Mercury Systems(MRCY) - 2021 Q4 - Annual Report

Part I Item 1. Business Mercury Systems is a technology company providing secure, rugged components and subsystems to the aerospace and defense industry, reporting $924.0 million in fiscal 2021 revenues | Financial Metric | Fiscal 2021 (Millions) | Fiscal 2020 (Millions) | | :--- | :--- | :--- | | Consolidated Revenues | $924.0 | $796.6 | | Acquired Revenues | $88.4 | $0.9 | | Net Income | $62.0 | $85.7 | | Diluted EPS | $1.12 | $1.56 | | Adjusted EPS | $2.42 | $2.30 | | Adjusted EBITDA | $201.9 | $176.2 | - The company's business model bridges the gap between commercial technology and aerospace/defense applications, focusing on secure, open-architecture solutions for C4ISR, electronic warfare, and radar systems[13][15][17] - Growth strategies are centered on organic investment, disciplined M&A, innovation in trusted and secure technologies, operational improvement, and talent retention[21][22][23] - In August 2021, Mercury launched "1MPACT," a company-wide initiative to drive growth and margin expansion over the next five years by focusing on organizational efficiency, supply chain optimization, and scalable processes[19] Our Company and Business Strategy Mercury positions itself as a leading technology provider for the aerospace and defense industry, specializing in adapting commercial technology for mission-critical applications - Mercury's products are deployed in over 300 programs with more than 25 defense prime contractors and commercial aviation customers[14] - The company's core growth strategies are: 1. Invest to grow organically. 2. Expand capabilities and market access through M&A. 3. Invest in trusted, secure innovation. 4. Continuously improve operational capability and scalability. 5. Attract and retain talent[21][22][23] - The 1MPACT initiative focuses on six areas: organization efficiency, procurement/supply chain, facilities optimization, R&D investment, capital efficiency, and scalable processes[19] Our Solutions and Products Mercury offers a wide range of products from discrete components to fully integrated subsystems, designed for compute-intensive applications - Product categories are defined as: - Components: Single-function elements like power amplifiers, converters, and chips. - Modules and Subassemblies: Combinations of components on a single board, such as embedded processing modules. - Integrated Subsystems: Multiple modules combined in a chassis with software to form a complete solution[41][42][43] - The company differentiates its offerings through six key capabilities: Silicon adaptation, Speed (high performance), SWaP optimization, open Software, built-in Security, and certifiable Safety[31][32][33] - Mercury partners with tech leaders like Intel®, Xilinx, and NVIDIA to deliver cutting-edge computing in rugged, field-deployable form factors[46] Recent Acquisitions Since July 2015, Mercury has completed 13 strategic acquisitions to expand its capabilities in embedded security, microelectronics, mission computing, and rugged servers | Name of Acquired Entity | Date of Acquisition | | :--- | :--- | | Physical Optics Corporation | December 30, 2020 | | Pentek | May 27, 2021 | | American Panel Corporation | September 23, 2019 | - Acquisitions have added substantial capabilities, including embedded security (LIT, Athena), custom microelectronics (Microsemi Carve-Out, Pentek), mission computing (CES, GECO, POC), and rugged servers (Themis, Germane)[29][55] Our Market Opportunity Mercury's market opportunity is driven by growing demand for secure, domestically produced sensor and mission processing capabilities in the aerospace and defense electronics market - The global aerospace and defense electronics market is estimated to be $129 billion in 2021, growing to $148 billion by 2025, with the U.S. defense electronics market estimated at $72 billion in 2021, growing to $78 billion by 2025[56] - Prime contractor outsourcing is identified as the largest secular growth opportunity, with the addressable U.S. Tier 2 embedded computing and RF market estimated at $24 billion in 2021[58] - The DoD has elevated microelectronics to its number one technology priority, creating opportunities for Mercury's capabilities in trusted, secure, and domestically produced silicon technologies[59] Backlog, Customers, and Human Capital As of July 2, 2021, Mercury's order backlog was $909.6 million, with Lockheed Martin and Raytheon Technologies as major customers | Metric | As of July 2, 2021 (Millions) | As of July 3, 2020 (Millions) | | :--- | :--- | :--- | | Total Backlog | $909.6 | $831.1 | | Backlog Expected in Next 12 Months | $530.0 | N/A | | Customer | % of FY21 Revenue | | :--- | :--- | | Raytheon Technologies | 19% | | Lockheed Martin Corporation | 15% | | United States Navy | 12% | - As of July 2, 2021, the company had 2,384 employees, with 791 in R&D. Women and racially/ethnically diverse employees represented 30% and 42% of the workforce, respectively[82][85] Item 1A. Risk Factors The company faces significant operational, strategic, regulatory, and IT risks, including defense program dependence and acquisition integration challenges - Business Operations Risks: Heavy dependence on defense programs (98% of FY21 revenue), which are subject to termination and funding delays. Loss of major customers like Raytheon (19%) or Lockheed Martin (15%) would materially harm the business[92][95] - Growth Strategy & M&A Risks: The 1MPACT value creation plan may not be successful or could divert management attention. Acquisitions pose integration challenges, potential for unanticipated liabilities, and failure to achieve expected synergies[119][124][125] - Legal & Regulatory Risks: Contracts are subject to termination for convenience by the government. The company must comply with complex regulations like FAR, CAS, and CMMC, with violations leading to fines or debarment[134] - IT & IP Risks: The business is subject to heightened risks of cyber intrusion, including ransomware and phishing. A data breach could lead to loss of sales, reputational damage, and loss of government contracts[141] - COVID-19 Risks: The pandemic poses risks of supply chain disruption, limitations on operations, and increased costs for health and safety measures[146] Item 2. Properties The company leases all significant properties across the U.S. and Switzerland, with major facilities supporting manufacturing and engineering | Location | Size (Sq. Feet) | Commitment | | :--- | :--- | :--- | | Andover, MA | 145,262 | Leased, expiring 2032 | | Phoenix, AZ | 125,756 | Leased, expiring 2031 | | Hudson, NH | 121,553 | Leased, expiring 2030 | | Torrance, CA | 85,125 | Leased, expiring 2029 | Item 3. Legal Proceedings The company is involved in a binding arbitration case with a former sales representative seeking approximately $9 million in damages - On June 23, 2021, former sales representative ERA filed for binding arbitration seeking ~$9 million in damages related to a terminated agreement[158] - The company believes the claims are without merit and intends to defend itself vigorously. The outcome is not expected to have a material impact[157][158] Item 4.1. Information About Our Executive Officers This section provides information on the company's executive officers, including the President and CEO, and EVP, CFO, and Treasurer - Mark Aslett has served as President and CEO since 2007[161] - Michael D. Ruppert was appointed EVP, Chief Financial Officer and Treasurer in 2018[164] Part II Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Mercury's common stock trades on Nasdaq under MRCY, with the company retaining earnings for growth and no cash dividends paid | Fiscal 2021 Quarter | High Price ($) | Low Price ($) | | :--- | :--- | :--- | | Fourth Quarter | $79.28 | $57.69 | | Third Quarter | $85.49 | $61.26 | | Second Quarter | $88.06 | $67.10 | | First Quarter | $79.89 | $66.65 | - The company has never declared or paid cash dividends and intends to retain earnings for future growth[170] Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Management discusses fiscal 2021 financial results, including a 16.0% revenue increase to $924.0 million, gross margin decline, and $62.0 million net income Results of Operations: Fiscal 2021 vs. Fiscal 2020 Fiscal 2021 revenues increased 16.0% to $924.0 million due to acquisitions and organic growth, with gross margin declining and net income decreasing to $62.0 million | Metric | Fiscal 2021 (Millions) | Fiscal 2020 (Millions) | Change | | :--- | :--- | :--- | :--- | | Net Revenues | $924.0 | $796.6 | +16.0% | | Gross Margin | $385.2 (41.7%) | $356.8 (44.8%) | -310 bps | | Income from Operations | $81.0 | $91.1 | -11.1% | | Net Income | $62.0 | $85.7 | -27.6% | - The increase in total revenue was driven by higher demand for integrated subsystems (+$153.1 million) and modules/sub-assemblies (+$25.4 million), partially offset by a decrease in components (-$51.1 million)[196] - Gross margin decline was primarily due to the acquisition of POC, which increased lower-margin Customer Funded R&D (CRAD), unfavorable program mix, and incremental COVID-related expenses of $7.2 million[197] - Restructuring and other charges increased significantly to $9.2 million in FY2021 from $1.8 million in FY2020, primarily due to severance costs and consulting fees for the 1MPACT initiative[202] Liquidity and Capital Resources The company's liquidity sources include cash from operations and a $750.0 million revolving credit facility, with cash decreasing by $113.0 million due to acquisitions | Cash Flow Metric (FY 2021) | Amount (Millions) | | :--- | :--- | | Net cash provided by operating activities | $97.2 | | Net cash used in investing activities | ($416.9) | | Net cash provided by financing activities | $206.2 | | Net decrease in cash | ($113.0) | - As of July 2, 2021, the company had $200.0 million in outstanding borrowings against its $750.0 million revolving credit facility, which matures in September 2023[215][216] - Total contractual obligations as of July 2, 2021, were $247.6 million, primarily consisting of $147.6 million in purchase obligations and $100.0 million in operating leases[221][222] Non-GAAP Financial Measures The company uses non-GAAP measures like Adjusted EBITDA ($201.9 million) and Adjusted EPS ($2.42) to evaluate performance | Non-GAAP Metric | Fiscal 2021 (Millions) | Fiscal 2020 (Millions) | | :--- | :--- | :--- | | Adjusted EBITDA | $201.9 | $176.2 | | Adjusted Income | $134.1 | $126.8 | | Adjusted EPS | $2.42 | $2.30 | | Free Cash Flow | $51.6 | $71.9 | - Adjustments to derive non-GAAP figures primarily exclude amortization of intangibles, stock-based compensation, restructuring charges, acquisition costs, and COVID-related expenses[232][236] Critical Accounting Policies and Significant Judgments and Estimates Management identifies critical accounting policies requiring significant judgment, including revenue recognition (42% of FY2021 revenue), goodwill impairment, and business combinations - Revenue Recognition: 42% of FY2021 revenue was recognized over time for long-term contracts, requiring significant judgment in estimating total costs and progress[248][251] - Goodwill: Goodwill is tested for impairment annually. In Q1 FY21, the company reorganized its reporting units into Processing, Microelectronics, and Mission. The annual test in Q4 FY21 indicated no impairment[259][262][400] - Business Combinations: The company uses the acquisition method, allocating purchase price to acquired assets and liabilities based on estimated fair values, which involves significant assumptions about future revenues, expenses, and discount rates[268] Item 7A. Quantitative and Qualitative Disclosures about Market Risk The company is exposed to market risks, including interest rate risk on $200.0 million in variable-rate borrowings, credit risk, and foreign currency risk - Interest Rate Risk: Exposure is primarily from the $200.0 million in variable-rate borrowings on the Revolver. A 100 basis point increase in interest rates would change annual interest expense by approximately $1.0 million on $100.0 million of debt[273][131] - Concentration of Credit Risk: As of July 2, 2021, five customers accounted for 60% of the company's receivables, unbilled receivables, and costs in excess of billings[275] - Foreign Currency Risk: The company is subject to exposure from adverse movements in exchange rates due to its foreign subsidiaries, but has not entered into any hedging instruments[276][277] Item 8. Financial Statements and Supplementary Data This section presents the company's audited consolidated financial statements for fiscal year 2021 and KPMG LLP's unqualified audit opinion - The report includes the full set of audited consolidated financial statements for the three fiscal years ended July 2, 2021[297][300][303] - KPMG LLP issued an unqualified opinion on the financial statements and internal controls. The audit of internal controls excluded the recently acquired POC and Pentek businesses, which represented 22% of total assets and 9% of total revenues[281][282] - Critical Audit Matters identified were: (1) the estimate of total contract costs for fixed-price contracts recognized over time, and (2) the valuation of customer relationship intangible assets from the POC acquisition[289][290][293] Note C. Acquisitions This note details fiscal 2021 and 2020 acquisitions, including Pentek ($65.0 million) and POC ($310.0 million), with purchase price allocations | Acquisition | Date | Purchase Price (Millions) | Goodwill (Millions) | Intangible Assets (Millions) | | :--- | :--- | :--- | :--- | :--- | | Pentek | May 27, 2021 | $65.0 | $35.2 | $24.1 | | Physical Optics Corp. (POC) | Dec 30, 2020 | $310.0 | $155.3 | $116.0 | | American Panel Corp. (APC) | Sep 23, 2019 | $100.0 | $53.0 | $33.2 | - The POC acquisition added $83.0 million in customer relationships and $25.0 million in completed technology to intangible assets[384] - Goodwill from the acquisitions is attributed to potential synergies and expansion of product offerings in complementary markets[381][385][390] Note G. Goodwill and H. Intangible Assets As of July 2, 2021, the company reported $804.9 million in goodwill and $307.6 million in net intangible assets, with no impairment found | Asset | Balance at July 2, 2021 (Millions) | Balance at July 3, 2020 (Millions) | | :--- | :--- | :--- | | Goodwill | $804.9 | $614.1 | | Net Intangible Assets | $307.6 | $208.7 | - The company reorganized its internal reporting units in Q1 FY21, which qualified as a triggering event for impairment testing; no impairment was found before or after the reorganization[398][400] - Estimated future amortization expense for existing intangible assets is $49.7 million for FY2022 and $41.4 million for FY2023[403] Note M. Debt The company's primary debt is a $750.0 million revolving credit facility maturing in September 2023, with $200.0 million outstanding - The company has a $750.0 million revolving credit facility that matures on September 28, 2023[429][431] - As of July 2, 2021, $200.0 million was outstanding on the Revolver, drawn to facilitate recent acquisitions[429] - The company was in compliance with all financial covenants, including minimum interest coverage and maximum net leverage ratios, as of the balance sheet date[434][435] Note Q. Operating Segment, Geographic Information and Significant Customers Mercury operates as a single segment, with 90% of FY21 revenue from the U.S., and Raytheon, Lockheed Martin, and the U.S. Navy as significant customers - The company operates as a single reportable segment[460] | Revenue by Product Grouping (FY2021) | Amount (Millions) | | :--- | :--- | | Components | $176.2 | | Modules and Sub-assemblies | $156.6 | | Integrated Subsystems | $591.2 | | Total | $924.0 | | Significant Customers (FY2021) | % of Revenue | | :--- | :--- | | Raytheon Technologies | 19% | | Lockheed Martin Corporation | 15% | | U.S. Navy | 12% | Item 9A. Controls and Procedures Management concluded that disclosure controls and internal control over financial reporting were effective as of July 2, 2021 - Management concluded that disclosure controls and procedures were effective as of July 2, 2021[477] - The assessment of internal control over financial reporting excluded the recently acquired POC and Pentek businesses, which together represented 22% of total assets and 9% of total revenues for fiscal 2021[480] Part III Part III incorporates information on directors, executive officers, compensation, and governance by reference from the company's 2021 Proxy Statement Items 10-14: Directors, Compensation, and Governance Information for Items 10-14, covering directors, executive compensation, and governance, is incorporated by reference from the 2021 Proxy Statement - Information on Directors, Executive Officers, Corporate Governance, Executive Compensation, Security Ownership, and Principal Accountant Fees is incorporated by reference from the 2021 Proxy Statement[484][485][486] Part IV Part IV contains the list of financial statements, financial statement schedules, and the exhibit index, including Schedule II and various filed documents Item 15. Exhibits and Financial Statement Schedules This section lists all financial statements, schedules, and exhibits filed with the report, including Schedule II and a comprehensive exhibit index - This section contains the list of all financial statements, schedules, and exhibits filed with the Form 10-K[491] | Schedule II - Allowance for Credit Losses | FY2021 (Thousands) | FY2020 (Thousands) | FY2019 (Thousands) | | :--- | :--- | :--- | :--- | | Beginning Balance | $1,451 | $1,228 | $359 | | Ending Balance | $1,720 | $1,451 | $1,228 | | Schedule II - Deferred Tax Asset Valuation Allowance | FY2021 (Thousands) | FY2020 (Thousands) | FY2019 (Thousands) | | :--- | :--- | :--- | :--- | | Beginning Balance | $11,264 | $16,666 | $16,992 | | Ending Balance | $15,257 | $11,264 | $16,666 |