Mercury Systems, Inc. — FY2015 First Quarter 10-Q
Reporting period: Three months ended September 30, 2014; comparative period is the three months ended September 30, 2013. Mercury supplies sensor-processing products and services to commercial, defense, and intelligence customers. Results exclude Mercury Intelligence Systems (MIS), which was classified as discontinued operations after the company decided to divest it.
Financial performance
| Metric | Q1 FY2015 | Q1 FY2014 |
|---|---|---|
| Revenue | $54.1 million | $50.7 million |
| Gross margin | $24.0 million; 44.4% | $21.6 million; 42.5% |
| Operating income (loss) | $0.7 million | ($4.0 million) |
| Continuing-operations income (loss) | $0.7 million | ($2.3 million) |
| Net income (loss) | $0.5 million | ($2.3 million) |
| Operating cash flow | $2.2 million | $2.2 million |
| Capital expenditures | $0.9 million | $1.1 million |
| Free cash flow, as defined by the company | $1.3 million | $1.1 million |
Adjusted EBITDA, a non-GAAP measure, was $8.0 million versus $3.3 million. Diluted earnings per share were $0.02 versus a loss of $0.07. The company recorded no income tax expense or benefit in the current quarter, compared with a $1.3 million tax benefit in the prior-year quarter.
Liquidity, debt, and commitments
Cash and cash equivalents were $48.9 million at September 30, 2014, up from $47.3 million at June 30. Total liabilities were $46.5 million and shareholders’ equity was $330.4 million. There were no borrowings under the credit agreement; $86.6 million of borrowing capacity was available, with $3.8 million in letters of credit outstanding. The facility permits borrowings up to $200 million subject to a trailing-EBITDA formula, and Mercury reported compliance with its covenants.
Management said existing cash, expected operating cash flow, available credit, and financing capabilities should cover anticipated cash requirements for at least the next 12 months. Contractual obligations totaled $55.8 million, including $31.1 million of purchase commitments due within one year and $24.5 million of operating lease obligations.
Material changes and business developments
- Revenue grew 7%, driven by higher defense sales, partly offset by lower commercial sales. MCE revenue rose 12% to $48.6 million; MDS revenue fell 32% to $5.4 million, primarily due to lower radar environment test and simulation sales.
- Gross margin improved 190 basis points, attributed to product mix, recovery in higher-margin MCE digital signal processing, and facility consolidations. SG&A fell 14% and R&D fell 15%, reflecting integration-related cost reductions, lower headcount, and more customer-funded development.
- Adjusted EBITDA increased, with MCE at $7.3 million versus $2.3 million; MDS declined to $0.5 million from $1.1 million.
- International revenue declined to $10.4 million from $15.4 million and represented 19% of revenue, versus 30% in the prior-year quarter.
- Raytheon and Lockheed Martin represented 35% and 30% of revenue, respectively. Four named programs—SEWIP, Patriot, Aegis, and F-35—accounted for 57% of revenue.
Outlook, risks, and unusual items
The filing provides no specific revenue or earnings guidance. Management noted that customer delivery schedules and order patterns can cause quarter-to-quarter fluctuations and that one quarter’s orders generally do not indicate future trends. The 2014 integration restructuring plan generated $1.3 million of charges in the quarter; approximately $1.1 million of additional charges were expected, with related actions expected to finish by the second quarter of FY2015. Periodic nominal charges could continue through FY2017 if the company cannot sublease unused headquarters space.
Other unusual items included a $0.3 million write-off of an escrow receivable. The company is pursuing the MIS divestiture; MIS generated $1.8 million of revenue and a $0.2 million after-tax loss in the quarter. Key disclosed risks include defense-program funding and timing, customer order variability, fixed-price contract costs, component shortages and production delays, export and procurement rules, acquisition integration, and customer and program concentration. Management reported no material change in risk factors from its FY2014 10-K, no material market-risk change, and effective disclosure controls. Pending legal matters were not expected to have a material financial impact. Certain intellectual-property indemnities may be unlimited.
Most important facts for investors to verify
- Whether defense-program sales and customer concentration persist, particularly given the large Raytheon and Lockheed Martin shares and the contribution of four major programs.
- Whether MDS revenue and profitability recover from the decline in radar test and simulation sales.
- Progress, remaining costs, and expected proceeds or timing of the MIS divestiture; the filing provides no clear value for expected sale proceeds.
- Execution and total cost of the restructuring plan, including the headquarters sublease assumption.
- Cash conversion and working-capital trends: receivables and unbilled receivables increased, while deferred revenue and customer advances declined.
- Availability of credit and compliance with covenants, along with the company’s ability to meet purchase commitments and other obligations.