Mercury Systems, Inc. — Form 10-Q Summary
Reporting period: Fiscal second quarter and six months ended December 27, 2019; comparisons are to the periods ended December 31, 2018. Amounts below are in millions except per-share data. Mercury supplies secure, mission-critical technology and systems to aerospace and defense customers.
Financial performance
| Metric | Q2 FY2020 | Q2 prior year | Six months FY2020 | Six months prior year |
|---|---|---|---|---|
| Revenue | $193.9 | $159.1 | $371.2 | $303.1 |
| Gross margin | 45.6% | 44.6% | 45.0% | 43.7% |
| Operating income | $20.8 | $19.9 | $38.3 | $33.7 |
| Net income | $15.7 | $12.4 | $34.9 | $19.9 |
| Diluted EPS | $0.29 | $0.26 | $0.63 | $0.42 |
| Adjusted EBITDA (non-GAAP) | $42.8 | $37.0 | $79.5 | $68.6 |
| Adjusted EPS (non-GAAP) | $0.54 | $0.47 | $0.98 | $0.86 |
| Operating cash flow | Not separately reported | Not separately reported | $56.4 | $45.3 |
| Free cash flow (non-GAAP) | $20.7 | $18.2 | $35.5 | $34.5 |
Balance sheet and liquidity
- Cash and cash equivalents were $182.0 at December 27, down from $257.9 at June 30, 2019. The decrease primarily reflected the APC acquisition, capital spending, and share repurchases used to settle employee tax liabilities.
- Current assets were $545.1 and current liabilities $107.9. Total assets were $1,512.6; total liabilities were $195.6 and shareholders’ equity was $1,317.1.
- No borrowings were outstanding under the $750 million revolving credit facility, which matures in September 2023. The company reported covenant compliance and $1.1 million of letters of credit outstanding.
- Six-month capital expenditures were $20.9. The company said cash, operating cash generation, available credit and financing capabilities should cover anticipated cash requirements for at least the next 12 months.
Material changes and operating drivers
- Revenue increased 21.9% in Q2 and 22.5% for the six-month period. Management attributed the growth to organic demand and acquisitions. Organic revenue grew 12% in Q2 and 14% in the six-month period; acquired revenue contributed $16.3 million and $35.6 million, respectively. Comparability is affected by the timing of multiple acquisitions.
- Management cited stronger demand in radar and electronic warfare components and modules in Q2, and in integrated subsystems and components across electronic warfare, other sensor and effector, and C4I applications for the six months. Program gains included Filthy Badger, F16/SABR, P8, SEWIP Block II, AIDEWS and a classified missile program; F-35 and other program declines partly offset growth.
- Gross margin improved 100 basis points in Q2 and 130 basis points for the six months, primarily due to program mix, operational efficiencies, lower customer-funded R&D and contributions from Athena and APC. Q2 included $0.6 million of APC inventory step-up expense.
- R&D rose 52.5% in Q2 and 49.5% for the six months, reflecting organic and acquired headcount and continued investment. Operating income grew more slowly than revenue; operating margin was 10.7% in Q2 versus 12.5% prior year and 10.3% for six months versus 11.1%.
- Net income benefited from lower interest expense and unusually large stock-compensation tax benefits in the six-month period. The six-month tax provision included a $6.5 million discrete tax benefit; the prior-year period included a $1.7 million benefit.
Outlook, risks and unusual items
- Remaining performance obligations were $297.6 million at December 27, 2019; management expected approximately 77% to be recognized as revenue within 12 months. This measure excludes certain short-duration and cancellable orders.
- No specific revenue or earnings guidance was provided in the supplied filing text. Management noted that customer order timing can cause quarter-to-quarter fluctuations and that a quarter’s orders may not indicate future demand.
- The company acquired American Panel Corporation for a net purchase price of $96.5 million, funded with cash. APC contributed $9.7 million of Q2 revenue and $1.5 million of pretax income. Its purchase-price allocation remained preliminary. Recent acquisitions also generated restructuring, acquisition, amortization and purchase-accounting costs; management expects acquisition-related costs to recur periodically.
- Near-term commitments included $97.1 million of non-cancelable purchase obligations, generally due within one year, and operating lease obligations. Product agreements may include intellectual-property indemnities whose potential payments are unlimited in some cases.
- Management identified risks including defense-program funding and timing, government shutdowns or continuing resolutions, order and product-mix changes, program delays, component shortages, fixed-price contract costs, acquisition integration and synergy execution, export-control and procurement rules, cybersecurity requirements, and retaining key employees and customers. The filing reported no material change to previously disclosed risk factors.
- Ordinary-course litigation was not expected to materially affect financial position, results or cash flows. The company reported no material change in market-risk exposure and stated that disclosure controls were effective; integration of APC into internal controls was ongoing.
Important facts for investors to verify
- How much reported growth and margin improvement is sustainable organically, apart from acquired revenue and purchase-accounting effects.
- Whether the large discrete stock-compensation tax benefit and lower interest expense are repeatable; GAAP and adjusted earnings differ materially.
- Cash conversion and investment needs, including the effects of acquisition spending, higher capital expenditures, inventory and contract assets, and employee tax-related share repurchases.
- Execution and integration of APC and other acquisitions, including final purchase-price allocations and expected synergies.
- Customer and program concentration: Lockheed Martin and Raytheon each represented 16% of Q2 revenue; together with Northrop Grumman, the three represented 42%. For six months, four customers represented 53%.
- Conversion and timing of the $297.6 million remaining performance obligations, and the extent to which excluded cancellable or short-duration orders affect visibility.