Mercury Systems, Inc. — Q2 FY2018 Form 10-Q
Reporting period: Quarter and six months ended December 31, 2017. The company supplies secure sensor and mission-processing electronics primarily to defense prime contractors. Results are unaudited; figures below are in U.S. dollars.
Financial performance
| Metric | Q2 FY2018 | Q2 FY2017 | Six months FY2018 | Six months FY2017 |
|---|---|---|---|---|
| Revenue | $117.9m | $98.0m | $224.0m | $185.7m |
| Gross margin | 45.9% | 48.3% | 46.8% | 46.8% |
| Operating income | $10.9m | $9.0m | $21.3m | $12.7m |
| Net income | $9.1m | $5.2m | $27.1m | $9.0m |
| Diluted EPS | $0.19 | $0.13 | $0.57 | $0.23 |
| Adjusted EBITDA (non-GAAP) | $26.9m | $23.0m | $51.9m | $41.2m |
| Adjusted diluted EPS (non-GAAP) | $0.28 | $0.30 | $0.65 | $0.52 |
Cash flow: For the six months, operating cash flow was $16.8m, down from $24.5m; capital spending was $7.6m, producing reported free cash flow of $9.2m versus $10.8m. Cash fell $9.6m to $32.0m. Working-capital uses included a $22.5m inventory increase and higher receivables/unbilled balances.
Liquidity and debt: At December 31, current assets were $268.9m and current liabilities $74.3m. The company had a $400m revolving credit facility expiring in June 2022 and reported no revolver borrowings at quarter-end, with $2.8m in letters of credit. After quarter-end, it drew $195m to fund the February 1, 2018 Themis acquisition. Total assets were $835.8m and shareholders’ equity $749.2m at quarter-end.
Changes and operating drivers
- Q2 revenue rose 20%; management attributed growth to Falcon Edge, SEWIP and E2D Hawkeye, as well as acquired revenue. Organic revenue grew 12% in Q2 and 9% for the six-month period under the company’s definition.
- Q2 gross margin declined 240 basis points, primarily due to a customer’s large last-time component buy and lower F-35 royalty revenue; lower acquired-inventory step-up amortization partly offset the decline. Six-month gross margin was unchanged year over year.
- Six-month operating margin improved to 9.5% from 6.9%, helped by revenue growth and lower operating expenses as a percentage of sales. Acquisitions increased headcount-related SG&A and R&D costs.
- Q2 diluted weighted-average shares increased to 47.4m from 40.0m, affecting per-share comparability.
Outlook, unusual items and risks
- No numerical revenue or earnings guidance is provided. Management said cash, operating cash generation, available revolver capacity and financing capabilities should meet anticipated cash requirements for at least the next 12 months; it also expects to continue pursuing acquisitions and strategic alliances.
- The February 1, 2018 acquisition of Themis was completed for $180m plus an estimated working-capital and cash adjustment, funded by the $195m revolver draw. The preliminary purchase-price allocation was not yet complete.
- The Tax Cuts and Jobs Act reduced the federal corporate rate to 21%, phased in at approximately 28% for FY2018. The six-month $7.0m tax benefit included discrete stock-compensation and acquired tax-attribute benefits; the filing describes tax amounts as provisional and subject to further evaluation.
- The company began factoring eligible receivables under a program capped at $30m; it factored $18.8m in Q2. Six-month factoring fees were $69,000. Factoring is treated as a sale and its cash flows are classified as operating activities.
- Customer and program demand can vary by quarter. The three largest customers represented 49% of Q2 revenue. Disclosed risks include defense funding and order timing, competition, component shortages, fixed-price contract cost estimates, acquisition integration and synergy realization, and tax-law changes.
- Purchase commitments totaled $50.7m, all due within one year; operating lease obligations totaled $70.3m. The company said ordinary-course legal matters were not expected to have a material financial impact. It also disclosed that some intellectual-property indemnification obligations may be unlimited.
Important facts for investors to verify
- Whether Q2 gross-margin pressure from product mix, last-time buys and F-35 royalties persists.
- How much reported growth is organic versus acquired, and whether acquired businesses deliver expected benefits.
- The post-acquisition debt balance, interest expense, covenant headroom and liquidity after the $195m revolver draw.
- Whether working-capital demands—especially inventory and receivables—and factoring affect sustainable operating cash flow.
- The final tax effects of the Tax Act and whether the discrete tax benefits underlying six-month net income recur.
- Revenue concentration among major defense customers and exposure to program funding, order timing and contract execution.