Mercury Systems, Inc. — Q2 FY2021 Form 10-Q
Reporting period: Quarter and six months ended January 1, 2021. Comparisons are to the quarter and six months ended December 27, 2019. Amounts below are in millions except per-share data.
Business context and results
Mercury supplies secure components, modules, and integrated subsystems to aerospace and defense customers. The company reports one operating segment. Q2 results included only two days of Physical Optics Corporation (POC), acquired December 30, 2020; six-month comparisons also reflect differing acquisition periods, so they are not fully comparable.
| Metric | Q2 FY2021 | Q2 prior-year period | Six months FY2021 | Six months prior-year period |
|---|---|---|---|---|
| Revenue | $210.7 (+8.6%) | $193.9 | $416.3 (+12.1%) | $371.2 |
| Gross profit / margin | $88.7 / 42.1% | $88.5 / 45.6% | $176.8 / 42.5% | $166.9 / 45.0% |
| Operating income / margin | $18.1 / 8.6% | $20.8 / 10.7% | $36.9 / 8.9% | $38.3 / 10.3% |
| Net income | $12.7 | $15.7 | $28.5 | $34.9 |
| Diluted EPS | $0.23 | $0.29 | $0.51 | $0.63 |
| Adjusted EBITDA (non-GAAP) | $45.3 | $42.8 | $88.1 | $79.5 |
| Adjusted EPS (non-GAAP) | $0.54 | $0.53 | $1.05 | $0.98 |
| Free cash flow (non-GAAP) | $10.2 | $20.7 | $22.1 | $35.5 |
Cash, debt, and liquidity
- At January 1, 2021, cash and cash equivalents were $109.1; restricted cash was $61.6, held against POC deferred consideration. Total cash, cash equivalents, and restricted cash were $170.7.
- Long-term debt was $160.0, drawn under the $750.0 revolving credit facility to fund the POC acquisition. The facility matures in September 2023; the company reported covenant compliance.
- For the six months, operating cash flow was $46.9, investing cash flow was negative $266.9, and financing cash flow was positive $163.1. Investing outflows included $243.6 for the POC acquisition and $24.8 of property and equipment purchases.
- Management said existing cash, operating cash generation, Revolver availability, and financing capabilities should meet anticipated cash needs for at least the next 12 months.
- Near-term commitments included $132.0 of non-cancelable purchase obligations and $61.6 of POC deferred consideration, paid in Q3 FY2021.
Material changes and drivers
- Q2 revenue rose $16.8, primarily from $16.5 of organic growth; six-month revenue rose $45.1, including $37.0 organic growth and $8.1 acquired revenue. Integrated subsystems, radar, and land and naval programs were important growth areas.
- Revenue mix shifted toward integrated subsystems: Q2 subsystem revenue was $135.0 versus $104.1, while components declined to $40.7 from $60.3. Radar revenue increased to $84.8 from $48.3 in Q2; airborne platform revenue declined to $91.7 from $106.3.
- Gross margin declined 350 basis points in Q2 and 250 basis points for the six months. Management cited direct COVID-related costs ($3.1 Q2; $5.0 six months), program mix, and higher customer-funded R&D; operational efficiencies and lower inventory step-up amortization partly offset these pressures.
- R&D expense increased to $28.1 in Q2 and $55.5 for six months as the company continued investment in avionics mission computers, secure processing, radar modernization, and trusted custom microelectronics. SG&A as a share of revenue improved, reflecting operating leverage.
- POC’s preliminary net purchase price was $305.3, funded with cash and Revolver borrowings. The acquisition added preliminary goodwill of $168.9; purchase accounting estimates remain subject to adjustment. POC more than doubles Mercury’s global avionics business.
Outlook, risks, and unusual items
- No specific revenue or earnings guidance is provided. Remaining performance obligations were $410.3 at January 1, 2021; the company expects to recognize approximately 69% within the next 12 months. This measure excludes certain short-duration and cancellable orders.
- Management identified risks including defense funding and procurement timing, COVID effects, supply-chain constraints, customer order and product mix changes, fixed-price contract costs, acquisition integration and synergy execution, competition, technology changes, and employee retention.
- Adjusted EBITDA, adjusted income/EPS, free cash flow, and organic/acquired revenue are non-GAAP measures. The company cautions they are not substitutes for GAAP results and may not be comparable with similarly titled measures at other companies.
- Customer concentration is material: Raytheon Technologies represented 25% of Q2 revenue and 24% of six-month revenue; Lockheed Martin represented 12% and 15%, respectively. No individual program accounted for 10% or more of revenue.
- Legal matters arising in the ordinary course were not expected to materially affect financial position, results, or cash flows. Potential intellectual-property indemnification payments may be unlimited in some cases. Management reported disclosure controls were effective and no material change in internal financial controls during the quarter; POC integration was ongoing.
Investor verification points
- Assess whether margin pressure from COVID costs, customer-funded R&D, and program mix is easing, and compare GAAP results with the company’s adjustment-heavy non-GAAP measures.
- Track cash conversion and working-capital needs, particularly inventory, unbilled receivables, purchase commitments, and the POC consideration payment.
- Review POC integration, final purchase accounting, expected synergies, and the use and repayment of Revolver borrowings.
- Monitor execution and timing of the remaining performance obligations, defense program funding, and concentration in major customers and programs.