Mercury Systems, Inc. — FY2018 Form 10-K
Reporting period: Fiscal year ended June 30, 2018. The filing also provides unaudited fourth-quarter results; fiscal Q4 is the three months ended June 30, 2018. Unless stated otherwise, amounts below are in U.S. dollars.
Business context and reporting period
Mercury supplies secure sensor-processing and safety-critical mission-processing products and subsystems, primarily to defense prime contractors. Its offerings include embedded computing, avionics, RF and microwave products, rugged servers, and related engineering and integration services. Approximately 96% of FY2018 revenue was tied to defense customers or programs. The company reported one operating segment.
Key financial metrics
| Metric | FY2018 | FY2017 |
|---|---|---|
| Revenue | $493.2 million | $408.6 million |
| Gross margin | 45.8% | 46.9% |
| Operating income / margin | $47.0 million / 9.5% | $37.4 million / 9.2% |
| Net income | $40.9 million | $24.9 million |
| Diluted EPS | $0.86 | $0.58 |
| Adjusted EBITDA (non-GAAP) | $115.4 million | $93.9 million |
| Cash from operations | $43.3 million | $59.1 million |
| Free cash flow (non-GAAP) | $28.2 million | $26.3 million |
FY2018 revenue grew 21% year over year; organic revenue grew 7%, with acquired revenue contributing $59.7 million. Net income rose about 64%. Adjusted EPS was $1.42 versus $1.15, a non-GAAP measure. Gross margin declined 110 basis points, primarily due to product mix, partly offset by lower acquired-inventory step-up amortization.
For fiscal Q4 2018, revenue was $152.9 million, gross margin was approximately 44.6%, operating income was $18.9 million, net income was $10.1 million, and diluted EPS was $0.21. Compared with Q4 FY2017, revenue increased from $115.6 million and operating income from $13.0 million; gross margin was approximately 46.6% in Q4 FY2017.
At June 30, 2018, cash and cash equivalents were $66.5 million, working capital was $260.1 million, and long-term debt was $195.0 million. The $400 million revolving facility expires in June 2022; $2.8 million of letters of credit were also outstanding. Current assets were $331.7 million and current liabilities $71.7 million. The company reported total assets of $1.064 billion and shareholders’ equity of $771.9 million.
Material changes versus the prior comparable period
- Revenue growth reflected higher activity on F-35, Aegis, MoDREx, PGK, and E2D Hawkeye programs, along with acquired revenue. Lower revenue from a large ground-based radar program partly offset growth.
- FY2018 included Themis, acquired in February 2018, and RTL, acquired in July 2017. Themis contributed $27.2 million of revenue and $1.3 million of pretax income after acquisition.
- Operating cash flow fell $15.8 million, mainly due to higher cash uses for taxes, receivables, payables, and inventory. Free cash flow increased modestly, partly reflecting lower capital expenditures.
- Investing cash outflow increased to $200.9 million, including $185.4 million for acquisitions. Financing cash flow included $195.0 million of net revolver borrowings.
- Research and development spending increased to $58.8 million, but declined as a share of revenue to 11.9% from 13.2%. Amortization of acquired intangibles rose to $26.0 million.
- The effective tax rate was 4.0%, versus 19.9% in FY2017, reflecting tax benefits including stock-based compensation and acquired tax attributes, as well as the Tax Act. Management cautions that the actual rate may vary.
Outlook, commentary, risks, contingencies, and unusual items
- The filing does not provide a clear numerical FY2019 revenue or earnings guidance. Management stated that cash, expected operating cash flow, available revolver capacity, and financing options should meet anticipated cash needs for at least 12 months.
- Management identified defense electronics outsourcing, secure processing, sensor data growth, and upgrades to existing platforms as market opportunities. These are expectations, not guaranteed outcomes.
- Backlog was $447.1 million at June 30, 2018, of which $328.5 million was expected to ship within 12 months. Orders may be canceled, reduced, or delayed; the company warns backlog is not a reliable indicator of future revenue.
- Customer concentration remains material: Lockheed Martin and Raytheon each represented 19% of FY2018 revenue; the three largest prime contractors together represented 47%. Radar applications were 32% of revenue. Government appropriations, program delays or terminations, and customer order timing are key risks.
- Acquisition integration and leverage warrant attention. Goodwill was $497.4 million and identifiable intangible assets were $177.9 million. Themis integration was ongoing, and its internal controls were excluded from management’s FY2018 controls assessment; management planned integration during FY2019.
- After year-end, Mercury acquired Germane Systems on July 31, 2018, for $45 million, funded through the revolver. The company also drew an additional $45 million on the revolver for this acquisition after June 30.
- A securities class action was filed July 10, 2018, alleging misleading public disclosures for October 24, 2017–April 24, 2018. Mercury considers the claims without merit and intends to defend itself. Management did not expect ordinary-course pending legal matters to have a material financial effect.
- Other notable items include $3.2 million of restructuring charges, primarily related to the elimination of 38 positions, and $2.5 million of acquisition-related expenses. The company reported effective disclosure controls and internal control over financial reporting; the auditor issued an unqualified opinion.
Important facts for investors to verify
- Check whether organic growth, backlog conversion, and demand on key programs persist, particularly given customer concentration and the decline in radar’s revenue share.
- Assess the drivers and sustainability of reported earnings, including non-GAAP adjustments, acquisition-related amortization and costs, and the unusually low FY2018 effective tax rate.
- Monitor operating cash conversion, inventory and receivables growth, capital spending, and borrowing following the Germane acquisition.
- Track gross-margin trends and whether product mix, integration costs, and acquired businesses affect profitability.
- Review Themis and Germane integration progress, expected synergies, goodwill and intangible-asset assumptions, and completion of Themis controls integration.
- Follow the securities litigation and any developments that could alter the company’s assessment of legal exposure.