compared to the six months ended December 30, 2022. R ESTRUCTURING A ND O THER C HARGES Restructuring and other charges were $9.5 million during the six months ended December 29, 2023, as compared to $3.6 million during the six months ended December 30, 2022. During the six months ended December 29, 2023 we initiated several immediate cost savings measures that simplify our organizational structure, facilitate clearer accountability, and align our priorities, including: (i) embedding the 1MPACT value creation initiatives and execution into our operations; (ii) streamlining organizational structure and removing areas of redundancy between corporate and divisional organizations; and (iii) reducing selling, general, and administrative headcount and rebalancing discretionary and third party spending to better align with our priority areas. On July 20, 2023, we executed the plan to embed the 1MPACT value creation initiatives into operations, and on August 9, 2023, we approved and initiated a workforce reduction that, together with the 1MPACT related action, eliminated approximately 150 positions resulting in $9.5 million of severance costs. Restructuring and other charges during the six months ended December 30, 2022 primarily related to 1MPACT including $1.7 million of third party consulting costs, $1.0 million of costs for facility optimization efforts including $0.8 million related to lease asset impairment, as well as $0.8 million of severance costs associated with the elimination of approximately 10 positions. On January 12, 2024, we initiated and approved a workforce reduction that will eliminate approximately 100 positions, resulting in expected restructuring charges of approximately $10 - 12 million. All of the restructuring and other charges will be classified as Operating expenses in the Consolidated Statements of Operations and Comprehensive Loss and any remaining restructuring obligations are expected to be paid within the next twelve months. A CQUISITION C OSTS AND O THER R ELATED E XPENSES Acquisition costs and other related expenses were $1.2 million during the six months ended December 29, 2023, as compared to $3.4 million during the six months ended December 30, 2022. The acquisition costs and other related expenses we incurred during the six months ended December 29, 2023 includes $0.3 million related to the conclusion of the Board of Directors' review of strategic alternatives, as well as $0.3 million for third-party advisory fees in connection with engagements 28 by activist investors. Acquisition costs during the six months ended December 30, 2022 were primarily related to $2.5 million for third party advisory fees in connection with engagements by activist investors and other acquisition related costs. I NTEREST E XPENSE We incurred $16.5 million of interest expense during the six months ended December 29, 2023, as compared to $11.1 million during the six months ended December 30, 2022. The increase was driven by an increase in interest rate and higher average borrowings outstanding on our Revolver as compared to the six months ended December 30, 2022. O THER E XPENSE , N ET Other expense, net increased $0.1 million to $2.9 million during the six months ended December 29, 2023 as compared to $2.8 million during the six months ended December 30, 2022. There was $1.9 million of litigation and settlement costs, $1.4 million of financing costs and $0.3 million of net foreign currency translation losses, partially offset by other income of $0.7 million. during the six months ended December 29, 2023. There was $1.4 million of litigation and settlement costs, $1.1 million of financing costs and $0.4 million of net foreign currency translation losses during the six months ended December 30, 2022. I NCOME T AXES We recorded an income tax benefit of $31.2 million and $3.2 million on a loss before income taxes of $113.5 million and $28.4 million for the six months ended December 29, 2023 and December 30, 2022, respectively. During the six months quarters ended December 29, 2023 and December 30, 2022, we recognized a tax provision of $1.6 and $1.7 million related to stock compensation shortfalls, respectively. During the six months ended December 30, 2022, we recognized a tax benefit of $2.3 million related to a release of income tax reserves for unrecognized income tax benefits due to the expiration of the statute of limitations. The effective tax rate for the second quarters ended December 29, 2023 and December 30, 2022 differed from the federal statutory rate primarily due to federal and state research and development credits, non-deductible compensation, stock compensation shortfalls and state taxes. The effective tax rate for the second quarter ended December 30, 2022 also differed from the federal statutory rate due to the release of previously unrecognized income tax benefits. The Tax Cuts and Jobs Act of 2017 requires companies to capitalize and amortize domestic research and development expenditures over five years for tax purposes, and foreign research and development expenditures over fifteen years for tax purposes, effective for us beginning in the fiscal year ended June 30, 2023. As a result, we have recorded a deferred tax asset through the second quarter ended December 29, 2023 of $88.9 million. During the six months ended December 29, 2023, we have made $15.3 million of tax payments related to this requirement. We will continue to monitor guidance and any proposed regulations and adjust the estimates as necessary. L IQUIDITY AND C APITAL R ESOURCES Our primary sources of liquidity come from existing cash and cash generated from operations, our Revolver, our ability to raise capital under our universal shelf registration statement and our ability to factor our receivables. Our near-term fixed commitments for cash expenditures consist primarily of payments under operating leases and inventory purchase commitments. We have experienced growth in our working capital balances and, in particular, related to unbilled receivables and inventory over the last several years. As we complete our challenged programs and then receive follow-on production awards, we believe that both unbilled receivables and inventory is expected to convert to cash reducing our working capital balances. 29 Based on our current plans and business conditions, we believe that existing cash and cash equivalents, our available Revolver, cash generated from operations and our financing capabilities will be sufficient to satisfy our anticipated cash requirements for at least the next twelve months. Shelf Registration Statement On October 4, 2023, we filed a shelf registration statement on Form S-3ASR with the SEC. The shelf registration statement, which was effective upon filing with the SEC, registered each of the following securities: debt securities, preferred stock, common stock, warrants and units. We intend to use the proceeds from financings using the shelf registration statement for general corporate purposes, which may include the following: • the acquisition of other companies or businesses; • the repayment and refinancing of debt; • capital expenditures; • working capital; and • other purposes as described in the prospectus supplement. We have an unlimited amount available under the shelf registration statement. Revolving Credit Facilities On February 28, 2022, we amended the Revolver to increase and extend the borrowing capacity to a $1.1 billion, 5-year revolving credit line, with the maturity extended to February 28, 2027. The borrowing capacity as defined under the Revolver as of December 29, 2023 is approximately $750.0 million, less outstanding borrowings of $616.5 million. On November 7, 2023, due to the uncertainty surrounding a government shutdown or prolonged continuing resolution and the potential impact on the second quarter and fiscal 2024 results, we proactively executed Amendment No. 5 to the Revolver, as amended to date, with a syndicate of commercial banks and Bank of America, N.A acting as the administrative agent allowing for a temporary increase in the Consolidated Total Net Leverage Ratio covenant requirement from 4.50 to 5.25 for the second quarter ended December 29, 2023. As of December 29, 2023, the Company was in compliance with all covenants and conditions under the Revolver and expects to be within our covenant and conditions for the remainder of the year. Refer to exhibit 10.1 filed on Form 8-K filed by the Company with the SEC on November 7, 2023. Receivables Purchase Agreement On September 27, 2022, we entered into an uncommitted receivables purchase agreement (“RPA”) with Bank of the West, as purchaser, pursuant to which we may offer to sell certain customer receivables, subject to the terms and conditions of the RPA. The RPA is an uncommitted arrangement such that we are not obligated to sell any receivables and Bank of the West has no obligation to purchase any receivables from us. Pursuant to the RPA, Bank of the West may purchase certain of our customer receivables at a discounted rate, subject to a limit that as of any date, the total amount of purchased receivables held by Bank of the West, less the amount of all collections received on such receivables, may not exceed $20.0 million. The RPA has an indefinite term and the agreement remains in effect until it is terminated by either party. On March 14, 2023, we amended the RPA to increase the capacity from $20.0 million to $30.6 million. On June 21, 2023, we further amended the RPA with BMO Harris Bank (as successor in interest to Bank of the West) to increase the capacity from $30.6 million to $60.0 million. We factored accounts receivable and incurred factoring fees of approximately $48.2 million and $1.3 million, respectively, for the six months ended December 29, 2023. We factored accounts receivable and incurred factoring fees of approximately $20.0 million and $0.1 million respectively, for the six months ended December 30, 2022. 30 C ASH F LOWS As of and For the Six Months Ended, (In thousands) December 29, 2023 December 30, 2022 Net cash provided by (used in) operating activities $ 6,426 $ (30,647) Net cash used in investing activities $ (16,005) $ (20,402) Net cash provided by financing activities $ 106,217 $ 62,330 Net increase in cash and cash equivalents $ 97,083 $ 11,290 Cash and cash equivalents at end of period $ 168,646 $ 76,944 Our cash and cash equivalents increased by $97.1 million from June 30, 2023 to December 29, 2023, primarily as the result of $6.4 million of cash generated from operating activities and $105.0 million of borrowings on our Revolver, partially offset by $16.0 million invested in purchases of property and equipment. Operating Activities During the six months ended December 29, 2023, we had an inflow of $6.4 million in cash from operating activities compared to a $30.6 million outflow during the six months ended December 30, 2022. The inflow during the six months ended December 29, 2023 was primarily due to a $69.7 million inflow from accounts receivable, unbilled receivables and costs in excess of billings as compared to a $30.9 million outflow during the six months ended December 30, 2022. The six months ended December 29, 2023 also included lower outflows due to inventory, prepaid expenses and other current assets, and accounts payable, accrued expenses, and accrued compensation as compared to the six months ended December 30, 2022. This activity was partially offset by outflows of $13.9 million, $5.8 million, and $2.7 million of income taxes payable, prepaid income taxes, and other non-current assets, respectively. Cash paid for income taxes and interest during the six months ended December 29, 2023 also increased by $12.4 million and $4.9 million, respectively, as compared to the six months ended December 30, 2022, further offsetting the increase. Investing Activities During the six months ended December 29, 2023, we invested $16.0 million, a decrease of $4.4 million, as compared to $20.4 million during the six months ended December 30, 2022 primarily due to lower purchases of property and equipment. Financing Activities During the six months ended December 29, 2023, we had $105.0 million of borrowings on our Revolver as compared to $100.0 million of borrowings during the six months ended December 30, 2022. During the six months ended December 30, 2022, the borrowings were partially offset by payments under credit facilities of $40.0 million while there were no such payments made during the six months ended December 29, 2023. C OMMITMENTS, C ONTRACTUAL O BLIGATIONS AND C ONTINGENCIES The following is a schedule of our commitments and contractual obligations outstanding at December 29, 2023: (In thousands) Total Less Than 1 Year 1-3 Years 3-5 Years More Than 5 Years Purchase obligations $ 122,449 $ 122,449 $ — $ — $ — Operating leases 96,252 14,607 28,044 25,476 28,125 $ 218,701 $ 137,056 $ 28,044 $ 25,476 $ 28,125 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 approxi mately $122.4 million at December 29, 2023. We have a liability at December 29, 2023 of $5.2 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. 31 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. 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, financing and other third party costs, fair value adjustments from purchase accounting, litigation and settlement income and expense, COVID related expenses, and stock-based and other non-cash compensation expense. We use adjusted EBITDA as an important indicator of the operating performance of our business. We use adjusted EBITDA in internal forecasts and models when establishing internal operating budgets, supplementing the financial results and forecasts reported to our board of directors, determining 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. 32 The following table reconciles our net loss, the most directly comparable GAAP financial measure, to our adjusted EBITDA: Second Quarters Ended Six Months Ended (In thousands) December 29, 2023 December 30, 2022 December 29, 2023 December 30, 2022 Net loss $ (45,581) $ (10,920) $ (82,289) $ (25,255) Other non-operating adjustments, net (1,042) (1,463) (311) 334 Interest expense, net 8,645 6,370 16,405 10,888 Income tax benefit (18,141) (2,151) (31,168) (3,173) Depreciation 9,923 13,697 20,068 22,824 Amortization of intangible assets 12,270 13,536 24,817 28,110 Restructuring and other charges 2 2,069 9,548 3,577 Impairment of long-lived assets — — — — Acquisition, financing and other third party costs 860 1,309 2,192 4,173 Fair value adjustments from purchase accounting 178 177 355 1 Litigation and settlement expense, net 1,383 70 1,886 1,375 COVID related expenses — — — 61 Stock-based and other non-cash compensation expense 10,195 13,003 19,146 23,943 Adjusted EBITDA $ (21,308) $ 35,697 $ (19,351) $ 66,858 Adjusted income and adjusted EPS exclude the impact of certain items and, therefore, have not been calculated in accordance with GAAP. We believe that exclusion of these items assists in providing a more complete understanding of our underlying results and trends and allows for comparability with our peer company index and industry. These non-GAAP financial measures may not be computed in the same manner as similarly titled measures used by other companies. We use these measures along with the corresponding GAAP financial measures to manage our business and to evaluate our performance compared to prior periods and the marketplace. We define adjusted income as net income before other non-operating adjustments, amortization of intangible assets, restructuring and other charges, impairment of long-lived assets, acquisition, financing and other third party costs, fair value adjustments from purchase accounting, litigation and settlement income and expense, COVID related expenses, and stock-based and other non-cash compensation expense. The impact to income taxes includes the impact to the effective tax rate, current tax provision and deferred tax provision. Adjusted EPS expresses adjusted income on a per share basis using weighted average diluted shares outstanding. Adjusted income and adjusted EPS are non-GAAP financial measures and should not be considered in isolation or as a substitute for financial information provided in accordance with GAAP. We expect to continue to incur expenses similar to the adjusted income and adjusted EPS financial adjustments described above, and investors should not infer from our presentation of these non-GAAP financial measures that these costs are unusual, infrequent or non-recurring. The following tables reconcile net loss and diluted loss per share, the most directly comparable GAAP measures, to adjusted (loss) income and adjusted EPS: 33 Second Quarters Ended (In thousands, except per share data) December 29, 2023 December 30, 2022 Net loss and loss per share $ (45,581) $ (0.79) $ (10,920) $ (0.19) Other non-operating adjustments, net (1,042) (1,463) Amortization of intangible assets 12,270 13,536 Restructuring and other charges 2 2,069 Impairment of long-lived assets — — Acquisition, financing and other third party costs 860 1,309 Fair value adjustments from purchase accounting 178 177 Litigation and settlement expense, net 1,383 70 COVID related expenses — — Stock-based and other non-cash compensation expense 10,195 13,003 Impact to income taxes (1) (2,446) (3,039) Adjusted (loss) income and adjusted (loss) earnings per share (2) $ (24,181) $ (0.42) $ 14,742 $ 0.26 Diluted weighted-average shares outstanding 57,424 56,477 (1) Impact to income taxes is calculated by recasting income before income taxes to include the items involved in determining adjusted income and recalculating the income tax provision using this adjusted income from operations before income taxes. The recalculation also adjusts for any discrete tax expense or benefit related to the items. (2) Loss per share and adjusted loss per share is calculated using basic shares whereas earnings per share and adjusted earnings per share is calculated using diluted shares. There was no impact to the calculation of adjusted earnings per share as a result of this for the second quarter ended December 30, 2022. Six Months Ended (In thousands, except per share data) December 29, 2023 December 30, 2022 Net loss and loss per share $ (82,289) $ (1.44) $ (25,255) $ (0.45) Other non-operating adjustments, net (311) 334 Amortization of intangible assets 24,817 28,110 Restructuring and other charges 9,548 3,577 Impairment of long-lived assets — — Acquisition and financing costs 2,192 4,173 Fair value adjustments from purchase accounting 355 1 Litigation and settlement expense, net 1,886 1,375 COVID related expenses — 61 Stock-based and other non-cash compensation expense 19,146 23,943 Impact to income taxes (1) (13,204) (8,230) Adjusted (loss) income and adjusted (loss) earnings per share (2) $ (37,860) $ (0.66) $ 28,089 $ 0.50 Diluted weighted-average shares outstanding 57,314 56,445 (1) Impact to income taxes is calculated by recasting income before income taxes to include the items involved in determining adjusted income and recalculating the income tax provision using this adjusted income from operations before income taxes. The recalculation also adjusts for any discrete tax expense or benefit related to the items. (2) Adjusted earnings per share is calculated using diluted shares whereas Net loss is calculated using basic shares. There was no impact to the calculation of adjusted earnings per share as a result of this for the six months ended December 30, 2022. 34 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 used in operating activities, the most directly comparable GAAP financial measure, to free cash flow: Second Quarters Ended Six Months Ended (In thousands) December 29, 2023 December 30, 2022 December 29, 2023 December 30, 2022 Net cash provided by (used in) operating activities $ 45,494 $ 35,392 $ 6,426 $ (30,647) Purchase of property and equipment (7,990) (13,176) (16,005) (20,504) Free cash flow $ 37,504 $ 22,216 $ (9,579) $ (51,151) Organic revenue and acquired revenue are non-GAAP measures for reporting the 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 December 29, 2023 and December 30, 2022, respectively: (In thousands) December 29, 2023 As a % of Total Net Revenue December 30, 2022 As a % of Total Net Revenue $ Change % Change Organic revenue $ 197,463 100 % $ 229,588 100 % $ (32,125) (14) % Acquired revenue — — % — — % — — % Total revenues $ 197,463 100 % $ 229,588 100 % $ (32,125) (14) % (In thousands) December 29, 2023 As a % of Total Net Revenue December 30, 2022 As a % of Total Net Revenue $ Change % Change Organic revenue $ 378,454 100 % $ 457,167 100 % $ (78,713) (17) % Acquired revenue — — % — — % — — % Total revenues $ 378,454 100 % $ 457,167 100 % $ (78,713) (17) % 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"). 35 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK There were no material changes in our exposure to market risk from June 30, 2023 to December 29, 2023.