Mercury Systems, Inc. — Form 10-Q Summary
Reporting period: Second quarter and first six months of fiscal 2022, ended December 31, 2021. Comparisons are with the quarter and six months ended January 1, 2021. Amounts below are in millions unless noted.
Financial performance and liquidity
| Metric | Q2 FY22 | Q2 prior year | Six months FY22 | Six months prior year |
|---|---|---|---|---|
| Revenue | $220.4 | $210.7 | $445.4 | $416.3 |
| Gross margin | $87.2; 39.6% | $88.7; 42.1% | $175.6; 39.4% | $176.8; 42.5% |
| Operating income (loss) | $(0.4) | $18.1 | $(6.0) | $36.9 |
| Net income (loss) | $(2.6) | $12.7 | $(9.8) | $28.5 |
| Diluted EPS | $(0.05) | $0.23 | $(0.18) | $0.51 |
| Adjusted EBITDA (non-GAAP) | $38.1 | $45.3 | $76.4 | $88.1 |
| Operating cash flow | $6.8 | $23.9 | $4.8 | $46.9 |
| Free cash flow (non-GAAP) | $(1.2) | $10.2 | $(8.6) | $22.1 |
At December 31, cash and cash equivalents were $105.2; long-term debt was $451.5, all outstanding under a $750.0 revolving credit facility. The company reported compliance with facility covenants and $0.963 of outstanding letters of credit. Six-month investing cash outflow was $259.9, principally reflecting acquisitions; financing provided $246.5, including $251.5 of revolver borrowings. Total assets were $2,230.8 and shareholders’ equity was $1,487.1.
Material changes versus the prior comparable period
- Q2 revenue rose 4.6%, but included $37.5 of acquired revenue while organic revenue fell 13% to $182.9. For the six months, revenue increased 7.0%, with $78.8 of acquired revenue and a 12% decline in organic revenue.
- Gross margin fell 250 basis points in Q2 and 310 basis points for the six months. Management cited product and program mix, acquired POC business and higher customer-funded research and development (CRAD); lower direct COVID-related costs partly offset the decline.
- Operating results shifted from profit to loss. Higher amortization, restructuring and acquisition-related expenses contributed to the decline; six-month restructuring charges were $16.1 versus $2.2 in the prior period.
- Six-month operating cash flow decreased to $4.8 from $46.9, reflecting the net loss, cash costs associated with restructuring and acquisitions, higher unbilled receivables and lower deferred revenue/customer advances, among other factors.
- Revenue composition shifted: C4I increased while radar declined; modules and sub-assemblies grew, while components and integrated subsystems declined. Comparability is affected by acquisitions, including POC, Pentek, Avalex and Atlanta Micro.
Outlook, management commentary and risks
- Management said cash, expected operating cash generation, revolver availability and financing capabilities should meet anticipated requirements for at least the next 12 months. This is management’s assessment, not a guarantee.
- The 1MPACT initiative aims to realize growth, margin expansion and adjusted EBITDA potential over five years through organizational efficiency, procurement and supply-chain improvements, facilities optimization, R&D investment, capital efficiency, and common processes and systems. Management expected a further $3.7 of 1MPACT restructuring charges in fiscal Q3 2022.
- Remaining performance obligations were $441.7 at December 31, 2021; approximately 59% was expected to be recognized as revenue in the following 12 months. Orders and delivery timing can fluctuate, and management cautioned that quarterly customer orders are not necessarily indicative of future trends.
- During the period, Mercury acquired Avalex for a net purchase price of $154.0 and Atlanta Micro for $89.2, funded through the revolver. Purchase accounting valuations were preliminary. Their combined reported Q2 revenue was about $6.0, and their combined pre-tax losses were about $1.3.
- Key risks include defense-program funding and timing, customer order patterns, component shortages and production delays, acquisition integration and expected synergies, fixed-price program costs, interest rates, and employee retention. The filing also describes shareholder activism: JANA Partners and Starboard Value disclosed positions, and the board adopted a limited-duration shareholder rights plan.
- Contingencies include an arbitration claim seeking approximately $9.0 in direct damages, with treble damages requested on some claims, and environmental matters involving alleged groundwater contamination and PFAS near a former facility. The company said it intends to defend the arbitration claims; responsibility for the environmental matters was too early to determine.
- Non-GAAP adjusted EBITDA, adjusted EPS and free cash flow exclude specified items; the filing cautions these measures are not substitutes for GAAP results and may not be comparable with similarly titled measures at other companies.
Most important facts for investors to verify
- Whether organic revenue and margins stabilize, particularly as radar and integrated-subsystem revenue trends evolve.
- Whether 1MPACT delivers the stated growth and margin objectives, and the total cost and timing of implementation.
- Acquisition integration, preliminary purchase accounting, and the contribution and profitability of acquired businesses.
- Cash conversion and working-capital trends, including unbilled receivables, inventory, and the gap between adjusted EBITDA and free cash flow.
- Debt levels, revolver capacity and covenant compliance as acquisition funding needs and interest costs change.
- Developments in the arbitration, environmental matters, shareholder activism and related rights plan.