Mercury Systems, Inc. — FY2019 Form 10-K
Reporting period: Fiscal year ended June 30, 2019. The filing also reports fourth-quarter results; this is an annual report, not a standalone quarterly filing.
Business context
Mercury supplies secure sensor-processing and safety-critical mission-processing subsystems, components, software and services for aerospace, defense and intelligence programs. Approximately 95% of FY2019 revenue was defense-related. The company reports one operating segment.
Financial performance and liquidity
| Metric | FY2019 | FY2018 |
|---|---|---|
| Revenue | $654.7 million | $493.2 million |
| Gross margin | $286.2 million; 43.7% | $225.9 million; 45.8% |
| Operating income | $76.6 million; 11.7% of revenue | $47.0 million; 9.5% |
| Net income | $46.8 million | $40.9 million |
| Diluted EPS | $0.96 | $0.86 |
| Adjusted EBITDA (non-GAAP) | $145.3 million | $114.6 million |
| Operating cash flow | $97.5 million | $43.3 million |
| Free cash flow (non-GAAP) | $70.8 million | $28.2 million |
- Revenue increased 33% year over year: $108.0 million organic growth and $53.5 million acquired revenue. Organic revenue grew 25%.
- Q4 FY2019 revenue was $177.0 million, gross profit $79.8 million (about 45.1% margin), operating income $20.9 million and net income $12.8 million; diluted EPS was $0.25.
- At June 30, 2019, cash and cash equivalents were $257.9 million, working capital $484.1 million and total assets $1.417 billion. Long-term debt was zero; the company had a $750 million revolving credit facility maturing in September 2023.
- FY2019 investing cash use was $153.8 million, including $127.1 million for acquisitions and $26.7 million for property and equipment. Cash rose by $191.4 million to $257.9 million.
- A May 2019 equity offering of 6.9 million shares generated $454.3 million net proceeds, used in part to repay revolver borrowings. Shares outstanding increased to 54.25 million at year-end from 46.92 million.
- Backlog was $625.4 million, versus $447.1 million a year earlier; $451.2 million was expected to ship within 12 months. Backlog orders may be canceled or rescheduled.
Material changes and unusual items
- Gross margin declined 2.1 percentage points, primarily due to Germane’s historically lower margins and increased customer-funded development work; higher-margin Athena and Syntonic contributions partly offset the decline.
- Operating income rose despite margin compression, with SG&A and R&D declining as percentages of revenue.
- Net income growth was tempered by a higher tax provision ($12.8 million versus $1.7 million) and higher interest and other expense. Other expense included $5.4 million to terminate an interest-rate swap after repaying the revolver.
- Fiscal 2019 acquisitions included Germane, GECO, Athena and Syntonic. Their purchase-price allocations were preliminary at year-end; acquisition integration and realization of expected synergies remain execution risks.
- On July 30, 2019, Mercury announced a pending $100 million all-cash acquisition of American Panel Corporation, expected to close in Q1 FY2020. The company stated it expected available cash, operating cash generation and credit capacity to cover anticipated needs for at least 12 months.
Outlook, risks and contingencies
- Management stated it expected above-industry-average growth, citing defense electronics demand, outsourcing by defense primes, platform upgrades and demand for secure processing. The filing provides no numerical revenue or earnings guidance.
- Major risks include dependence on government defense funding and appropriations, program delays or cancellations, and customer concentration: Raytheon and Lockheed Martin together represented 37% of FY2019 revenue.
- Other notable risks include acquisition integration, competition and technology changes, sole-source components and contract manufacturers, cybersecurity and export-control compliance, and cost overruns on fixed-price contracts.
- Goodwill and identifiable intangible assets totaled $768.3 million at year-end. Annual impairment testing found no impairment, but future adverse performance or market changes could require a charge.
- Contractual commitments included $69.6 million of operating lease payments and $73.8 million of purchase obligations. Certain intellectual-property indemnities may be unlimited; management did not expect pending legal matters to materially affect results or cash flows.
- The auditor issued unqualified opinions on the financial statements and internal controls. The internal-control assessment excluded four FY2019 acquisitions, representing 11% of assets and 7% of revenue; integration into company controls was in progress.
Most important facts for investors to verify
- Whether organic growth and backlog convert to revenue, and whether backlog cancellations or program funding changes affect deliveries.
- Whether gross margins recover as acquisition mix and customer-funded development work evolve.
- Whether the acquisitions deliver expected growth and synergies, and whether preliminary purchase accounting changes.
- How the equity issuance’s dilution compares with the returns from acquisitions and future investment; confirm current debt, cash and revolver availability.
- Whether customer concentration, fixed-price contract estimates, supplier dependencies and the excluded acquired-company controls create emerging financial or operational issues.