Mercury Systems, Inc. — Form 10-Q Summary
Business context and reporting period. The filing covers the quarter and six months ended December 31, 2015 (fiscal 2016 Q2), compared with the corresponding 2014 periods. Mercury supplies secure processing subsystems and related capabilities for defense and intelligence programs through Mercury Commercial Electronics (MCE) and Mercury Defense Systems (MDS). The former Mercury Intelligence Systems (MIS) segment was sold in January 2015 and is reported as discontinued operations.
Financial performance
| Metric | Three months ended Dec. 31, 2015 | Six months ended Dec. 31, 2015 | Comparable 2014 period |
|---|---|---|---|
| Revenue | $60.4 million, up 6% | $118.8 million, up 7% | $57.1 million; $111.2 million |
| Gross margin | 47.3%, down 0.1 percentage point | 47.2%, up 1.3 percentage points | 47.4%; 45.9% |
| Income from continuing operations | $4.8 million | $6.8 million | $2.9 million; $3.6 million |
| Net income | $4.8 million | $6.8 million | $0.3 million; $0.8 million, including losses from discontinued operations |
| Diluted GAAP EPS | $0.14 | $0.20 | $0.01; $0.02 |
| Adjusted EPS (non-GAAP) | $0.23 | $0.42 | $0.20; $0.33 |
| Adjusted EBITDA (non-GAAP) | $12.6 million | $24.4 million | $10.7 million; $18.7 million |
Drivers and segments. Quarterly revenue growth reflected higher defense sales, led by SEWIP, DEWS and an airborne surveillance program, partly offset by lower commercial sales and Global Hawk revenue. For the six-month period, growth came primarily from P8, Reaper, DEWS and airborne surveillance, partly offset by lower commercial sales and lower Global Hawk and Patriot revenue. MCE generated 87% of six-month revenue; MDS generated 13%. MDS adjusted EBITDA was $0.4 million negative for the quarter and $0.1 million positive for the half, with results affected by a $1.5 million increase in its inventory reserve. MCE adjusted EBITDA improved in both periods.
Cash, liquidity and obligations
- Six-month operating cash flow was $17.5 million, versus $10.4 million; capital expenditures were $3.2 million, yielding reported free cash flow (non-GAAP) of $14.3 million, versus $8.3 million.
- Cash and cash equivalents were $81.6 million at December 31, 2015, up $4.0 million from June 30, 2015. Investing used $13.1 million, including $9.8 million for the LIT acquisition; financing used $0.5 million, including $4.1 million for retirement of common stock.
- No credit-facility borrowings were outstanding. Available borrowing capacity was $162.7 million, with $5.1 million in letters of credit; the company reported compliance with covenants. The filing states cash, operating cash generation and available financing should cover anticipated needs for at least 12 months.
- At period-end, current assets were $199.0 million and current liabilities $41.4 million. Total liabilities were $46.6 million.
- Contractual obligations included $24.2 million of purchase commitments due within one year and $40.3 million of operating lease commitments. A new 12-year headquarters lease has stated base rent obligations of $21.1 million; the company expected to occupy the site by May 2017.
Material changes, outlook and risks
- Mercury acquired Lewis Innovative Technologies (LIT) in December 2015 for a net purchase price of $9.8 million, funded with cash. The acquisition expands secure embedded-processing capabilities in MDS. Preliminary allocation included $5.6 million goodwill; the purchase accounting remained subject to adjustment. A $0.2 million impairment related to a pre-existing relationship was recorded.
- Six-month operating income rose to $9.5 million from $4.3 million. Lower restructuring charges contributed, while the current period included $2.0 million of acquisition-related costs. Prior-year net income was also affected by MIS discontinued-operation losses, including a $2.3 million goodwill impairment.
- Management provided no specific revenue or earnings forecast in this filing. It cautioned that customer ordering is program- and delivery-driven and that quarterly orders may not indicate future trends. Management expects periodic acquisition-related costs and potentially nominal restructuring charges through fiscal 2017 if it cannot sublease space at its former headquarters.
- Key stated risks include changes in defense funding and program timing, customer order patterns, competition and technology shifts, export and procurement rules, component shortages and production quality, fixed-price contract cost estimates, and the integration and realization of acquisition benefits. Two customers, Raytheon and Lockheed Martin, together represented 55% of quarterly revenue and 54% of six-month revenue.
- Pending legal matters were not expected to materially affect results, cash flows or financial position. The IRS was auditing fiscal 2013; unrecognized tax benefits could decrease by up to $0.8 million within 12 months, with no expected effective-tax-rate impact. Certain product indemnities can be unlimited, although no material claims were reported. The company said there were no material changes to the risk factors in its 2015 Form 10-K.
Important facts for investors to verify
- Whether defense-program demand and the reported growth in MDS and MCE are sustained, given customer delivery timing and concentrated customer/program exposure.
- Whether gross margin, especially MDS performance following the $1.5 million inventory-reserve increase, improves or faces further inventory-related charges.
- How LIT integration, preliminary purchase accounting and future acquisition costs affect reported earnings and cash generation.
- Whether working-capital movements, purchase commitments and the new headquarters lease remain consistent with management’s liquidity expectations.
- How much reported improvement depends on non-GAAP adjustments, including stock compensation, amortization, restructuring and acquisition costs; management notes such costs may recur.