Q4 2020 Mercury Systems Inc Earnings Call
[music].
Good day, everyone and welcome to the Mercury systems fourth quarter fiscal 2020 conference call today's call is being recorded.
It's time for opening remarks, and introduction I'd like to turn the call over to the company's executive Vice President and Chief Financial Officer like 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've not 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.
The 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 would 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 results or 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's SEC filings, including the cautionary statement and risk factor related to covert 19.
I'd also like you mentioned that in addition to reporting financial results in accordance with generally accepted accounting principles or gap.
During our call. We will 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 to 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 we hope that you. When you will finally is staying safe and healthy.
I'll begin today's call with the business update Mike will review the financials and guidance and then we'll open it up your questions.
Mercury finished a record year to school 20 by delivering strong Q4 results against the very challenging backdrop.
We are beginning to New York any great position strategically with strong topline momentum.
The team is doing an outstanding job managing through a difficult period and although the risks associated with co would remain elevated we're positive about the outlook for fiscal 20 walk.
We continue to believe that Mercury is targeting the right parts of the markets our bookings and design win activity continues to reflect the three fundamental trends that we discussed in the past.
Supply chain de layering by the government and the primes the price flight to quality supplies and the shift to outsourcing by our customers at the subsystem level.
Potentially a fourth trend is the government's increased focus on creating a domestic supply chain to secure and trusted advanced electronics capabilities designed and built in the U.S.
For the fourth quarter total bookings increased 15% year over year, establishing a new company record in leading to a record year in backlog.
Our 12 month forward revenue coverages strong positioning us well so fiscal 21.
Our largest bookings in the quarter were at 35 SEAWIP outcomes, the classified radar program and filthy buzzard.
For the full fiscal year total bookings increased 22% hitting a record as well.
It was also a record year for new design wins, which totaled more than $2 billion in potential lifetime value.
We've increased mercury's footprint over the past seven or eight years to more than 300 different programs and platforms.
Our top line growth reflects this expansion.
For the fourth quarter revenue increased 23% in total and 17% organically year over year.
Our largest revenue programs in the quarter with SEAWIP Filthy Buzzard F 35 at 16 Sabre and the classified radar program.
For fiscal 20 as a whole total revenue was R, 22% year over year and organic revenue grew 14%.
Our business model is performing extremely well and we continue to deliver strong results on the bottom line.
Mercury's adjusted EBITDA increased 31% and 21% for Q4 and for the fiscal year, respectively, setting New records for both periods.
Fiscal 2000 free cash flow it was a record when we concluded the year with zero debt and nearly a billion dollars of financial capacity.
Looking ahead as Mike will discuss in detail, we expect fiscal 21 to be another year of double digit growth in revenue and adjusted EBITDA.
We expect this growth to be driven by high single digit low double digit organic revenue growth inline with our long term strategy.
That said, we're well aware of the risks related to covert both in the short and long term.
Moving to slide four last quarter, we were worried about the potential for cobot related closures of our suppliers facilities those closures did not occur as anticipated.
The team here at Mercury is being very adept at managing in mitigating the supply chain risks that continue to exist overall the supply side of our business seems somewhat improved from what it was three months ago.
Last quarter, we were also concerned about how the pandemic could affect our ability to our talent resources into the business to support our ongoing growth those concerns proved to be unfunded also.
Our talent attraction team has done a fantastic job in recruiting great people, even with the backdrop of cobot.
We've transitioned our recruiting and onboarding to fully virtualized process, and there's been no real erosion not timing to hiring new people or productivity metrics, it's gratifying to see the number as well as the tons of the people will bring into the company.
As we discussed last quarter, we sort of a cobot crisis team and defined full goals to guide us during the pandemic.
The most important goals to protect the health safety in livelihoods of our employees and to continue to deliver an active commitments to both our customers and shareholders.
We've used these goals alone Mercury's purpose culture and values as a touchstone for setting our priorities for the past six months.
We put our employees at the center of our decision, making in return, they're performing incredibly well in maintaining that productivity and overcoming the challenges we're facing.
Everyone in the company, who can work from home has been doing so since March we expect that they will continue to work remotely at least through the end of this calendar year.
At this stage in the pandemic, we believe the co. Good risks related to Mercury's manufacturing operations are increasing as a result of the economy's reopening and the resurgence of the virus in large parts of the country.
Although we have seen Cobra cases, all of our manufacturing facilities have remained open and operational for the past seven months.
We continue to adjust workplace conditions to ensure proper physical distancing and make things even safer inside the locations, where our employees coming to work every day.
We've implemented cobot symptom checking in temperature screening for all personnel entering our facilities along with mandatory use of masks and now face shields in certain areas.
We've also contracted the chief medical advisor to provide best practice advice, given the evolving nature of the pandemic.
With cobot searching surging in Arizona, California, and our states, where we need of operations, we've decided to implement weekly onsite testing in our largest manufacturing locations.
Weekly Cobot testing has begun in Phoenix and will be progressively rolled out across other manufacturing locations in the weeks and months ahead.
We will continue to quarantine anyone was tested positive as exhibited symptoms or has been exposed to the virus.
In addition, we're working to arrange rapid external testing at other company locations. The team members, who may need to travel.
Anticipating that will be living with the pandemic through the entirety of fiscal 21, we believe that leaning in and being highly proactive around testing will be crucial in managing covered risks to the business, both operationally and financially.
We will continue to be innovative and open to adopting new best practices as the pandemic in science around it evolve.
Last quarter, we also talked about defense spending from recovered risk perspective, and this remains an area of concern.
Turning to the industry outlook on slide five that's the potential for a delay in the approval of with defense Appropriations Bill due to an extended continuing resolution.
It's also the prospect of another round of massive fiscal stimulus and the potential for those dollars over time to cry to have discretionary spending including defense.
The counterbalances that the national security environment is probably the most challenging it's being for quite some time in particular with Chinese militarization and heightened us China diplomatic on economic tensions.
There is also risk and having a distributed non national supply chain the critical defense technologies.
Especially with the manufacturing be incentives and potentially America's largest and most sophisticated other sorry.
A recent DMD study focused on this film vulnerability determining the majority of the IP and micro electronics is generated in the U.S., but most of the packaging and manufacturing is done offshore which is where the risk lives.
Turning to slide six.
Given the investments we've made over the past few years and secure processing on trusted microelectronics domestically. This is a strategic opportunity for mercury.
Unlike what we saw in the past with sequestration today, the seems to be a strongest sense of bi partisan commitment to defense spending overall as well as dealing with these specific threats.
The DMD has publicly identified us produced trusted microelectronics as the government's number one defense technology priority.
Congress has jumped on board with the bipartisan American foundries octave Twentytwenty, which promotes promote proposals as much as $25 billion in spending in three major areas of Microelectronics. These include 15 billion for commercial manufacturing 5 billion for defense and fight Bill.
In in R&D spending to secure us microelectronics leadership.
Over the past 10 years, we focused on pioneering and next generation defense Electronics company sitting at the intersection of Tech in defense.
Our goal is to transition commercially developed technologies and to make them profoundly more accessible to the defense industry.
Given the national security threats emerging with curve. It this strategy couldn't be more timely.
We also think the processing in different formats, whether it be secure processing or edge processing of the chip level will enable the next generation of applications that currently can't be done with existing technology.
We are hearing great feedback from our semiconductor partners customers on the DLD on our microelectronics strategy.
We believe that we can help to address the significant national security issue.
Everything that we've done to position Mercury is an industry leader in embedded security IP and trust Microelectronics is now coming into focus.
Referenced participating in the dialogue that's going on at the national level.
We expect to see more opportunities to expand our business as a result of the strategy that we've created.
As outlined on slide seven we're optimistic about mercury's ability to continue delivering organic revenue growth at a rate that far exceeds the industry average.
The cargo business conditions remain surprisingly robust our businesses mission critical to our customers and end users and Mercury strong topline performance in Q4 ons fiscal 20 bears this out.
We are somewhat concerned that our new business pursuits may take longer because of ongoing travel difficulties and the realities associated with working from home with to date, we see no significant change in fundamental demand.
At this stage, we have not changed our long term baseline forecast for low single digit growth in overall defense spending.
We continue to believe that we're targeting and participating in the right parts of the market.
The wave of monetization occurring in radar VW and see fly continues to drive growth in the business.
Demand in weapon systems space avionics processing and mission computing as well as secure rocket service remains healthy.
We have the balance sheet strength to supplement Mercury's organic growth with M&A.
We continue to focus our M&A pursue solar sensors effect emission systems and see fly markets.
We're looking for deals the strategically aligned and have the potential to be accretive in both short and long term.
While M&A activity has been on hold as a result of cobot, we're beginning to see a pick up in our deal pipeline is robust right now as is our liquidity.
In addition, we believe that mercury's perceived to be a great buyer, given our purpose culture and values, our strategy and positioning as well as the performance of our business.
Once we get through the crisis, we anticipate seeing more opportunities than before.
When M&A activity does accelerates and we believe that it will will be in a strong position to continue to execute on our strategy, namely to deliver strong margins, while growing the business organically and supplementing that organic growth with disciplined M&A and full integration.
Turning to slide eight in summary, we believe this strategy will continue to generate significant value for our shareholders over the long term as we execute our plans 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 with acquisitions.
The second is to invest in secure and trusted technologies, our facilities manufacturing assets in business systems as well as in our people.
Third as manufacturing insourcing as was driving strong operating performance across our manufacturing locations.
Fourth we are 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 and revenue synergies.
The synergies combined with other areas the plan should produce attractive returns for our shareholders.
This strategy has worked very well over the past six years, given our ability to execute we're confident mercury will extend this record of success.
We're generating strong organic growth in our business model is performing extremely well, we've aligned our strategy and technology with dominant industry trends, we fully engage our employees in the mission of delivering value to our customers and shareholders, we've been diligence in reducing in mitigating risk and managing through this.
Period of uncertainty.
And finally.
We're committed to doing everything that we can to once again delivered strong results in fiscal 21 with that I'd like to turn the call over to Mike Mike.
Thank you Mark and good afternoon again, everyone.
I'll begin by extending my appreciation to our employees for the outstanding work. They did this quarter and this year.
We've made it our top priority to protect their health safety and livelihoods and they've worked extremely hard to deliver the results we've seen.
Thanks to the efforts of our team we were able to manage through the impact of Covidien conclude a record year in fiscal 20 with record fourth quarter bookings revenue net income adjusted EBITDA EPS and adjusted EPS.
Turning the fourth quarter on slide nine our bookings and book to Bill metrics continue to be strong.
Bookings increased 15% year over year to a record 279 million driving a 1.28 book to Bill ratio.
As a result, we're beginning in fiscal 2001 with record backlog.
We had record revenue in Q4 217 million exceeding the top end of our Q4 guidance organic revenue was up 17% year over year.
GAAP net income and GAAP EPS were up 113% and 96% respectively year over year.
These increases were a result of strong operating performance as well as a 1.5 million gain on investment net of tax or three cents per share as well as 6.6 million industry discrete tax benefits or 12 cents per share.
Adjusted EBITDA for Q4 was up 31% year over year to a record $49.6 million above the top end of our guidance.
In Q4, we had a 2.2 million adjustment for cobot related expenses. These are primarily for payments from our employee relief fund supplies and services required for work for safety and other employee benefits.
Approximately $1.3 million of these expenses were charged to cost of goods sold and approximately 900000 merchants to operating expenses.
We're continuing to invest in protecting the health safety and livelihoods of our employees as well as in de risking the business due to the pandemic.
Turning to our full year results on slide 10, we successfully manage the impacts of Kobe during the second half, resulting in the strongest year financially in Mercury history.
We delivered record bookings revenue net income adjusted EBITDA as adjusted EPS and free cash flow.
The volume of new design wins was the highest we've seen in our history and we continue to position the business for future growth through investments in R&D and Capex.
Bookings for fiscal 20 increased 22% year over year to 954 million driven primarily by growth in key markets, such as radar FW and see for I.
Our book to Bill for the year with one point tip.
We ended fiscal 20 with record total backlog of 831 million up 33% from a year ago.
Backlog expected to ship within the next 12 months was 568 million.
This equates to approximately 65% of the midpoint of our fiscal 21 revenue guidance, providing us with a solid foundation for continued organic growth.
Revenue in fiscal 2000 increased 22% year over year to 797 million.
Exceeding our guidance of 785 to 795 million.
In fiscal 20, no single program represented more than 4% of our revenue.
Our top five programs represented less than 20% of our revenue highlighting the diversification in our program base.
GAAP net income and GAAP EPS in fiscal 2000 were up 83% and 63% respectively.
These increases were driven by strong operating performance as well as some one time non operating items.
These included 5.6 million and gains on investments net of tax or 10 cents per share and 15.5 million of discrete tax benefits or 28 cents per share.
Adjusted EBITDA for fiscal 2000 increased 21% year over year to 176.2 million or 22.1% of revenue.
Higher gross margins year over year enabled us to increase our investments in R&D by 43% year over year to an industry, leading 12.4% of revenue, while still delivering strong adjusted EBITDA margins.
Free cash flow for the year was 71.9 million compared with 70.8 million in fiscal 19.
The strong free cash flow of the base business allowed us to continue our growth focused capital investments as well as investments in inventory related to reducing supply chain risk as a result of recovering pandemic.
Slide 11 presents Mercury's balance sheet for the last five quarters.
Entering Q4, Mercury had cash and cash equivalent to $407 million.
This cash included 200 million from the funded portion of our revolving credit facility, which we drill in Q3 as recovered precaution.
Based on our strong free cash flow and reduce turbulence in the capital markets in the fourth quarter, we paid down the 200 million that we kept from the revolver in Q3.
As a result, Mercury concluded Q4, with cash and cash equivalents of 227 million, which combined with our unfunded $750 million revolver provides us with nearly $1 billion financial capacity.
Despite the continued public health and economic uncertainties Mercury remains extremely well positioned from a liquidity standpoint to continue investing in organic and acquisition driven growth.
As Mark said, while M&A has been slower due to covered our pipeline remains robust and we continue to be active looking and new opportunities.
As activity picks back up we'll have plenty of financial capacity to execute our acquisition strategy.
Turning to cash flow on slide 12.
Free cash flow for Q4 was 17.2 million representing 35% of adjusted EBITDA.
This was inline with our expectations as slightly lower than expected capex was offset by higher inventory.
During the quarter, we also had cash outflows related to cobot expenses.
For fiscal 20 free cash flow was 71.9 million compared to $70.8 million last year.
Fiscal tiny free cash flow as a percentage of adjusted EBITDA was 41%, which is inline with our expectations coming into the year.
As I mentioned, we had slightly lower expansion capex than expected as a result of covered related delays, but that was offset by slightly higher inventory.
Fiscal 20 inventory was driven by growth in the business as well as precautionary covered pre buys in order to mitigate potential disruptions to the supply chain.
Capital expenditures in fiscal 2000 were 43.3 million or 5.4% of revenue compared to 26.7 million or 4.1% last year.
During fiscal 20, our expansion Capex was primarily related to our $13 million investment in our custom microelectronics business. During the year. We also completed investment in the consolidation of our west coast facilities.
Without the custom microelectronics investment our capex as a percentage of revenue would have been slightly below fiscal 19 and closer to our maintenance capex levels at approximately 4% of revenue.
As I said earlier strong free cash flow generation in the base business is allowing us to continue to invest in R&D and de risking the supply chain as well as in expansion Capex.
I'll now turn to our financial guidance, starting with the full year fiscal 21 on slide 13.
Our guidance for Q1, and the full fiscal year assumes no major operational impacts associated with coated which as we've discussed we've made every effort to mitigate.
Mark also talked about the potential for headwinds related to the defense budget.
While we believe that is a possibility we believe we're in the right parts of the market and on well supported programs that align with current threats.
We have a diversified program base and we believe we'll also continue to benefit from the fundamental trends driving our growth, including outsourcing by our customers.
We're also entering fiscal 21 with record total and 12 month backlog, which provides us good visibility as we began the year.
As in fiscal 20 were anticipating strong organic growth and continued growth investments in R&D capital and business infrastructure.
For the full fiscal year 21, we currently expect revenue of 860 to 885 million representing growth of 8% to 11% from fiscal 20.
As Mark said, we expect to continue to deliver high single digit low double digit organic growth.
Like we saw in fiscal 19 and fiscal 20, we expect Mercury's revenue in fiscal 2001 to progressively increase by quarter throughout the year and the percentage split between each one and HQ revenue to be similar to last year and weighted toward the second half.
Total GAAP net income on a consolidated basis for fiscal 21 is expected to be 68.5 to 74.4 million or $1.23 to $1.34 per share.
This is down year over year, reflecting approximately $21 million or 38 cents per share of non operating income and discrete tax benefits that I mentioned, we had in fiscal 20 that we're not forecasting in fiscal 2001.
Excluding these items GAAP net income and GAAP EPS are expected to be up 11, and 9% respectively at the midpoint of our fiscal 21 guidance.
Adjusted EPS for fiscal 21 is expected to be in the range of 2015 to 2026 cents per share.
This is down year over year as a result of a discrete tax benefit of approximately 8 million or 15 cents per share applicable to adjusted EPS that we had in fiscal 20.
Adjusted EBITDA for fiscal 21 is expected to be in the range of $188 million to $196 million, an increase of 7% to 11% from fiscal 20.
Adjusted EBITDA margins are expected to be approximately 22%, which is in line with fiscal 20.
Like revenue, we expect adjusted EBITDA margins to progressively increase from quarter to quarter.
As a result, we expect fiscal 21 to look a lot like fiscal 20 with SGN, a driven operating leverage offsetting higher R&D spend as we move through the year.
Looking further ahead, we believe the investments that we've made in fiscal 20, and we'll continue to make in fiscal 21 will result in adjusted EBITDA margin expansion over the next few years.
We expect Capex for fiscal 21 to be approximately 6% of revenue.
This is above our maintenance capex levels, primarily as a result of continued investment in our custom micro electronics business some of which was delayed in fiscal 20 due to covance.
It also reflects the buildout of our Cyprus and Andover facilities to support growth as well as to provide more secure space needed for an increase volume of classified work.
Finally for the year, we expect free cash flow to be approximately 40% to 45% of adjusted EBITDA.
This is slightly below our 50% long term target as we continue to invest in the business and capex as well as the investments, we're making related to coated such as increased testing and facility modernization where appropriate.
Like revenue and EBITDA, we expect free cash flow conversion to be lower in the first quarter and increase as the year goes on.
Turning now to our first quarter fiscal 21 guidance on slide 14, we're forecasting total revenue in the range of 190 to 205 million, an increase of 7% to 16% compared with Q1 last year.
Q1, GAAP net income is expected to be 10.1 to 12.3 million or 18 to 22 cents per share again, the decrease year over year is primarily related to 6.6 million or 12 cents per share of discrete tax benefits in Q1, 20 that we're not forecasting for Q1 21.
We're also forecasting cobot related expenses in Q1 of 2.2 million or three cents per share net of tax primarily related to continued supplies and services, including coded testing at our major manufacturing facilities.
Adjusted EPS is expected to be 43 to 47 cents per share.
Adjusted EBITDA for Q1 is expected to be 38 to 41 million representing approximately 20% of revenue.
Again for the full fiscal year, we expect our adjusted EBITDA margin to be approximately 22% of revenue.
We expect Capex in Q1 fiscal 21 to be approximately 7% of sales.
This is primarily related to the completion of our custom micro electronics investments as well as the investments in our facility Buildouts that I mentioned earlier.
We expect free cash flow to adjusted EBITDA for Q1 to be lower than the 40% to 45% full year guidance due to year end bonuses, which we always pay in Q1 as well as the covered related expenses and higher capex that I discussed.
In Q1 and fiscal 2001, we're continuing to invest to take advantage of the opportunities we have for continued growth.
Turning to slide 15 in summary, while the last two quarters were dominated by challenges related to the pandemic Mercury delivered record financial results for the second half and full fiscal year.
The cobot challenges are likely to persist for fiscal 2001.
Nonetheless, we believe we're in a strong position to continue executing on our long term value creation strategy of high single digit low double digit organic revenue growth, coupled with EBITDA margin expansion supplemented with strategic and accretive M&A.
With that we'll be happy to take your questions. Operator, you can proceed with acuity now.
Thank you.
As a reminder to ask a question you'll need to press star one on your telephone to withdraw your question press the pound.
Please stand by Apollo Cheniere upstairs.
Our first question comes from Jon Rubin with City you May proceed to your question.
Hi, Thank you.
Hey, guys.
You're not going to love. This question, but I'll try anyway, we implied organic growth an appetite 21, Mike you talked about it it's a slight deceleration from 20.
It was a lot going on you guys have the record investments from the women's on new designs and your line at all this new stuff and microelectronic, a super important etcetera etcetera.
Realize it's a bit of what have you done for me lately, but any perspective on the opportunity to accelerate organic growth on or should we be looking for some sort of inflection in the future. When a lot of is big new wins start to really pick up thank you.
Sure John So we feel pretty good about the organic growth.
We've kind of said high single digit low double digits.
Is what we're aiming for over the long term I think the guidance that we've given is in line with off it is slightly lower than obviously, what we delivered last year, but if you look it typically what happens is that as the year progresses and kind of visibility continues to improve the number.
Tends to trend upwards so.
We'll see what happens, but we feel good with the guidance winner.
Thank you and then just a follow up almost a similar question mark on on the margin and I realize update.
Yeah David.
The framework for thinking about you guys is really on the organic growth from the margins are strong while you invest to support that growth, putting or adding a third year of 22%.
EBITDA margins like you did mention.
The idea to expand margins at some point or over the next few years.
It is there some sort of in fluctuates you're waiting for any any sense of when those margins might start to expand thank you.
Yes, I mean, John I'll take that one I think that.
What we mentioned with the fiscal 21.
Guidance is that we expected to look a lot like fiscal 20.
And in fiscal 20, we were able to grow the business and we increased R&D by over 40% in 43% year over year and we increased R&D.
From tenant a half percent and fiscal 19, where we also delivered 22% EBITDA margins, but we're able to increase R&D as a percentage of sales to 12.4% still deliver 22% EBITDA margins and Thats really.
Driven by the growth in R&D is really driven by the opportunities that were seeing in so when we look at the fiscal 21 guidance Mark talked about a lot of a new design wins that we're seeing a lot of the opportunities that we have the markets, where we're playing we don't specifically guide R&D, but.
I think if you look at fiscal 21, youre going to see R&D levels that are similar as a percentage of sales to what we had in fiscal 20, but continue to have the 22% EBITDA margins and as you referred to in as I mentioned in the prepared remarks, we do see EBITDA margin expansion over time.
I think we've got a clear path to do that that we talked about in the past in terms of programs transitioning from new programs starts into higher margin full rate production as well as some of the operating leverage so we're investing in fiscal 21 to take advantage the opportunities, but we do see margin expansion.
After that.
Thank you.
Thank you. Our next question comes from Greg Palm not the Jefferies. You May proceed in your question.
Hey, good evening.
Just to follow up on kind of the last line of questioning you mean, you were talking about R&D and I think customer funded R&D came up a lot through this past year I mean, how did mix kind of play into fiscal year, 21, and maybe expectations around.
Customer investments.
Yes, Greg So we don't specifically guide.
Customer funded R&D, but when we do talk about as new programs starts and we do have a lot of new programs ramping up at the same time, we've invested a lot in the operations team, we've seen a lot of operational improvements.
So again, when you think about the gross margin.
Again, we don't guide it, but I think you're going to see fiscal 21 looking a lot like.
Fiscal 20, where we had new program starts picking up but we also had some.
Some operational efficiencies, which led to in fiscal 20 gross margins just under 45%. So again fiscal 21, I think is going to look a lot like fiscal 2000.
And then in the prepared comments you mentioned the four trend around creating an advanced supply chain around microelectronics and kind of size some of the potential budget dollars that could be behind that I mean, it seems like there has been good movement with that are you thinking about maybe the incremental opportunity, but also the time.
Good morning, and how mumps momentum that has in terms of moving forward and when it could actually turn into revenues.
Yeah, Greg So it's hard to actually no comment on the specific timing I think the the number. So this kind of two trends going on in parallel one is obviously I think we've seen with covert just the risk of having a non domestic supply chain for Faro technologies.
And capabilities as well as all the supplies.
Longer term is you know, we're investing in secure and trusted microelectronics capability, which as I mentioned in my prepared remarks is the DMD is number one.
Technology.
Priority and what we're very well positioned.
So we're making the investments we're seeing a.
A fair amount of opportunity across the customer base, both in terms of directly to the government and also with our traditional customers for the microelectronics capability because it really is an enabler.
Next generation.
Capabilities and application. So I think both the trusted domestic supply chain for existing capabilities, and then trust and micro electronics, but next.
Of both pretty important trends that were well positioned for.
Thank you.
Thank you. Our next question comes on subsequent with JP Morgan You May proceed with your question.
Thanks, very much okay. Good afternoon involved.
I was wondering.
Maybe not with a very precise number body and kind of a round number or qualitative way.
As a way to split out the amount of organic growth that you thought to pad in 2020 and in 2020 wide as coming from.
In increased outsourcing persons.
Of.
More of the underlying market growth.
Yeah, it's hard to split it out you know specifically set but if you look in say Q4.
Yeah, we kind of use our growth in sub systems revenue is really being a proxy for outsourcing because today most of the outsourcing that we see is occurring at the sub system level, while sub systems revenue in the fourth quarter was up 44% year over year, then for fiscal 20 as a whole.
No. It was up 27% to know 44% of total company revenue, so and as I look forward into fiscal 2000 the warm.
Yes, we expect that.
Growth.
From subsystems in terms of.
The revenue associated with that is actually going to probably be the highest of the is the growth associated with our product lines, which subsystems modules and sub assemblies and components. So we think that the subsystem growth trend, which is being driven by outsourcing is absolutely alive and well.
Okay.
I'll call.
And then Mike you mentioned the the opportunity to.
Beginning to see some margin expansion.
Potentially beyond fiscal 2001, we think about what drives that is there.
The R&D dollars sort of start to plateau, and so there's an opportunity.
Gain leverage on that or is there something that.
Ranging in the mix.
Also how should we think about the scale of the opportunity there.
Yes, So I think it's it's all the things you mentioned two degrees so starting with gross margins I think we see two things and I always tend to think in five years and as we look over the five year plan gross margins between mix.
The mix between new program starts in full rate production should switch more towards production, which is higher margin at the same time you talked about over the last couple of quarters. We've invested heavily in the operations team, we see opportunity for gross margin expansion. There. So gross margin expansions area number one.
Number two is R&D day, we're going to continue to invest significantly in R&D as you know, it's a key part of our model, but we do see as we go forward over the next five years opportunity for.
Leverage in R&D.
Across multiple of our products. So while R&D is going to continue to grow there is an opportune for that to come down as a percentage of sales over the next five years again thats going to be dictated by the opportunity set.
That we see but we do think leverage there and then finally.
His SGN, a we do think theres an opportunity for for operating leverage as we grow revenues faster than we grow opex over the five year period. So it's really all three of those areas.
Great. Thanks very much.
Thank you. Our next question comes from Peter Arment with Baird. You May proceed in your question.
Yeah, Good evening Mark Mike.
Mark on on the M&A environment, just how are you having news you've seen a few these cycles before regarding the budget cycles I'm alluding to is it just how you're how you're thinking about any is there are your any more cautious going into what could be a little bit of a softer next 12 months. If they start we start seeing some that crowd.
Now just what's your high level thoughts I guess on your M&A approach in that environment.
Yeah, I don't think it's changed Peter quite honestly I mean, we've been very focused on it really acquiring in the core of the business.
Which gives us the opportunity.
Generating both cost on revenue synergies and we've been very successful doing that over time.
And that's really what has allowed us to create significant value. It also allows us to actually diligence those businesses fault that other than if we would step stepping outside of our core market. So we're going to continue to focus really acquiring in censored affect the mission systems and see fly we still think that deserve a lot.
The runway that both in terms of organic as well as M&A related growth. So I'm not too concerned with what's happening with the backdrop and our ability to continue to acquire.
Okay, and then just just a follow up just circling back to your comments on the Seth's question regarding the outsourcing the sub systems as a proxy is there is there.
Are there other areas either services or platforms like thinking airborne versus name or other areas, where there are ahead and where there is still an opportunity for you to patent further penetrate.
Yes so.
Yes, we're doing pretty well I mean, I like the way in which kind of the mix of the businesses position right now. So if you look at all.
I have one business.
Fiscal 20 was up 31% revenue wise.
Year over year on label business was up 15% and ground, which is a smaller percentage of the total was up 24.
I think we're going to continue to see growth in those areas.
We'll probably see a pick up in ground next fiscal year, because we're going to begin to see revenues associated with L. Tom's, which.
For us is classified as ground platform.
But I like the way in which we're positions in terms of end markets and.
We think that we're going to continue to see.
Growth.
Not only in 21, but obviously over the next five years as well.
Thanks for the color. Thanks.
Thank you.
Thank you. Our next question comes from Michael Ciarmoli with.
Securities You May proceed with your question.
Hey, good evening guys. Thanks for taking the questions.
I mean, maybe Mike on the.
Just on the outlook for 21 and kind of been touched on but you know what actually needs to improve from a visibility standpoint, there I mean I understand some of the conservatism, but you've got.
65% of your revenue and backlog are you looking for clarity it around the budget environment is it just clarity around certain programs and when you get certain peos from customers.
What I guess, what specifically on the visibility if it is it some of the co big related disruptions what drives that improved visibility because I think it's pretty compelling right now.
Yes, I mean, I think that it's a little of all those things by going I think we'll as we progress through the year, we'll get more visibility on on a lot of that so it was we were thinking about our guidance, we're definitely entering fiscal 21 with with a good 12 month backlog.
More of a more than we did last year in terms the midpoint of our guidance last year about 65% the midpoint of our guidance. This year and 12 month backlog were about 60%. When we entered last year, but there is more uncertainty and thats related to the potential for a CR and especially in extended CR.
We've got the elections coming up.
We've got covert out there and so as we thought about the guidance. What we wanted to do is make sure that we gave a range that we we though is reasonable and hopefully as some of those uncertainties that we're facing now as we progress through the years those those go away and we can do.
More visibility and hopefully be towards the higher end of the range.
Got it and you mentioned I think you called out three cents of Colgate expenses in the first quarter do you have anything else baked in for the remainder of the year.
We don't so you're right, we forecasted 2.2 million in Q1 for cobot expenses.
That's the same level that we incurred in Q4, we think the makeup Mike will be different but the amount to be similar when I said different we've started koby testing at our major manufacturing facilities or expect to fully in Q1.
And there'd be some other employee related benefits.
But we only forecasted for Q1 is hard to forecast for the rest of the year. So as we go through the year, we'll provide more guidance, but as a reminder, last quarter. We adjusted the definition of adjusted EBITDA and adjusted EPS to add back those covert expenses, so won't impact adjusted EBITDA adjusted.
EPS by who obviously have an impact on a GAAP net income and GAAP EPS, but as of now we've only guided for Q1.
Got it and then just the last one on the cash generation and maybe that conversion I, maybe would have thought that you guys would have seen some of that flow through from the accelerated progress payments from some of your customers. I mean are are you seeing any of that benefit or.
Should we expect that in the coming quarters here.
No not really Mike I mean, when you think about the progress payments increasing from 80% to 90%. It really has a minimal impact on us.
Most of our programs are still commercial sales and where we do have longer term contracts, which we are getting more and more of because of those sub system work. We tend to have performance based milestone payments with our customers. So less exposure to progress payments, we do have it on a few.
Contracts and where we have we've been able to see some some increased cash from that but it really hasn't been.
Material for us.
Got it thanks, guys I'll jump back thank you.
Thank you and as a reminder to ask a question you press star one in cellphone.
Next question comes from on Epstein with Bank of America pursued in your question.
Yes, good had been debt.
So mark is there an opportunity for you guys.
The non if you're not already on.
Yes, I mean is TSP core program. It seems like that's more important than ever now given the person.
Micro electronics and processes.
So which program was not wrong.
Yeah, the advanced Tech support program.
For.
Where there are no funding.
A bunch of large contractors to do some microelectronics work.
If you guys aren't on it.
Just curious are the place where you guys should maybe try and some additional thing to do.
Yes, im not little where specifically about program, but the opportunity set around both secure and trusted microelectronics. We think is is pretty substantial so there's a whole bunch of all the programs that we're actually the lives of already bid on or bidding on certain systems architecture.
Factors that chip scale.
Is warm E.W. domain, there are other ones in the radar as well as columns and so we're seeing opportunities really across the board.
Yeah, and obviously the big one is going to be ships phase two.
Yes, so we'll see wallets.
See what happens with docs.
So ships is ships phase two is the big one around trust of Microelectronics Romas tried to bringing Bach potentially a foundry to the us as well as you know strengthening the entire supply chain for both packaging and securing.
Those devices and we really did the heart of.
Yes that initiative with a number of different suppliers. So.
It's it's just maybe just a question on that plan.
The big enough customer to justify having a foundry in the your RASM doesn't have to somehow be.
Do you see.
A piece of a broader commercial foundry or can you really just do a deal.
Is there enough that low I think it look it's a great question and I think the answer to that is now.
Yes, I don't think with DMD is large enough.
To create a trusted domestic foundry the way in which they did previously I think we've gone down not pop in the past with diabetes Fishkill, which is now global foundries the market is simply not large enough.
And Joe the technologies moving to quickly enough to stand up a follow up and the infrastructure associated with it for purely Deo day. So what we believe needs to happen is that there needs to be a commercial time breaks in the U.S. that is keeping up with the state of the off then produce.
Seeing commercial silicon when the DMD needs to basically take off silicon and to leveraging in defense applications, and so and I think thats in essence, when we come come to to participate that we can take that commercial silicon we can combine it together with silicon from different suppliers.
We can security and we can package it domestically.
And because of the high mix low volume matrix defense and because of the fact that we actually are a horizontal player in the industry were ideally suited to make those technologies profoundly more accessible than what we would be in any of the way. So we think that the onset video d. is both having try.
Adjusted or domestic manufacturing.
For commercial silicon, coupled with the source of capabilities that mercury can bring to bear.
For use in side of the DFT. So I think the answers it's both wrong.
That makes a lot of sense and then then Mike maybe just a quick accounting kind of question.
Have you looked at are you comfortable talking about what what the impact could be for you guys in in 2022, if the R&D tax credit.
No that piece a lot doesnt change as because right now in that.
The way you amortize earned the.
For tax purposes for change pretty dramatically in 2022.
What would be the impact on cash if you can say.
Yes.
So it's obviously some that we we are aware of and we have have looked at it.
First of all of the role is implemented as is currently written it would have an impact on us starting in our fiscal 2003, So as you mentioned.
It goes into effect calendar 2022.
Hit us in fiscal 2003, the other impact around it as you know the five year amortization rather than.
Expensing or deducted in the year that it's.
That it's an incurred for us R&D just to highlight the obvious vast majority of our R&D is in the U.S. So after five years, we'd be through the transition.
In terms of the impact we have begun to assess it and there's still a lot of ambiguity Ron but based on our current interpretation of the regular as regulation.
And taking what we would view as a conservative estimate we think in fiscal 2003, it could have a cash flow impact as high as 30 to 40 million.
Which went as you know decline over the next five years until were run rate near five.
You mentioned accounting just to clarify that the cash impact there isn't a gap impact associated with it.
I know everyone's talking about it I would add when we talk about our business model.
And what the DMD is looking for in the government's looking for we don't believe the intent of the government was to penalize R&D and technological innovation. So we do think there could be change before it's implemented I will say and so as everything becomes.
Clear, Rob will give some more guidance, but again I want to impact us until fiscal 2003.
Got it thank you very much.
Thank you. Our next question comes from Jonathan Ho with William Blair. You May proceed in your question.
Hi, Good afternoon, I just wanted to understand if you could give us a little bit of additional color in terms of what inning. You are in terms of integrating some of the recent acquisitions that you've made and where do you maybe expect to see some operating leverage as you continue to go through that process.
Okay. So to answer the first part and yes, I think Mike maybe you can to revisit some of his comments on the operating leverage.
That you mentioned earlier, so we're pretty much done Jonathan the we've got a timing a little bit of look to do on the acquisition of APC.
So that really got disrupted a little bit with covert, but it's not thing that's going to stop us basically.
From getting back into M&A going forward. So we're pretty much done with the integration of the businesses that we previously.
Purchased Mike.
Yes, Hi, Jonathan I'll, just say from an operating leverage perspective that the.
The tenants in Germain acquisitions that we did in those were the I'd say the most recent acquisitions, where we expected to see a meaningful cost synergies between the two I think we've done a very good job there both in SDMA as well as gross margins and purchasing power if you'll recall, we budget remain the gross margins that business were.
We are pretty low and we've done a great job and the teams done a great job getting those those gross margins. So weve recognized a lot of those synergies I think a little bit of room to go.
SD was more of a platform acquisition in terms of the ability to integrate that with some of other capabilities and technologies and sell more subsystems and bigger products. So that's not really a cost synergy.
Angle to that so I think for the specific acquisitions were in pretty good shape I don't see a lot more margin expansion or synergies coming out of those I think we've already run rated most of those I think as we do future acquisitions as Mark always talks about I think our.
Our integration capability is solid and I think we can keep doing what we've been doing over the last couple of years, which is buying companies integrating them and recognizing operating leverage associated with them.
Got it and then just in terms of a similar line of questioning you talked about your secure capabilities and Im just wondering what some of the design wins that you have now when do we maybe see those start to get injected a little bit more into new programs and my guess delivering additional leverage given.
Yes, I would assume the margins unsecure components are going to be a bit higher.
Yeah. So yeah, we've won a lot in new programs Jonathan over the last several years and some of them all beginning to transition.
Into production.
Beginning next fiscal year. However, we are still spending significantly on the R&D just given the environment that we're in the opportunity set that we see so our capabilities and secure processing is clearly crossed the chasm.
Probably the primary driver of growth right now that we see in both modernization on the sensor processing side of things as well, let's see flights.
And so literally two of our largest bookings this year.
We will both related to those capabilities and where we're pretty excited about the opportunity. So.
Great. Thank you.
Thank you.
This has led it appears there are no further questions. Therefore, I would like to turn the call back over to you for any closing remarks.
Okay, well. Thank you very much joining the call today, we look forward to screen to again next quarter tikka. Thank you.
Thank you ladies and gentlemen. This concludes today's conference call. Thank you for parties spanning you may now disconnect.
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