Mercury Systems, Inc. — Q3 FY2021 Form 10-Q
Reporting period: Third quarter and nine months ended April 2, 2021. Comparatives are the periods ended March 27, 2020. Amounts below are in millions unless stated otherwise.
Business context
Mercury supplies secure components, modules, and integrated subsystems to aerospace and defense customers, including defense contractors, the U.S. government, and commercial aerospace OEMs. It reported one operating and reportable segment. The quarter included a full period of results from Physical Optics Corporation (POC), acquired December 30, 2020; the nine-month period included POC results only from the acquisition date. Accordingly, comparisons are affected by the acquisition.
Financial performance
| Metric | Q3 FY2021 | Q3 FY2020 | Nine months FY2021 | Nine months FY2020 |
|---|---|---|---|---|
| Revenue | $256.9 | $208.0 | $673.2 | $579.2 |
| Gross margin | $105.6; 41.1% | $93.3; 44.9% | $282.4; 42.0% | $260.2; 44.9% |
| Operating income | $21.7; 8.5% | $26.3; 12.7% | $58.6; 8.8% | $64.6; 11.2% |
| Net income | $15.6 | $23.6 | $44.1 | $58.5 |
| Diluted EPS | $0.28 | $0.43 | $0.80 | $1.06 |
| Adjusted EBITDA (non-GAAP) | $54.8 | $47.1 | $142.8 | $126.6 |
| Adjusted EPS (non-GAAP) | $0.64 | $0.60 | $1.69 | $1.58 |
Q3 revenue rose 23.5%; management attributed $38.5 million to acquired revenue and $10.3 million to organic growth. Nine-month revenue rose 16.2%, including $47.3 million of organic growth and $46.6 million of acquired growth. Integrated subsystems and C4I contributed strongly; components, modules and sub-assemblies declined in the quarter. Despite higher sales, GAAP operating income and net income fell in both comparison periods, with gross margin down 380 basis points in Q3 and 290 basis points for nine months.
Management attributed margin pressure principally to POC-related customer-funded R&D, incremental COVID-related expenses, and program mix; operational efficiencies partly offset these effects. Q3 COVID-related expenses were $2.7 million and nine-month expenses were $8.4 million. SG&A as a percentage of revenue improved, while R&D spending increased to support growth initiatives.
Cash flow, debt, and liquidity
- Nine-month operating cash flow was $70.1 million, versus $86.5 million; free cash flow, a company-defined non-GAAP measure, was $35.3 million, versus $54.7 million.
- Investing cash outflow was $338.4 million, including $305.3 million for POC and $34.7 million of property and equipment purchases. Financing cash inflow was $163.1 million, including $160.0 million borrowed to help fund POC.
- At April 2, 2021, cash and cash equivalents were $121.9 million and long-term debt was $160.0 million. The $750 million revolving facility matures in September 2023; the company reported compliance with its covenants and $799,000 of outstanding letters of credit.
- Current assets were $626.9 million and current liabilities were $162.7 million. Inventory was $226.8 million, up from $178.1 million at July 3, 2020; contract assets (unbilled receivables and costs in excess of billings) were $138.4 million, up from $90.3 million.
- Management said existing cash, operating cash generation, available Revolver capacity, and financing capabilities should be sufficient for anticipated cash requirements for at least the next 12 months.
Material developments, outlook, and risks
- POC acquisition: Net purchase price was $305.3 million, funded with cash and Revolver borrowings. Preliminary purchase accounting recorded $168.2 million of goodwill and $114.0 million of identifiable intangible assets; estimates remain subject to adjustment. POC contributed $38.5 million of Q3 revenue and $1.1 million of pretax income.
- Orders and outlook: Remaining performance obligations were $352.2 million at quarter-end; the company expects approximately 70% to be recognized as revenue in the next 12 months. The filing does not provide clear quantified full-year revenue or earnings guidance. Management cited ongoing investment in facilities, R&D, and potential acquisitions.
- Operating and market risks: Management highlighted uncertainty around defense program funding and timing, COVID effects, supply-chain shortages, customer order patterns, program execution and fixed-price engagements, acquisition integration and synergies, competition, and employee retention. Quarterly defense orders may not indicate future trends.
- Other items: Nine-month restructuring charges of $2.2 million related primarily to eliminating 42 positions; $0.5 million of severance liability remained. Non-cancelable purchase commitments totaled $145.0 million, all due within one year. Ordinary-course litigation was not expected by management to materially affect results or financial position, though certain IP indemnification obligations may be unlimited. Disclosure controls were deemed effective; integration of POC into financial controls was ongoing.
Important facts for investors to verify
- Whether organic growth persists after separating it from POC’s acquired contribution, and whether the expected POC benefits and synergies are realized.
- Whether gross margins recover as customer-funded development, program mix, and COVID-related costs change.
- How inventory, contract assets, and operating cash flow evolve, given inventory purchases and rising unbilled balances.
- Whether the $352.2 million remaining performance obligations convert to revenue on the stated schedule and are supported by customer funding and delivery execution.
- How acquisition spending, facility investments, and Revolver borrowings affect liquidity and leverage; review the company’s non-GAAP adjustments alongside GAAP results.
- Customer concentration: Raytheon Technologies represented 18% of Q3 revenue and Lockheed Martin 14%; the U.S. Navy represented 16%.