Business context and reporting period
Mercury Systems, Inc. designs and manufactures processing technologies, components, modules and integrated subsystems for aerospace and defense customers. This Form 10-K covers the 52-week fiscal year ended July 1, 2022; it does not provide a separate fourth-quarter results summary. Results include contributions from acquisitions, and are not fully comparable with fiscal 2021.
Financial performance and liquidity
| Metric | FY2022 | FY2021 |
|---|---|---|
| Revenue | $988.2 million | $924.0 million |
| Gross margin | 40.0% | 41.7% |
| Operating income | $31.6 million | $81.0 million |
| Net income | $11.3 million | $62.0 million |
| Diluted EPS | $0.20 | $1.12 |
| Adjusted EBITDA (non-GAAP) | $200.5 million | $201.9 million |
| Adjusted EPS (non-GAAP) | $2.19 | $2.42 |
| Operating cash flow | $(18.9) million | $97.2 million |
| Free cash flow (non-GAAP) | $(46.5) million | $51.6 million |
Reported revenue rose 7.0%, but organic revenue fell 5.4% to $870.4 million; $117.8 million was acquired revenue. Gross margin declined 170 basis points, which management attributed primarily to program mix, award delays, supply constraints, inflation and higher engineering content on development work. Higher SG&A, amortization, restructuring, acquisition-related costs and interest expense contributed to the reduction in GAAP operating income and net income. Adjusted EBITDA was broadly flat year over year.
At year-end, cash and cash equivalents were $65.7 million, down from $113.8 million. Current assets were $815.3 million and current liabilities were $193.9 million. Long-term debt was $451.5 million, drawn under a $1.1 billion revolving credit facility maturing February 28, 2027. The company reported compliance with its credit covenants and said available cash, operating cash generation, revolving credit and financing capabilities should cover anticipated needs for at least 12 months. Inventory was $270.3 million, versus $221.6 million, and unbilled receivables and costs in excess of billings were $303.4 million, versus $162.9 million.
Material changes, outlook and management commentary
- Growth was acquisition-led: acquired revenue increased $114.4 million, while organic revenue decreased $50.2 million. Avalex and Atlanta Micro were acquired during FY2022; their purchase prices were approximately $154.1 million and $89.2 million, respectively.
- Backlog increased to approximately $1.04 billion from $909.6 million; $646.7 million was expected to be delivered within 12 months. Backlog orders may be canceled or delayed.
- Management’s 1MPACT initiative aims over five years to improve growth, margins, adjusted EBITDA and free cash flow through organizational streamlining, procurement and supply-chain improvements, facilities optimization, R&D investment and common processes and systems. The filing gives no specific FY2023 revenue or earnings guidance.
- Management cited strong bookings and design wins and favorable aerospace and defense demand trends, while noting that supply constraints and award delays impaired delivery, revenue conversion and cash flow. The company incurred substantial labor and materials inflation and said it may be unable to pass all cost increases through to customers.
- Customer concentration remains significant: Raytheon Technologies and the U.S. Navy each represented 14% of FY2022 revenue; Lockheed Martin represented 10%. No single program represented 10% or more of revenue.
Risks, contingencies and unusual items
- Key risks include dependence on government defense funding and a small group of customers; semiconductor and other supplier shortages; inflation; employee attrition and retention costs; execution of 1MPACT and acquisition integration; competition; cybersecurity and export-control obligations; and variable-rate debt exposure.
- FY2022 restructuring and other charges were $27.4 million, including $17.4 million of consulting costs and $9.2 million of severance associated with approximately 135 eliminated positions. Acquisition costs and other related expenses were $11.4 million; these included $6.8 million of advisory and settlement costs connected with activist investors. The company reached settlements with JANA Partners and Starboard Value, including two board appointments.
- Contingencies include a former sales representative’s arbitration claim seeking approximately $9 million in direct damages, with treble damages requested on some claims, and an environmental demand related to alleged contamination at a former site. The company disputes the arbitration claims; it said responsibility for the environmental matters was too early to determine. Management did not expect pending matters, overall, to materially affect results, cash flows or financial position.
- The auditor issued an unqualified opinion on the financial statements and internal control over financial reporting. Avalex and Atlanta Micro, representing 12% of consolidated assets and 3% of revenue, were excluded from the internal-control assessment while integration was ongoing.
Important facts for investors to verify
- Whether supply-chain constraints, inflation and higher inventory and unbilled receivables ease, and whether cash flow returns to positive levels.
- Whether organic revenue, gross margin and GAAP profitability improve independently of acquisitions, and how recurring or comparable the non-GAAP adjustments are.
- Whether backlog converts to revenue on schedule, given cancellation rights, award delays and customer concentration.
- Progress, costs and measurable benefits of 1MPACT, including whether it delivers the stated margin and free-cash-flow potential.
- Debt, interest-rate exposure and covenant headroom, as well as the resolution and potential financial impact of the arbitration and environmental matters.