Mercury Systems, Inc. — FY2013 Form 10-K
Business context and reporting period. Mercury supplies embedded sensor-processing, RF/microwave, electronic-warfare and intelligence-data systems, software and services, primarily to defense contractors and government customers. This annual report covers the fiscal year ended June 30, 2013; fiscal Q4 ended on that date. The company reported two segments: Mercury Commercial Electronics (MCE) and Mercury Defense and Intelligence Systems (MDIS).
Financial performance
| Metric | FY2013 | FY2012 |
|---|---|---|
| Revenue | $208.8 million | $244.9 million |
| Gross margin | $82.7 million; 39.6% | $136.2 million; 55.6% |
| Operating income (loss) | $(23.7) million | $30.1 million |
| Net income (loss) | $(13.2) million; $(0.44) per diluted share | $22.6 million; $0.75 per diluted share |
| Adjusted EBITDA (non-GAAP) | $11.7 million | $48.9 million |
| Cash from operating activities | $(1.9) million | $31.9 million |
| Free cash flow (non-GAAP) | $(5.8) million | $22.4 million |
- Fiscal Q4: revenue was $55.4 million versus $60.9 million in FY2012 Q4. Gross margin was $22.1 million; operating loss was $4.0 million and net loss was $2.0 million, compared with operating income of $6.0 million and net income of $5.7 million in the prior-year quarter.
- Segment results: MCE revenue fell 25% to $152.6 million and adjusted EBITDA declined to $2.8 million from $40.5 million. MDIS revenue rose 38% to $56.1 million and adjusted EBITDA increased to $8.8 million from $8.2 million.
- Liquidity and obligations: cash and cash equivalents were $39.1 million, down from $116.0 million; working capital was $115.5 million, down from $170.8 million. The company reported no borrowings under its new revolving credit facility, but $3.9 million of letters of credit were outstanding. Reported borrowing capacity was $35.8 million, subject to EBITDA and covenant terms. Long-term obligations were $15.1 million.
- Operating indicators: bookings were $220 million, with a 1.1 book-to-bill ratio. Backlog was $140.3 million, up from $104.6 million; $113.2 million was expected to ship or be invoiced within 12 months. Backlog may be canceled or delayed and is not a reliable forecast of future revenue.
Material changes versus the prior year
- Revenue declined 15%, largely reflecting a $51.4 million decrease in MCE revenue, including lower defense revenue. MDIS growth partly offset the decline, supported by a full year of KOR and PDI contributions.
- Gross margin fell 16 percentage points. Management attributed the decline to lower sales of higher-margin MCE embedded-computing products and a greater contribution from comparatively lower-margin Micronetics and MDIS businesses.
- The company acquired Micronetics in August 2012 for a net purchase price of $68.2 million. It contributed $35.5 million of FY2013 revenue and a $3.8 million net loss. Cash used for acquisitions, net of cash acquired, was $67.7 million.
- Operating cash flow turned negative, primarily due to the earnings decline and increased cash use for payables and accrued expenses. Cash fell by $76.8 million during the year, principally due to the Micronetics acquisition and debt repayment assumed in that acquisition.
Outlook, commentary and risks
- Management cited defense-budget uncertainty, sequestration, continuing-resolution risk and reduced bookings and revenue as factors behind the year’s actions. The filing provides no specific FY2014 revenue or earnings guidance.
- Two FY2013 restructuring actions eliminated 159 positions and included facility actions. Charges were $7.1 million; management expected approximately $22 million in annualized savings. Research and development expense fell 29% to $32.7 million, and management expected R&D as a share of revenue to trend lower.
- Management believed existing cash, operating cash generation, available credit and financing capabilities would cover anticipated requirements for at least 12 months. The $200 million unsecured revolver is subject to borrowing limits based on EBITDA and financial covenants; covenant compliance was reported at year-end.
- Key risks include reliance on defense programs and government appropriations, customer concentration, changing program timing, competition and technology requirements, fixed-price project cost overruns, and dependence on sole-source components and a primary contract manufacturer. Three defense contractors represented 37% of revenue, down from 54% in FY2012. Defense-related sales were approximately 91% of revenue.
- Unusual items include a $10.0 million income-tax benefit despite a pretax loss, $7.1 million in restructuring charges, and $8.7 million of acquired-intangible amortization. The non-GAAP adjusted EBITDA measure excludes several recurring categories of expense; the company cautions it is not a substitute for GAAP results.
- The DOJ/PDI matter was settled in August 2012 without an admission of liability; Mercury reported full indemnification by former KOR shareholders. Other ordinary-course claims were not expected by management to have a material financial impact.
- Management and the auditor reported effective internal control over financial reporting, but Micronetics—representing 17% of consolidated revenue and 23% of assets—was excluded from the control assessment.
Investor verification priorities
- Reconcile the sharp gross-margin and MCE profitability decline, and assess whether restructuring savings can offset weaker revenue and lower-margin mix.
- Evaluate cash conversion and working-capital trends after negative operating cash flow and substantial acquisition-related cash use.
- Check the revolver’s EBITDA-based borrowing limit, covenant headroom and actual liquidity available if operating performance remains weak.
- Assess backlog quality, customer/program concentration and exposure to defense-budget decisions; backlog is not a revenue guarantee.
- Review Micronetics integration progress, purchase-accounting estimates, and the acquired business’s excluded internal controls.
- Compare GAAP losses and cash flows with non-GAAP adjusted EBITDA, including the excluded costs and assumptions in management’s reconciliation.