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MRCY > SEC Filings for MRCY > Form 10-K on 14-Aug-2014All Recent SEC Filings

Show all filings for MERCURY SYSTEMS INC

Form 10-K for MERCURY SYSTEMS INC


14-Aug-2014

Annual Report


ITEM 7. 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. You can identify these statements by the use of the words "may," "will," "could," "should," "would," "plans," "expects," "anticipates," "continue," "estimate," "project," "intend," "likely," "forecast," "probable," "potential" and similar expressions. These forward-looking statements 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, the timing and amounts of such funding, general economic and business conditions, including unforeseen weakness in the Company's markets, effects of continued geopolitical unrest and regional conflicts, competition, changes in technology and methods of marketing, delays in completing engineering and manufacturing programs, changes in customer order patterns, changes in product mix, continued success in technological advances and delivering technological innovations, changes in, or in the U.S. Government's interpretation of, federal export control or procurement rules and regulations, market acceptance of the Company's products, shortages in components, production delays due to performance quality issues with outsourced components, inability to fully realize the expected benefits from acquisitions, divestitures 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 this Annual Report on Form 10-K. 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.


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OVERVIEW
Mercury Systems provides commercially developed, specialized processing subsystems and services for critical commercial, defense, and intelligence applications. We deliver innovative solutions, rapid time-to-value and 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"), Gorgon Stare, Predator and Reaper. Our organizational structure allows the Company to deliver capabilities that combine technology building blocks and deep domain expertise in the defense sector. We believe our total portfolio of services and solutions is unique in the industry for a commercial company. Mercury Systems operates across a broad spectrum of defense programs and, effective for fiscal 2015, we deliver our solutions and services via two business units: (i) Mercury Commercial Electronics; and (ii) Mercury Defense Systems. In the fourth quarter of fiscal 2014, we initiated a plan to divest our Mercury Intelligence Systems business unit. Consequently, its operating results are included in discontinued operations for all periods presented (see Note C to the consolidated financial statements).
As of June 30, 2014, we had 632 employees. Our revenue, (loss) from continuing operations and adjusted EBITDA for fiscal 2014 were $208.7 million, $(4.1) million, and $23.5 million, respectively. See the Non-GAAP Financial Measures section for a reconciliation of our (loss) income from continuing operations to adjusted EBITDA.
Our operations are organized in the following two reportable segments: (i) Mercury Commercial Electronics ("MCE") and (ii) Mercury Defense Systems ("MDS"). Mercury Commercial Electronics, or MCE, provides affordable, innovative, commercially designed and developed, specialized processing subsystems for critical commercial, defense and intelligence applications. We deliver innovative solutions, rapid time-to-value and service and support to our prime defense contractor customers. Our technologies and capabilities include embedded processing modules and subsystems, RF and microwave multi-function assemblies as well as subsystems, and RF and microwave components.
MCE utilizes leading edge, high performance computing technologies architected by leveraging open standards and open architectures to address highly data-intensive applications that include signal, sensor and image processing; all of this while addressing the packaging challenges, often referred to as "SWaP" (size, weight, and power) that are common in military as well as some commercial applications. In addition, MCE designs and builds RF and microwave components and subsystems to meet the needs of the EW, SIGINT and other high bandwidth communications requirements and applications. In fiscal 2014, MCE accounted for 84% of our total net revenues.
Mercury Defense Systems, or MDS, provides significant capabilities relating to pre-integrated, open, affordable electronic warfare ("EW"), electronic attack ("EA") and electronic counter measure ("ECM") subsystems, and signals intelligence ("SIGINT") and electro-optical/infrared (EO/IR) technologies. MDS deploys these solutions on behalf of defense prime contractors and the Department of Defense ("DoD"), leveraging commercially available technologies and solutions (or "building blocks") from our MCE business and other commercial suppliers. MDS leverages this technology to develop integrated sensor processing subsystems, often including classified application-specific software and intellectual property ("IP") for the C4ISR (command, control, communications, computers, intelligence, surveillance and reconnaissance), EW, and ECM markets. MDS brings significant domain expertise to customers, drawing on over 25 years of experience in EW, SIGINT, and radar environment test and simulation. In fiscal 2014, MDS accounted for 16% 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.
BUSINESS DEVELOPMENTS:
FISCAL 2014
During fiscal 2014, we moved into our new manufacturing facility in Hudson, New Hampshire that will provide a platform for continued growth in our RF and microwave product lines. During the year, we consolidated four facilities into the new plant and installed integrated business systems that will allow us to scale our RF and microwave capabilities both organically and through merger and acquisition activities.


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In fiscal 2014, we announced a restructuring plan ("2014 Plan") that was implemented as part of the final phase of integration activities relating to our recent acquisitions. The integration plan includes the consolidation of manufacturing facilities, centralization of administrative and manufacturing functions using common information systems and processes and rebalancing of research and development investments. The restructuring plan included the elimination of 70 positions largely in engineering, manufacturing and administrative functions. Additionally, we closed four facilities relocating all related activities to the Company's Advanced Microelectronics Center ("AMC") in Hudson, New Hampshire. During the fourth quarter of fiscal 2014, we also consolidated facilities at our corporate headquarters. These restructuring expenses associated with our fiscal 2014 integration plan amounted to $5.4 million and affected both the MCE and MDS reportable segments. Future restructuring expenses associated with the integration plan are expected to be approximately $3.1 million, which are anticipated to be completed by the end of the second quarter of fiscal 2015.
FISCAL 2013
During the first quarter of fiscal 2013, we announced a restructuring plan ("Q1 2013 Plan") impacting primarily the MCE business segment as a result of a significant decline in bookings and revenue. The plan consisted of the elimination of 142 positions primarily in engineering and support staff areas. Additionally, during the fourth quarter of fiscal 2013, as a result of the first phase of integration activities surrounding our recent acquisitions, we initiated a restructuring plan ("Q4 2013 Plan") that included the sale of our Hudson, New Hampshire facility and the elimination of 17 positions primarily in operations. We incurred restructuring charges of $7.1 million for the fiscal year ended June 30, 2013.
In fiscal 2013, we acquired Micronetics Inc., a leading designer and manufacturer of microwave and RF subsystems and components for defense and commercial customers. Revenue and net loss from continuing operations of Micronetics included in our consolidated statements of operations for fiscal 2013 were $35.5 million and $(3.8) million, respectively.
FISCAL 2012
On December 30, 2011, we acquired KOR Electronics. Based in Cypress, California, KOR Electronics designs and develops DRFM units for a variety of modern EW applications, as well as radar environment simulation and test systems for defense applications. The amount of revenue and net income of KOR Electronics included in our consolidated statements of operations for fiscal 2012 were $11.9 million and $2.3 million, respectively.
In fiscal 2012, we concluded the financial targets which underlie the $5.0 million earn-out related to the LNX acquisition would not be achieved. During the fourth quarter of fiscal 2012, we did not receive a purchase order for long lead-time materials associated with the JCREW counter IED program. This timing issue, in itself, triggered a reversal of the earn-out (see Note D to the consolidated financial statements). This reversal of the earn-out was recorded as an offset to operating expenses.
In fiscal 2012, we announced a restructuring plan ("2012 Plan") affecting both the MCE and MDS reportable segments. The 2012 Plan primarily consisted of involuntary separation costs related to the reduction in force which eliminated 41 positions largely in engineering and manufacturing functions; and facility costs related to outsourcing of certain manufacturing activities at our Huntsville, Alabama site.


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RESULTS OF OPERATIONS:

FISCAL 2014 VS. FISCAL 2013
The following tables set forth, for the periods indicated, financial data from
the consolidated statements of operations:

                                                       As a % of                       As a % of
                                                       Total Net                       Total Net
(In thousands)                        Fiscal 2014       Revenue       Fiscal 2013       Revenue
Net revenues                         $    208,729         100.0  %   $    194,231         100.0  %
Cost of revenues                          113,985          54.6           116,073          59.8
Gross margin                               94,744          45.4            78,158          40.2
Operating expenses:
Selling, general and administrative        53,685          25.7            54,764          28.2
Research and development                   35,693          17.1            32,604          16.8
Amortization of intangible assets           7,328           3.5             8,222           4.2
Restructuring and other charges             5,443           2.6             7,060           3.6
Acquisition costs and other related
expenses                                        -             -               318           0.2
Total operating expenses                  102,149          48.9           102,968          53.0
Loss from operations                       (7,405 )        (3.5 )         (24,810 )       (12.8 )
Other income, net                           1,492           0.7               527           0.3
Loss from continuing operations
before income taxes                        (5,913 )        (2.8 )         (24,283 )       (12.5 )
Tax benefit                                (1,841 )        (0.8 )         (10,501 )        (5.4 )
Loss from continuing operations            (4,072 )        (2.0 )         (13,782 )        (7.1 )
(Loss) income from discontinued
operations, net of taxes                   (7,353 )        (3.5 )             574           0.3
Net loss                             $    (11,425 )        (5.5 )%   $    (13,208 )        (6.8 )%


REVENUES

                              As a % of                  As a % of
                 Fiscal       Total Net      Fiscal      Total Net
(In thousands)    2014         Revenue        2013        Revenue      $ Change    % Change
MCE            $ 175,766          84 %     $ 152,606         79 %     $ 23,160         15  %
MDS               34,217          16 %        41,491         21 %       (7,274 )      (18 )%
Eliminations      (1,254 )         -             134          -         (1,388 )   (1,036 )%
Total revenues $ 208,729         100 %     $ 194,231        100 %     $ 14,498          7  %

Total revenues increased $14.5 million, or 7%, to $208.7 million during fiscal 2014 compared to $194.2 million during fiscal 2013. The increase was driven by higher defense revenues of $16.9 million, partially offset by lower commercial sales of $2.4 million. The increase in total revenues is primarily attributed to a recovery in our higher margin digital signal processing products within MCE, specifically increases in the Aegis, Patriot, and UAV related programs, partially offset by decreases in the SEWIP program as well as MDS's DRFM jammer and Gorgon Stare programs. International revenues, which consist of foreign military sales through prime defense contractor customers and direct sales to non-U.S. based customers, decreased by $1.7 million to $51.3 million during fiscal 2014 compared to $53.0 million during fiscal 2013. The decrease was primarily driven by lower international revenues in the Asia Pacific region. International revenues represented 25% and 27% of total revenues during fiscal 2014 and 2013, respectively.
Net MCE revenues increased $23.2 million, or 15%, during fiscal 2014 compared to fiscal 2013. The increase in net MCE revenues was primarily driven by higher net defense revenues of $24.2 million, partially offset by lower commercial revenues of $2.4 million. The increase in net MCE defense revenues was driven by a recovery in our higher margin digital signal processing products, specifically increases in the Aegis, Patriot and UAV related programs, which were partially offset by decreases in the SEWIP and Navy Multiband Terminal ("NMT") programs. Defense revenue accounted for 90% of net MCE revenues during fiscal 2014 compared to 87% in fiscal 2013.


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Net MDS revenues decreased $7.3 million, or 18%, during fiscal 2014 compared to fiscal 2013. This decrease was driven by the decreases in a DRFM jammer program and the Gorgon Stare program.
Eliminations revenue is attributable to development programs where the revenue is recognized in both segments under contract accounting, and reflects the reconciliation to our consolidated results.
GROSS MARGIN
Gross margin was 45.4% for fiscal 2014, an increase of 520 basis points from the 40.2% gross margin achieved in fiscal 2013. The higher gross margin in fiscal 2014 was due to a more favorable product mix, primarily driven by a recovery in our higher margin digital signal processing products within MCE and facilities consolidations as part of our integration plan. In addition, fiscal 2013 included a $2.1 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 decreased $1.1 million, or 2%, to $53.7 million during fiscal 2014 compared to $54.8 million during fiscal 2013. The overall decrease was primarily due to lower employee compensation expenses as a result of progress achieved on our plan of integrating and consolidating facilities, systems, and processes. Selling, general and administrative expenses decreased as a percentage of revenue to 25.7% during fiscal 2014 from 28.2% during fiscal 2013 due to higher revenues in fiscal 2014 and overall expense reductions, as compared to the comparable period in fiscal 2013.
RESEARCH AND DEVELOPMENT
Research and development expenses increased $3.1 million, or 9.5%, to $35.7 million during fiscal 2014 compared to $32.6 million for fiscal 2013. The increase was primarily due to $0.8 million lower customer funded projects, $0.9 million higher prototype expenses, and $2.0 million increased employee compensation expenses, including stock compensation expense. Research and development expenses accounted for 17.1% and 16.8% of our revenues during fiscal 2014 and fiscal 2013, respectively. These increases were partially offset by lower depreciation expenses.
AMORTIZATION OF INTANGIBLE ASSETS
Amortization of intangible assets decreased $0.9 million, or 11%, to $7.3 million during fiscal 2014 compared to $8.2 million for fiscal 2013, primarily due to a portion of the Micronetics related intangible assets being fully amortized during the first quarter of fiscal 2014.

RESTRUCTURING EXPENSE
Restructuring and other charges decreased 23%, or $1.6 million, to $5.4 million during fiscal 2014 compared to $7.1 million in fiscal 2013. The fiscal 2014 restructuring activities included the elimination of 70 positions largely in engineering, manufacturing and administrative functions. Additionally, we closed four facilities relocating all related activities to the Company's Advanced Microelectronics Center ("AMC") in Hudson, New Hampshire. We also completed the first phase of our Chelmsford, Massachusetts headquarters consolidation in the fourth quarter of fiscal 2014. Future restructuring expenses associated with the integration plan are expected to be approximately $3.1 million.We expect to realize approximately $16 million in annualized savings from the fiscal 2014 cost reduction activities, which are expected to be completed by the end of the second quarter of fiscal 2015.
The restructuring plans implemented during fiscal 2013 consisted of $5.5 million of involuntary separation costs related to the reduction in force which eliminated 159 positions, primarily from our engineering, administrative, and manufacturing functions, and $1.4 million in facility charges for our Hudson, New Hampshire, Huntsville, Alabama, and Ewing, New Jersey sites. Our fiscal 2013 restructuring plans were implemented to cope with reduced defense revenues and the near term uncertainties in the defense industry driven by the potential for defense budget sequestration. Additionally, fiscal 2013 activities were implemented as a result of integration efforts of recent acquisitions and the planned consolidation of our manufacturing facilities in Salem, New Hampshire and Hudson, New Hampshire.
OTHER INCOME
Other income increased $1.0 million to $1.5 million during fiscal 2014 compared to $0.5 million in fiscal 2013. The increase was a result of foreign currency exchange gains during fiscal 2014 compared to losses during fiscal 2013 primarily driven by changes in the Japanese yen versus the U.S. dollar. Other income included $1.2 million in amortization of the gain on the sale leaseback of our corporate headquarters located in Chelmsford, Massachusetts during fiscal 2014 and 2013. Interest income and interest expense for fiscal years 2014 and 2013 were de minimis.


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INCOME TAXES
We recorded an income tax benefit of $1.8 million in fiscal 2014 compared to an income tax benefit of $10.5 million in fiscal 2013. The effective tax rates for fiscal 2014 and fiscal 2013 were 31.1% and 43.2%, respectively.
Our effective tax rate for fiscal 2014 differed from the federal statutory rate primarily due to non-deductible equity compensation, partially offset by benefits related to research and development tax credits, domestic manufacturing deductions and foreign tax credits.
The difference in the effective tax rates is mainly driven by fiscal 2014 including only six-months of federal research and development tax credits compared to 18 months in fiscal 2013 due to the timing of the tax credit extension and lower non-deductible stock compensation in fiscal 2013.
DISCONTINUED OPERATIONS
We incurred a loss from discontinued operations of $7.4 million in fiscal 2014 compared to income from discontinued operations of $0.5 million in fiscal 2013. The loss from discontinued operations in fiscal 2014 includes a $6.7 million impairment of goodwill in our MIS business.
SEGMENT OPERATING RESULTS
Adjusted EBITDA, the non-GAAP profitability measure for our segment reporting, is defined as earnings from continuing operations before interest income and expense, income taxes, depreciation, amortization of acquired intangible assets, restructuring and other charges, impairment of long-lived assets, acquisition costs and other related expenses, fair value adjustments from purchase accounting and stock-based compensation costs. We utilize the adjusted EBITDA financial measure to assist in providing a more complete understanding of our underlying operational measures in order to manage the business, evaluate our performance compared to prior periods and the marketplace, and to establish operational goals.
Adjusted EBITDA for MCE increased $15.7 million to $18.5 million during fiscal 2014, as compared to $2.8 million during fiscal 2013. The increase in adjusted EBITDA was primarily driven by higher revenues and higher gross margins due to favorable product revenue mix. MCE generated $184.8 million in revenues including intersegment revenues in fiscal 2014 compared to $166.3 million in fiscal 2013. This increase in revenues was coupled with higher margins driven by the recovery of our higher margin digital signal processing products. Adjusted EBITDA for MDS decreased by $1.4 million during fiscal 2014 to $5.7 million, as compared to $7.1 million in fiscal 2013. The decrease is primarily driven by lower MDS revenues including intersegment revenues in fiscal 2014 of $34.2 million as compared to $41.5 million in fiscal 2013. See Note Q to our consolidated financial statements for more information regarding our operating segments as well as the Company's reconciliations of loss from continuing operations to its adjusted EBITDA.


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FISCAL 2013 VS. FISCAL 2012
The following tables set forth, for the periods indicated, financial data from
the consolidated statement of operations:

                                                       As a % of                       As a % of
                                                       Total Net                       Total Net
(In thousands)                        Fiscal 2013       Revenue       Fiscal 2012       Revenue
Net revenues                         $    194,231         100.0  %   $    237,070         100.0  %
Cost of revenues                          116,073          59.8           103,262          43.6
Gross margin                               78,158          40.2           133,808          56.4
Operating expenses:
Selling, general and administrative        54,764          28.2            55,625          23.5
Research and development                   32,604          16.8            45,984          19.4
Amortization of intangible assets           8,222           4.2             3,551           1.4
Restructuring and other charges             7,060           3.6             2,712           1.1
Acquisition costs and other related
expenses                                      318           0.2             1,219           0.5
Change in the fair value of the
liability related to the LNX
earn-out                                        -             -            (4,938 )        (2.0 )
Total operating expenses                  102,968          53.0           104,153          43.9
(Loss) income from operations             (24,810 )       (12.8 )          29,655          12.5
Other income, net                             527           0.3             1,659           0.7
(Loss) income from continuing
operations before tax (benefit)
provision                                 (24,283 )       (12.5 )          31,314          13.2
Tax (benefit) provision                   (10,501 )        (5.4 )           8,991           3.8
(Loss) income from continuing
operations                                (13,782 )        (7.1 )          22,323           9.4
Income from discontinued operations,
net of taxes                                  574           0.3               296           0.1
Net (loss) income                    $    (13,208 )        (6.8 )%   $     22,619           9.5  %


REVENUES

                               As a % of                  As a % of
                   Fiscal      Total Net      Fiscal      Total Net
(In thousands)      2013        Revenue        2012        Revenue      $ Change      % Change
MCE              $ 152,606         79 %     $ 203,979         86 %     $ (51,373 )     (25 )%
MDS                 41,491         21 %        32,731         14 %         8,760        27  %
Eliminations           134          -             360          -            (226 )     (63 )%
Total revenues   $ 194,231        100 %     $ 237,070        100 %     $ (42,839 )     (18 )%

Total revenues decreased $42.8 million, or 18%, to $194.2 million during fiscal 2013 compared to $237.1 million during fiscal 2012. International revenues, which consist of foreign military sales through prime defense contractor customers and direct sales to non-U.S. based customers, decreased by $2.2 million to $41.5 million during fiscal 2013 compared to $43.7 million during fiscal 2012. International revenues represented 21% of total revenues during fiscal 2013 and 18% of total revenue during fiscal 2012.
Net MCE revenues decreased $51.4 million, or 25%, to $152.6 million during fiscal 2013 compared to $204.0 million in fiscal 2012. The decrease in net MCE revenues was primarily driven by lower net defense revenues of $56.2 million driven by a decline in our digital signal processing product revenue. These declines were net of an offset of $35.5 million of revenues contributed by . . .

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