Mercury Systems, Inc. — Form 10-Q Summary
Reporting period: Fiscal third quarter and nine months ended March 31, 2012. Financial amounts are in U.S. dollars; amounts below are stated in millions unless noted. Mercury designs embedded signal and image-processing systems and software, microwave products, and defense and intelligence services. Its reportable segments are Advanced Computing Solutions (ACS) and Mercury Federal Systems (MFS).
Financial performance
| Metric | Three months ended March 31, 2012 | Prior-year quarter | Nine months ended March 31, 2012 | Prior-year nine months |
|---|---|---|---|---|
| Revenue | $67.0 | $59.9 | $184.1 | $167.5 |
| Gross margin | $35.1; 52.3% | $32.9; 54.9% | $105.9; 57.5% | $95.2; 56.8% |
| Income from operations | $7.1 | $7.0 | $24.2 | $18.8 |
| Net income | $5.2 | $5.4 | $16.9 | $14.2 |
| Diluted EPS | $0.17 | $0.20 | $0.56 | $0.57 |
| Adjusted EBITDA, non-GAAP | $12.0 | $11.3 | $39.6 | $30.8 |
- Quarterly revenue rose 12%; nine-month revenue rose 10%. Quarterly net income declined modestly, while nine-month net income increased about 19%.
- Quarterly gross margin fell 260 basis points, which management attributed mainly to acquired KOR and PDI revenue carrying lower margins than Mercury’s historical mix. Nine-month gross margin increased 70 basis points, reflecting favorable mix in the first six months, partly offset by manufacturing costs and higher warranty and inventory provisions.
- Quarterly revenue was essentially flat at ACS ($56.4 million) and increased 156% at MFS ($8.8 million). Nine-month ACS revenue grew 4% to $165.9 million; MFS grew 105% to $18.2 million. MFS growth included a wide-area persistent-surveillance contract and PDI contribution.
- Nine-month operating cash flow was $27.7 million, compared with $22.8 million. Capital expenditures were $6.4 million, yielding reported free cash flow, a non-GAAP measure, of $21.2 million versus $17.5 million.
Liquidity, debt and balance sheet
- At March 31, cash and cash equivalents were $114.8 million, down from $162.9 million at June 30, 2011. Total assets were $379.3 million and current liabilities were $37.5 million.
- Cash decreased $48.0 million over the nine months, principally reflecting $70.4 million of net cash used for the KOR/PDI acquisition and $6.4 million of capital expenditures, partly offset by operating cash generation.
- The company had a $35 million revolving credit facility, with no borrowings since inception, and reported compliance with its covenants. Facility maturity is February 11, 2014. Management said existing cash, the facility and operating cash flow should cover anticipated needs for at least 12 months, while noting acquisitions could require additional financing.
- Goodwill increased to $132.3 million, including $52.8 million recorded for the acquisition; acquired intangible assets were $26.2 million. Purchase-price allocations were preliminary.
Acquisition, outlook and risks
- Mercury acquired KOR Electronics and its subsidiary PDI on December 30, 2011, for a net purchase price of $70.4 million, funded with cash. KOR adds electronic-warfare radio-frequency memory and radar simulation products; PDI adds intelligence-community analytics and data-fusion services. The filing reports $10.5 million of acquired-business revenue and $1.5 million of operating income included for the quarter and nine-month period; it does not clearly separate those amounts by entity.
- No specific financial guidance was provided. Management noted that customer requests and delivery schedules drive quarterly revenue and that order patterns generally do not establish future trends. It also cited ongoing uncertainty in defense budgets.
- Key disclosed risks include defense-program funding and timing, customer order changes, competition, technology and production delays, component shortages, fixed-price contract costs, acquisition integration and realization of expected benefits, export rules, and employee and customer retention.
- The DOJ is investigating alleged conduct by certain former PDI employees in 2008–2009 that may have violated the Procurement Integrity Act. No resolution or litigation had occurred. Mercury said it is entitled to indemnification supported by acquisition escrow and does not expect a material financial impact.
- Revenue concentration remains notable: the three largest customers represented 57% of nine-month revenue (Raytheon 24%, Northrop Grumman 20%, and Lockheed Martin 13%). Management reported no material change in risk factors from its prior annual report.
Important facts for investors to verify
- Whether acquired KOR/PDI revenue and expected synergies continue to grow without further diluting gross margins.
- Whether defense funding, the surveillance contract and major-customer demand support continued revenue and cash generation.
- Progress and potential exposure from the DOJ investigation, including the scope and adequacy of acquisition indemnity and escrow.
- Final acquisition purchase-price allocations and subsequent goodwill impairment testing; the recorded allocations were preliminary.
- Cash needs for acquisitions, working capital and purchase commitments, and continued compliance with credit-facility covenants.