Business context and reporting period
Mercury Systems, Inc. supplies secure sensor and mission-processing subsystems, primarily for defense and intelligence applications. This unaudited Form 10-Q covers the quarter and nine months ended March 31, 2017. Comparisons with 2016 are not like-for-like: 2017 includes the acquired Carve-Out Business and CES, neither of which was included in the comparable 2016 results.
Financial performance and position
| Metric | Three months ended March 31 | Nine months ended March 31 |
|---|---|---|
| Revenue | $107.3 million, up 63% | $293.0 million, up 59% |
| Gross margin | 47.3%, versus 47.7% | 47.0%, versus 48.4% |
| Operating income | $11.7 million; 11.0% margin | $24.4 million; 8.3% margin |
| Net income | $7.0 million, versus $4.4 million | $16.1 million, versus $12.3 million |
| Diluted EPS | $0.16, versus $0.13 | $0.39, versus $0.36 |
| Adjusted EBITDA (non-GAAP) | $25.0 million, versus $14.6 million | $66.1 million, versus $39.0 million |
For the nine months, operating cash flow was $49.4 million, compared with $23.2 million; capital expenditures were $26.8 million, producing reported free cash flow (non-GAAP) of $22.6 million, versus $18.3 million. Cash and cash equivalents were $270.2 million at March 31, 2017, up from $81.7 million at June 30, 2016, largely reflecting $215.7 million in net equity-offering proceeds. Gross term-loan principal was $192.5 million; the balance-sheet carrying value of current and long-term debt totaled $186.1 million after unamortized issuance costs. The $100 million revolving facility had no borrowings and $94.8 million available after letters of credit. The company reported compliance with debt covenants.
Material changes and unusual items
- Management attributed $25.9 million of quarterly and $76.1 million of nine-month revenue to the Carve-Out Business, and $6.4 million and $10.3 million, respectively, to CES. Reported organic revenue growth was $9.1 million for the quarter and $21.9 million for the nine months.
- Gross margin declined year over year. Management cited product mix and acquisition-related inventory step-up amortization of $0.3 million for the quarter and $3.2 million for the nine months.
- Interest expense rose to $1.9 million for the quarter and $5.6 million for the nine months, mainly due to the term loan entered into in May 2016. The February 2017 equity offering sold 6.9 million shares for net proceeds of $215.7 million, increasing shares outstanding.
- On April 3, 2017, after quarter-end, Mercury acquired Delta Microwave for $40.5 million, subject to adjustments, funded with cash on hand.
Outlook, risks, and contingencies
No specific revenue or earnings guidance is provided. Mercury expected fourth-quarter fiscal 2017 capital expenditures of approximately $7–8 million and stated that available cash, operating cash flow, borrowing capacity, and financing options should cover anticipated requirements for at least 12 months. Management cautioned that customer orders can fluctuate and may not predict future orders. Key risks include defense-program funding and timing, customer order patterns and product mix, competition, component shortages and production delays, fixed-price contract cost estimates, and integrating acquisitions and realizing expected benefits.
Two customers, Lockheed Martin and Raytheon, represented 41% of quarterly revenue and 39% of nine-month revenue combined. Non-cancelable purchase commitments totaled $36.7 million, primarily due within one year. The company said pending legal matters were not expected to have a material impact, but certain intellectual-property indemnities may be unlimited. The IRS was auditing fiscal 2013; unrecognized tax benefits could decrease by up to $0.8 million within 12 months, with no expected effective-tax-rate impact if recognized. Acquisition purchase-price allocations remained preliminary. Management reported effective disclosure controls; integration of the Carve-Out Business and CES into internal controls was ongoing.
Important facts for investors to verify
- How much future growth is organic versus attributable to acquisitions, and whether acquired businesses improve margins and cash generation.
- Whether gross-margin pressure, including product mix and purchase-accounting inventory costs, persists.
- Cash conversion and capital needs, including acquisition spending, debt repayments, and the $36.7 million purchase commitment.
- Customer and program concentration, defense funding and delivery timing, and the successful integration of recent acquisitions.
- How non-GAAP adjusted EBITDA, adjusted EPS, and free cash flow reconcile to GAAP results; these measures exclude costs the company expects may recur.