Mercury Systems, Inc. — Form 10-Q Summary
Reporting period: Fiscal first quarter ended September 30, 2018. The filing compares the quarter with the three months ended September 30, 2017. Amounts below are in U.S. dollars; financial statement amounts are converted from thousands to millions unless noted.
Business context
Mercury supplies secure sensor and safety-critical processing systems, components and services, primarily to defense prime contractors. Results include a full quarter of Themis Computer and Germane Systems revenue only from its July 31, 2018 acquisition date; accordingly, year-over-year results are not directly comparable. Mercury adopted ASC 606 revenue guidance retrospectively on July 1, 2018 and reported no material impact to its financial statements.
Financial performance
| Metric | Q1 FY2019 | Q1 FY2018 | Change / context |
|---|---|---|---|
| Revenue | $144.1 million | $106.1 million | Up 36%; $31.3 million was acquired revenue. Organic revenue rose 6% to $112.8 million. |
| Gross profit / margin | $61.6 million / 42.8% | $50.7 million / 47.8% | Margin declined 5.0 percentage points. |
| Operating income / margin | $13.8 million / 9.7% | $10.4 million / 9.9% | Income increased, while margin edged down. |
| Net income | $7.5 million | $18.0 million | Diluted EPS was $0.16 versus $0.38. Prior-year net income benefited from unusually large tax benefits. |
| Adjusted EBITDA (non-GAAP) | $31.6 million | $25.3 million | Up from prior year; see company reconciliation and definition. |
| Operating cash flow | $20.0 million | $8.0 million | Free cash flow, a non-GAAP measure, was $16.3 million versus $4.4 million. |
Revenue growth reflected acquisitions and organic increases in F-35, UAV Predator and Stormbreaker programs, partly offset by lower SEWIP Block II and Aegis revenue. C4I revenue rose notably, primarily due to acquired businesses and Predator. Gross margin pressure reflected lower-margin Themis and Germane businesses, program mix and increased customer-funded credits; lower inventory step-up costs partly offset the decline. SG&A and R&D increased in dollars, largely with acquired headcount, while each declined as a share of revenue.
Cash, debt and liquidity
- Cash and cash equivalents were $72.9 million at September 30, 2018, up $6.3 million from June 30, 2018.
- Long-term debt was $240.0 million, up from $195.0 million at June 30. The September 28 amendment increased the revolving credit facility to $750.0 million and extended maturity to September 2023. Mercury reported compliance with covenants; $2.5 million of letters of credit were outstanding.
- Cash used in investing activities was $50.0 million, including $46.3 million for Germane and $3.7 million for property and equipment. Financing activities provided $36.3 million, principally from $45.0 million of revolver borrowings.
- Current assets were $364.2 million and current liabilities were $82.8 million. Inventory was $121.2 million; accounts receivable were $113.9 million.
- Management said available cash, operating cash generation, revolver availability and financing capabilities should cover anticipated cash requirements for at least the next 12 months.
Outlook, risks and unusual items
- No specific revenue or earnings guidance was provided. Remaining performance obligations were $166.9 million; the company expected to recognize approximately 64% as revenue over the next 12 months. This measure excludes certain cancellable orders and contracts with expected durations of one year or less.
- Management cited risks including defense program funding and timing, government shutdowns or continuing resolutions, customer order patterns, competition, technology and execution challenges, component shortages, fixed-price contract cost overruns, acquisition integration and realization of synergies, interest rates, export controls, cybersecurity requirements and tax changes.
- The Germane acquisition had a preliminary net purchase price of $46.8 million, including estimated goodwill of $23.8 million. Its post-acquisition revenue included in the quarter was $9.0 million; its included pretax loss was $0.4 million. Purchase accounting estimates remained preliminary.
- The quarter included $2.3 million of interest expense on the revolver and $0.5 million of restructuring and other charges, primarily related to severance at Germane. The 2017 comparison included an $8.4 million income tax benefit, including discrete tax benefits; the current quarter included a $3.1 million tax provision.
- A securities class action filed in July 2018 alleges misleading disclosures concerning October 2017–April 2018. Mercury said it considers the claims without merit and intends to defend itself. The company stated that ordinary-course legal matters were not expected to materially affect its financial position, results or cash flows.
- Mercury reported effective disclosure controls and no material change in internal control over financial reporting during the quarter; integration of Themis and Germane controls was ongoing.
Important facts for investors to verify
- How much of subsequent growth and margin performance is organic, given that acquisitions contributed $31.3 million of current-quarter revenue and reduced gross margin.
- Whether the remaining performance obligations convert to revenue on the stated timetable, and how much is subject to cancellation or other execution risk.
- Debt levels, interest expense, covenant headroom and cash generation after acquisition-related spending and purchase commitments.
- Final purchase accounting for Germane and Themis, integration costs, and whether expected acquisition synergies are realized.
- Potential developments and financial exposure in the securities class action, and any changes in defense funding, program demand or other disclosed risks.
- The sustainability of reported GAAP earnings versus non-GAAP adjusted results, particularly given tax benefits in the prior-year comparison and recurring adjustment categories.