Business context and reporting period
Mercury Systems, Inc. supplies secure sensor and safety-critical mission-processing products and services for aerospace, defense, and intelligence customers. This unaudited Form 10-Q covers the fiscal third quarter and first nine months ended March 31, 2019; comparisons are with the corresponding 2018 periods. Results include acquisitions, so periods are not directly comparable.
Financial performance
Amounts are in millions of dollars except per-share data and percentages.
| Metric | Three months ended March 31 | Nine months ended March 31 |
|---|---|---|
| Revenue | $174.6; up 50% year over year | $477.8; up 40% |
| Gross margin | 42.3%, versus 45.4% | 43.2%, versus 46.3% |
| Operating income | $22.1, versus $6.8 | $55.7, versus $28.1 |
| Net income | $14.1, versus $3.7 | $34.0, versus $30.8 |
| Diluted EPS | $0.29, versus $0.08 | $0.71, versus $0.65 |
| Adjusted EBITDA (non-GAAP) | $38.8, versus $25.1 | $107.4, versus $76.9 |
| Operating cash flow | $26.2, versus $0.9 | $71.5, versus $17.7 |
| Free cash flow (non-GAAP) | $19.2, versus negative $2.6 | $53.7, versus $6.6 |
For the quarter, revenue growth comprised $33.0 million of organic growth and $25.3 million from acquired businesses. For the nine-month period, the respective contributions were $52.1 million and $85.3 million. GAAP net income for the nine months rose less than operating income, in part because the prior-year period included a $4.8 million tax benefit, while the current period recorded a $13.0 million tax provision.
Financial position and liquidity
- At March 31, 2019, cash and cash equivalents were $112.5 million, long-term debt was $276.5 million, and shareholders’ equity was $812.4 million. Current assets were $425.2 million versus current liabilities of $93.8 million.
- The $750 million revolving credit facility matures in September 2023. The company reported compliance with its covenants. A $175 million interest-rate swap fixes the rate on that portion of borrowings at 2.54%; remaining borrowings are exposed to variable rates.
- Nine-month investing cash outflow was $99.4 million, including $81.5 million for acquisitions and $17.9 million for property and equipment. Financing cash inflow was $73.9 million. Cash increased by $46.0 million from June 30, 2018.
- Remaining performance obligations were $162.0 million at March 31; the company expected to recognize approximately 58% as revenue in the next 12 months. This measure excludes qualifying contracts of one year or less and cancellable orders as described in the filing.
Material changes and management commentary
- Revenue gains reflected demand for integrated subsystems and components, including classified missile, SEWIP Block II, WIN-T, and CPS programs. Management cited lower revenue in certain programs, including Aegis and Patriot in the quarter; nine-month organic growth was partly offset by decreases in Aegis and SEWIP Block II.
- Gross margin declined 310 basis points in both comparison periods. Management attributed the decline mainly to acquired businesses with historically lower margins, program mix, and increased customer-funded engineering on long-term contracts; lower acquisition-related inventory step-up amortization partly offset these effects.
- Quarterly SG&A and R&D spending increased in dollars, but each declined as a percentage of revenue, which management associated with operating leverage and revenue growth.
- Acquisitions included Germane Systems and GECO Avionics during fiscal 2019. On April 18, 2019, after quarter-end, Mercury acquired Athena Group and Syntonic Microwave for a combined stated purchase price of $46.0 million, subject to adjustments, and drew $48.0 million on the revolver to fund the closings.
- Management stated that cash, operating cash generation, revolver availability, and financing capabilities should meet anticipated cash needs for at least the next 12 months. No specific revenue or earnings guidance is provided in the filing.
Risks, contingencies, and unusual items
- Acquisitions contributed materially to growth and increased debt; the company identified integration, realization of synergies, and acquired-business margins as relevant concerns. Preliminary purchase accounting for Germane and GECO remained subject to adjustment.
- Two customers, Lockheed Martin and Raytheon, represented 43% of quarterly revenue and 37% of nine-month revenue combined. Defense funding, program timing, customer order patterns, supply constraints, fixed-price execution, export controls, and geopolitical conditions are among the cited business risks.
- At March 31, purchase commitments totaled $76.3 million, all due within one year; operating lease commitments totaled $59.9 million. Certain intellectual-property indemnification obligations may be unlimited. Management did not expect pending ordinary-course legal matters to materially affect results or financial position.
- A securities class-action case filed in 2018 was voluntarily dismissed without prejudice in December 2018 and was no longer pending. The filing reports $0.3 million of litigation and settlement expense for the nine-month period.
- The filing describes adjusted EBITDA, adjusted EPS, and free cash flow as non-GAAP measures. It cautions that adjustments include costs that may recur and that these measures are not substitutes for GAAP results.
Important facts for investors to verify
- How much of reported revenue and earnings growth is sustainable organic growth versus acquisition contribution, and how acquired-business margins develop.
- Whether operating cash flow remains strong as receivables, contract assets, and inventory grow; contract assets were $55.9 million, up from $39.8 million at June 30, 2018.
- Debt and interest exposure following the post-quarter acquisitions, including revolver utilization, covenant headroom, and the effect of variable interest rates.
- Program-level demand and concentration in major defense customers, as well as funding, delivery, and supply-chain developments.
- Final purchase accounting for recent acquisitions and the assumptions behind remaining performance obligations and non-GAAP adjustments.