Mercury Systems, Inc. — FY2017 Form 10-K
Reporting period: Fiscal year ended June 30, 2017. The filing also reports fourth-quarter results; “2017 Q4” is not a separate quarterly filing. Mercury provides secure sensor-processing and safety-critical mission-processing systems, primarily for aerospace, defense and intelligence customers.
Financial performance
| Metric | FY2017 | FY2016 |
|---|---|---|
| Revenue | $408.6 million | $270.2 million |
| Gross margin | 46.9% | 47.2% |
| Operating income / margin | $37.4 million / 9.2% | $24.0 million / 8.9% |
| Continuing-operations income | $24.9 million | $19.7 million |
| Diluted continuing-operations EPS | $0.58 | $0.56 |
| Adjusted EBITDA (non-GAAP) | $93.9 million | $57.3 million |
| Operating cash flow | $59.1 million | $36.9 million |
| Capital expenditures | $32.8 million | $7.9 million |
| Free cash flow (non-GAAP) | $26.3 million | $29.1 million |
Revenue rose 51%; management attributed growth to acquisitions and higher sales on a large ground-based radar program and ProVision. Acquired revenue was $130.9 million, or 32% of FY2017 revenue; organic revenue grew 10%. The comparison is not like-for-like: FY2016 included only two months of the Carve-Out Business and excluded CES and Delta. Gross margin dipped 30 basis points, partly reflecting $3.7 million of acquisition-related inventory step-up amortization. Operating income increased, but net income margin fell to 6.1% from 7.3%, amid higher interest expense and acquisition-related amortization.
FY2017 Q4: Revenue was $115.6 million, gross profit $53.9 million, operating income $13.0 million, continuing-operations income $8.8 million and diluted EPS $0.19. Revenue and operating income increased sequentially from Q3; quarterly results are not necessarily indicative of future performance.
Liquidity, debt and balance sheet
- Cash and cash equivalents were $41.6 million at year-end, down from $81.7 million. Working capital was $173.4 million; total assets were $815.7 million.
- Mercury repaid its remaining $200 million term-loan principal in June 2017 using cash on hand. It amended and expanded its revolving facility to $400 million, expiring June 2022; it was undrawn at year-end except for $5.9 million of letters of credit.
- Operating cash flow improved, but higher capital spending reduced free cash flow year over year. Acquisition payments and capital expenditures were major investing uses; the February equity offering generated $215.7 million net proceeds from 6.9 million shares.
- Contractual commitments included $43.5 million of operating leases and $59.2 million of purchase obligations, largely due within one year.
Business developments, outlook and risks
- FY2017 acquisitions included CES, adding safety-critical avionics and mission-computing capabilities, and Delta, expanding RF, microwave and space-related offerings. RTL was acquired in July 2017, after year-end. Management’s strategy emphasizes product development, subsystem integration, acquisitions and expansion into adjacent markets.
- The filing provides no specific FY2018 revenue or earnings guidance. Management said available cash, operating cash generation and the revolving facility should meet anticipated requirements for at least the next 12 months.
- Management identified integration and synergy realization, fixed-price contract execution, supply availability, technology competition and defense-program funding as important uncertainties. Government contracts may be delayed, reduced or terminated; backlog was $357.0 million, including $290.8 million expected to deliver within 12 months, but may be canceled or rescheduled.
- Customer and market concentration remain significant: Lockheed Martin accounted for 20% and Raytheon 16% of revenue. Defense-related sales represented approximately 96% of revenue, and radar applications 37%. The company expects to lose its small-business status during FY2018.
- Other notable items: the planned Manteca, California facility closure involved 33 positions and $0.9 million of severance-related expense. Goodwill and identifiable intangible assets were $380.8 million and $129.0 million, respectively; annual impairment testing found no impairment. The company reported effective internal control, but the FY2017 assessment excluded CES and Delta, which represented 12% of assets and 5% of revenue.
Key investor verification points
- Separate organic growth from acquisition contribution and assess whether acquired businesses deliver expected earnings, cash flow and integration benefits.
- Monitor gross margins, acquisition-related amortization, elevated R&D and capital spending, and conversion of operating cash flow into free cash flow.
- Track exposure to major defense customers and programs, government appropriations, backlog cancellations and the concentration in radar applications.
- Confirm integration of CES, Delta and post-year-end RTL into financial controls and operations; review goodwill and intangible-asset impairment sensitivity.
- Review the revolving facility’s covenant compliance and future borrowing needs, as well as dilution from equity issuance and the effect of the term-loan repayment on interest costs.