Business context and reporting period
Mercury Systems, Inc. filed this Form 10-Q for the quarter ended September 30, 2016, its first quarter of fiscal 2017. Mercury supplies secure processing and other electronics for defense and intelligence programs. The filing describes one operating and reportable segment.
Financial results and liquidity
| Metric | Quarter ended Sep. 30, 2016 | Prior-year quarter |
|---|---|---|
| Revenue | $87.6 million | $58.4 million |
| Gross profit / margin | $39.4 million / 45.0% | $28.3 million / 48.5% |
| Operating income / margin | $3.7 million / 4.3% | $3.1 million / 5.4% |
| Net income | $3.8 million | $2.9 million |
| Diluted EPS | $0.10 | $0.08 |
| Operating cash flow | $10.3 million | $6.6 million |
| Capital expenditures | $6.1 million | $1.9 million |
| Free cash flow (non-GAAP) | $4.2 million | $4.7 million |
Revenue increased 50%; $24.3 million came from the acquired Microsemi carve-out business and approximately $4.9 million from organic growth. The quarter included $18.2 million of adjusted EBITDA and $0.22 adjusted EPS, both non-GAAP measures. Cash and cash equivalents were $77.3 million at quarter-end. Term-loan principal outstanding was $197.5 million; the balance-sheet carrying value of debt was $190.2 million, net of unamortized issuance costs. The $100 million revolver had no borrowings, with $1.9 million of letters of credit outstanding. Mercury reported compliance with its credit covenants.
Material changes versus the prior-year quarter
- Gross margin declined 3.5 percentage points, primarily due to $2.1 million of acquired-inventory step-up amortization and product mix.
- Operating expenses rose, including higher SG&A and R&D from acquired-business headcount, and higher intangible amortization following acquisitions. Acquisition costs fell to $0.4 million from $2.1 million.
- Interest expense rose to $1.8 million following the May 2016 term loan. Net income nevertheless increased, supported in part by a $1.3 million income-tax benefit; the company cited a $2.2 million discrete benefit from excess tax benefits on stock compensation.
- Operating cash flow improved, but higher capital spending and financing uses—including $6.1 million for retirement of common stock and $2.5 million of debt principal payments—contributed to a $4.4 million decline in cash during the quarter.
Outlook, commentary, risks and contingencies
Management gave no specific revenue or earnings guidance. It said existing cash, operating cash flow, available revolver capacity and financing capabilities should cover anticipated requirements for at least 12 months. It expected approximately $13 million of capital expenditures in fiscal Q2 for the new headquarters, acquired businesses and integration activities. On November 3, 2016, Mercury signed an agreement to acquire CES Creative Electronic Systems for approximately $38 million, subject to adjustments and expenses, with closing expected in fiscal Q2 and funding expected from cash on hand.
The Carve-Out Business contributed $24.3 million of revenue and a $2.4 million net loss in the quarter. Its purchase-price allocation remained preliminary. Risks identified include defense-program funding and timing, customer order variability, fixed-price contract estimates, competition, component availability, acquisition integration and realizing expected synergies, and interest-rate changes. Lockheed Martin and Raytheon represented 25% and 15% of revenue, respectively. Non-cancelable purchase commitments totaled $39.3 million, all due within one year. The company said pending legal matters were not expected to have a material impact, but certain intellectual-property indemnification obligations may be unlimited. An IRS audit of fiscal 2013 remained open; uncertain tax benefits could decrease by up to $0.8 million within 12 months. Management reported effective disclosure controls and said it was integrating the acquired business into internal controls.
Most important facts for investors to verify
- Whether acquired-business integration, performance and margins improve, given its reported quarterly net loss and the quarter’s lower gross margin.
- Whether planned capital spending and the CES acquisition affect cash, debt repayment and revolver availability as expected.
- How much earnings growth reflects recurring operations versus discrete tax benefits and non-GAAP adjustments.
- Defense-program funding, customer concentration and order timing, and the company’s ability to meet purchase commitments while generating operating cash.