Mercury Systems(MRCY) - 2021 Q3 - Quarterly Report

PART I. FINANCIAL INFORMATION This section presents the Company's financial statements, management's discussion, market risks, and internal controls ITEM 1. FINANCIAL STATEMENTS This section presents unaudited consolidated financial statements, including balance sheets, income, equity, cash flows, and detailed accounting notes Consolidated Balance Sheets This section presents the Company's consolidated balance sheets as of April 2, 2021, and July 3, 2020 Consolidated Balance Sheets | Metric | April 2, 2021 (in thousands) | July 3, 2020 (in thousands) | | :-------------------------------- | :--------------------------- | :-------------------------- | | Total assets | $1,903,320 | $1,610,720 | | Total liabilities | $449,340 | $225,936 | | Total shareholders' equity | $1,453,980 | $1,384,784 | - Total assets increased by $292.6 million (18.17%) from July 3, 2020, to April 2, 2021, primarily driven by increases in goodwill, intangible assets, and inventory[9] - Total liabilities increased significantly by $223.4 million (98.88%), mainly due to the addition of $160.0 million in long-term debt and increases in deferred income taxes and current liabilities[9] Consolidated Statements of Operations and Comprehensive Income This section presents consolidated statements of operations and comprehensive income for Q3 and nine months ended April 2, 2021 Consolidated Statements of Operations and Comprehensive Income | Metric (in thousands) | Q3 2021 (April 2, 2021) | Q3 2020 (March 27, 2020) | 9 Months 2021 (April 2, 2021) | 9 Months 2020 (March 27, 2020) | | :---------------------- | :---------------------- | :----------------------- | :---------------------------- | :----------------------------- | | Net revenues | $256,857 | $208,016 | $673,154 | $579,233 | | Gross margin | $105,623 | $93,325 | $282,409 | $260,231 | | Income from operations | $21,712 | $26,342 | $58,595 | $64,643 | | Net income | $15,635 | $23,565 | $44,119 | $58,488 | | Basic EPS | $0.28 | $0.43 | $0.80 | $1.07 | | Diluted EPS | $0.28 | $0.43 | $0.80 | $1.06 | - Net revenues increased by 23.5% for Q3 2021 and 16.2% for the nine months ended April 2, 2021, compared to the prior year periods[12] - Net income decreased by 33.7% for Q3 2021 and 24.6% for the nine months ended April 2, 2021, primarily due to higher operating expenses, interest expense, and income tax provision[12] Consolidated Statements of Shareholders' Equity This section presents consolidated statements of shareholders' equity as of April 2, 2021, and July 3, 2020 Consolidated Statements of Shareholders' Equity | Metric (in thousands) | April 2, 2021 | July 3, 2020 | | :---------------------- | :------------ | :----------- | | Common Stock | $552 | $547 | | Additional Paid-in Capital | $1,100,188 | $1,074,667 | | Retained Earnings | $356,574 | $312,455 | | Accumulated Other Comprehensive Loss | $(3,334) | $(2,885) | | Total Shareholders' Equity | $1,453,980 | $1,384,784 | - Total shareholders' equity increased by $69.2 million from July 3, 2020, to April 2, 2021, driven by net income, stock-based compensation, and issuance of common stock under employee plans[15] Consolidated Statements of Cash Flows This section presents consolidated statements of cash flows for the nine months ended April 2, 2021, and March 27, 2020 Cash Flow Summary (in thousands, 9 Months Ended) | Activity | April 2, 2021 | March 27, 2020 | | :-------------------------------- | :------------ | :------------- | | Net cash provided by operating activities | $70,053 | $86,458 | | Net cash used in investing activities | $(338,433) | $(123,980) | | Net cash provided by financing activities | $163,133 | $186,713 | | Net (decrease) increase in cash and cash equivalents | $(104,895) | $149,214 | | Cash and cash equivalents at end of period | $121,943 | $407,146 | - Net cash provided by operating activities decreased by $16.4 million, primarily due to higher inventory purchases and lower net income[17][156] - Net cash used in investing activities increased significantly by $214.5 million, mainly due to the acquisition of Physical Optics Corporation (POC) for $305.3 million[17][157] - Net cash provided by financing activities decreased by $23.6 million, despite $160.0 million in borrowings for the POC acquisition, compared to $200.0 million borrowed in the prior period[17][158] A. Description of Business This section describes Mercury Systems, Inc. as a technology company serving the aerospace and defense industry - Mercury Systems, Inc. is a leading technology company serving the aerospace and defense industry, providing solutions optimized for mission success in challenging environments[19][104] - The Company manufactures essential components, modules, and subsystems, selling to defense prime contractors, the U.S. government, and OEM commercial aerospace companies[20][105] - Key technologies include secure embedded processing, mission computers, rugged servers, safety-critical avionics, RF components, and custom microelectronics, with investments in AI and open architectures[22][107] B. Summary of Significant Accounting Policies This section outlines the significant accounting policies used in preparing the Company's financial statements - The financial statements are prepared in accordance with GAAP for interim financial information, with certain disclosures condensed or omitted[25] - Revenue recognition follows ASC 606, with 53% of Q3 2021 revenues recognized at a point in time and 47% recognized over time for long-term contracts[31][32][34] - Contract assets (unbilled receivables) increased to $138.4 million as of April 2, 2021, from $90.3 million as of July 3, 2020, due to growth in revenue recognized over time[39] - Recently adopted accounting pronouncements, including ASU No. 2016-13 (Credit Losses) and ASU No. 2017-04 (Goodwill Impairment), did not have a material impact on the financial statements[47][48] C. Acquisitions This section details the Company's acquisition of Physical Optics Corporation (POC) and its financial impact - On December 30, 2020, the Company acquired Physical Optics Corporation (POC) for a net purchase price of $305.3 million, funded by cash on hand and its revolving credit facility[52][53] POC Acquisition (Preliminary Fair Values as of April 2, 2021) | Item | Amount (in thousands) | | :---------------------------------- | :-------------------- | | Net purchase price | $305,263 | | Estimated fair value of net tangible assets acquired | $25,884 | | Estimated fair value of identifiable intangible assets | $114,000 | | Estimated goodwill | $168,234 | - POC contributed $38.5 million in revenues and $1.1 million in income before income taxes for the third quarter ended April 2, 2021[55] - The goodwill from the POC acquisition, largely reflecting potential synergies and market expansion, is not deductible for tax purposes[54] D. Fair Value of Financial Instruments This section discusses the fair value measurements of the Company's financial instruments and related transactions - The Company sold a cost-method investment, receiving $1.5 million in gross proceeds and recording a loss of $0.4 million during the nine months ended April 2, 2021[59] - Carrying values of cash, accounts receivable/payable, and accrued liabilities approximate fair value due to short-term maturities. Long-term debt's carrying value also approximates fair value due to variable interest rates[60] E. Inventory This section provides a breakdown of the Company's inventory composition and changes over time Inventory Composition (in thousands) | Category | April 2, 2021 | July 3, 2020 | | :--------------- | :------------ | :----------- | | Raw materials | $148,279 | $111,225 | | Work in process | $54,667 | $49,647 | | Finished goods | $23,894 | $17,221 | | Total | $226,840 | $178,093 | - Total inventory increased by $48.7 million (27.3%) from July 3, 2020, to April 2, 2021, with raw materials showing the largest increase[61] F. Goodwill This section details the changes in the Company's goodwill carrying amount, primarily due to acquisitions Goodwill Carrying Amount (in thousands) | Item | Amount | | :-------------------------------- | :------- | | Balance at July 3, 2020 | $614,076 | | Goodwill adjustment for the APC acquisition | $346 | | Goodwill arising from the POC acquisition | $168,234 | | Balance at April 2, 2021 | $782,656 | - Goodwill increased by $168.6 million during the nine months ended April 2, 2021, primarily due to the POC acquisition[62] G. Restructuring This section outlines the restructuring charges incurred by the Company due to business and market conditions - The Company incurred net restructuring and other charges of $2.2 million during the nine months ended April 2, 2021, mainly for severance costs related to the elimination of 42 positions[63][141] - These charges were due to changing market and business conditions, including talent shifts and resource redundancy from an internal reorganization[63][141] H. Income Taxes This section presents the Company's income tax provision and explains the effective tax rate differences Income Tax Provision (in thousands) | Period | Income Before Taxes | Income Tax Provision | | :-------------------------------- | :------------------ | :------------------- | | Q3 Ended April 2, 2021 | $20,997 | $5,362 | | Q3 Ended March 27, 2020 | $28,928 | $5,363 | | 9 Months Ended April 2, 2021 | $56,112 | $11,993 | | 9 Months Ended March 27, 2020 | $66,943 | $8,455 | - The effective tax rate for Q3 and nine months ended April 2, 2021, differed from the Federal statutory rate due to R&D credits, excess tax benefits on stock-based compensation, non-deductible compensation, and state taxes[67][132][148] I. Debt This section details the Company's revolving credit facility and related interest expenses - The Company has a $750.0 million revolving credit facility (Revolver) maturing in September 2023[70][154] - As of April 2, 2021, outstanding borrowings on the Revolver totaled $160.0 million, drawn to facilitate the POC acquisition[70][71][154] Interest Expense (in thousands) | Period | Amount | | :---------------------- | :----- | | Q3 Ended April 2, 2021 | $549 | | 9 Months Ended April 2, 2021 | $622 | J. Employee Benefit Plan This section describes the Company's defined benefit pension plan for Swiss employees and associated costs - The Company maintains a defined benefit pension plan for its Swiss employees, with a net liability of $12.3 million as of April 2, 2021[72][73] Pension Benefit Plan (in thousands) | Period | Net Periodic Benefit Costs | | :---------------------- | :----------------------- | | Q3 Ended April 2, 2021 | $420 | | 9 Months Ended April 2, 2021 | $1,253 | | Q3 Ended March 27, 2020 | $304 | | 9 Months Ended March 27, 2020 | $896 | K. Stock-Based Compensation This section details the Company's stock incentive plan, award types, and related compensation expenses - The Company's 2018 Stock Incentive Plan authorized 6,782 thousand shares, with 4,645 thousand shares available for future grant as of April 2, 2021[74] - Performance-based restricted stock awards are granted to executives and employees, vesting based on service period and specific financial performance targets[75] Stock-Based Compensation Expense (in thousands) | Period | Before Tax | Net of Income Taxes | | :---------------------- | :--------- | :------------------ | | Q3 Ended April 2, 2021 | $7,411 | $5,484 | | Q3 Ended March 27, 2020 | $6,814 | $5,042 | | 9 Months Ended April 2, 2021 | $21,865 | $16,180 | | 9 Months Ended March 27, 2020 | $19,004 | $14,063 | L. Operating Segment, Geographic Information and Significant Customers This section provides revenue breakdown by end-user, application, and significant customers, and geographic information - The Company operates as a single operating and reportable segment, despite internal reorganization[80] Net Revenues by End User (in thousands) | End User | Q3 2021 | Q3 2020 | 9 Months 2021 | 9 Months 2020 | | :----------------------------- | :------ | :------ | :------------ | :------------ | | Domestic | $217,255 | $187,560 | $577,093 | $516,659 | | International/Foreign Military Sales | $39,602 | $20,456 | $96,061 | $62,574 | | Total Net Revenue | $256,857 | $208,016 | $673,154 | $579,233 | Net Revenues by End Application (in thousands) | End Application | Q3 2021 | Q3 2020 | 9 Months 2021 | 9 Months 2020 | | :-------------------- | :------ | :------ | :------------ | :------------ | | Radar | $81,481 | $78,113 | $238,650 | $164,360 | | Electronic Warfare | $25,782 | $37,488 | $91,342 | $109,684 | | Other Sensor & Effector | $25,252 | $26,279 | $72,352 | $80,681 | | C4I | $107,144 | $47,351 | $219,284 | $154,140 | | Other | $17,198 | $18,785 | $51,526 | $70,368 | | Total Net Revenue | $256,857 | $208,016 | $673,154 | $579,233 | Significant Customers (10% or more of revenues) | Customer | Q3 2021 | Q3 2020 | 9 Months 2021 | 9 Months 2020 | | :---------------------- | :------ | :------ | :------------ | :------------ | | Raytheon Technologies | 18 % | 17 % | 22 % | 15 % | | U.S. Navy | 16 % | * | * | * | | Lockheed Martin Corporation | 14 % | 17 % | 15 % | 17 % | | L3Harris Technologies | * | * | * | 10 % | | Total | 48 % | 34 % | 37 % | 42 % | M. Commitments and Contingencies This section outlines the Company's legal contingencies, purchase commitments, and indemnification obligations - The Company is subject to litigation, claims, investigations, and audits in the ordinary course of business, but does not expect a material impact on financial position[96][186] - Non-cancelable purchase commitments for inventory components and services aggregated $145.0 million as of April 2, 2021, all due within one year[98][159] - The Company has indemnification obligations for intellectual property infringement claims, with potential future payments being unlimited in some instances[97][162] N. Subsequent Events This section confirms the evaluation of subsequent events with no material disclosures required - The Company evaluated subsequent events through the financial statements issuance date and found no material events requiring disclosure[101] ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Management discusses financial condition and results for Q3 and nine months, covering operations, liquidity, capital resources, and non-GAAP measures FORWARD-LOOKING STATEMENTS This section cautions readers about forward-looking statements, subject to various risks and uncertainties - The report contains forward-looking statements subject to risks and uncertainties, including continued defense program funding, economic conditions, geopolitical unrest, competition, and integration challenges from acquisitions[103] - Readers are cautioned not to place undue reliance on these statements, which speak only as of their date, and the Company undertakes no obligation to update them[103] OVERVIEW This section provides an overview of Mercury Systems, Inc.'s business model, market, and key financial highlights - Mercury Systems, Inc. is a technology company serving the aerospace and defense industry, providing mission-critical solutions for over 300 programs with more than 25 defense prime contractors[104][105] - The Company's business model focuses on bridging commercial technology with aerospace and defense applications through R&D investments and secure design/manufacturing capabilities[106][107] - Customer delivery requirements, rather than sequential trends, primarily drive revenue fluctuations due to the varied nature of defense programs[109][110] Key Financial Highlights (in millions) | Metric | Q3 2021 | 9 Months 2021 | | :------------------- | :------ | :------------ | | Consolidated revenues | $256.9 | $673.2 | | Acquired revenues | $38.5 | $47.5 | | Net income | $15.6 | $44.1 | | Diluted net EPS | $0.28 | $0.80 | | Adjusted EPS (Non-GAAP) | $0.64 | $1.69 | | Adjusted EBITDA (Non-GAAP) | $54.8 | $142.8 | OUR RESPONSE TO COVID This section details the Company's measures to protect employees and maintain operations during the COVID-19 pandemic - The Company's response to COVID-19 focused on protecting employee health and safety, mitigating operational/financial risks, and delivering on customer commitments[114] - Measures included additional sick leave, work-from-home policies, increased overtime pay, a $1 million COVID Relief Fund, and enhanced safety protocols at facilities[115][116] - As an 'essential business' in the defense industrial base, facilities continued to operate with social distancing and disinfection protocols[116] RESULTS OF OPERATIONS: This section analyzes the Company's financial performance for the third quarter and nine months ended April 2, 2021 - Results for Q3 2021 include a full period from the POC acquisition, while nine-month results include POC from December 30, 2020, making direct comparisons challenging[118] Q3 2021 vs. Q3 2020 Financial Performance This section compares the Company's financial performance for the third quarter ended April 2, 2021, against the prior year Q3 Financial Data (in thousands, as a % of Total Net Revenue) | Metric | April 2, 2021 | % Revenue | March 27, 2020 | % Revenue | | :-------------------------------- | :------------ | :-------- | :------------- | :-------- | | Net revenues | $256,857 | 100.0 % | $208,016 | 100.0 % | | Cost of revenues | $151,234 | 58.9 % | $114,691 | 55.1 % | | Gross margin | $105,623 | 41.1 % | $93,325 | 44.9 % | | Total operating expenses | $83,911 | 32.7 % | $66,983 | 32.2 % | | Income from operations | $21,712 | 8.5 % | $26,342 | 12.7 % | | Net income | $15,635 | 6.1 % | $23,565 | 11.3 % | - Net revenues increased by $48.8 million (23.5%), driven by $38.5 million in acquired revenue (POC) and $10.3 million in organic revenue, primarily from integrated subsystems and C4I end applications[120] - Gross margin decreased by 380 basis points to 41.1%, mainly due to increased Customer Funded Research and Development (CRAD) from the POC acquisition, incremental COVID-related expenses, and program mix[121] - Income from operations decreased by $4.6 million (17.6%), and net income decreased by $7.9 million (33.7%), largely due to higher operating expenses (amortization, acquisition costs) and interest expense[119][124][126][128] 9 Months 2021 vs. 9 Months 2020 Financial Performance This section compares the Company's financial performance for the nine months ended April 2, 2021, against the prior year 9 Months Financial Data (in thousands, as a % of Total Net Revenue) | Metric | April 2, 2021 | % Revenue | March 27, 2020 | % Revenue | | :-------------------------------- | :------------ | :-------- | :------------- | :-------- | | Net revenues | $673,154 | 100.0 % | $579,233 | 100.0 % | | Cost of revenues | $390,745 | 58.0 % | $319,002 | 55.1 % | | Gross margin | $282,409 | 42.0 % | $260,231 | 44.9 % | | Total operating expenses | $223,814 | 33.2 % | $195,588 | 33.7 % | | Income from operations | $58,595 | 8.8 % | $64,643 | 11.2 % | | Net income | $44,119 | 6.6 % | $58,488 | 10.1 % | - Total revenues increased by $93.9 million (16.2%), with $47.3 million from organic growth and $46.6 million from acquired revenues, primarily in radar and C4I end applications and integrated subsystems[137] - Gross margin decreased by 290 basis points to 42.0%, attributed to increased CRAD from the POC acquisition, COVID-related expenses, and program mix[138] - Net income decreased by $14.4 million (24.6%), influenced by higher operating expenses (R&D, acquisition costs, restructuring) and interest expense[136][140][141][142][144] LIQUIDITY AND CAPITAL RESOURCES This section discusses the Company's liquidity sources, capital resources, cash flows, and contractual obligations - Primary liquidity sources include existing cash, cash from operations, the $750.0 million Revolver, and a universal shelf registration statement[151][153][154] - The Company believes current liquidity is sufficient to meet anticipated cash requirements for at least the next twelve months, despite ongoing investments in facilities and R&D[151][152] Cash Flow Summary (in thousands, 9 Months Ended) | Activity | April 2, 2021 | March 27, 2020 | | :-------------------------------- | :------------ | :------------- | | Net cash provided by operating activities | $70,053 | $86,458 | | Net cash used in investing activities | $(338,433) | $(123,980) | | Net cash provided by financing activities | $163,133 | $186,713 | | Net (decrease) increase in cash and cash equivalents | $(104,895) | $149,214 | | Cash and cash equivalents at end of period | $121,943 | $407,146 | - Cash and cash equivalents decreased by $104.9 million, primarily due to the $305.3 million POC acquisition and $34.7 million in capital expenditures, partially offset by $160.0 million in Revolver borrowings[155] Commitments and Contractual Obligations (in thousands, as of April 2, 2021) | Type | Total | Less Than 1 Year | 1-3 Years | 3-5 Years | More Than 5 Years | | :------------------ | :------ | :--------------- | :-------- | :-------- | :---------------- | | Purchase obligations | $145,019 | $145,019 | $0 | $0 | $0 | | Operating leases | $99,242 | $12,279 | $24,636 | $20,986 | $41,341 | | Total | $244,261 | $157,298 | $24,636 | $20,986 | $41,341 | NON-GAAP FINANCIAL MEASURES This section presents and reconciles non-GAAP financial measures, including adjusted EBITDA, EPS, and free cash flow - The Company discusses non-GAAP measures like adjusted EBITDA, adjusted income, adjusted EPS, free cash flow, organic revenue, and acquired revenue to provide a more complete understanding of underlying results[165] Adjusted EBITDA Reconciliation (in thousands) | Metric | Q3 2021 | Q3 2020 | 9 Months 2021 | 9 Months 2020 | | :-------------------------------- | :------ | :------ | :------------ | :------------ | | Net income | $15,635 | $23,565 | $44,119 | $58,488 | | Adjustments (total) | $39,122 | $23,521 | $98,720 | $68,131 | | Adjusted EBITDA | $54,757 | $47,086 | $142,839 | $126,619 | Adjusted Income and EPS Reconciliation (in thousands, except per share data) | Metric | Q3 2021 | Q3 2020 | 9 Months 2021 | 9 Months 2020 | | :-------------------------------- | :------ | :------ | :------------ | :------------ | | Net income | $15,635 | $23,565 | $44,119 | $58,488 | | Adjusted income | $35,450 | $33,272 | $93,754 | $87,002 | | Diluted EPS | $0.28 | $0.43 | $0.80 | $1.06 | | Adjusted EPS | $0.64 | $0.60 | $1.69 | $1.58 | Free Cash Flow Reconciliation (in thousands) | Metric | Q3 2021 | Q3 2020 | 9 Months 2021 | 9 Months 2020 | | :-------------------------------- | :------ | :------ | :------------ | :------------ | | Cash provided by operating activities | $23,185 | $30,082 | $70,053 | $86,458 | | Purchase of property and equipment | $(9,955) | $(10,869) | $(34,708) | $(31,788) | | Free cash flow | $13,230 | $19,213 | $35,345 | $54,670 | Revenue Breakdown (in thousands) | Metric | Q3 2021 | % Revenue | Q3 2020 | % Revenue | 9 Months 2021 | % Revenue | 9 Months 2020 | % Revenue | | :-------------------------------- | :------ | :-------- | :------ | :-------- | :------------ | :-------- | :------------ | :-------- | | Organic revenue | $218,365 | 85 % | $208,016 | 100 % | $625,609 | 93 % | $578,290 | 100 % | | Acquired revenue | $38,492 | 15 % | $0 | 0 % | $47,545 | 7 % | $943 | 0 % | | Total revenues | $256,857 | 100 % | $208,016 | 100 % | $673,154 | 100 % | $579,233 | 100 % | RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS This section discusses recently issued accounting pronouncements and their expected non-material impact on financial statements - The Company does not expect ASU No. 2018-14 (Defined Benefit Plans), ASU No. 2019-12 (Income Taxes), or ASU No. 2021-03 (Goodwill Impairment) to have a material impact on its financial statements or disclosures[44][45][46][178] RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS This section details recently adopted accounting pronouncements and their non-material impact on the Company's financials - The Company adopted ASU No. 2016-13 (Credit Losses), ASU No. 2017-04 (Goodwill Impairment), and ASU No. 2018-15 (Internal-Use Software) effective July 4, 2020, with no material impact[47][48][49][179] - SEC Final Rule Release No. 33-10786 (Acquired and Disposed Businesses) was early adopted in conjunction with the POC acquisition, also without material impact[50][179] ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK No material changes in the Company's market risk exposure occurred between July 3, 2020, and April 2, 2021 - No material changes in market risk exposure occurred from July 3, 2020, to April 2, 2021[181] ITEM 4. CONTROLS AND PROCEDURES Management evaluated disclosure controls and internal control over financial reporting, concluding effectiveness and integrating the POC business - The Chief Executive Officer and Chief Financial Officer concluded that disclosure controls and procedures were effective as of April 2, 2021[182] - No material changes in internal control over financial reporting occurred during the quarter, but the recently acquired POC business is being integrated into the overall control environment[183] PART II. OTHER INFORMATION This section covers legal proceedings, risk factors, and exhibits related to the Company's operations ITEM 1. LEGAL PROCEEDINGS The Company is involved in ordinary course legal proceedings, expecting no material impact on its financial position or results - The Company is involved in ordinary course legal proceedings but expects no material impact on its financial position or results[186] ITEM 1A. RISK FACTORS No changes occurred in the risk factors disclosed in the Company's 2020 Annual Report on Form 10-K - No changes have occurred in the risk factors disclosed in the Company's 2020 Annual Report on Form 10-K[187] ITEM 6. EXHIBITS This section lists exhibits filed with Form 10-Q, including CEO/CFO certifications and XBRL documents - Exhibits include CEO and CFO certifications (Sarbanes-Oxley Act Sections 302 and 906) and various XBRL documents for financial reporting[188] Signatures This section contains the required signatures for the Form 10-Q, certifying its submission by the CFO and Treasurer - The report was signed by Michael D. Ruppert, Executive Vice President, Chief Financial Officer, and Treasurer, on May 11, 2021[190][191]