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MRCY > SEC Filings for MRCY > Form 10-Q on 5-Nov-2012All Recent SEC Filings

Show all filings for MERCURY COMPUTER SYSTEMS INC

Form 10-Q for MERCURY COMPUTER SYSTEMS INC


5-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FORWARD-LOOKING STATEMENTS

From time to time, information provided, statements made by our employees or information included in our filings with the Securities and Exchange Commission may contain statements that are not historical facts but that are "forward-looking statements," which involve risks and uncertainties. The words "may," "will," "would," "should," "could," "plan," "expect," "believe," "anticipate," "continue," "estimate," "project," "intend," "likely," "forecast," "probable," and similar expressions are intended to identify forward-looking statements regarding events, conditions and financials trends that may affect our future plans of operations, business strategy, results of operations and financial position. These forward-looking statements, which include those related to our strategic plans, business outlook, and future business and financial performance, involve risks and uncertainties that could cause actual results to differ materially from those projected or anticipated. Such risks and uncertainties include, but are not limited to, continued funding of defense programs and the timing of such funding, including the potential for a continuing resolution for the defense budget, the potential for defense budget sequestration, and the budget uncertainty related to the Presidential election, general economic and business conditions, including unforeseen economic weakness in our markets, effects of continued geo-political unrest and regional conflicts, competition, changes in technology and methods of marketing, delays in completing various engineering and manufacturing programs, changes in customer order patterns, changes in product mix, continued success in technological advances and delivering technological innovations, changes in the U.S. Government's interpretation of federal procurement rules and regulations, market acceptance of our products, shortages in components, production delays due to performance quality issues with outsourced components, inability to fully realize the expected benefits from acquisitions or divestitures or delays in realizing such benefits, challenges in integrating acquired businesses and achieving anticipated synergies, changes to export regulations, increases in tax rates, changes to generally accepted accounting principles, difficulties in retaining key employees and customers, unanticipated costs under fixed-price service and system integration engagements, and various other factors beyond our control. These risks and uncertainties also include such additional risk factors as set forth under Part I-Item 1A (Risk Factors) in the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2012. We caution readers not to place undue reliance upon any such forward-looking statements, which speak only as of the date made. We undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made.

OVERVIEW

We design, manufacture and market commercially-developed, high-performance embedded, real-time digital signal and image processing sub-systems and software for specialized defense and commercial markets. Our solutions play a critical role in a wide range of applications, processing and transforming sensor data to information for storage, analysis and interpretation. Our goal is to grow and build on our position as a critical component of the defense and intelligence industrial base and be the leading provider of open and affordable sensor processing subsystems for intelligence, surveillance and reconnaissance ("ISR"), electronic warfare ("EW"), and missile defense applications. In military reconnaissance and surveillance platforms, our sub-systems receive, process, and store real-time radar, video, sonar and signals intelligence data. We provide radio frequency ("RF") and microwave products for enhanced signal acquisition and communications in military and commercial applications. Additionally, Mercury Federal Systems, our wholly owned subsidiary, focuses on direct and indirect contracts supporting the defense, intelligence, and homeland security agencies. We have growing capabilities in the area of "Big Data" processing, analytics and analysis in support of both the U.S. Department of Defense ("DoD") and to the intelligence community as they enhance their ability to acquire, process and exploit large amounts of data for both real-time analytics and "forensic" analysis.

Our products and solutions address mission-critical requirements within the defense industry for C4ISR (command, control, communications, computers, intelligence, surveillance and reconnaissance) and electronic warfare, systems and services, and target several markets including maritime defense, airborne reconnaissance,


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ballistic missile defense, ground mobile and force protection systems and tactical communications and network systems. We deliver commercially developed technology and solutions that are based on open system architectures and widely adopted industry standards, and support all of this with services and support capabilities.

As of September 30, 2012, we had 810 employees. Our revenue, net loss and adjusted EBITDA for the three month period ended September 30, 2012 were $49.4 million, ($7.2) million and $1.6 million, respectively. See the Non-GAAP Financial Measures section for a reconciliation of our adjusted EBITDA to net loss from operations.

Our operations are presently organized in the following two business segments:

Advanced Computing Solutions, or ACS. This business segment is focused on specialized, high-performance embedded, real-time digital signal and image processing solutions that encompass signal acquisition, including microwave front-end, digitization, digital signal processing, exploitation processing, high capacity digital storage and communications, targeted to key market segments, including defense, communications and other commercial applications. ACS's open system architecture solutions span the full range of embedded technologies from board level products to fully integrated sub-systems. Our products utilize leading-edge processor and other technologies architected to address highly data-intensive applications that include signal, sensor and image processing within environmentally challenging and size, weight and power constrained military and commercial applications. In addition, ACS has a portfolio of RF and microwave sub-assemblies to address needs in EW, signal intelligence ("SIGINT"), electronic intelligence ("ELINT"), and high bandwidth communications subsystems.

These products are highly optimized for size, weight and power, as well as for the performance and ruggedization requirements of our customers. Customized design and sub-systems integration services extend our capabilities to tailor solutions to meet the specialized requirements of our customers. We continue to innovate our technologies around challenging requirements and have technologies available today and planned for the future to address them as they evolve and become increasingly demanding.

With the addition of KOR Electronics ("KOR") in December 2011, we added a focus on the exploitation of RF signals. Leveraging our analog-to-digital and digital-to-analog technologies and expertise, KOR delivers innovative high end solutions and services to the defense communities:

DRFM (Digital Radio Frequency Memory) products which offer state of the art performance at low cost, for EW applications; and

radar and EW environment test and simulator products that are DRFM based and use modular and scalable building blocks including commercial-off-the-shelf hardware.

With the acquisition of Micronetics, Inc. ("Micronetics") in August 2012, we added a leading designer and manufacturer of microwave and RF subsystems and components for defense and commercial customers. The acquisition was directly aligned with our strategy of expanding our capabilities, services and offerings along the sensor processing chain.

For the three months ended September 30, 2012, ACS accounted for 80% of our total net revenues.

Mercury Federal Systems, or MFS. This business segment is focused on services and support work with the DoD and federal intelligence and homeland security agencies, including designing, engineering, and deploying new ISR capabilities to address present and emerging threats to U.S. forces. With the addition of Paragon Dynamics, Inc. ("PDI") in December 2011, our MFS segment also provides sophisticated analysis and exploitation, multi-sensor data fusion and enrichment, and data processing services for the U.S. intelligence community. MFS is part of our long-term strategy to expand our software and services presence and pursue growth within the intelligence community. MFS offers a wide range of engineering architecture and design services that enable clients to deploy leading edge computing capabilities for ISR applications on an accelerated time cycle. This business segment enables us to combine classified intellectual property with the commercially


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developed application-ready sub-systems being developed by ACS, providing customers with platform-ready, affordable ISR sub-systems. For the three months ended September 30, 2012, MFS accounted for 20% of our total net revenues.

Since we are an OEM supplier to our commercial markets and conduct business with our defense customers via commercial items, requests by customers are a primary driver of revenue fluctuations from quarter to quarter. Customers specify delivery date requirements that coincide with their need for our products. Because these customers may use our products in connection with a variety of defense programs or other projects of different sizes and durations, a customer's orders for one quarter generally do not indicate a trend for future orders by that customer. Additionally, order patterns do not necessarily correlate amongst customers and, therefore, we generally cannot identify sequential quarterly trends, even within our business units.

RESULTS OF OPERATIONS:

The following tables set forth, for the three months periods indicated,
financial data from the consolidated statements of operations:



                                                          As a % of                                    As a % of
                                  September 30,           Total Net            September 30,           Total Net
(In thousands)                        2012                 Revenue                 2011                 Revenue
Net revenues                     $        49,428               100.0 %        $        49,122               100.0 %
Cost of revenues                          29,038                58.7                   19,206                39.1

Gross margin                              20,390                41.3                   29,916                60.9
Operating expenses:
Selling, general and
administrative                            14,533                29.4                   13,645                27.8
Research and development                  10,039                20.3                   11,865                24.1
Amortization of acquired
intangible assets                          1,788                 3.6                      816                 1.6
Restructuring and other
charges                                    4,984                10.1                       -                   -
Acquisition costs and
other related expenses                       230                 0.5                       25                 0.1

Total operating expenses                  31,574                63.9                   26,351                53.6

(Loss) income from
operations                               (11,184 )             (22.6 )                  3,565                 7.3
Other income, net                            333                 0.6                      402                 0.8

(Loss) income from
operations before
income tax                               (10,851 )             (22.0 )                  3,967                 8.1
Tax (benefit) provision                   (3,651 )              (7.4 )                  1,314                 2.7

Net (loss) income                $        (7,200 )             (14.6 )%       $         2,653                 5.4 %

REVENUES



                       September 30,       September 30,
     (In thousands)        2012                2011            $ Change        % Change
     ACS              $        37,808     $        45,397      $  (7,589 )          (17) %
     MFS                        9,916               4,171          5,745             138 %
     Eliminations               1,704                (446 )        2,150             482 %

     Total revenues   $        49,428     $        49,122      $     306               1 %

Total revenues increased $0.3 million, or 1%, to $49.4 million during the three months ended September 30, 2012 as compared to the comparable period in fiscal 2012. International revenues represented approximately 4% and 5% of total revenues during the three months ended September 30, 2012 and 2011, respectively.


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Net ACS revenues decreased $7.6 million, or 17%, during the three months ended September 30, 2012 as compared to the same period in fiscal 2012. This decrease was primarily driven by lower defense sales of $8.4 million which were slightly offset by a $0.8 million increase in commercial sales. Excluding the addition of KOR and Micronetics, defense revenues for the three months ended September 30, 2012 declined $17.7 million as a result of lower revenues in two particular programs year over year and a general slowdown in funding due to current constraints on U.S. defense spending and uncertainties surrounding the future defense budget.

Net MFS revenues increased $5.7 million during the three months ended September 30, 2012 as compared to the same period in fiscal 2012. This increase was primarily driven by higher revenues from a wide area persistent surveillance contract and revenues contributed by PDI.

Eliminations revenue is attributable to development programs where the revenue is recognized in each segment under contract accounting, and reflects the reconciliation to our consolidated results.

GROSS MARGIN

Gross margin was 41.3% for the three months ended September 30, 2012, a change of 19.6% from the 60.9% gross margin achieved during the same period in fiscal 2012. The decrease in gross margin was primarily due to a shift in program revenue mix and as a result of our acquisitions of KOR, PDI, and Micronetics during the past year which realize lower gross margins, coupled with a revenue decline in our higher margin core ACS digital computing business.

SELLING, GENERAL ANDADMINISTRATIVE

Selling, general and administrative expenses increased $0.9 million, or 7%, to $14.5 million during the three months ended September 30, 2012, compared to $13.6 million during the comparable period in fiscal 2012. The increase was primarily due to a $0.8 million increase in employee compensation expense, including stock based compensation, primarily as a result of the KOR, PDI and Micronetics acquisitions. Selling, general and administrative expenses increased as a percentage of revenues to 29.4% during the three months ended September 30, 2012 from 27.8% during the same period in fiscal 2012.

RESEARCH AND DEVELOPMENT

Research and development expenses decreased $1.8 million, or 15%, to $10.0 million during the three months ended September 30, 2012, compared to $11.9 million during the comparable period in fiscal 2012. The decrease was primarily due to cost reduction initiatives as a result of our fiscal 2012 restructuring, including a $0.6 million decrease in employee compensation expense, including stock-based compensation, a $0.6 million decrease in costs of prototype and development materials, and $0.7 million in higher resource allocations to customer funded projects. These decreases were partially offset by the inclusion of KOR, PDI, and Micronetics.

AMORTIZATION OF ACQUIRED INTANGIBLE ASSETS

Amortization of acquired intangible assets increased $1.0 million, to $1.8 million for the three months ended September 30, 2012 as compared to $0.8 million during the comparable period in fiscal 2012, primarily due to amortization of intangible assets from the KOR, PDI and Micronetics acquisitions completed after the first quarter of fiscal 2012.

RESTRUCTURING EXPENSE

There was $5.0 million of restructuring expense recorded during the three months ended September 30, 2012. The restructuring plan implemented in the first quarter of fiscal 2013 consisted of involuntary separation costs related to the reduction in force which eliminated 35 positions at Micronetics and 107 positions primarily


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from our corporate headquarters located in Chelmsford, Massachusetts. These 142 positions were largely from our engineering, administrative and manufacturing functions. The 2013 Plan was implemented to cope with reduced defense revenues and the near term uncertainties in the defense industry driven by the potential for sequestration. We expect to realize approximately $20.0 million in annualized savings from these cost reduction activities.

ACQUISITION COSTS AND OTHER RELATEDEXPENSES

We incurred $0.2 million of acquisition costs and other related expenses during the three months ended September 30, 2012, in connection with the acquisition of Micronetics.

OTHER NET INCOME

Other net income decreased $0.1 million, or 17%, to $0.3 million during the three months ended September 30, 2012, as compared to the same period in fiscal 2012. Other income consists of $0.3 million in amortization of the gain on the sale leaseback of our corporate headquarters located in Chelmsford, Massachusetts and foreign currency exchange gains and losses. Interest income and interest expense were deminimis.

INCOME TAXES

We recorded an income tax benefit of $3.7 million during the three months ended September 30, 2012 reflecting a 33.5% effective tax rate as compared to a $1.3 million income tax provision, reflecting a 34.1% effective tax rate for the same period in fiscal 2012. Our effective tax rate for the three months ended September 30, 2012 differed from the federal statutory tax rate of 35% primarily due to the impact of a Section 199 manufacturing deduction, state taxes and stock compensation. Our effective tax rate for the three months ended September 30, 2011 differed from the federal statutory rate primarily due to the impact of a Section 199 manufacturing deduction and research and development tax credits.

SEGMENTOPERATING RESULTS

Adjusted EBITDA, the profitability measure for our segment reporting, for ACS decreased $8.6 million during the three months ended September 30, 2012 to $(0.4) million as compared to $8.2 million for the same period in fiscal 2012. The decrease in adjusted EBITDA is primarily driven by lower revenues of $7.6 million coupled with lower margins driven by a shift in program mix.

Adjusted EBITDA for the MFS segment increased $1.0 million during the three months ended September 30, 2012 to $1.5 million as compared to $0.5 million for the same period in fiscal 2012. The increase in adjusted EBITDA was primarily due to a $5.7 million increase in revenues.

See Note K to our consolidated financial statements included in this report for more information regarding our operating segments.

LIQUIDITY AND CAPITAL RESOURCES

Our primary source of liquidity came from existing cash. Our near-term fixed commitments for cash expenditures consist primarily of payments under operating leases and inventory purchase commitments with our contract manufacturers. We do not currently have any material commitments for capital expenditures.

Based on our current plans and business conditions, we believe that existing cash, cash equivalents, available line of credit, cash generated from operations, and financing capabilities will be sufficient to satisfy our anticipated cash requirements for at least the next twelve months.


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Senior Unsecured Credit Facility

On October 12, 2012, we entered into a credit agreement (the "Credit Agreement") with a syndicate of commercial banks, with KeyBank National Association acting as the administrative agent. The Credit Agreement provides for a $200.0 million senior unsecured revolving line of credit (the "Revolver"). We can borrow up to $200.0 million subject to compliance with the financial covenants discussed below. The Revolver is available for working capital, acquisitions, and general corporate purposes of the Company and its subsidiaries. The Revolver is available for borrowing during a five year period, with interest payable periodically during such period as provided in the Credit Agreement and principal due at the maturity of the Revolver.

The Credit Agreement has an accordion feature permitting us to request from the lenders an increase in the aggregate amount of the credit facility in the form of an incremental revolver or term loan in an amount not to exceed $50.0 million. Any such increase would require only the consent of the lenders increasing their respective commitments under the credit facility.

The interest rates applicable to borrowings under the Credit Agreement involve various rate options that are available to us. The rates are calculated using a combination of conventional base rate measures plus a margin over those rates. The base rates consist of LIBOR rates and prime rates. The actual rates will depend on the level of these underlying rates plus a margin based on our leverage at the time of borrowing.

Borrowings under the Credit Agreement are senior unsecured loans. Each of our domestic subsidiaries is a guarantor under the Credit Agreement.

The Credit Agreement provides for conventional affirmative and negative covenants, including a maximum leverage ratio of 3.50x and a minimum interest coverage ratio of 3.0x. Each of the two ratios referred to above is calculated based on consolidated EBITDA, as defined in the Credit Agreement, on a consolidated basis for each consecutive four fiscal quarter period, after giving pro forma effect for any acquisitions or dispositions. Acquisitions are permitted under the Credit Agreement without any dollar limitation so long as, among other requirements, no default or event of default exists or would result therefore; we are in compliance with a maximum leverage ratio of 3.25x and a minimum interest coverage ratio of 3.0x, in each case, after giving pro forma effect to the applicable acquisition. In addition, the Credit Agreement contains certain customary representations and warranties, and events of default. We have not borrowed under the Credit Agreement to date.

Senior Secured Credit Facility

On September 30, 2012, we had a loan and security agreement (the "Loan Agreement") with Silicon Valley Bank that provided a $35 million revolving line of credit (the "Revolver"), with interest payable monthly and the principal due at the February 11, 2014 maturity of the Revolver. We had no borrowings under the Loan Agreement since inception and were in compliance with all covenants as of September 30, 2012.

Shelf Registration Statement

On August 2, 2011, we filed a shelf registration statement on Form S-3 with the SEC. The shelf registration statement, which has been declared effective by the SEC, registered up to $500 million of debt securities, preferred stock, common stock, warrants and units. We intend to use the proceeds from a financing using the shelf registration statement for general corporate purposes, which may include the following:

the acquisition of other companies or businesses;

the repayment and refinancing of debt;

capital expenditures;

working capital; and

other purposes as described in the prospectus supplement.


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CASH FLOWS



                                                             As of and for the
                                                                period ended
                                                               September 30,
   (In thousands)                                           2012           2011
   Net cash (used in) provided by operating activities    $  (9,949 )    $   4,216
   Net cash used in investing activities                  $ (68,966 )    $  (1,666 )
   Net cash (used in) provided by financing activities    $  (6,479 )    $     406
   Net (decrease) increase in cash and cash equivalents   $ (85,396 )    $   2,987
   Cash and cash equivalents at end of period             $  30,568      $ 165,862

Our cash and cash equivalents decreased by $85.4 million from June 30, 2012 to September 30, 2012, primarily as a result of the $67.7 million payment, net of cash acquired, to acquire Micronetics, $6.6 million payment to repay debt held by Micronetics immediately prior to its acquisition by us, and $9.9 million cash out flow from operating activities.

Operating Activities

During the three months ended September 30, 2012, we used $9.9 million in cash for operating activities compared to $4.2 million in cash generated from operating activities during the same period in fiscal 2012. The $14.2 million increase in cash used in operating activities was primarily a result of lower comparable net income of $9.9 million and a $4.8 million smaller reduction in the change in receivables. Our ability to generate cash from operations in future periods will depend in large part on profitability, the rate of collection of accounts receivable, our inventory turns and our ability to manage other areas of working capital.

Investing Activities

During the three months ended September 30, 2012, we used cash of $69.0 million in investing activities compared to $1.7 million used by investing activities during the same period in fiscal 2012. The $67.3 million increase in cash used in investing activities was primarily driven by the $67.7 million used to purchase Micronetics on August 8, 2012.

Financing Activities

During the three months ended September 30, 2012, we used $6.5 million in financing activities compared to $0.4 million generated from financing activities during the same period in fiscal 2012. The $6.9 million change in cash from financing activities was primarily due to a $6.6 million payment to settle debt acquired as part of the Micronetics acquisition.

COMMITMENTS AND CONTRACTUAL OBLIGATIONS

The following is a schedule of our commitments and contractual obligations
outstanding at September 30, 2012:



                                             Less Than        2-3         4-5       More Than
   (In thousands)               Total         1 Year         Years       Years       5 Years
. . .
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