Mercury Systems, Inc. — Q2 FY2023 Form 10-Q
Reporting period: Second quarter and six months ended December 30, 2022. Amounts below are in U.S. dollars; financial statement amounts are in millions unless otherwise noted. Mercury supplies processing technologies and systems to aerospace and defense customers.
Financial performance and liquidity
| Metric | Q2 FY2023 | Q2 FY2022 | Six months FY2023 | Six months FY2022 |
|---|---|---|---|---|
| Revenue | $229.6 | $220.4 | $457.2 | $445.4 |
| Gross margin | 35.3% | 39.6% | 34.8% | 39.4% |
| Operating loss | $(7.5) | $(0.4) | $(14.7) | $(6.0) |
| Net loss | $(10.9) | $(2.6) | $(25.3) | $(9.8) |
| Diluted loss per share | $(0.19) | $(0.05) | $(0.45) | $(0.18) |
| Adjusted EBITDA (non-GAAP) | $35.7 | $38.1 | $66.9 | $76.4 |
| Adjusted EPS (non-GAAP) | $0.26 | $0.39 | $0.50 | $0.80 |
- Cash flow: Six-month operating cash flow was a use of $30.6 million, versus $4.8 million provided in the prior-year period. Capital expenditures were $20.5 million, producing non-GAAP free cash flow of negative $51.2 million, versus negative $8.6 million. Q2 operating cash flow was $35.4 million and free cash flow was $22.2 million.
- Balance sheet and debt: At December 30, 2022, cash was $76.9 million, long-term debt was $511.5 million, total assets were $2.35 billion, and shareholders’ equity was $1.54 billion. Debt was drawn under the $1.1 billion revolving credit facility, maturing February 2027. The company reported covenant compliance and $0.96 million of outstanding letters of credit.
- Liquidity and commitments: Current assets were $896.9 million and current liabilities were $200.6 million. Management said available cash, the revolver, operating cash generation, and financing capabilities should meet anticipated cash needs for at least 12 months. Purchase commitments totaled $142.9 million, all due within one year; operating lease commitments totaled $89.1 million.
Changes versus the comparable period
- Q2 revenue increased 4.2%; the filing attributes $7.2 million of the $9.2 million increase to acquired revenue and $2.0 million to organic growth. For six months, revenue increased 2.6%, including $19.0 million of acquired revenue, while organic revenue declined $7.3 million, or 2%.
- Gross margin fell 430 basis points in Q2 and 460 basis points for the six-month period. Management cited product/program mix, delayed customer funding on a large Foreign Military Sales program, more lower-margin development work, and $2.5 million of incremental depreciation.
- Six-month net loss widened to $25.3 million from $9.8 million. Higher interest expense—$11.1 million versus $1.7 million—reflected increased borrowings and interest rates. Adjusted EBITDA and adjusted EPS also declined year over year.
- Cash and cash equivalents rose by $11.3 million from July 1, 2022, mainly due to $60.0 million of net revolver borrowing, despite operating and capital-spending cash outflows. Inventory increased to $312.0 million from $270.3 million; management linked cash use partly to advance purchases intended to mitigate component and semiconductor supply risks.
Outlook, commentary, risks, and unusual items
- Demand visibility: Remaining performance obligations were $580.3 million at December 30, 2022; the company expects to recognize approximately 64% over the next 12 months. This is not full guidance, and the filing provides no clear numerical full-year revenue or earnings forecast.
- Strategic developments: On January 31, 2023, the board announced a review of strategic alternatives, including a potential sale; there is no assurance of a transaction. CFO Michael Ruppert was to step down effective February 17, 2023, with Chief Accounting Officer Michelle McCarthy serving as interim CFO. Management expected related review costs.
- Tax and accounting items: Q2 included a $2.3 million tax benefit from releasing reserves after a statute of limitations expired. The company estimated approximately $36 million of fiscal 2023 cash impact from required tax amortization of R&D costs. It also recorded a $3.1 million cumulative depreciation adjustment for an immaterial correction to useful lives of certain leasehold improvements.
- Restructuring: Six-month restructuring charges were $3.6 million, primarily tied to the 1MPACT organizational and facility initiative; the prior-year period included $16.1 million. Q2 charges included facility optimization, lease asset impairment, severance, and consulting costs.
- Contingencies and operating risks: An environmental matter involving alleged groundwater contamination and nearby PFAS detections at a former site remains unresolved; Mercury said its potential responsibility was too early to determine. The company also disclosed potentially unlimited intellectual-property indemnification obligations. Key stated risks include defense funding and order timing, supply-chain delays, inflation and labor availability, program execution, acquisition integration, interest rates, and retention of employees and customers during the strategic review.
- Other: A former sales representative’s arbitration claim seeking about $9 million in direct damages was resolved in January 2023 with an award of $72,000 in damages and fees. The company reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether organic revenue and gross margins recover, particularly as delayed customer funding and development-program mix change.
- Whether operating cash flow improves as inventory, unbilled receivables, billing milestones, and customer advances convert to cash.
- Revolver balance, borrowing costs, covenant headroom, and the effect of interest rates; only $300 million of borrowings was covered by the interest-rate swap at a fixed 3.79% rate.
- Progress and outcome of the strategic alternatives review, potential transaction costs, and the CFO transition.
- Resolution and potential exposure from the environmental matter, as well as execution of facility restructuring and the reported depreciation-life correction.
- Interpret non-GAAP adjusted EBITDA, adjusted EPS, and free cash flow alongside GAAP results; the filing notes these measures may not be comparable across companies and include adjustments for costs that may recur.