Mercury Systems, Inc. — Q3 FY2018 Form 10-Q
Reporting period: Quarter and nine months ended March 31, 2018. Mercury supplies secure sensor and mission-processing products and subsystems, primarily to defense prime contractors. Results are not fully comparable year over year because acquisitions, including Themis, Delta and RTL, contributed revenue in FY2018; the nine-month FY2017 comparison included only part of CES’s results.
Financial performance
Amounts are in millions of dollars, except per-share data and percentages.
| Metric | Q3 FY2018 | Q3 FY2017 | Nine months FY2018 | Nine months FY2017 |
|---|---|---|---|---|
| Revenue | $116.3 | $107.3 | $340.3 | $293.0 |
| Gross margin | 45.4% | 47.3% | 46.3% | 47.0% |
| Operating income | $6.8 | $11.7 | $28.1 | $24.4 |
| Net income | $3.7 | $7.0 | $30.8 | $16.1 |
| Diluted EPS | $0.08 | $0.16 | $0.65 | $0.39 |
| Operating cash flow | Not separately shown in the cash-flow statement | Not separately shown in the cash-flow statement | $17.7 | $49.4 |
| Free cash flow (non-GAAP) | $(2.6) | $11.9 | $6.6 | $22.6 |
- Quarterly revenue rose 8%, but organic revenue declined 6%; acquired businesses contributed $15.7 million. For nine months, revenue increased 16%, including 7% organic growth and $27.9 million of acquired revenue.
- Quarterly net income fell year over year despite higher revenue, with operating income down and gross margin lower. Management attributed margin pressure to program mix and Themis inventory step-up amortization.
- Nine-month net income benefited from a $4.8 million income-tax benefit, versus a $3.7 million tax provision in the prior-year period. The filing identifies discrete tax benefits, including stock-based compensation and acquired net operating loss carryforwards; the reported earnings increase should be assessed in that context.
- Adjusted EBITDA, a non-GAAP measure, was $25.8 million for Q3 and $77.7 million for nine months, versus $25.0 million and $66.1 million, respectively. Adjusted EPS was $0.30 and $0.95, versus $0.29 and $0.82. These measures exclude specified costs and should be considered alongside GAAP results.
Liquidity, debt and balance sheet
- At March 31, cash and cash equivalents were $44.2 million; total assets were $1.057 billion and shareholders’ equity was $755.8 million.
- Long-term debt was $195.0 million, drawn under a $400.0 million revolving facility expiring in June 2022. Mercury reported covenant compliance and $2.8 million in outstanding letters of credit.
- Nine-month operating cash flow was $17.7 million, down from $49.4 million. The company cited lower receivable collections, higher inventory purchases and lower income taxes payable; it also said inventory investment supported growth and its transition toward insourced manufacturing.
- Investing cash outflow was $196.8 million, principally reflecting $185.4 million for acquisitions. Financing cash inflow was $181.9 million, primarily reflecting revolver borrowings, partly offset by share repurchases/retirements used for employee tax withholding.
- Inventory rose to $117.1 million from $81.1 million at June 30, 2017; accounts receivable rose to $101.4 million from $76.3 million. Management stated that available cash, operating cash generation, the revolver and financing capabilities should cover anticipated cash needs for at least 12 months.
Material changes and management commentary
- Mercury completed its $179.7 million net purchase-price acquisition of Themis on February 1, 2018, funded with revolver borrowings. Themis contributed $9.5 million of revenue and $0.3 million of pretax income in the quarter. Purchase-price allocation remained preliminary, including $114.5 million of estimated goodwill.
- Program trends were mixed. Management cited growth from Aegis, F-35 and E2D Hawkeye in Q3, partly offset by lower SEWIP Block II, Patriot and a large ground-based radar program. Electronic Warfare revenue fell $16.4 million year over year in the quarter; C4I revenue increased $16.4 million, with Themis and F-35 contributing.
- Revenue concentration remained notable: Raytheon and Lockheed Martin each represented 19% of nine-month revenue; Northrop Grumman represented 10%. No individual program represented 10% or more of Q3 FY2018 revenue.
- The company had $57.1 million of purchase obligations due within one year and $61.5 million of operating lease commitments in total. It expects to continue pursuing acquisitions and may incur further transaction costs.
Outlook, risks and contingencies
- The filing provides no specific revenue or earnings guidance. Management’s stated liquidity expectation covers anticipated cash requirements for at least the next 12 months.
- Management cited risks including defense-program funding and timing, customer order variability, government shutdowns or continuing resolutions, competition, component shortages, production delays, fixed-price contract cost overruns, acquisition integration and synergy execution, interest-rate increases, export-control changes, tax-law uncertainty, and retaining key employees and customers.
- The Tax Cuts and Jobs Act reduced the federal statutory rate to 21% for subsequent fiscal years; Mercury used an approximately 28% rate for FY2018. Some tax effects remained subject to estimation and finalization. The company said it had recorded known and estimable impacts and expected to finalize its transition-tax conclusions by fiscal year-end.
- Ordinary-course legal matters were not expected by management to materially affect cash flows, results or financial position. Certain intellectual-property indemnification obligations may be unlimited. Management reported effective disclosure controls; integration of Delta and Themis into financial controls was ongoing.
Important facts for investors to verify
- Whether organic growth and program demand can offset declining or variable contributions from SEWIP, Patriot and other programs, and how acquisition revenue develops as acquired businesses enter comparable periods.
- Whether lower gross margins, acquisition-related amortization and integration expenses persist, and how much reported earnings depend on discrete tax benefits and non-GAAP adjustments.
- Whether working-capital investment—particularly receivables and inventory—converts into cash, given the sharp year-over-year reduction in operating cash flow and free cash flow.
- The final purchase accounting and operating contribution for Themis, and the company’s capacity to fund acquisitions and other commitments while carrying $195.0 million of revolver debt.
- Defense customer and program concentration, upcoming contract and funding timing, and execution against the stated 12-month liquidity outlook.