Mercury Systems, Inc. — Form 10-Q Summary
Reporting period: Fiscal second quarter and six months ended December 31, 2012. Unless stated otherwise, financial amounts are in U.S. dollars in millions. Mercury supplies embedded signal- and image-processing systems, RF and microwave products, software, and services, primarily for defense and intelligence customers.
Financial performance
| Metric | Quarter ended Dec. 31, 2012 | Prior-year quarter | Six months ended Dec. 31, 2012 | Prior-year six months |
|---|---|---|---|---|
| Revenue | $49.8 | $68.0 | $99.2 | $117.1 |
| Gross margin | $17.6; 35.3% | $40.9; 60.2% | $38.0; 38.3% | $70.8; 60.5% |
| Operating income (loss) | $(7.1) | $13.5 | $(18.3) | $17.1 |
| Net income (loss) | $(4.8) | $9.0 | $(12.0) | $11.7 |
| Diluted earnings (loss) per share | $(0.16) | $0.30 | $(0.40) | $0.39 |
| Adjusted EBITDA | $1.0 | $18.8 | $2.6 | $27.6 |
Revenue fell 27% for the quarter and 15% year to date. Management attributed the decline mainly to reduced organic Advanced Computing Solutions (ACS) defense revenue amid lower program activity and uncertainty over U.S. defense funding. Acquisitions partly offset the decline. Gross margin contracted sharply because of lower revenue and a less favorable mix, including acquired businesses with lower margins than Mercury’s organic digital-computing business. Management said it expects long-term gross margins to be in line with a 45% target.
Research and development expense declined year over year following cost reductions; amortization increased following acquisitions. Six-month operating expenses included $5.2 million of restructuring charges. The six-month tax benefit was $5.8 million; management expected an additional $1.2 million tax benefit in the second half of fiscal 2013 from the retroactive extension of research and development tax credits.
Cash, liquidity, and debt
- Cash and cash equivalents were $33.9 million at December 31, 2012, down from $116.0 million at June 30, 2012. Current assets were $143.8 million and current liabilities $35.3 million.
- For the six months, operating cash flow was negative $8.4 million, versus positive $15.2 million a year earlier. Capital expenditures were $1.7 million; reported free cash flow was negative $10.1 million.
- Investing cash outflow was $69.8 million, including $67.7 million paid net of cash acquired for Micronetics. Mercury also paid $6.6 million to settle Micronetics’ debt.
- Mercury entered a five-year, $200 million senior unsecured revolving facility in October 2012 and terminated its former secured facility. At December 31, there were no revolver borrowings, $3.0 million of letters of credit, and $77.0 million of stated borrowing capacity. The company reported compliance with its covenants.
- Contractual obligations totaled $27.5 million, including $12.6 million of purchase commitments due within one year. The filing also identifies $2.6 million of uncertain tax-position liabilities and expects $0.6 million of payments within 12 months.
Material changes, outlook, and risks
- Micronetics acquisition: Closed August 8, 2012, for a net purchase price of $68.2 million, funded with cash. Preliminary purchase accounting included $46.5 million of goodwill and $18.5 million of identifiable intangibles; valuations remained subject to adjustment. Micronetics contributed $14.4 million of revenue and a $4.5 million net loss during the six-month period.
- Restructuring: The fiscal 2013 plan eliminated 142 positions, primarily in engineering, manufacturing, and administration, partly in connection with Micronetics integration. Management expected approximately $25 million in annualized savings from fiscal 2012 and 2013 cost reductions. It anticipated about $0.2 million of additional fiscal 2013 restructuring expense, alongside about $0.4 million remaining under the prior plan.
- Segment trends: Six-month ACS revenue declined 26% to $81.3 million; MFS revenue increased 90% to $17.8 million, helped by the PDI acquisition. Adjusted EBITDA fell substantially in both segments compared with the prior year.
- Key risks: Management highlighted potential defense-budget sequestration and funding delays, changing customer orders and product mix, program delays, component shortages, acquisition integration and synergy execution, and fixed-price contract costs. The company noted that customer orders can fluctuate and may not indicate future demand. Northrop Grumman accounted for 13% of quarterly revenue and 12% year-to-date; no single program reached 10% of current-period revenue.
- Contingencies and controls: A DOJ investigation concerning former PDI employees was settled, with PDI released from civil monetary claims and no admission of liability; Mercury reported indemnification for the matter. Other ordinary-course legal matters were not expected to have a material impact. Management reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether defense-program funding and orders stabilize, and how much of the revenue decline is temporary versus sustained.
- Whether the stated $25 million annualized restructuring savings are achieved and whether integration or further restructuring costs arise.
- Micronetics’ final purchase accounting, contribution to margins and earnings, and integration performance.
- Cash generation and working-capital trends, particularly given negative six-month operating cash flow and the sharp decline in cash.
- Actual availability under the revolver, covenant headroom, and the company’s ability to sustain liquidity if operating performance remains weak.
- Progress toward the long-term 45% gross-margin target and the assumptions behind the expected tax benefits.