Mercury Systems, Inc. — FY2020 Form 10-K
Reporting period: Fiscal year ended July 3, 2020, a 53-week year. The filing also reports fourth-quarter results. Fiscal 2019 was a 52-week year, and the periods are not fully comparable; FY2020 also included a full year of several recent acquisitions and APC results from its September 2019 acquisition date.
Business context
Mercury supplies secure, mission-critical components, modules, and integrated subsystems for aerospace and defense, primarily through defense prime contractors. Its products support more than 300 programs. Defense-related sales represented approximately 95% of revenue in FY2020. Lockheed Martin and Raytheon Technologies each contributed 16% of FY2020 revenue (32% combined); no single program accounted for 10% or more.
Financial highlights
| Metric | FY2020 | FY2019 |
|---|---|---|
| Revenue | $796.6 million | $654.7 million |
| Gross margin | 44.8% | 43.7% |
| Operating income | $91.1 million | $76.6 million |
| Net income | $85.7 million | $46.8 million |
| Diluted EPS | $1.56 | $0.96 |
| Adjusted EBITDA (non-GAAP) | $176.2 million | $145.3 million |
| Adjusted EPS (non-GAAP) | $2.30 | $1.84 |
| Operating cash flow | $115.2 million | $97.5 million |
| Free cash flow (non-GAAP) | $71.9 million | $70.8 million |
Revenue increased 22% year over year: $91.4 million was attributed to organic revenue growth and $50.5 million to acquired revenue. Management cited demand across product groupings, particularly integrated subsystems and radar, and higher revenue on P-8, SEWIP, and AIDEWS programs. Gross margin improved 110 basis points, primarily from program mix and operating efficiencies, partly offset by higher customer-funded development work, COVID-related costs, and inventory step-up amortization. R&D expense rose 43% to $98.5 million, or 12.4% of revenue.
Fourth quarter: Revenue was $217.4 million versus $177.0 million in FY2019 Q4; gross margin was $96.6 million, operating income $26.4 million, net income $27.2 million, and diluted EPS $0.49. Comparable FY2019 Q4 diluted EPS was $0.25.
Cash, liquidity, and obligations: Cash and cash equivalents were $226.8 million at year-end, down from $257.9 million. Working capital was $508.9 million. The company had no Revolver borrowings outstanding at year-end, with $750 million of revolving capacity maturing in September 2023; it drew and repaid $200 million during FY2020 amid pandemic uncertainty. Operating cash flow increased, while capital expenditures rose to $43.3 million. Total assets were $1.61 billion and total liabilities $225.9 million; reported liabilities include $67.0 million of long-term operating lease liabilities. Contractual obligations included $103.5 million of purchase commitments due within one year and $94.0 million of undiscounted operating lease payments. Management stated available cash, operating cash flow, credit availability, and financing capacity should meet anticipated needs for at least 12 months.
Backlog: $831.1 million at July 3, 2020, up from $625.4 million a year earlier; $567.7 million was expected to ship or invoice within 12 months. Backlog orders may be canceled or rescheduled.
Material changes and unusual items
- FY2020 included $64.0 million of acquired revenue, compared with $13.5 million in FY2019. Acquisition timing and the extra three days in FY2020 affect comparisons.
- APC was acquired for a net purchase price of $96.5 million, funded with cash. FY2020 included $27.4 million of APC revenue and $3.3 million of pretax income.
- Net income growth also reflected lower interest expense and a swing in other income/expense. FY2019 included $5.4 million of costs to terminate an interest-rate swap; FY2020 included investment gains, including $6.4 million of other investment income. FY2020’s 8.8% effective tax rate was affected by R&D credits and excess stock-compensation tax benefits.
- Cash used in investing activities was $135.5 million, including $96.5 million for APC and $43.3 million of property and equipment purchases. Inventory increased $41.0 million, partly due to demand and precautionary purchases related to potential COVID supply disruptions.
- FY2020 adjusted EBITDA and adjusted EPS are non-GAAP measures. Their adjustments include stock-based compensation, acquisition-related items, and COVID expenses; management cautions they are not substitutes for GAAP results.
Outlook, risks, and contingencies
The filing provides no specific FY2021 revenue or earnings guidance. Management described expected market growth and stated it intended to continue investing in facilities, including expansion of trusted custom microelectronics. It cited defense outsourcing, secure domestic microelectronics, and demand for electronic warfare, radar, and onboard processing as opportunities, while acknowledging uncertainty from COVID-19.
- Key risks include changes or delays in defense appropriations, program cancellations, government shutdowns or continuing resolutions, and dependence on a small number of prime contractors.
- COVID-19 could disrupt staffing, facilities, suppliers, customer performance, costs, cybersecurity, and defense budgets. The ultimate impact was described as uncertain.
- Several critical components are sole-sourced or available from limited suppliers; the company also relies on contract manufacturers. Supply disruption could delay deliveries or raise costs.
- Acquisition integration, goodwill and intangible-asset impairment, fixed-price contract cost estimates, cybersecurity and export compliance, competition, and retention of specialized personnel are material risks.
- Goodwill was $614.1 million and intangible assets $208.7 million. The annual goodwill impairment test found no impairment. The Swiss pension plan was underfunded by $11.9 million.
- Legal proceedings in the ordinary course were not expected by management to materially affect financial position, results, or cash flows. Certain product agreements include intellectual-property indemnities that may be unlimited.
- KPMG issued unqualified opinions on the financial statements and internal control over financial reporting. APC, representing approximately 7% of assets and 3% of revenue, was excluded from the internal-control assessment while integration was underway. The auditor identified estimates of total costs on fixed-price contracts recognized over time as a critical audit matter.
Important facts for investors to verify
- Whether backlog converts to revenue on schedule and whether cancellations or rescheduling increase.
- How much future growth and margin performance depends on organic demand versus acquisitions, and whether recent acquisitions deliver expected integration benefits.
- Whether gross-margin improvement persists amid rising R&D spending, COVID-related costs, and changing program mix.
- Whether the large customer concentration and exposure to defense appropriations or key programs change materially.
- Whether operating cash flow continues to cover capital investment, working-capital needs, and acquisition spending without additional borrowing or equity issuance.
- How fixed-price contract estimates, supplier concentration, goodwill, and APC’s integration into internal controls develop in subsequent filings.