Mercury Systems(MRCY) - 2022 Q4 - Annual Report

Part I Business Mercury Systems provides processing platforms for aerospace and defense, emphasizing organic growth, M&A, and operational improvements - Mercury Systems is a technology company providing processing platforms for the aerospace and defense industry, serving over 25 defense prime contractors across more than 300 programs[14][15] Fiscal 2022 vs. 2021 Key Financial Metrics (in millions) | Metric | Fiscal 2022 | Fiscal 2021 | | :--- | :--- | :--- | | Consolidated Revenues | $988.2 million | $924.0 million | | Acquired Revenues | $117.8 million | $3.4 million | | Net Income | $11.3 million | $62.0 million | | Diluted EPS | $0.20 | $1.12 | | Adjusted EPS | $2.19 | $2.42 | | Adjusted EBITDA | $200.5 million | $201.9 million | - The company's growth strategy is built on five pillars: organic growth, M&A, R&D investment, operational improvement (including the 1MPACT initiative), and talent management[23][24][25] - The company's products are categorized into Components, Modules and Subassemblies, and Integrated Subsystems, designed to be Mission-Ready, Trusted and Secure, Software-Defined, and Open and Modular[36][44][45] - Total backlog as of July 1, 2022, was approximately $1,037.7 million, an increase from $909.6 million as of July 2, 2021. $646.7 million of the current backlog is expected to be delivered within the next twelve months[84] - As of July 1, 2022, the company employed 2,386 people, with 853 in R&D, 1,026 in manufacturing, 149 in sales/marketing, and 358 in G&A[85] - In fiscal 2022, Lockheed Martin Corporation and Raytheon Technologies collectively accounted for 24% of total revenues. The U.S. Navy accounted for 14%[90] Risk Factors The company faces risks from defense program dependence, supply chain disruptions, customer concentration, and acquisition integration - The company is heavily dependent on defense electronics programs, with sales to U.S. and foreign governments accounting for approximately 97% of total net revenues in fiscal 2022[95] - Significant customer concentration exists, with Raytheon (14%), the U.S. Navy (14%), and Lockheed Martin (10%) accounting for a large portion of fiscal 2022 revenues[100] - The company faces supply chain risks, particularly for sole-source components like FPGAs from Xilinx and processors from Intel, leading to disruptions and lower revenue[106] - Acquisitions, a key part of the growth strategy, pose risks including integration challenges, failure to achieve synergies, and potential impairment of acquired assets, with the 1MPACT plan also carrying execution risk[131][132] - The business is subject to heightened risks of cyber intrusions, which could lead to piracy of product designs, business system shutdowns, and significant financial and reputational damage[153] - Shareholder activism, such as Schedule 13D filings by JANA Partners and Starboard Value, could cause significant expense, disrupt business, and impact the stock price[165][166] Unresolved Staff Comments The company reports no unresolved staff comments - None[167] Properties The company leases all significant properties, primarily in the U.S., including key facilities in Andover, MA, and Phoenix, AZ Significant Leased Properties (as of July 1, 2022) | Location | Size (Sq. Feet) | Lease Expiration | | :--- | :--- | :--- | | Andover, MA | 145,262 | 2032 | | Phoenix, AZ | 125,756 | 2031 | | Hudson, NH | 121,553 | 2030 | | Torrance, CA | 85,125 | 2029 | | Oxnard, CA | 72,673 | 2025 | Legal Proceedings The company faces ordinary course litigation, including a $9 million arbitration and an environmental claim - A former sales representative, Embedded Reps of America, LLC (ERA), has filed for binding arbitration seeking approximately $9 million in damages related to a terminated agreement[171] - The company received an environmental demand letter from National Technical Systems, Inc. (NTS) related to alleged groundwater contamination at a former facility in Acton, MA, with potential responsibility yet to be determined[172] Mine Safety Disclosures This section is not applicable to the company - Not Applicable[173] Information About Our Executive Officers This section provides biographical information for executive officers, including Mark Aslett (CEO) and Michael Ruppert (CFO) - Mark Aslett, 54, has served as President and CEO since 2007[175] - Michael D. Ruppert, 48, was appointed EVP, Chief Financial Officer, and Treasurer in 2018[179] - Thomas Huber, 45, joined as EVP, Chief Transformation Officer in September 2021 to lead the 1MPACT initiative[177] Part II Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Mercury's common stock trades on Nasdaq (MRCY); the company has never paid dividends and retains earnings for growth Fiscal 2022 Quarterly Stock Price Range | Quarter | High | Low | | :--- | :--- | :--- | | Q4 2022 | $66.04 | $54.24 | | Q3 2022 | $69.81 | $51.11 | | Q2 2022 | $55.92 | $46.71 | | Q1 2022 | $66.78 | $45.31 | - The company has never declared or paid cash dividends and intends to retain future earnings for growth[187] - There were no active share repurchase programs during fiscal 2022[189] Selected Financial Data This item is no longer required due to the company's early adoption of changes to Regulation S-K - The company has elected to early adopt changes to Regulation S-K, and therefore this section is no longer required[191] Management's Discussion and Analysis of Financial Condition and Results of Operations Fiscal 2022 revenues grew to $988.2 million, but net income declined to $11.3 million, impacted by higher expenses and negative operating cash flow Overview and Business Developments In FY22, Mercury Systems advanced its 1MPACT initiative, amended its credit facility to $1.1 billion, and completed two key acquisitions - The company's 1MPACT initiative, announced in August 2021, aims to drive growth, margin expansion, and scalability following 15 acquisitions since fiscal 2014[203] - On February 28, 2022, the company amended and increased its revolving credit facility to $1.1 billion with a maturity date of February 28, 2027[204] - Acquired Atlanta Micro, a designer of high-performance RF modules and MMICs, for $90.0 million on November 29, 2021[205] - Acquired Avalex Technologies, a provider of mission-critical avionics, for $155.0 million on November 5, 2021[207] Results of Operations FY22 revenues increased to $988.2 million, but gross margin declined and operating expenses rose, significantly reducing operating income Consolidated Statement of Operations (Fiscal 2022 vs. 2021) (In thousands) | (In thousands) | Fiscal 2022 | Fiscal 2021 | | :--- | :--- | :--- | | Net revenues | $988,197 | $923,996 | | Gross margin | $394,956 | $385,188 | | Gross margin % | 40.0% | 41.7% | | Total operating expenses | $363,346 | $304,187 | | Income from operations | $31,610 | $81,001 | | Income before income taxes | $18,395 | $77,173 | | Net income | $11,275 | $62,044 | - Total revenue increased by $64.2 million (7.0%), primarily due to $114.4 million in incremental acquired revenues, which was partially offset by a $50.2 million decrease in organic revenues[213] - Gross margin decreased by 170 basis points to 40.0%, driven by unfavorable program mix, supply chain constraints, inflation, and a $28.5 million increase in lower-margin Customer Funded R&D (CRAD)[214] - Selling, general and administrative (SG&A) expenses increased by $22.7 million (16.9%), primarily due to acquisitions and an $8.3 million increase in stock compensation expense[216] - Restructuring and other charges increased to $27.4 million from $9.2 million, mainly related to the 1MPACT initiative, including $17.4 million in consulting costs and $9.2 million in severance[219] Liquidity and Capital Resources Liquidity relies on cash and a $1.1 billion credit facility, but FY22 operating cash flow was negative due to increased receivables and inventory Cash Flow Summary (Fiscal Years Ended) (In thousands) | (In thousands) | July 1, 2022 | July 2, 2021 | | :--- | :--- | :--- | | Net cash (used in) provided by operating activities | $(18,869) | $97,247 | | Net cash used in investing activities | $(274,320) | $(416,887) | | Net cash provided by financing activities | $245,754 | $206,229 | | Net decrease in cash and cash equivalents | $(48,185) | $(112,999) | - The company amended its revolving credit facility on Feb 28, 2022, increasing it to $1.1 billion. As of July 1, 2022, $451.5 million was outstanding[229] - Cash used in operating activities was $18.9 million in FY22, a $116.1 million decrease from FY21, primarily due to an increase in unbilled receivables and inventory driven by award delays and supply chain constraints[232] Contractual Obligations (as of July 1, 2022) (In thousands) | (In thousands) | Total | Less Than 1 Year | 1-3 Years | 3-5 Years | More Than 5 Years | | :--- | :--- | :--- | :--- | :--- | :--- | | Operating leases | $97,504 | $14,757 | $26,838 | $21,594 | $34,315 | | Purchase obligations | $153,729 | $153,729 | — | — | — | | Total | $251,233 | $168,486 | $26,838 | $21,594 | $34,315 | Non-GAAP Financial Measures The company uses non-GAAP measures; FY22 Adjusted EBITDA was $200.5 million, and free cash flow was negative $46.5 million Reconciliation of Net Income to Adjusted EBITDA (In thousands) | (In thousands) | July 1, 2022 | July 2, 2021 | | :--- | :--- | :--- | | Net income | $11,275 | $62,044 | | Plus: Adjustments | | | | Interest, Taxes, D&A | $106,200 | $83,273 | | Restructuring & other charges | $27,445 | $9,222 | | Acquisition, financing costs | $13,608 | $8,600 | | Stock-based compensation | $38,459 | $29,224 | | Other adjustments | $2,520 | $9,549 | | Adjusted EBITDA | $200,507 | $201,896 | Reconciliation of Net Income to Adjusted Income & EPS (In thousands, except per share data) | (In thousands, except per share data) | Fiscal 2022 | Fiscal 2021 | | :--- | :--- | :--- | | Net income | $11,275 | $62,044 | | Diluted EPS | $0.20 | $1.12 | | Total pre-tax adjustments | $142,298 | $98,562 | | Impact to income taxes | ($32,309) | ($25,697) | | Adjusted income | $122,265 | $134,115 | | Adjusted EPS | $2.19 | $2.42 | Reconciliation to Free Cash Flow (In thousands) | (In thousands) | July 1, 2022 | July 2, 2021 | | :--- | :--- | :--- | | Net cash (used in) provided by operating activities | $(18,869) | $97,247 | | Purchase of property and equipment | $(27,656) | $(45,599) | | Free cash flow | $(46,525) | $51,648 | Critical Accounting Policies and Significant Judgments and Estimates Critical accounting policies involve significant judgment in revenue recognition, inventory valuation, income taxes, and business combinations - Revenue recognition is a critical policy. In FY22, 55% of revenue was recognized over time, primarily using a cost-to-cost input method, which requires significant judgment in estimating total contract costs and progress[264][267][269] - For contracts with multiple performance obligations, the company allocates the transaction price using the expected cost plus a margin approach to estimate standalone selling prices, as they are not directly observable[266] - Business combinations are accounted for using the acquisition method, which requires significant estimates to determine the fair value of acquired assets (tangible and intangible) and liabilities assumed[279] - Income tax accounting requires estimates for deferred tax assets/liabilities and judgments regarding the realizability of deferred tax assets and the measurement of uncertain tax positions[275][277][278] Quantitative and Qualitative Disclosures about Market Risk The company faces market risks from interest rates, customer credit concentration (45% from five customers), and foreign currency fluctuations - The company is exposed to interest rate risk through its variable-rate borrowings on its revolving credit facility. As of July 1, 2022, $451.5 million was outstanding[282][285] - Concentration of credit risk is significant. As of July 1, 2022, five customers accounted for 45% of the company's receivables, unbilled receivables, and costs in excess of billings[287] - Foreign currency risk exists due to operations in Switzerland, the UK, France, Japan, Spain, and Canada, where fluctuations in local currency exchange rates can impact consolidated financial statements[288] Financial Statements and Supplementary Data This section presents audited financial statements and KPMG's unqualified opinion, with recent acquisitions excluded from internal control assessment Report of Independent Registered Public Accounting Firm KPMG issued an unqualified opinion on financial statements and internal controls, highlighting contract cost estimation as a critical audit matter - KPMG LLP provided an unqualified audit opinion on the consolidated financial statements and internal control over financial reporting[293] - The audit of internal controls excluded the recently acquired Avalex and Atlanta Micro businesses, as permitted[294] - A Critical Audit Matter was identified related to the estimation of total costs to be incurred for fixed-price contracts where revenue is recognized over time, due to the complexity and subjectivity of the estimates[301][303] Consolidated Financial Statements FY22 total assets reached $2.30 billion, liabilities increased, and net income significantly declined to $11.3 million on $988.2 million revenue Consolidated Balance Sheet Data (in thousands) | | July 1, 2022 | July 2, 2021 | | :--- | :--- | :--- | | Total current assets | $815,252 | $643,100 | | Goodwill | $937,880 | $804,906 | | Total assets | $2,304,415 | $1,955,137 | | Total current liabilities | $193,927 | $150,823 | | Long-term debt | $451,500 | $200,000 | | Total liabilities | $767,230 | $470,991 | | Total shareholders' equity | $1,537,185 | $1,484,146 | Consolidated Statement of Operations Data (in thousands) | | FY 2022 | FY 2021 | FY 2020 | | :--- | :--- | :--- | :--- | | Net revenues | $988,197 | $923,996 | $796,610 | | Gross margin | $394,956 | $385,188 | $356,844 | | Income from operations | $31,610 | $81,001 | $91,062 | | Net income | $11,275 | $62,044 | $85,712 | | Diluted EPS | $0.20 | $1.12 | $1.56 | Consolidated Statement of Cash Flows Data (in thousands) | | FY 2022 | FY 2021 | FY 2020 | | :--- | :--- | :--- | :--- | | Net cash (used in) provided by operating activities | $(18,869) | $97,247 | $115,184 | | Net cash used in investing activities | $(274,320) | $(416,887) | $(135,486) | | Net cash provided by (used in) financing activities | $245,754 | $206,229 | $(10,932) | | Net decrease in cash | $(48,185) | $(112,999) | $(31,094) | Notes to Consolidated Financial Statements Notes detail accounting policies, acquisitions, goodwill, revenue recognition, debt, and segment information, with the U.S. as the primary market - Acquisitions (Note C): Details the acquisitions of Atlanta Micro ($90M), Avalex ($155M), Pentek ($65M), and Physical Optics Corporation ($310M), including preliminary purchase price allocations and resulting goodwill[387][390][394][398] - Goodwill (Note G): Goodwill increased to $937.9 million at FYE 2022 from $804.9 million at FYE 2021, primarily due to the Avalex and Atlanta Micro acquisitions, with no impairment found[409] - Intangible Assets (Note H): Net intangible assets were $351.5 million as of July 1, 2022, consisting mainly of customer relationships ($250.5M) and completed technologies ($92.8M)[411] - Restructuring (Note I): Incurred $27.4 million in restructuring and other charges in FY22, primarily related to the 1MPACT initiative, including $17.4 million in consulting costs and $9.2 million in severance[415][417] - Debt (Note M): The company amended its revolving credit facility to $1.1 billion, with $451.5 million outstanding as of July 1, 2022[445][453] - Segment and Geographic Information (Note Q): The company operates as a single reportable segment. In FY22, 88% of revenue originated from the U.S. and 12% from international markets. Key end applications were C4I (38.6%) and Radar (25.4%)[482][483][488] Changes in and Disagreements with Accountants on Accounting and Financial Disclosure The company reports no changes or disagreements with its accountants on accounting and financial disclosure - None[496] Controls and Procedures Management concluded disclosure controls and internal controls were effective as of July 1, 2022, excluding recent acquisitions from the assessment - Management concluded that disclosure controls and procedures were effective as of July 1, 2022[497] - Management's assessment of internal control over financial reporting concluded they were effective, based on the COSO 2013 framework[499] - The assessment of internal controls excluded the recently acquired Avalex and Atlanta Micro businesses, which will be integrated into the control environment in fiscal year 2023[500] Other Information The company reports no other information for this item - None[502] Part III Directors, Executive Officers and Corporate Governance Information on directors, executive officers, and corporate governance is incorporated by reference from the 2022 Proxy Statement - Information is incorporated by reference from the 2022 Proxy Statement[504] Executive Compensation Executive compensation information is incorporated by reference from the 2022 Proxy Statement - Information is incorporated by reference from the 2022 Proxy Statement[505] Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Security ownership information is incorporated by reference from the 2022 Proxy Statement - Information is incorporated by reference from the 2022 Proxy Statement[506] Certain Relationships and Related Transactions, and Director Independence Information on related transactions and director independence is incorporated by reference from the 2022 Proxy Statement - Information is incorporated by reference from the 2022 Proxy Statement[507] Principal Accountant Fees and Services KPMG LLP is the independent auditor; fee information is incorporated by reference from the 2022 Proxy Statement - The company's independent registered public accounting firm is KPMG LLP. Further information is incorporated by reference from the 2022 Proxy Statement[508] Part IV Exhibits and Financial Statement Schedules This section lists all financial statements, schedules, and exhibits filed as part of the Form 10-K, including Schedule II - Lists all financial statements, schedules, and exhibits included in or incorporated by reference into the report[510] - Includes Financial Statement Schedule II: Valuation and Qualifying Accounts, which details changes in the allowance for credit losses and the deferred tax asset valuation allowance[511][513]