Business context and reporting period
Mercury Systems, Inc. provides processing hardware, software and services for commercial, defense and intelligence applications. This unaudited Form 10-Q covers the quarter and nine months ended March 31, 2014; comparisons are with the same periods of fiscal 2013. The company reports two segments: Mercury Commercial Electronics (MCE) and Mercury Defense and Intelligence Systems (MDIS).
Financial results and liquidity
| Metric | Quarter ended March 31 | Nine months ended March 31 |
|---|---|---|
| Revenue, 2014 | $55.5 million | $162.5 million |
| Revenue growth year over year | 3% | 6% |
| Gross margin | 45.3%, versus 41.7% | 44.7%, versus 39.5% |
| Net income (loss), 2014 | $(0.6) million | $(3.9) million |
| Adjusted EBITDA, non-GAAP | $7.7 million, versus $5.2 million | $16.4 million, versus $7.9 million |
| Operating cash flow | $2.2 million, versus $1.7 million | $11.7 million, versus $(6.7) million |
| Free cash flow, non-GAAP | $1.1 million, versus $1.2 million | $6.7 million, versus $(9.0) million |
At March 31, 2014, cash and cash equivalents were $45.7 million, up from $39.1 million at June 30, 2013. Total assets were $373.6 million and total liabilities were $41.3 million. The company had no borrowings under its senior unsecured revolver, $66.1 million of borrowing capacity available and $4.1 million of outstanding letters of credit; it reported compliance with credit covenants. The filing says existing cash, operating cash generation and available financing should meet anticipated cash needs for at least 12 months.
Material changes and management commentary
- Quarterly revenue rose $1.4 million, driven by defense sales and programs including classified airborne, UAV, Aegis and Patriot. MCE revenue increased 4%; MDIS revenue fell 15%, reflecting lower DRFM jammer sales and customer funding delays.
- For the nine-month period, MCE revenue increased 17% to $128.8 million, while MDIS revenue decreased 24% to $32.7 million. Higher Aegis, Patriot, F-15 and UAV-related sales supported MCE; lower Gorgon Stare and DRFM jammer sales and funding delays weighed on MDIS.
- Management attributed improved gross margin to a more favorable mix, particularly recovery in higher-margin digital signal processing products. The nine-month comparison also benefited from a $2.1 million purchase-accounting charge in the prior-year period.
- Operating losses persisted: the quarter recorded a $1.8 million operating loss and the nine-month period a $7.8 million operating loss. Quarterly net results were also affected by $3.5 million of restructuring charges.
- Customer orders can vary by quarter and are not necessarily indicative of future orders. Lockheed Martin accounted for 19% of nine-month revenue; Aegis accounted for 16%.
Outlook, risks, contingencies and unusual items
The company announced an integration restructuring plan in January 2014, including elimination of 61 positions, closure of its Monroe, Connecticut facility and consolidation of operations in Hudson, New Hampshire. It expects approximately $5.4 million of additional restructuring expense, with completion expected by January 2015, and anticipates $16.0 million of gross annualized expense savings upon completion. These are management expectations, not guaranteed outcomes.
Management said it expects to be taxable and pay taxes in fiscal 2014 as temporary differences reverse. Net deferred tax assets were approximately $8.6 million; their realization depends on estimates of future taxable income and other factors. The company also disclosed $27.6 million of non-cancelable purchase commitments, primarily due within one year, and $2.8 million of liabilities for uncertain tax positions, including an expected $1.1 million payment within 12 months. Certain intellectual-property indemnification obligations may be unlimited. Routine litigation, claims, investigations and audits were not expected to materially affect financial position, results or cash flows.
Risks identified include defense-program funding and timing, customer order variability, competition, technology and product-mix changes, component shortages, production or quality delays, fixed-price contract cost overruns, acquisition and restructuring integration, export rules, and retention of key employees and customers. The filing reported no material change in previously disclosed risk factors or market-risk exposure.
Important facts for investors to verify
- Whether MCE growth and improved gross margins continue, and whether MDIS revenue and profitability recover from program declines and funding delays.
- Actual remaining restructuring costs, timing of completion and realization of the projected $16.0 million annualized savings.
- Cash conversion and working-capital trends, particularly receivable collections; nine-month operating cash flow improved, but the filing cites collection timing as a significant factor.
- Availability under the revolver and covenant compliance; the reported $66.1 million borrowing capacity is subject to facility terms and EBITDA-based limits.
- Assumptions supporting deferred tax asset realization and the timing and amount of uncertain-tax-position payments.
- Revenue concentration: major defense customers and the Aegis program represent meaningful exposure to individual customers and programs.