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MRCY > SEC Filings for MRCY > Form 10-Q on 7-Nov-2013All Recent SEC Filings

Show all filings for MERCURY SYSTEMS INC

Form 10-Q for MERCURY SYSTEMS INC


7-Nov-2013

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 financial 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 and amounts of such funding, including the potential for a continuing resolution for the defense budget and the potential for continued defense budget sequestration, 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 and restructurings 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, 2013. 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
Mercury Systems, Inc. (the "Company" or "Mercury") provides commercially developed, open sensor and Big Data processing systems, software and services for critical commercial, defense and intelligence applications. We deliver innovative solutions, rapid time-to-value and world-class service and support to our defense prime contractor customers. Our products and solutions have been deployed in more than 300 programs with over 25 different defense prime contractors. Key programs include Aegis, Patriot, Surface Electronic Warfare Improvement Program ("SEWIP"), Predator and Reaper. We also deliver services and solutions in support of the intelligence community. Mercury operates across a broad spectrum of defense and intelligence programs and we deliver our solutions and services via three business units: (i) Mercury Commercial Electronics ("MCE"); (ii) Mercury Defense Systems ("MDS") and; (iii) Mercury Intelligence Systems ("MIS").
As of September 30, 2013, we had 752 employees. Our revenue, net loss and adjusted EBITDA for the three month period ended September 30, 2013 were $53.9 million, $(2.3) million, and $3.6 million, respectively. See the Non-GAAP Financial Measures section for a reconciliation of our net loss to adjusted EBITDA.
Our operations are organized in the following two reportable segments: (i) Mercury Commercial Electronics ("MCE") and (ii) Mercury Defense and Intelligence Systems ("MDIS"). We combined the MDS and MIS businesses as they both entail similar products and services and have a similar customer base. See below for a description of our two reportable segments:
Mercury Commercial Electronics, or MCE, delivers innovative, commercially developed, open sensor and Big Data processing systems for critical commercial, defense and intelligence applications. We deliver solutions that are secure and based upon open architectures and widely adopted industry standards. MCE's products include, but are not limited to, embedded processing boards, digital receiver boards, chassis-based systems using air, conduction, and proprietary cooling technologies and RF and microwave technologies, including tuners, converters, transceivers, switch filters, and power amplifiers and limiters. We deliver rapid time-to-value and world-class service and support to prime defense contractors and commercial customers. MCE provides solutions to prime contractor customers on a variety of programs. MCE also provides technology building blocks to Mercury Defense Systems on key classified and unclassified programs. MCE has a legacy of embedded multi-computing and embedded sensor processing expertise. More recently, MCE has added substantial capabilities around radio frequency ("RF") and microwave technologies as well as emerging new manufacturing capabilities to bring design, production and test capabilities of our RF and microwave solutions to market on a more scalable basis.
For the three months ended September 30, 2013, MCE accounted for 79% of our total net revenues.


Mercury Defense and Intelligence Systems, or MDIS, leverages the technology building blocks developed within MCE for key solutions required by our prime contractor customers. This segment represents an aggregation of Mercury Defense Systems ("MDS") and Mercury Intelligence Systems ("MIS"). Technology building blocks from MCE are deployed as part of solutions that fall into the areas of electronic warfare ("EW"), electronic counter measures ("ECM"), signals intelligence ("SIGINT"), electro optical/infrared, and radar test and simulation. Most of this work is done with Defense Contract Audit Agency ("DCAA") oversight on behalf of one or more of our prime contractor customers and U.S. Department of Defense agencies. MDIS's products include, but are not limited to, Digital Radio Frequency Memory ("DRFM") jammers and radar environment simulators. MDIS also provides analyst and systems engineering support, also under DCAA oversight, to the intelligence community. This professional services work falls into the critical areas of Big Data processing, predictive analytics and multi-intelligence analysis.
For the three months ended September 30, 2013, MDIS accounted for 21% of our total net revenues.
Since we are an OEM supplier to our commercial markets and conduct much of our 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:
Three months ended September 30, 2013 compared to the three months ended
September 30, 2012
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)                                2013           Revenue          2012           Revenue
Net revenues                             $      53,940        100.0  %   $      49,428        100.0  %
Cost of revenues                                31,355         58.1             29,038         58.7
Gross margin                                    22,585         41.9             20,390         41.3
Operating expenses:
Selling, general and administrative             15,101         28.0             14,533         29.4
Research and development                         9,344         17.3             10,039         20.3
Amortization of intangible assets                2,108          3.9              1,788          3.6
Restructuring and other charges                    (15 )          -              4,984         10.1
Acquisition costs and other related
expenses                                             -            -                230          0.5
Total operating expenses                        26,538         49.2             31,574         63.9
Loss from operations                            (3,953 )       (7.3 )          (11,184 )      (22.6 )
Other income, net                                  418          0.8                333          0.6
Loss before income taxes                        (3,535 )       (6.5 )          (10,851 )      (22.0 )
Tax benefit                                     (1,279 )       (2.4 )           (3,651 )       (7.4 )

Net loss $ (2,256 ) (4.1 )% $ (7,200 ) (14.6 )%


REVENUES

                  September 30,     September 30,
(In thousands)        2013               2012          $ Change    % Change
MCE              $      43,488     $        31,897    $ 11,591         36  %
MDIS                    11,130              15,827      (4,697 )      (30 )%
Eliminations              (678 )             1,704      (2,382 )     (140 )%
Total revenues   $      53,940     $        49,428    $  4,512          9  %

Total revenues increased $4.5 million, or 9%, to $53.9 million during the three months ended September 30, 2013 as compared to the comparable period in fiscal 2013. This increase was driven by higher commercial sales of $2.6 million, coupled with a $1.9 million increase in defense sales. The increase in total revenues is primarily attributed to increases in the SEWIP and B-1 Bomber programs, as well as increased revenues from international customers, including foreign military sales through our prime customers and direct sales to non-U.S. based customers. International sales increased from $10.2 million in the three months ended September 30, 2012 to $15.4 million for the three months ended September 30, 2013. Key programs driving the increase in international revenues were Patriot, F-16, F-15 and higher shipments to a telecommunications customer for product that was designated as end of life.
Net MCE revenues increased $11.6 million, or 36%, during the three months ended September 30, 2013 as compared to the same period in the prior fiscal year. This increase was primarily driven by higher defense sales of $8.9 million related to increases from the Patriot, SEWIP, F-16, F-15 and B-1 Bomber programs, partially offset by lower Joint Strike Fighter revenues, and a $2.6 million increase in commercial sales as the result of higher shipments to a telecommunications customer for product that was designated as end of life.
Net MDIS revenues decreased $4.7 million, or 30%, during the three months ended September 30, 2013 as compared to the same period in the previous fiscal year. This decrease was primarily driven by lower revenues from the Gorgon Stare program, as well as lower DRFM jammer and MIS revenues due to customer funding delays.
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 41.9% for the three months ended September 30, 2013, an increase of 60 basis points from the 41.3% gross margin achieved during the same period in fiscal 2013. The higher gross margin between years was due to a more favorable product mix and lower inventory provision. In addition, for the three months ended September 30, 2012 there was a $0.8 million non-recurring charge for a fair value adjustment from purchase accounting resulting from the Micronetics acquisition.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative expenses increased $0.6 million, or 4%, to $15.1 million during the three months ended September 30, 2013, compared to $14.5 million during the comparable period in fiscal 2013. The increase was primarily due to an increase in employee stock compensation expense. Selling, general and administrative expenses decreased as a percentage of revenues to 28.0% during the three months ended September 30, 2013 from 29.4% during the same period in fiscal 2013 due to higher revenues in the first quarter of fiscal 2014 as compared to the comparable period in fiscal 2013.
RESEARCH AND DEVELOPMENT
Research and development expenses decreased $0.7 million, or 7%, to $9.3 million during the three months ended September 30, 2013, compared to $10.0 million during the comparable period in fiscal 2013. The decrease was primarily due to savings related to restructuring actions initiated in fiscal 2013 that were partially offset by lower resource allocations to customer funded projects.
AMORTIZATION OF INTANGIBLE ASSETS
Amortization of acquired intangible assets increased $0.3 million, to $2.1 million for the three months ended September 30, 2013 as compared to $1.8 million during the comparable period in fiscal 2013, primarily due to amortization of intangible assets from the Micronetics acquisition which was completed midway through the first quarter of fiscal 2013.


RESTRUCTURING EXPENSE
We implemented restructuring plans in the first and fourth quarters of fiscal 2013. These plans consisted of involuntary separation costs related to a reduction in force and facility charges for our Hudson, NH, Huntsville, AL, and Ewing, NJ sites. The plans were implemented to cope with reduced defense revenues and the near term uncertainties in the defense industry driven by the potential for sequestration. The $5.0 million of restructuring expense recorded during the three months ended September 30, 2012 related to the elimination of 142 positions largely from our engineering, administrative and manufacturing functions.
OTHER INCOME, NET
Other income, net increased to $0.4 million during the three months ended September 30, 2013, as compared to $0.3 million for the same period in fiscal 2013. Other income, net 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 de minimis.
INCOME TAXES
We recorded an income tax benefit of $1.3 million during the three months ended September 30, 2013 as compared to a $3.7 million income tax benefit for the comparable period in the prior fiscal year. Our income tax benefit for the three months ended September 30, 2013 differed from the federal statutory tax rate of 35% primarily due to the impact of federal research and development tax credits,
Section 199 manufacturing deduction and stock compensation. Our effective tax rate during the comparable period in fiscal 2013 also differed from the federal statutory rate primarily due to the impact of the Section 199 manufacturing deduction, state taxes and stock compensation.
As of September 30, 2013, we had approximately $3.5 million in net deferred tax assets. Each quarter, we determine the probability of the realization of deferred tax assets, using significant judgments and estimates with respect to, among other things, historical operating results, expectations of future earnings and tax planning strategies. If we determine in the future that there is not sufficient positive evidence to support the valuation of these assets we may be required to further adjust the valuation allowance to reduce our deferred tax assets.
SEGMENT OPERATING RESULTS
We use adjusted EBITDA as the profitability measure for our segment reporting. Adjusted EBITDA for MCE increased $4.5 million during the three months ended September 30, 2013 to $2.3 million as compared to $(2.2) million for the comparable period in fiscal 2013. The increase in adjusted EBITDA is primarily driven by higher revenues of $11.6 million primarily from the Patriot, SEWIP, and B-1 Bomber programs, coupled with higher gross margins.
Adjusted EBITDA for MDIS decreased $1.8 million during the three months ended September 30, 2013 to $1.4 million as compared to $3.2 million for the comparable period in fiscal 2013. The decrease in adjusted EBITDA was primarily due to lower revenues from the Gorgon Stare and DRFM jammer programs and corresponding gross margin due to customer funding delays.
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 comes from existing cash and cash generated from operations. 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. 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 based on consolidated EBITDA for the four quarters ended September 30, 2013 and 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 or 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; at September 30, 2013, we are in compliance with a maximum leverage ratio of 3.25x and a minimum interest coverage ratio of 3.0x. In addition, the Credit Agreement contains certain customary representations and warranties, and events of default.
As of September 30, 2013, there was $43.1 million of borrowing capacity available. There were no borrowings outstanding on the Credit Agreement; however, there were outstanding letters of credit of $4.3 million. We were in compliance with all covenants and conditions under the Credit Agreement. 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.

CASH FLOWS
                                                          As of and for the
                                                             period ended
                                                            September 30,
(In thousands)                                            2013         2012
Net cash provided by (used in) operating activities    $  2,173     $  (9,949 )
Net cash used in investing activities                  $ (1,108 )   $ (68,966 )
Net cash used in financing activities                  $    (61 )   $  (6,479 )
Net increase (decrease) in cash and cash equivalents   $    980     $ (85,396 )
Cash and cash equivalents at end of period             $ 40,106     $  30,568

Our cash and cash equivalents increased by $1.0 million from June 30, 2013 to September 30, 2013, primarily as a result of $2.2 million in cash generated from operating activities, partially offset by $1.1 million in purchases of property and equipment.
Operating Activities
During the three months ended September 30, 2013, we generated $2.2 million in cash from operating activities compared to $9.9 million in cash used for operating activities during the same period in fiscal 2013. The $12.1 million increase in cash generated by operating activities was primarily a result of a smaller comparable net loss of $4.9 million, $4.8 million in lower inventory purchases, and a $3.1 million decrease in cash used for payables and accrued expenses. These increases in cash generated from operations were partially offset by $2.5 million in higher accounts receivable. Our ability to generate cash from


operations in future periods will depend in large part on profitability, the rate and timing of collections 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, 2013, we used cash of $1.1 million in investing activities compared to $69.0 million used by investing activities during the same period in fiscal 2013. The $67.9 million decrease in cash used in investing activities was driven by $67.7 million of cash spent on the Micronetics acquisition during the three months ended September 30, 2012. Financing Activities
During the three months ended September 30, 2013, we used $0.1 million for financing activities compared to $6.5 million used for financing activities during the same period in fiscal 2013. The $6.4 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 during the three months ended September 30, 2012.

COMMITMENTS AND CONTRACTUAL OBLIGATIONS
The following is a schedule of our commitments and contractual obligations
outstanding at September 30, 2013:
                                                   Less Than       2-3        4-5       More Than
(In thousands)                          Total        1 Year       Years      Years       5 Years
Purchase obligations                  $ 17,373    $    17,373    $     -    $     -    $         -
Operating leases                        24,652          4,892      8,745      4,641          6,374
Capital lease obligations and other        633            419        209          5              -
                                      $ 42,658    $    22,684    $ 8,954    $ 4,646    $     6,374

We have a liability at September 30, 2013 of $2.9 million for uncertain tax positions, not included in the table above, that has been taken or is expected to be taken in various income tax returns. We expect to make a payment of $0.7 million in the next twelve months as a result of resolutions of certain tax positions.
Purchase obligations represent open non-cancelable purchase commitments for certain inventory components and services used in normal operations. The purchase commitments covered by these agreements are for less than one year and aggregated approximately $17.4 million at September 30, 2013.
Our standard product sales and license agreements entered into in the ordinary course of business typically contain an indemnification provision pursuant to which we indemnify, hold harmless, and agree to reimburse the indemnified party for losses suffered or incurred by the indemnified party in connection with certain intellectual property infringement claims by any third party with respect to our products. Such provisions generally survive termination or expiration of the agreements. The potential amount of future payments we could be required to make under these indemnification provisions is, in some instances, unlimited.
OFF -BALANCE SHEET ARRANGEMENTS
Other than our lease commitments incurred in the normal course of business and certain indemnification provisions, we do not have any off- balance sheet financing arrangements or liabilities, guarantee contracts, retained or contingent interests in transferred assets, or any obligation arising out of a material variable interest in an unconsolidated entity. We do not have any majority-owned subsidiaries that are not consolidated in the financial statements. Additionally, we do not have an interest in, or relationships with, any special purpose entities.
NON-GAAP FINANCIAL MEASURES
In our periodic communications, we discuss two important measures that are not calculated according to U.S. generally accepted accounting principles ("GAAP"), adjusted EBITDA and free cash flow.
Adjusted EBITDA, the profitability measure for our segment reporting, is defined as net income (loss) before interest income and expense, income taxes, depreciation, amortization of acquired intangible assets, restructuring, . . .

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