Q2 2020 Earnings Call
Today's call is being recorded.
It's time for opening remarks, and introductions I like to turn the call over to the company's executive Vice President and Chief Financial Officer, Mike Rupert. Please go ahead Sir.
Good afternoon, and thank you for joining US with me today is our president and Chief Executive Officer, Mark Aslett.
If you know received a copy of the earnings press release, we issued earlier. This afternoon, you can find it on our website at MRC why dot com.
Slide presentation that Mark and I will be referring to is posted on the investor Relations section of the website under events and presentations.
Please turn to slide two in the presentation.
Before we get started I'd like to remind you that today's presentation includes forward looking statements, including information regarding Mercury's financial outlook future plans objectives business prospects and anticipated financial performance. These forward looking statements are subject to future risks and uncertainties that could cause our actual result.
Yeah sure performance to differ materially.
All forward looking statements should be considered in conjunction with the cautionary statements on slide two in the earnings press release and the risk factors included in Mercury SEC filings.
I'd also like dimension that in addition to reporting financial results in accordance with generally accepted accounting principles or gap during our call Weve also discuss several non-GAAP financial measures specifically adjusted income adjusted earnings per share adjusted EBITDA free cash flow organic revenue and acquired revenue.
A reconciliation of these non-GAAP metrics is included as an appendix today's slide presentation and in the earnings press release, I'll now turn the call over to Mercury's President and CEO Mark Aslett, Please turn to slide three.
Thanks, Mike Good afternoon, everyone and thanks for joining us I'll begin with the business update Mike will review the financials and guidance and then we'll open it up your questions.
But we delivered solid results from the second quarter fiscal 20 building on the momentum from Q1.
It was a record quarter for total revenue adjusted EPS and adjusted EBITDA.
The industry environment is positive as we begin the second tall, there's a defense appropriations bill in place and design win activity is very robust.
Our business model is performing extremely well, we're investing to inflect growth in the business was the same time delivering record results regain racing fiscal 20 guidance total revenue adjusted EBITDA for the just the P.S., we now expect to deliver 13% to 14% organic growth for the year.
Turning to our Q2 financial highlights on slide four total revenue for the first quarter increased 22% from Q2 fiscal 19, we delivered 12% to accommodate growth one point higher than a year ago.
Our largest revenue programs in the quarter were P. Eight F 35, filthy Badger F 16 say the next generation missile system.
Q2 was another very strong quarter for new business total bookings were up 21% year over year, leading to a record backlog and the book to Bill at 1.0 weight.
Our largest bookings programs in the quarter Ale off 56 held Toms Pro vision particle involved an international so.
Profitability for the quarter was strong adjusted EBITDA was up 16% from Q2 last year free cash flow was above our expectations at 48% of adjusted EBITDA working capital continue to improve when we maintained a strong unlevered balance sheet.
Turning to slide five.
Let me say ability to win new business has never been better we've successfully pioneered the next generation defense Electronics company.
We're making commercially available trusted unsecure technologies profoundly more accessible to the defense industry.
We've created a proven transformational business model that sits at the intersection of the high Tech World in the defense industry.
It's fueled by R&D levels that of four to five times the industry average focused on developing highly innovative trust and secure mission critical technologies.
In addition, we're funding growth capital investments at a rate Thats two to three times, what most consider the healthy level of capex in our industry.
We're creating pre integrated sensor processing and seep why subsystems and the way in which we're doing that allows us to introduce new capabilities follow quickly with lower risk and far more affordably than ever before.
We have industry, leading secure computing solutions the developed by a highly cleared workforce the solutions of both developed and produced in trusted domestic facilities.
Sitting at the intersection of Defense and high Tech, We believe Mercury's business model is perfectly aligned with recent defense procure reform initiatives.
While it's still focus on affordability the major shifts that we seen is the DCE focus on accelerating innovation and feeling new technologies and capabilities.
This has to deal with rising obsolescence and maintenance costs as well as emerging threats.
The TNT is seeking to speed things up by leveraging more the investments in the innovation occurring in the high Tech World. This includes using different types of contracting methodologies and greater reliance on non traditional defense contractors, which mercury is warm.
The nation faces, a very challenging global security environment, with Chinese militarization and power projection research in Russia, as well as general instability in the Middle East and all this is leading to increased defense spending.
Turning to slide six.
Our target markets Sensoryeffects emission systems on C line, well funded and growing faster than the defense market overall.
Over the past five years, we've delivered 18% compound annual growth in sensor defect to revenue and greater than 84% growth in seek wine.
The estimated lifetime value of our top 30 program. Some pursuits has grown more than five times since fiscal 14.
For the second quarter censored effect emission systems revenue was 57% of total revenue increasing 24% from Q2 last year.
C revenue increased 22% year over year to 30% of revenue.
This growth was driven by our ability to odd content on existing programs and expand into new programs like El terms, which we announced last quarter.
We're benefiting from a significant wave of modernization occurring in rate all E.W. in see fly. We're also seeing new opportunities in weapons systems space avionics processing and mission computing as well as secure rugged service.
Turning to new business in Q2, we had the largest number of new design wins, we've ever hot in the single quarter.
These wins encompass existing platforms as well as new platforms, we're winning new designs in existing and new markets. In particular, we've seen significant activity around mercury's industry, leading secure processing capabilities.
The customer level Mercury's growth is being driven by three dominant trends we've discussed in the past.
These trends include first supply chain delayering by the government in the primes.
Second the flight to quality supply is by the primes. That's most important increased outsourcing by our customers at the sub system level.
We continue to see outsourcing is the largest secular growth opportunity in defense.
These trends play the Mercury spreads today, we're tracking well over 100 active programs and our top programs are growing faster than total company revenue.
Turning to slide seven.
What we've done strategically through M&A over the past seven years or so is to focus on low risk content expansion into as while capability set an addressable markets.
First we acquired new capabilities, the transformed mercury from a tier three product company into a company that provides tier two solutions at the sub system level.
Second we use the acquired capabilities to expand more broadly non traditional sense and effective mission systems market.
We're in the midst of the market expansion into the other types of computers onboard military platforms. These encompass C III processing as well as platform and mission management.
And finally, we see an exciting opportunity to expand our existing microelectronics business by replicating our sensor processing subsystems integration strategy, but chip scale.
We believe that Mercury is uniquely positioned to provide the defense industry with trusted secure chip with based silicon solutions to support next generation defense applications.
As we discussed last quarter, we're investing $15 million not trusted microelectronics business and Phoenix to capitalize on this opportunity.
The build I suppose the clean room the team in Phoenix are underway.
We're engaged with several silicon Oems.
Involved in discussions with key customers.
The response to what we're doing has been overwhelmingly positive.
Looking at our footprint more broadly we're now on a multiyear journey to improve and scale, our trusted domestic manufacturing capabilities.
The latest milestone this effort was completing a west coast RF facility build out and consolidation.
As a result, we know state of the art money RF manufacturing located in close proximity to our customers on both the east and west coasts.
We're also continued to make solid progress integrating mercury's previous acquisitions and the integration of APC, which closed in Q1 has begun.
So now turning to slide eight and that strategy, that's delivering the above average levels of growth and profitability.
To grow a business, we strongly believe that you need to invest organically.
We have invested people processes technologies and trusted domestic manufacturing capabilities to support the continued organic growth in the business.
At the same time, we've used M&A strategically in three ways to expand our capability set gain access to adjacent markets and then to penetrate those markets over time.
As a full integrated we've generated significant cost and revenue synergies as a result, our adjusted EBITDA has grown faster at a rate faster than revenue.
We've invested in trust and secure innovations that really model for the aerospace and defense industries. Finally, we've never been to better position to attract retain and engage the best possible today that we need to grow up business.
Turning to slide nine we're positive about our business outlook, we're seeing very high levels of new design win activity and opportunities for continued growth.
The defense Appropriations Bill is being approved being that we are no longer operating under a see all the momentum in the business remains strong.
Over the longer term baseline forecast is for overall defense spending to increase at low single digit rights.
Our goal is to deliver organic revenue growth at a rate that far exceeds this industry average.
We're also well position to supplement our high levels of organic growth with M&A.
We continue to be successful acquiring and rapidly integrating businesses that fit well with mercury.
The M&A pipeline is robust and we're seeing interesting opportunities of varying sizes that are consistent with our strategy.
We intend to remain active in disciplined did our approach to M&A focusing on the censored effective mission systems Onsie fly markets as we have in the past.
We're looking for deals this strategically aligned and that have the potential to be accretive in the short and long term.
The combination of strong margins and organic revenue growth supplemented with disciplined M&A in full integration forms the core of our strategy.
We believe this strategy will continue to generate significant value for shareholders over the longer term as we execute uplands in five areas.
First is to grow our revenues organically at high single digit to low double digits, averaging 10% over time.
And to supplement this high level of organic growth was acquisitions.
This is consistent with the 26%.
Compound annual growth in total company revenue, we've delivered over the last five fiscal years.
The second is to invest and new technologies facilities manufacturing assets and business systems. We will also invest heavily enough people.
Third as manufacturing in sourcing as well as driving strong operating performance across our manufacturing locations.
The goal here is to enhance margins quality on time delivery, while improving working capital efficiencies over time.
For we're seeking to grow revenues faster than operating expenses. This will allow us to continue investing in organic growth, while maintaining strong operating leverage in the business.
And finally, we're fully integrating the businesses, we acquired to generate cost on revenue synergies.
These synergies combined with other areas of the plant should produce attractive returns to shareholders.
So in summary.
The stretchy I've just outlined has worked very well over the past five years, we look forward to extend this record of success.
We're anticipating another year of double digit growth in revenue and adjusted EBITDAR in fiscal 20, now, including 13% to 14% organic revenue growth.
Mike will take you through the guidance in detail, but before Mike begins I'd like to note that earlier this month Orlando Caballo form SVP of Lockheed Martin's Aeronautics business was elected to Mercury's board of directors.
London has deep experience for his many is and senior executive roles across major defense programs, including the F 35.
We welcome Orlando Mercury and look forward to benefiting from his knowledge and insight as we execute our strategy.
With that I'd like to turn the call over to Mike Mike.
Thank you Mark and good afternoon again, everyone.
Q2 is another quarter of strong financial results for Mercury, marking a solid first half of fiscal year 20.
As Mark mentioned revenue adjusted EBITDA and adjusted EPS were up significantly from Q2 last year and all at record levels, we delivered solid bookings growth and concluded the quarter with another record backlog.
Mercury's first half performance gives us the flexibility to continue investing for growth during the second half while still delivering strong results, we're increasing our full year fiscal 2000 guidance for revenue adjusted EBITDA and adjusted EPS and I'll go through those numbers shortly.
Turning now to the metrics on slide 10, Mercury's continued bookings and revenue growth translated into solid profitability in Q2.
Following a strong bookings quarter in Q1, Q2 bookings were about 200 million for the third consecutive quarter.
Total bookings increased 21% from Q2 last year to 210 million driving a 1.08 book to Bill ratio.
For the first half bookings were up 21% from each one last year with a strong book to Bill of 1.15. This increase was driven by large contract wins across the business.
We ended the second quarter with record backlog of 728 million, an increase of 39% compared to Q2 fiscal 19.
Backlog expected to ship within the next 12 months increased 34% from Q2 last year to 522 million.
12 month backlog is now 72% of total backlog, providing us with solid visibility into the second half.
Total revenue increased 22% from Q2 last year to 194 million near the high end of our guidance of 185 to 195 million.
Q2 results included an aggregate of approximately 16.3 million of revenue attributable to the gecko avionics Athena group syntactic microwave and APC acquired businesses.
APC, which we closed at the end of Q1 performed well in Q2, and we're pleased with our progress on the integration so far.
Organic revenue was up 12% year over year in Q2 and up 14% in each one compared to the first half last year.
As a reminder, organic revenue excludes acquired revenue, which represents revenue from acquired companies through the first for full quarters since the acquisition date.
Based on our year to date performance, coupled with continued momentum in design wins and bookings, we now expect 13% to 14% organic growth for the fiscal year.
Gross margin for Q2 was 45.6% up from 44.6% in Q2 fiscal 19.
In addition to favorable program mix Q2, gross margin benefited from operational efficiencies, including increased throughput at our manufacturing facilities as well as continued purchasing power synergies from the chemists and Germain combination.
In HQ, we expect gross margin to be similar to what we saw in Q1 driven by the continued ramp up in new program starts.
Our strong gross margin is allowing us to continue to invest in organic growth opportunities, while also delivering record results.
Internal R&D spend for Q2 was 24.7 million up 52% compared to 16.2 million a year ago, primarily driven by investments to support design wins across key franchise programs like El Tams.
We also saw an increase in R&D related to our acquisitions over the last 12 months.
As a percentage of sales R&D was 12.7%, which is up approximately 2.5 points from 10.2% in Q2 fiscal 19.
For the first half R&D was 12.5% of sales compared to 10.3% in each one last year demonstrating the increased percentage of sales were investing back into the business.
Cdna for Q2 was 32.8 million an increase of 17.9% from 27.8 million in Q2 last year, driven by our organic and acquired growth over the last 12 months.
As a percentage of sales SC in a declined to 16.9% from 17.5% in Q2 fiscal 19, driven by strong operating leverage in the business.
We expect this trend to continue in the second half.
Q2, GAAP net income and EPS increased 27% and 12% year over year, respectively.
Adjusted income for the second quarter increased 31%.
Cdps was 54 cents up 15% from 47 cents in Q2 last year and above our guidance of 46 to 48 cents.
Adjusted EBITDA for Q2 increased 16% year over year to a record 42.8 million.
This exceeded our guidance of 38.5 to 40.5 million driven primarily by strong gross margin.
Adjusted EBITDA margin in Q2 was 22.1 per cent compared to 23.2% in Q2 last year.
This reflects the increase in R&D as a percentage of sales as we invest in opportunities for growth in the business.
Q2, adjusted EBITDA margins were above our guidance of approximately 21% primarily driven by strong gross margin as a percentage of sales.
Finally, free cash flow, which we defined as cash flow from operations less capital expenditures was 20.7 million up 14% from 18.2 million in Q2 of fiscal 19.
This increase was driven by record operating cash flow, which was partially offset by higher capital expenditures compared to a year ago.
Slide 11 presents Mercury's balance sheet for the last five quarters.
We ended Q2 fiscal 2000 with cash and cash equivalents of 182 million up from 161 million in Q1, driven by the free cash flow generation in the business.
From a capital structure perspective, we remain well positioned with continued flexibility and good access to capital at the ended the quarter, we had zero debt and 182 million of cash on the balance sheet.
In addition, we have a 750 million unfunded revolver with attractive rates. This provides us with significant financial capacity for future R&D and capital investments to drive organic growth as well as capacity to execute on our M&A pipeline.
Turning to cash flow on slide 12, operating cash flow for Q2 with a record 32.1 million up 27% from 25.3 million in Q2 fiscal 19.
This increase was driven by higher net income and noncash adjustments.
The increasing cash flow from operations was partially offset by higher capital expenditures as we invest in new growth opportunities.
Capex in Q2 was 11.3 million or 5.8% of revenue compared with 7.1 million or 4.4% of sales in Q2 last year.
While completing the majority of the capital outlays associated with the consolidation of our West Coast RF facilities, we continued investing in the trusted micro electronics Buildout in Phoenix.
Looking forward, we expect capex to be approximately 7% of revenue for the full fiscal year.
Capex for the first half of fiscal 20 was 20.9 million or 5.6% of revenue.
We expect the majority of the remaining capex associated with the Phoenix Buildout to occur in H. two of this fiscal year.
Free cash flow for Q2 was 20.7 million or 48% of adjusted EBITDA.
As a result of our growth investments, we continue to expect free cash flow to come in at approximately 40% of adjusted EBITDA for the year for the first half free cash flow is approximately 45% of adjusted EBITDA.
Turning to slide 13, Mercury's Q2 results position us well to continue to execute our long term financial model as Mark said and as we discussed during the Investor day, we've created a differentiated and attractive financial profile for mercury by executing strategically against three objectives.
First we are delivering industry, leading adjusted EBITDA margins in our goal is to increase those margins overtime. We expect to continue to benefit from the operating leverage that we built into the business. We have a large number of new design wins and development programs.
These are the precursor to higher margin hardware annuity revenues as these programs transition into production over time.
We've made substantial investments to improve operating efficiencies across the business and at the same time as full integrators, we've delivered significant margin expansion through cost synergies from our recent acquisitions.
Our second objective is to grow our revenues organically at high single digits to low double digits, averaging 10% over time driven by above industry average levels of internal R&D as a percentage of sales were leveraging the trend towards outsourcing to expand our content on existing programs.
At the same time, we're taking share in our core markets and expanding into adjacent markets.
Our third objective is to supplement our margin expansion and organic growth, but strategic M&A over.
Over the past four years, we've completed 11 acquisitions deploying over 800 million of capital and we continue to have a large pipeline of acquisition targets were fully integrating the companies, we acquired a generate cost synergies and inflect their growth and our strong unlevered balance sheet.
Balance sheet positions us for continued acquisition driven growth.
Overall, Mercury's strategy and business model continued to deliver financial performance in Q2.
That was well above the industry averages and consistent with our unique financial profile.
So with that I'll now turn to our financial guidance.
Starting with Q3 guidance on slide 14, we're forecasting revenue to be 190 to 200 million.
Q3, GAAP net income is expected to be 15.9 to 17.4 million or 29 to 32 cents per share.
Adjusted EPS is expected to be 50 to 53 cents.
Finally, adjusted EBITDA is expected to be 40 to 44 million representing approximately 22.1% of revenue.
We expect to see continued expansion capex in Q3, as we continue our investment in growing the business, including our investments in Phoenix.
Turning to slide 15, our fiscal 20 outlook reflects continued growth and profitability.
For the full fiscal year, we now expect revenues of 780 to 795 million.
This represents 19% to 21% growth from fiscal 19 and is an increase from our previous guidance. In addition, we now expect organic growth of 13% to 14% for fiscal 2000.
Total GAAP net income for fiscal 20 is expected to be 71.7 to 74.5 million or $1.30 to $1.35 per share.
Adjusted EPS is expected to be in the range of $2 and nine to $2.13, an increase of 14% to 16% compared to fiscal 19 results.
Our guidance for adjusted EBITDA was 172.5 to 176 million or approximately 22% of revenue.
This increase reflects our higher revenue guidance as well as additional planned R&D investments in the second half.
And as I mentioned, we expect Capex for fiscal 20 to be approximately 7% of revenue.
Turning to slide 16 in summary, Mercury delivered a strong second quarter and first half of fiscal 20 as a result, we're well positioned to make substantial growth investments in the business, while continuing to deliver strong results for the fiscal year.
With that we'll be happy to take your questions. Operator, you can proceed with the QNX.
Thank you as a reminder, if you'd like to ask a question. Please press Star then one on your touched on telephone to withdraw your question press the pound key.
And by what we compile the culinary roster.
Our first question comes from Jon Raviv from Citi. Your line is now open.
Hey, guys. Good afternoon, thank so much hi, Joe.
Hey.
Certainly appreciate that.
Adjusted EBITDA margin or expanding adjusted EBITDA margins part of the business the differentiated financial profile you've laid out.
For the year and any additional visibility on on potentially getting beyond the 22% as you digest the mix the investments.
Some of those new development programs and new business lines ramp up in Q.
Sure John .
So as we look at the year you can see that our EBITDA margins for Q2 were 20.
2.1% the midpoint.
Our guidance for Q3 is 22.1%.
And the midpoint of our guidance for fiscal 20 is 22.1%.
So we had 20.7% in Q1, which implies higher EBITDA margins in Q4 at the at the midpoint. So we do expect to see some more operating leverage in the second half.
Really driven by higher revenue in Q4, and as I mentioned in my prepared remarks that somewhat offset by some of the additional investment that we're making in the business.
Thank you and then just speaking about customer funded R&D versus internally funded R&D.
Like one point, we'd had sort of the mix headwinds from the higher customer funded and then your hired went down and now we're having some gross margin opportunity here, but then your higher a higher right. It's going up I mean that effect on adjusted EBITDA margins somewhat unchanged for you just talk about that journey and kind of what drives that pendulum between the two sites.
Yes, so from a from a numbers perspective, you're right.
If you look at our gross margins they vary quarter by quarter.
A lot of its based on program mix of which is some see rad.
And if you look at this quarter, you'll see that see RASM is actually down a little bit year over year is down about 10%, but again a lot of that's just timing.
And in the second half, we expect to see Rad to pick back up.
And what you'll see is you also see that impact as you mentioned in our I read numbers. So our high rat as a percentage of sales was higher this quarter, we expected to be a little bit less in the second half as a percentage of sales, even though we're investing more in the business for the future and it's really John why we've started looking at.
EBITDA margins because of that mix that we're seeing we think that EBITDA margins is the right way to look at the business and as we just talked about we see expansion of those in H. too.
Thank you.
Thank you. Our next question comes it comes from Stat, Seth Seifman with JP Morgan. Your line is now open.
Thanks, very much and good evening.
Hi.
I was just wondering within the last maybe six weeks are here six weeks or so here, we've seen a couple of deals announced by others in the space with some pretty.
Some pretty big multiples on them.
Just kind of wondering what you're seeing out there and.
How.
What seems to be.
Expanding valuations for transactions in the space are affecting your M&A opportunities.
So clearly.
Yes, I think the market is being pretty on we've got a pretty robust pipeline of opportunities I think you're right. When you look it is a few transactions that were known as the last quarter.
Well, the multiples and us on those deals with slightly higher than what we've seen in the past.
We believe that it affects our ability to you that compete for transactions so to get deals done.
But we're going to remain disciplined in our approach as we have in the boss the Pos.
Great.
And then just I know some years.
The seasonality seems to vary a little bit are there one or two things you can kind of point too.
The fourth quarter that.
Give you the confidence in kind of nice revenue step up that looks like it.
Got it and the guidance.
Yes, so I think when we when we build our guidance right. We build it bottoms up program by program.
Yes, we which gives us the confidence.
Given our backlog position.
As our ability to execute against the plan. So it's really those two things, it's none of which programs that were on where those programs are up coupling.
Coupled with record backlog.
Great. Thanks very much.
Thank you. Our next question comes from Pete Skibitski with Limbic Global Your line is now open.
Good evening, guys nice quarter.
Hey, Mike the prior full year R&D guidance. It was 11% for that for the full year has that changed now.
So pay we didn't specifically guide R&D in terms of a percentage of sales and the reason is because of the shifts that we talked about between see Brad and I Rad that are neutral at the EBITDA level.
That having been said, we do see R&D in terms of the new opportunities that.
We're that are in front of us we do see R&D picking up significantly from last year, you can see it was up over two points from where we were in Q2 of last year. So we do see a picking up during the year, but we're not providing specific guidance because of that balance between see rat in Iraq.
Okay.
To start to the repeat that I think we're in a very unique environment right with the amount of modernization activity a new design wins.
Mentioned in my prepared remarks that this is probably in fact is a record in terms the number of design wins that we've ever achieved in the quarter.
It doesn't look like it's slowing does so there's a tremendous amount of opportunity for what we do.
Given the defense is a long term business, we want to capture those design wins.
To allow us to continue to grow organically at the rates that we have been.
Sounds great Mark if I could ask just one program.
Sure. This DARPA gaps program I don't usually at least publicly senior Mercury name associated with the DARPA program, but it seems like you have a big rollout can you talk about that program and kind of your role on it and which site is working and maybe what kind of opportunity could lead to in the future.
I'm not actually what's that over the program pit.
DARPA gaps program, maybe it's too small.
With the I think it's a with some on the West Coast Port Kuga.
Hi.
Don't mention that let me ask us instead, Lockheed Martin has been talking a lot more about some of their international radar efforts. Despite seven apparently just got designated do you guys typically get on their international radar programs are they simply have to go to maybe in country sourcing for for your type role I was curious, though we typically do.
So part of the business model is that when we win a.
Position on a specific program.
We get dragged along in those international sales. So yes, I mean, many of the the major radar programs, while providing the domestically and internationally.
Great. Thank you yes.
Thank you enter next question comes from Sheila Kahyaoglu from Jefferies.
Mine is now open. Thank you good evening guys.
Mark you mentioned, a few bookings in the quarter programs that I hadn't.
I don't think you called out before as your top bookings.
Would you mind, maybe going over them and some of them are completely new business, you mentioned that design wins as well.
So.
AOL 56, as a new program for US. This is a competitive win in the RF space. The radar early warning receivable, which we're pretty pleased about.
The second win.
Which we announced last quarter, but we also received the first booking.
This quarter was the L. Toms.
We had a large international booking.
The customer direct and then if part when modes of seeking program. So, yes, a range of new as well as existing.
Bonds the markets in which with we normally operate so low rate R&D W.
Okay, and I know, we beat the R&D question to death, but.
Should we think about a growing longer term organically in line with.
Sales graph.
Yes. Your sales are growing high single digits, that's what R&D should grow or does it.
Pace that the kinds of outside investment.
Yes, it really depends shale and we don't give guidance, obviously beyond fiscal 20, but if you. If you look back at our R&D as a percentage of sales we were 13% in fiscal 17 were 12% fiscal 18, we had a lot of see Rad in fiscal 19 silver.
Lower we were tenant a half percent.
We were kind of 12.5% for for each one of this year, 12.7% in Q2.
And so it really jumps.
Around depending on the opportunities that we see in front of us, where we're investing with our customers as well as the amount of see Brad that we're getting from our customers.
That having been said.
We've talked about a lot, but R&D is an important part of our business model and we're going to continue to invest at high levels.
And then last question once the Phoenix.
Facility is that 100% complete do you go back to a maintenance capex level or do you continue the business.
So this.
He's obviously high based upon really to activities one is the consolidation.
Have already locations on the West coast not activity is coming to an end.
But right behind that is the decision that we made to invest.
To expand the capabilities.
Cost of microelectronics business in Phoenix, So we're going to continue to invest in the business to be able to continue to grow our revenues organically at rates that are well above the industry average, but it really depends upon what's going on into the opportunities to inflect growth is.
Well as to generate the right returns.
Yes.
It literally it depends on what we see you keep winning youre going to investments the bottom line audits I said, if you keep winning youre going to keep building. So yes, I mean, absolutely. We're at a very unique period of time of the industry with all the modernization and yes, we've got some critical technologies and capabilities that we think.
Or important.
To the industry and to our ability to grow the business and so we're going to continue to invest in those areas that we think that will allow us to to generate higher levels of growth and strong margins. Okay. Thanks.
Thank you. Our next question comes from Peter Arment with Baird. Your line is now open.
Good evening Mark Mike.
Mark I, just kind of staying on the outsourcing or the design win team.
Are you seeing the you know the design wins is because you're putting the secure processing capabilities together or is it just as bow wave of monetization spending is there any way to parse the difference.
It's it's actually both so I think we is seeing significant modernization activities in rate all E.W. as well as see fly.
And yes.
We got great growth really across those.
Market segments.
We think we're going to continue to see that going forward as I said in my prepared remarks, we have seen a pretty substantial uptick.
In secure processing.
I think wall, it's kind of crossed the chasm than we've seen a move away from you or the use of waivers.
Had previously been in place and yes, we don't know.
Fourth generation of those sets of capabilities and we think the we're very well positioned so.
A number of different trends that are underway Peter.
And just when we think about the monetization efforts are your design efforts I know element.
Unfair to compare to LTM since that was your largest win in history, but are there other large pursuits out there that you see that our other opportunities for the company.
They are all I mean that one is the largest that we think we've won in the company's history.
Last quarter.
There was a classified program that we won.
Well, providing some very advanced processing.
That is $300 million in potential lifetime value. So, yes, we're winning some nice awards and pursuing some other loans and yes, I feel really good about positioning in terms of capabilities and the markets in which we're participating.
And I guess, just lastly, you mentioned the M&A pipeline.
Any in terms of deal size I mean, you obviously have a lot of capacity generating a lot of cash.
Are you seeing.
Larger deals given that you are have the capacity now to do that.
We also I mean as I said in my prepared remarks, right, we're seeing deals.
Varying sizes.
Yes, some larger than what we've done all this more in line with the sorts of deals that we've done all.
Our goal is really it's not to just focus on the size is to make sure that we're doing the right deals that fits strategically with us well, we can extract cost and revenue synergies over time and that continue to build a capability set that is in the month customers. So they were going to remain.
Yes, very active from an M&A perspective, but disciplined at the site time, Mike If you want to oddities into the no. That's we've looked at deals of all sizes and as Mark said, our focus is big ensures got the rights strategic fit in the right financial profile.
Appreciate the color thanks, guys.
Thanks Bill.
Thank you. Our next question comes from Ken Herbert with Canaccord. Your line is now open.
Hi, good evening, Mark and Mike.
Yeah.
Hey, I just wanted to Mark ask if I could have sequentially from the first of the second quarter. I mean, you've had several quarters now a very strong bookings is there anything you'd call out on the bookings front. It was maybe unique in the third quarter or is it might sort of better you could you talk about that would maybe help illustrate whether it be on the flight to quality or.
Subsystem outsourcing or de layering.
The extent, which you're seeing that was reflected in the bookings any change sequentially or maybe just to unpack the bookings a little bit and anything that would specifically stick out in the third in the second quarter in the second quarter. So I mean, we hot the two largest bookings in the second quarter as I mentioned AOL 56.
Which is a competitive displacement one part, but also greater outsourcing by our customers in the our estimate or customer in the our estimate in L. terms.
Again as an example.
Really outsourcing.
In multiple different dimensions.
Yeah, it off partnering extremely well with Raphael benefiting from the significant investments that we've made in internally funded R&D in some very advanced capabilities that the.
Taking advantage of.
I would say all that design win front there was some nice wins this quarter.
Yes that particularly in the mission computing area.
Well.
I think again, we're seeing.
Examples of outsourcing for work that was previously done in hosts and now that we've built up and continue to build up a strong business and platform and mission computing.
Taking taking some share so it's really yeah, we're seeing those major trends of de layering and outsourcing.
In in pretty much all of the markets in which would participate income.
That's helpful and coming out of the Investor day, obviously, you'd spend a lot of time, they're focusing on GW and with the additions to the team and capabilities.
Just trying to us as a follow up to that provide a little bit more on maybe some of the how you're seeing the opportunity set expand any initial wins or anything else you might might call out on the CW front.
Yes.
W. business was up 41% in Q2.
Year over year in the first half its up 52% and we continue to.
When some nice business.
Whether it be on existing programs, where we continue to take share all winning new programs.
So I think there's more to come so.
I feel pretty pretty good about positioning for the capability Ppas perspective.
And we're seeing that wave of modernization occur.
Great. Thanks, a lot very nice quarter.
Thanks, Ken.
Thank you. Our next question comes from Michael Ciarmoli with Suntrust. Your line is now open.
Hey, good evening, guys nice quarter and thanks for taking the questions here.
Mark.
You've got the backlog growth you've got the bookings modernization tailwind outsourcing tailwind you've kind of laid out that five year hypothetical model.
You are saying, yes, I guess you construct the outlook with a bottoms up all the programs can you give us any color just directionally on the program portfolio, maybe you know what percentage of the portfolios in early growth mode, what might be in sort of that mid growth mode. If there are any programs in the portfolio that.
Declining maybe some of your legacy programs or even.
Turning to portfolio that might be sort of flatlining at a steady state as sort of.
Implementations continue.
It's not something that we've really talked about.
Mike and are ready to kind of disclose at this point, but again I think we feel pretty comfortable but our ability to be able to grow the business.
Likely at the high single digit to low double digit rates as we've talked about in the two major markets in which we're focused on which is sensoryeffects emission systems and see fly I think as we laid out in detail.
At Investor Day.
We believe this is still a lot of opportunity for us to continue to grow more traditional sense of matsons processing market.
We're at the very early stages is beginning to penetrate both C API as well as platform and mission management. So.
There's a lot of opportunity for us to continue to execute against that strategy that we've laid out and to deliver against the financial profile, Mike discussed in his prepared remarks.
Got it and then just on on gross margins I know, you're kind of deemphasizing goes a little bit at the expense of EBITDA margins, but they were a multi year high you called out I think some of the PEO synergies on premise in Jermaine.
Just wondering if that's more tied to.
Consolidation and everything going on at auction art can those types of.
Synergies accelerate even as you look at continued progression on maybe APC and can we maybe see some more levers there on just overall cost synergies.
Yes, I mean, it's Mike I think Thats, a core part of the strategy and the acquisition philosophy. So.
Chemists and Germain the purchasing power synergies.
Have been.
Ben impressive if you'll recall when we first is the Germain acquisition, we laid out some of their gross margins than they were down at the 23% gross margin range and we've really been able to put them together with chemists and get their growth mode margin profile into two.
Our range and we think we can continue to do that and we've done it on previous acquisitions and as we look at acquisitions, whether it be and see for IR sensor and effector as we integrate them together, we think we've got a good track record of recognizing synergies on the gross margin line, but also from an Opex perspective, and then we.
Also been able to to leverage R&D from an expense standpoint, and don't forget one of the most important things we've been able to do as inflect their growth from a revenue perspective. So yes, I do think it's something that we can continue to do going forward.
Got it helpful. Thanks, a lot guys I'll jump back into queue.
Thank you. Our next question comes from Jonathan Ho with William Blair. Your line is now open.
Hi, good afternoon, and thanks for taking my questions I'm, just wondering just start out with you or maybe a broader landscape question as you start to take share on the outsourcing and consolidation side are you seeing any changes in the competitive landscape, particularly with smaller players that maybe can't match your scale and breadth of capability.
Yes, I think the answer is yes to the Jonathan I think where we see those smaller companies challenged is that really their ability to invest and in this environment.
With the the shift in defense procurement reform too.
Mall beta for type contracting in the U.S, though ta pace.
Our customers not customers customers were expecting.
Industry that basically step up and invest more.
All of the small companies.
How the wherewithal to invest in the new capabilities and technologies that the industry is looking for and in particular as we've seen in particular in the or estimating there's very little capital expenditure you around modernization or facility consolidation that could and we've clearly better.
From the reason that would taking share. So yes, I think that were extremely well positioned with the business model that we've created.
As it were generating.
Hi levels.
Profitability, but we're investing box significantly in the business.
To capture new growth opportunities than you can see that in.
Forecast for the with organic growth.
13% to 14%, which is significantly off.
From where it was previously or what we did last June .
Got it and then yes, we start to look at some of the commercial advances in merchant silicon around chip Blitz, and AMDR custom development.
Can you talk a little bit about like does that change the landscape do others have maybe the ability to take advantage or some of the cutting edge commercial development and is that starting to show up in some of the new design wins that you are talking about thank you.
Yes, so clearly our strategy is to leverage the best it what is commercially available silicon and two pockets and secure the capability for.
Specific defense applications, and we think that we're in an extremely strong position to be able to do the first of all yes. We've already got a strong microelectronics business that is more than doubled in size. Since we did the microsemi acquisition back in 2016.
As a business, we got very deep domain expertise in the two areas that we're going to target initially which is in rate already W.
Yes, we've got trusted domestic packaging capability.
Which is critically important.
To be able to take that commercially available silicon and create these unique.
Silicon.
Devices for use for the applications that we're targeting yeah, we industry, leading sick embedded security IP, which comes into play is which took targeting and creating these unique capabilities and then we have Gulf to clear workforce to be able to go after these opportunity.
For the so.
As well as having a very strong channel. So I think we've got we're in a unique position to really become.
Doc conduit for the innovation that's occurring in the high Tech world into the defense industry and not to in essence, how we've positioned the company.
Thank you.
Thank you and we have a follow up from Jon Raviv from Citi. Your line is now open.
Thanks, So much for this a follow up just on your comment Mike about.
The guidance implying that.
EBITDA margin steps up a bit in Fourq Q is that.
So is the comment there or the implication there that that is where we start to see some of the benefits in terms of mix and volume leverage that should then flow beyond.
This fiscal year, certainly well aware that this fiscal year is 22%.
Well youre thinking a little bit forward and heading.
Kind of within that 20% to 26% range.
Is it fair to assume that for Q is a bit of abates.
I think I'd look at it on an annual basis, John because we always have a bigger second half than first half. So we tend to see depending on program mix, we can see more operating.
Leverage in this Q4, our revenue is going to be out significant significantly over our midpoint guidance for Q3, So we're going to see a little bit more operating leverage in Q4, So what I look at his EBITDA margins on an annual basis, and then as we talked about Investor day.
Setting out on a clear path to expand those EBITDA margins overtime.
Thank you.
Thank you have next question from Ronald Epstein from Bank of America. Your line is now open.
Hey.
Good afternoon guys.
When you talk about the opportunity that China prison, I mean, how do you think about that remaining.
Every procurement.
Today's officer wherever you talked to in India. The there's been this.
Yes, Flushing, China out of the procurement system kind of at all levels right I mean everything from.
Robert equity funding down to tier four tier three tier two suppliers the whole nine yards.
What.
What kind of opportunities that present for you and then I guess my flip question is also what risk does that present using commercial so.
Again I mean.
So I think it's an enormous opportunity right I mean, if you go back to Ron how we position the company which is to be.
Developing technologies and capabilities and funding it like a high Tech company, but recognizing that what we do is operating inside of the defense industry, which requires us.
US citizens trusted domestic development and manufacturing. So we think that we've created a very unique business model to be able to give the department of defense. So the defense industry as a whole.
This too.
Emotionally developed capabilities far more quickly and far more affordably than whats ever being done before and that's how we kind of position the company and we can do that for the capabilities that that we're working on which now.
With this latest investment that we're making kind of takes it to chip scale.
So if you look at it from a silicon perspective the risk.
Actually in large part.
Is no in the silicon itself, it's actually in the packaging is the silicon.
And that's basically while we're building in Phoenix is the ability to be able to.
Package commercially developed silicon in very unique ways, combining the best of what's available into heterogeneous devices on a layer of security IP, which Macquarie there's invested in.
Acquisitions over time, and the package it and be able to produces here in the U.S. So I think there's an enormous opportunity for us to to capitalize on what is really a.
So the capabilities that all.
Really required to take these systems to the next level.
And to benefit from not given our business model over time.
Okay, great. Thanks.
Thank you and as a reminder to ask a question you will need to press Star then the one key on your touched on telephone to withdraw your question press the pound key.
Our next question comes from Noah Poponak with Goldman Sachs. Your line is now open.
Hey, good evening gentlemen.
Hi, Noah.
Is your is your M&A pipeline right now substantially more active than your average period in history or is it more in line.
So we're seeing a lot of opportunities.
Different sizes as I think as Mike laid out Investor day.
So is we have kind of moved from.
Our traditional market, if said sort affect the.
Mission system processing into these two other markets in particular.
C III processing as well as platform and mission monitor which encompasses all avionic strategy I think this far more opportunity available to us than what we've seen in the past.
Okay.
Mike You've got the chart that.
Shows the pro forma multiple paid for acquisitions in the past with with after you've achieved all of your synergies is.
Four or five turns lower than when you announced that.
Our the businesses that are less than a year from acquisition.
On track to achieve that.
Yes, I mean, I think the way we were able to achieve those is by businesses at reasonable multiples.
And at multiples that were supported by the Standalone value.
The company and then integrate those in to Mercury and so if you look at that chart over the years.
Clearly with the Microsemi transaction, we were able to do that Tennyson Germain we talked about on this call.
Like that is going incredibly well both from a revenue perspective and design win opportunity as well as cost synergies and as a result of that we're averaging that multiple down.
And then as you look at the the newer acquisitions. The answer is we do feel that we can inflect their growth in average down the multiple but two to varying degrees. So APC as new platform opportunity with us for us it wasn't a cost synergy acquisition when we bought it we've already.
James.
Really good new design win opportunities associated with that along with the gecko avionics acquisition. So we do think that as we our strategy of integrating the acquisitions and inflecting their growth is going to continue to work and we're seeing it in the new design wins as we.
Get more platforms and like we did with your main when we added that onto a tennis, we do see additional opportunity for cost synergies as we integrate those future potential acquisitions into the new platforms.
Okay.
On the input of new programs ramping up being dilutive to the margin.
What kind of margins to our new programs coming in versus the total company average just trying to.
Better understand that degree of dilution, but you have initially.
Yes, we've never broken that out in terms of the margins that we have it can vary program to program, but.
We haven't broken out that margins, we normally get on C. Rad versus new program wins versus our first full rate production 'cause it varies.
Okay last one just.
When you expect the Phoenix built out to be complete just so we can.
Think about when Capex normalizes.
Yes, so right now our goal is to have a complete by the end of this fiscal year.
A lot of the clean room.
Build out has been done a lot of it is getting new equipment into the facility. So we are targeting the end of this fiscal year, although that could slip a little bit into Q1 of next year. So within the next six to nine months.
Okay.
Thanks, so much thanks so.
Thank you.
And Mr. I'd say it appears there are no further questions. Therefore, I'd like to turn the call back over to you for any closing remarks.
Okay, well thanks, everyone for listening we look forward to speaking to again next quarter. Thank you.
Ladies and gentlemen, thank you for your participation on today's conference. This does conclude your program and you may now disconnect.