Mercury Systems, Inc. — Form 10-Q Summary
Reporting period: Fiscal second quarter and six months ended December 31, 2014; filed February 5, 2015. Comparisons are with the corresponding prior-year periods. Amounts below are in millions unless stated otherwise.
Business context
Mercury supplies secure and sensor-processing subsystems for defense and intelligence applications. Continuing operations comprise Mercury Commercial Electronics (MCE) and Mercury Defense Systems (MDS). The Mercury Intelligence Systems (MIS) segment is reported as discontinued operations; its sale closed January 23, 2015.
Financial performance
| Metric | Quarter ended Dec. 31, 2014 | Quarter prior year | Six months ended Dec. 31, 2014 | Six months prior year |
|---|---|---|---|---|
| Revenue | $57.1 | $50.9 | $111.2 | $101.7 |
| Gross margin | 47.4% | 47.8% | 45.9% | 45.1% |
| Operating income (loss) | $3.5 | $(1.7) | $4.3 | $(5.7) |
| Income (loss) from continuing operations | $2.9 | $(0.8) | $3.6 | $(3.1) |
| Net income (loss) | $0.3 | $(1.0) | $0.8 | $(3.3) |
| Diluted earnings (loss) per share | $0.01 | $(0.03) | $0.02 | $(0.11) |
| Adjusted EBITDA (non-GAAP) | $10.7 | $5.2 | $18.7 | $8.6 |
- Quarterly revenue increased 12%; six-month revenue increased 9%. Growth was driven mainly by defense programs including Patriot, SEWIP and F-35.
- MCE revenue rose 22% for the quarter and 17% for six months. MDS revenue fell 44% and 38%, respectively, mainly due to lower Gorgon Stare sales; six-month results also reflected lower radar environment test and simulation sales.
- Quarterly gross margin declined 0.4 percentage points, reflecting product mix; six-month gross margin improved 0.8 points, supported by higher-margin MCE digital signal processing products.
- Operating expenses decreased year over year as SG&A fell with integration savings and R&D expense declined, partly because more development was customer-funded. Six-month restructuring charges were $2.4 million versus less than $0.1 million in the prior period.
- Net income included a $2.6 million quarterly and $2.8 million six-month loss from discontinued operations. These losses included a $2.3 million goodwill impairment at MIS following buyer negotiations.
Cash flow, balance sheet and liquidity
- Six-month operating cash flow was $10.4 million, versus $9.5 million. Capital expenditures were $2.1 million, resulting in reported non-GAAP free cash flow of $8.3 million, versus $5.6 million.
- Cash and cash equivalents rose to $57.0 million from $47.3 million at June 30, 2014. Total assets were $385.4 million and total liabilities $51.2 million at December 31, 2014.
- No credit-facility borrowings were outstanding. The company reported $101.4 million of borrowing capacity under a facility with a stated maximum of $200 million, subject to trailing-four-quarter EBITDA; $3.9 million of letters of credit were outstanding. The company said it was covenant-compliant.
- Current assets were $179.0 million and current liabilities $39.5 million. Non-cancelable purchase commitments totaled $34.3 million, all due within one year; operating lease commitments totaled $23.5 million.
- Management said cash, operating cash generation and available credit should meet anticipated requirements for at least the next 12 months. It reported no material capital expenditure commitments.
Outlook, risks and unusual items
- The filing provides no numerical revenue or earnings guidance. Management cautioned that customer order patterns and delivery timing can vary by quarter and are not necessarily predictive.
- Demand and funding for defense programs, U.S. government procurement and export rules, competition, technical and production delays, component availability, fixed-price contract costs, and integration or divestiture execution are identified risks.
- Customer concentration is notable: Raytheon represented 36% of quarterly revenue and 35% for six months; Lockheed Martin represented 18% and 24%, respectively. Aegis, Patriot and F-35 were among programs representing at least 10% of revenue in applicable periods.
- The company completed its integration restructuring plan during the quarter. Some periodic charges may continue through fiscal 2017 if it cannot sublease unused headquarters space.
- The MIS sale closed after quarter-end for a price approximating the business’s net book value after the impairment. Management stated pending legal matters were not expected to materially affect financial position, results or cash flows; the company was also under IRS audit for fiscal 2013.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. It reported no material change in market-risk exposure.
Key facts for investors to verify
- Whether MCE growth and defense-program demand can offset continuing weakness in MDS and variability in customer orders.
- Whether reported operating improvement and cash generation are sustainable, given working-capital timing, restructuring costs and reliance on non-GAAP adjusted EBITDA.
- The realized proceeds and final accounting for the MIS divestiture, including any post-sale adjustments or obligations.
- Exposure to major customers and programs, and the status of defense funding, contract schedules and fixed-price cost estimates.
- Capacity under the credit facility after applying its EBITDA-based borrowing limit, and the company’s ability to meet near-term purchase and lease commitments.