Mercury Systems, Inc. — Form 10-Q Summary
Reporting period: Fiscal first quarter ended September 30, 2015, compared with the three months ended September 30, 2014, unless otherwise noted. Mercury supplies secure and sensor-processing subsystems for defense and intelligence applications. Results reflect its MCE and MDS segments; the MIS segment was sold in January 2015 and is reported as discontinued operations.
Financial performance
| Metric | Quarter ended Sep. 30, 2015 | Prior-year quarter | Change |
|---|---|---|---|
| Revenue | $58.4 million | $54.1 million | Up 8% |
| Gross margin | $27.5 million; 47.1% | $24.0 million; 44.4% | Up 270 basis points |
| Operating income | $3.1 million | $0.7 million | Up $2.4 million |
| Income from continuing operations | $2.0 million | $0.7 million | Up $1.2 million |
| Net income | $2.0 million | $0.5 million | Prior period included a $0.2 million discontinued-operations loss |
| Adjusted EBITDA (non-GAAP) | $11.8 million | $8.0 million | Up 48% |
| Operating cash flow | $5.6 million | $2.2 million | Up $3.4 million |
| Free cash flow (non-GAAP) | $3.7 million | $1.3 million | Up $2.5 million |
Basic and diluted EPS were both $0.06, versus $0.02 in the prior-year quarter. The income-tax provision was $1.3 million, compared with none in the prior-year quarter. Management attributed the higher gross margin primarily to product mix, including stronger sales of certain higher-margin digital-processing products.
Segments, cash, and debt
- MCE: Revenue was $50.0 million, up 3%; adjusted EBITDA rose to $11.5 million from $7.3 million. Higher P-8 and Reaper sales and improved mix contributed to results.
- MDS: Revenue was $8.0 million, up 49%, mainly reflecting strength in an airborne-surveillance program. Adjusted EBITDA was approximately $0.5 million, essentially flat year over year.
- Liquidity: Cash and cash equivalents were $79.1 million at September 30, up from $77.6 million at June 30, 2015. Current assets were $200.9 million and current liabilities $42.8 million.
- Debt and credit: No borrowings were outstanding under the senior credit facility. Available borrowing capacity was $155.9 million; $4.9 million of letters of credit were outstanding. Mercury reported compliance with its credit covenants.
- Cash uses and obligations: Capital expenditures were $1.9 million, and $3.7 million was used to retire common stock. Non-cancelable purchase commitments totaled $26.9 million, due within one year. Reported operating-lease obligations totaled $37.5 million.
Material changes and management commentary
Revenue growth was driven by a $6.3 million increase in defense sales, partly offset by a $2.0 million decline in commercial sales. MCE growth reflected P-8 and Reaper programs, partly offset by lower SEWIP revenue; MDS growth reflected an airborne-surveillance program. International revenue declined to $8.4 million from $10.4 million. Restructuring charges fell to $0.3 million from $1.3 million, while acquisition-related costs increased to $2.1 million from none. Management said it expects to continue evaluating acquisition opportunities, but gave no quantified revenue, earnings, or cash-flow guidance.
Management stated that cash, operating cash generation, and available credit should meet anticipated cash requirements for at least the next 12 months. It cautioned that quarterly orders are difficult to predict, since defense customers set delivery schedules according to program needs. The company entered a lease for a new Andover, Massachusetts headquarters, expected to be occupied by May 2017, with minimum base rent of $17.9 million over a 12-year term.
Risks, contingencies, and unusual items
- Customer concentration remains significant: Raytheon represented 38% and Lockheed Martin 16% of quarterly revenue, together 54% (versus 65% a year earlier). Patriot represented 17% of revenue; no other program exceeded 10% in the quarter.
- Results are exposed to defense-program funding and timing, shifts in customer orders and product mix, competition, technology changes, export and procurement rules, component availability, production delays, and cost-estimation risk on fixed-price contracts.
- Acquisition costs and other related expenses may recur and may be material whether or not a transaction is completed. Management also noted that periodic restructuring charges could continue through fiscal 2017 if it cannot sublease unused headquarters space.
- The company was under IRS audit for fiscal 2013. Unrecognized tax benefits could decrease by up to $0.8 million within 12 months; management said any decrease would not affect the effective tax rate.
- Management did not expect pending ordinary-course legal matters to materially affect results, cash flows, or financial position. Certain intellectual-property indemnities may be unlimited; indemnification obligations related to the MIS sale are generally subject to caps.
Important facts for investors to verify
- Whether defense-program demand and the favorable product mix supporting the gross-margin improvement persist, especially in P-8, Reaper, SEWIP, and the airborne-surveillance program.
- Whether working-capital movements—particularly receivables, unbilled receivables, and inventory—continue to support operating cash flow.
- The nature, timing, and potential amount of the quarter’s acquisition-related costs and any transactions they relate to.
- How customer and program concentration, defense funding, and the large purchase and lease commitments affect future liquidity and results.
- How the new headquarters lease, IRS audit, and any potential indemnification or legal exposures develop.