Q1 2022 Mercury Systems Inc Earnings Call
Good day, everyone and welcome to the Mercury Systems' first quarter fiscal 2022 conference call. Today's call is being recorded at this time for opening remarks, and introductions I'd 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 asthma.
We'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.
I'd also like to mention that in addition to reporting financial results in accordance with generally accepted accounting principles or GAAP during.
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 Aslet, Please turn to slide three.
Thanks, Mike Good afternoon, everyone and thanks for joining us I'll begin with a business update Mike will review the financials and guidance and then we'll open it up your questions.
Our results for the first quarter of fiscal 'twenty two in line with our expectations.
Total revenue exceeded our guidance and adjusted EBITDA came in above the midpoint.
Our impact transformation efforts are progressing well and we continue to execute strategically.
During the quarter, we signed an agreement to acquire <unk> technologies, while continuing to invest in the business organically.
Our outlook for fiscal 'twenty, two remains unchanged, reflecting the lower bookings in backlog exiting last fiscal year, we continue to expect flat organic revenue growth versus fiscal 'twenty one.
We expect total company revenue to grow 10% in fiscal 'twenty, two eclipsing $1 billion for the first time.
Due to the timing of the expected close our Q2 fiscal 'twenty two guidance excludes all blacks as well as any future M&A.
We also anticipate margin expansion and record adjusted EBITDA.
We expect to deliver substantial year over year growth in bookings in fiscal 'twenty, two weighted towards the second half and especially Q4.
This should lead to a positive book to bill for the year and solid growth in our backlog setting the stage with strong results in fiscal 'twenty three.
That said the risk levels have become elevated in three areas since last quarter.
The potential for prolong defense budget, continuing resolution second the Whitehouse Fox nation mandates for the defense industry, and the resulting impact on our employees and operations and third inflation and supply chain constraints in the semiconductor industry.
We're working diligently to mitigate risk wherever we can and anticipate a return to high single digit to low double digit organic growth in fiscal 'twenty three.
This growth coupled with margin expansion driven by improved operating leverage impact efforts should lead to strong fiscal 'twenty three results overall.
We're optimistic about our growth prospects over the longer term, we believe that mercury is well aligned with the national defense strategy.
The government continues to push for modernization speed and affordability in both sensor and effector mission systems and C fly.
The need for secure processing trusted microelectronics in open mission systems are increasing.
We are well positioned to benefit from the longer term secular growth trends that we discussed in the past supply chain delayering by the government and the primes the flight to quality suppliers the shift to outsourcing by our customers at the subsystem level and the governments increased focus on supply chain re shoring for microelectronics.
<unk>.
Our vision of being the leading commercial provider of trusted and secured devices to systems is what our customers are seeking.
They are looking to partner more with companies like Mercury and buy less from traditional suppliers as.
As a result, our engagements are becoming larger and more strategic for our customers and for us.
Our five year plan remains intact.
Is to deliver high single digit to low double digit organic revenue growth, averaging 10% over time, coupled with M&A and margin expansion.
Taking a quick look at the financial highlights on slide four Q1 is typically our seasonally weakest quarter bookings.
Bookings were down slightly year over year as expected and our book to Bill for the quarter was 0.89, we feel confident that Q1 represents the low watermark for bookings in fiscal 'twenty two.
Our largest bookings programs in the quarter were F. 35 are classified EW program classified C. Two program F 18, and F 16.
Total revenue was up 9% year over year above the high end about guidance organic revenue was down 11% slightly better than anticipated.
Our largest revenue programs in the quarter with MH 60.
The fight C. Two program classified radar program P eight unnecessary five.
We continue to see high levels of new business activity, our pipeline remains strong with design wins in Q1 totaling nearly $500 million in estimated lifetime value.
Free cash flow for the quarter was slightly negative on the bottom line. However, adjusted EPS came in at higher end of our Q1 guidance on adjusted EBITDA at the midpoint down, 20% and 10% year over year, respectively.
Turning to slide five.
We expect Mercury's total company revenue to continue growing faster than overall defense spending time.
We focused the business on large and faster growing parts of the defense market and we now participate in more than 300 different programs.
We designed you know on our top programs with the majority being sole source positions.
No single program was more than 5% of total company revenue in fiscal 'twenty one.
Looking ahead to the next five years no single program is expected to be more than 6% of total revenue.
The fiscal 'twenty, two we expect bookings and revenue to increase as we move through the year.
As I said earlier risk levels have increased related to the defense budget and see our COVID-19 vaccine mandates on the supply chain.
We successfully managed code related risks throughout the pandemic.
During the second quarter, we intend to comply with the White House vaccine Monday.
This should enhance the resiliency of the business by protecting our employees and strengthening our ability to deliver on our commitments in the short term. However, it may result in higher employee turnover and impacts to our operations.
Beyond the challenges associated with Covid, we continue to see the effects of inflation and semiconductor supply chain constraints.
The team is working daily with our suppliers to address these challenges.
Over time, we believe the vaccine mandates will help alleviate programmatic delays as our employees and our customers on the D. O D. Ultimately return to on site work.
The vaccines could also have a positive effect on some of the supply chain issues we're facing.
As a result, we're cautiously optimistic that bookings will grow substantially year over year in fiscal 'twenty, two leading to a positive book to bill and growth in backlog.
We anticipate double digit growth in bookings in the second half of fiscal 'twenty, two driven by our top 20 programs.
This growth should be led by programs such as F 35, <unk>, which is not bold Goldstein filthy buzzard Sea whip and berries Fms programs.
In addition to these franchise program bookings, we expect growth from recently acquired programs to accelerate in the second half also.
Looking ahead to fiscal 'twenty, three we expect bookings from our top 20 programs to ramp yet again.
We anticipate seeing fewer delays in key programs among them F 35, tier three and block four as well as naval and airborne upgrades, such as sea whip and filthy buzzard.
As I've said this should lead to strong results in fiscal 'twenty, three driven by a return to high single digit to low double digit organic growth.
Turning to slide six since fiscal 14, we completed 13 acquisitions deploying $1 $2 billion of capital dramatically scaling and transforming the business as a result.
We've grown total company revenue four four times and through synergy adjusted EBITDA more than nine times over that period.
This has resulted in substantial value creation for shareholders.
We believe this additional volume to be hot going forward.
As we discussed last quarter early this calendar year, we proactively launched a companywide effort, which we called impact to lay the foundation for our next phase of value creation at scale.
The goal is to achieve Mercury's full growth margin expansion and adjusted EBITDA potential organically and through M&A over the course of the next five years.
The first opportunity is to streamline and simplify our organizational structure, which we began in Q4 and have now largely completed.
We're anticipating a $22 million net benefit in total for fiscal 'twenty two related to this impact activity.
The Q1 actions alone accounted for $14 million total.
To lead impact during the first quarter, we hi, Thomas Suba previously with Boston Consulting group, Mckinsey and Bain as our Chief transformation Officer.
His impact progresses over the course of the next two to three years. In addition to growth will be focusing on six major areas aimed at incremental EBITDA uplift leading to margin expansion over time.
We're beginning to move from planning into the execution phase and several of these areas. We continue to target $30 million to $50 million of the incremental adjusted EBITDA by fiscal 'twenty five as a result of this activity.
Again this includes a $22 million net benefit in fiscal 'twenty two.
Complementing impart we've also strengthened the leadership team. In addition to Thomas Hoover, Mitch Stevenson joined Murphy from Raytheon as Chief growth Officer early last months yesterday, we announced that Roger Wells has joined US from fleet at Teledyne is president of all Microelectronics Division. We are very pleased to have.
Thomas Mitch and Roger a board.
Turning to slide seven over the past seven years, our acquisitions and integration processes have generated significant cost and revenue synergies, creating tremendous volume.
We believe that deploying impact will accelerate and increase the value we create through M&A going forward.
Impact could also allow us to increase our deal cadence and potentially the size of our transactions.
Combined with the synergies generated this could have a compounding effect on future value creation.
The M&A environment continues to be extremely active in our pipeline is strong.
We remain disciplined in our approach in terms of deal pursuits diligence pricing and integration.
We were very busy from an M&A perspective in Q1, resulting in the acquisition of <unk>, which we expect to close early this month.
<unk> continues to build out our avionics and mission computing business complementing our recent acquisition of physical Optics Corporation.
As we discussed last quarter potentially on most important fiscal 'twenty one design win related to the always Amcs program win that was enabled by POC as well as prior acquisitions.
Like those transactions, we expect <unk> to leverage supply chain delayering, and further strengthen our position and platform and mission management.
We look forward to welcoming the <unk> team to Mercury.
Turning to slide eight we remain strategically committed to delivering strong margins, while growing the business organically and supplementing this organic growth with disciplined M&A and full integration.
This strategy is working extremely well.
We believe it will continue to generate significant value for our shareholders over the longer term as we execute our plans in five areas.
The first is to grow our revenues organically at high single digits to low double digits, averaging 10% over time supplemented by growth from acquisitions.
The second is to invest in new technologies, our facilities manufacturing assets and business systems as well as in our people.
Third is manufacturing insourcing as well as driving stronger operating performance across our manufacturing locations and supply chain.
Fourth we're seeking to grow revenues faster than operating expenses. This should 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 acquire to generate cost and revenue synergies over time.
The synergies combined with impact and other areas of the plan should produce attractive returns for our shareholders.
Turning to slide nine.
We're expecting substantial growth in bookings and backlog in fiscal 'twenty. Two this should lead to a stronger year in fiscal 'twenty three as organic growth returns to more normal levels and margins expand as a result of impart.
In the short term risks have increased related to the defense budgets COVID-19 vaccine mandates in the supply chain.
Looking ahead longer term, we remain very optimistic.
We've aligned our business with the National Defense strategy and the industry's key market trends our model sitting at the intersection of the high Tech industry and defense is exceptionally well positioned.
Our strategy and investments and secure processing trusted microelectronics in open mission systems are serving as the engines of growth in the business.
Our M&A pipeline is robust positioning us for continued acquisition related growth, we streamlined our organizational structure strengthened our leadership team and launched impact.
As a result, we believe that we can replicate what we've done successfully since fiscal 2014 and achieve Mercury's full growth and adjusted EBITDA potential organically and through M&A over the next five years.
Before I turn the call over to Mike I'd like to welcome Mercury's newest director Deborah Plunkett.
<unk> was elected to the board at our annual meeting October the 27 correct.
Our extensive experience in cyber national security and information assurance will be a significant asset to mercury.
In addition, as planned Vince visa has retired from the board.
This contributed valuable insight and counsel, that's directed more than 15 years. The last 10 of them in his role as chairman.
And behalf of all of Us at Mercury I extend our deep appreciation to Vince for his dedicated service and leadership.
At the same time I would like to welcome directed below Bryan as our new Chairman I look forward to working with bill to achieve Mercury's full potential in the years ahead.
Finally, I'd like to recognize the entire mercury team for a tremendous effort. During these challenging times my sincere. Thanks for the outstanding work and all of your contributions with that I'd like to turn the call over to Mike Mike.
Thank you Mark and good afternoon again, everyone.
As usual I'll start with our first quarter results and then move to our Q2 and fiscal 'twenty two guidance.
As Mark said Mercury's Q1 results were in line with our expectations total revenue exceeded our guidance, while adjusted EBITDA exceeded the midpoint and adjusted EPS came in at the high end of guidance.
We remain on track towards achieving our previously announced revenue and adjusted EBITDA guidance for full year fiscal 'twenty two.
We expect a double digit increase in bookings versus fiscal 'twenty one.
Positive book to Bill for the year and strong growth in our backlog.
We continue to expect the year to be weighted towards H, two and especially Q4.
We expect margins to expand in the second half of the year and free cash flow to begin to normalize.
Looking further ahead to fiscal 'twenty three we expect a return to high single digit low double digit organic revenue growth driven by bookings and backlog growth in fiscal 'twenty two we.
We expect this organic growth coupled with improved operating leverage and the impact initiatives to result in strong margin expansion and EBITDA growth in fiscal 'twenty three versus fiscal 'twenty two.
Turning to our Q1 results on slide 10 bookings in Q1 were $199 million down 1% compared to Q1 'twenty one are.
Our book to Bill was 0.89.
Our backlog at the end of the quarter was $884 million up 7% from Q1, 'twenty, one and down two 8% compared to Q4 'twenty one.
Our total backlog declined from last quarter, our 12 month backlog was up four 5% compared to last quarter as a result of bookings shifting into near term revenue.
As a result, we have better visibility into the second half of fiscal 'twenty two.
Coupled with bookings on key programs that we expect to receive in Q2, we're optimistic about our results for the full year.
Revenue in Q1 increased 9% from Q1 $21 million to $225 million exceeding the top end of our guidance of $210 million to $220 million.
Organic revenue was $184 million down 11% year over year, but better than anticipated driven by timing and mix on several of our larger programs.
Acquired revenue, which included physical optics Corporation, and Pentech was $41 3 million.
The Avalanche <unk> acquisition that we announced in September and is expected to close in early November and therefore was not in our Q1 results.
Gross margins for Q1 were 39, 3% compared to 42, 9% in Q1 fiscal 'twenty, one down 360 basis points.
This was primarily driven by the inclusion of POC, which had a 240 basis point impact.
We also had more new program starts and development work compared to a year ago.
These programs tend to have lower margins in the near term, but are the precursor to higher margin production work over time.
Operating expenses in Q1 were up 35, 5% compared to last year.
This was primarily driven by an increase in restructuring and other charges.
It also reflected higher amortization expense associated with the recent acquisitions as well as acquisition related expenses.
In Q1, we recorded $12 3 million of restructuring and other charges, reflecting a workforce reduction in the quarter as well as third party consulting costs associated with our impact program.
Our investments in R&D continue to exceed the industry average as we continue to invest for growth.
R&D for Q1 was $28 9 million up 5% compared to $27 4 million in Q1 'twenty one.
The biggest drivers of R&D in Q1 were in mission computing and secure processing.
Since fiscal 17, we've now invested over $400 million in new technologies, such as secure processing trusted microelectronics and mission computing that will drive our growth going forward.
In Q1, we incurred a GAAP net loss of $7 1 million or negative <unk> 13 per share.
The loss was driven primarily by $12 3 million of restructuring and other charges in the quarter.
Adjusted EBITDA for Q1 was $38 3 million within our guidance range of 36, 8% to $39 6 million or.
Our adjusted EBITDA margins were 17% for the quarter down 380 basis points from 28% in Q1 fiscal 'twenty one this.
This was primarily driven by program mix.
Free cash flow for Q1 was an outflow of $7 4 million driven primarily by our net loss, including cash outflows associated with restructuring and other charges.
We also saw some changes in customer payment patterns.
We believe these resulted from the debt ceiling negotiations and potential government shutdown coinciding with quarter end.
Slide 11 presents Mercury's balance sheet for the last five quarters.
We ended Q1 with cash and cash equivalents of $96 million compared to $114 million in Q4 'twenty one.
The reduction was primarily driven by our negative free cash flow during the quarter.
We also used cash for the net share settlement of vested restricted stock units in connection with our annual grant vesting.
We ended Q1 with $200 million of debt funded under our $750 million revolving credit facility.
We expect the Avalanche <unk> acquisition to close this month and to finance the $155 million cash purchase price using the revolver.
Following the acquisition, we will have approximately $355 million of debt and leverage of one three times net debt to adjusted EBITDA.
From a capital structure perspective, we remain well positioned with continued flexibility and great access to capital.
Upon closing the Avalere acquisition, we will have invested $530 million in capital in the last 12 months towards M&A, marking the largest capital deployment in a 12 month period and Mercury's history.
We continue to invest in strategic acquisitions that are aligned with our R&D investments.
Turning to cash flow on slide 12.
Free cash flow for Q1 was an outflow of $7 4 million.
Our net loss in Q1 was the biggest driver of our cash flow compared to previous periods.
Q1 is typically seasonally lower due to employee bonus and tax payments.
However, this quarter, we also had cash outflows for restructuring and other charges associated with impact as well as acquisition related expenses, primarily associated with Avalere acts.
As previously noted we experienced some changes in customer payment patterns. We also invested in inventory related to forecasted revenue growth in the second half of the year.
I'll now turn to our financial guidance, starting with Q2 on slide 13.
Our guidance for the second quarter and the full fiscal year assumes no incremental acquisition related expense our guidance for Q2 includes restructuring and other charges of $5 2 million related to the impact initiatives.
Our Q2 in fiscal 'twenty, two guidance does not reflect avalanche <unk>, which we expect to close this month.
As we announced Avalanche <unk> is expected to generate approximately $40 million in revenue for the 12 months ended December 31, 2022, with adjusted EBITDA margins of approximately 25% or $10 million.
Assuming we closed the acquisition at the beginning of this month, we would expect revenue and adjusted EBITDA of approximately $3 million and 750000 in Q2, respectively.
For the second half of our fiscal year, we expect <unk> to contribute approximately $20 million in revenue and $5 million and adjusted EBITDA.
Since the acquisition has not yet closed this is not included in our Q2 or full year guidance.
Heading into Q2, we expect a rebound in bookings with Q1 being the low point for the year.
In Q2, we expect a book to Bill above one which will drive the revenue growth and margin expansion in the second half of the fiscal year.
In Q2, we expect our backlog to increase and have even greater visibility into the revenues expected for the remainder of the year.
For Q2, we currently expect revenue in the range of $215 million to $225 million.
This is approximately 4% growth at the midpoint compared to the second quarter last year.
At the midpoint, we expect organic revenue to be down approximately 15% from Q2 last year as a result of bookings in the last few quarters.
We currently expect gross margins in Q2 to be in line with Q1 due to similar program mix between development programs in production programs.
In the second half of fiscal 'twenty, two we expect gross margins to increase as we complete several of our lower margin development contracts.
The revenue growth in each two is expected to be driven by higher margin production programs.
Q2, GAAP net income is expected to be 300000 to $1 million or breakeven to <unk> <unk> per share the.
The year over year declines reflect the expected incremental impact related expenses.
Two adjusted EPS is expected to be 39 to <unk> 43 per share.
We expect adjusted EBITDA for Q2 to be $38 million to $41 million, representing approximately 18% of revenue at the midpoint.
This is about 100 basis points higher than Q1, even as gross margins are similar.
As sales ramp up in the second half of the year, we expect an increase in gross margin combined with operating leverage to result in EBITDA margin expansion.
We expect free cash flow to adjusted EBITDA for Q2 to be approximately 15% driven by continued impact cash outflows.
Turning to slide 14, we're maintaining our guidance for fiscal 'twenty two for revenue and adjusted EBITDA were increasing our guidance for adjusted EPS, primarily as a result of lower expected depreciation expense compared to our prior guidance.
Our updated GAAP net income and GAAP EPS guidance reflects the restructuring and other charges as well as acquisition related expenses incurred in Q1. In addition to the incremental known impact related expenses expected in the year.
As Mark discussed there is continued uncertainty associated with the defense budget and contracting environment Covid as well as the supply chain.
The team is working diligently to minimize these risks and to date has been able to do so.
Our guidance assumes that we'll be able to continue to manage these risks without material impact to our results.
For the full fiscal year 'twenty, two we're expecting double digit bookings growth and a book to bill above one.
We expect total company revenue of one to one point O 3 billion. This.
This represents 8% to 11% growth from fiscal 'twenty, one in line with our previous guidance and flat organic growth year over year.
Again, our revenue guidance does not include the avalanche transaction and his prior to additional acquisitions.
We expect our revenue in fiscal 'twenty, two to be weighted heavily towards the second half and in particular Q4.
Total GAAP net income on a consolidated basis for fiscal 'twenty, two is expected to be $54 six to $59 7 million or <unk> 98.
To $1 seven per share.
GAAP net income and earnings per share are lower year over year as a result of expected restructuring and other charges as well as non operating activity in discrete tax benefits in fiscal 'twenty, one which are not guided for fiscal 'twenty two.
Adjusted EPS for fiscal 'twenty, two is expected to be in the range of $2 51 to $2 60 per share an increase of 4% to 7% compared to fiscal 'twenty one.
Adjusted EBITDA for fiscal 'twenty, two is expected to be in the range of $220 million to $227 million up 9% to 12% from fiscal 'twenty one adjust.
Adjusted EBITDA margins are expected to be approximately 22%.
As Mark said, we've included approximately $22 million of savings in our fiscal 'twenty two guidance related to the impact of actions taken in Q4 and Q1.
Like revenue, we expect adjusted EBITDA and EBITDA margins to be heavily weighted towards the second half and in particular Q4.
As revenue ramps throughout the year, we expect an increase in gross margins and operating leverage to lead to adjusted EBITDA margin expansion.
From a free cash flow perspective, we're targeting approximately 30% free cash flow to adjusted EBITDA in fiscal 'twenty two.
We expect cash flow to begin to normalize in each to driving improved conversion for the year.
We have guided certain additional cost associated with impact that are incorporated into this estimate although we may incur additional expenses that are not yet probable or estimable.
Turning to slide 15 in summary, our Q1 revenue exceeded expectations and adjusted EBITDA was in line with expectations as we continue to invest in the business for the rest of the year, we expect a rebound in bookings solid revenue growth and margin expansion.
We believe our fiscal 'twenty to bookings and backlog growth will position us for a strong fiscal 'twenty three as organic growth returns to our target high single digit low double digit range and margins expand as a result of positive operating leverage and impact.
Looking further ahead, we're well positioned for accelerated growth and continued adjusted EBITDA margin expansion.
We've invested significantly in Capex R&D and M&A over the last few years driving key design wins on franchise programs.
As a result, we have high confidence in our ability over the next five years to continue executing on our strategy for long term value creation.
With that we'll be happy to take your questions. Operator, you can proceed with the Q&A now.
Thank you Sir.
Ladies and gentlemen, if you would like to ask a question you will need to press Star then one on your telephone keypad again star one to queue for a question to withdraw your question press the pound key.
Order to allow as many callers as possible to ask a question management requests that you limit yourself to one question. Thank you.
And our first question is going to come from the line of Pete.
Peter Skibinski with Alembic global.
Hey, good evening, Mark and Michael Thanks for all the color.
I guess, just a quick one I guess for me.
A nice revenue quarter.
Your adjusted EBITDA guidance here for the first quarter, Michael you touched on the adjusted EBITDA margin below your expectation was that just the incremental revenue that came through was just maybe a little bit more see rad revenue than expected is that kind of what you meant by program mix.
Yeah, that's the right way to think about it.
It really is just program mix and.
The higher revenue was associated with the lower margin development programs our sea Ray.
Okay.
<unk> was up 13% year over year.
Okay, that's great and if I could sneak one last one and then looking into the second corner.
Mark what are you kind of most concerned about is that.
The CR or is it the semi shortage is it the vaccine mandate is there is there a way to kind of rank kind of what you guys are most concerned about.
Yeah. It's a good question, it's actually all of those things so as I said on the call in the prepared remarks.
The risk level is elevated across all of those areas.
Yeah, No I think we still feel pretty good that Q1 is the low watermark for bookings this fiscal year.
We're going to see progressive growth in both bookings and revenue as the year progresses.
We're very mindful of the risks in those three areas and we will see how things evolve.
Thank you. Our next question will come from the line of Seth <unk> with J P. Morgan.
Hey, Thanks, very much good afternoon.
Maybe just a follow up there digging in on the question of the CR.
If it.
If it gets pumped it out through the first calendar quarter.
This call or I guess, if it gets pointed out through the first calendar quarter of 2022.
What does that mean in terms of the bookings you expect in your in your second half and to what degree is your booking target bookings target reliant upon.
An appropriations bill.
And what time period do you need that.
Sure. So yes in our guidance Seth we've actually assumed a one quarter.
Yeah, we don't have that many.
No new program starts and much of the bookings growth.
In the second half is actually tied to growth.
Existing coal markets and largely around our top 20 programs, which were existing programs.
So yeah, it's hard to say for sure what the risk could be.
Is there a unknown unknowns, but we've assumed one level sorry, one quarter of <unk>.
The CR in the guidance.
Thank you. Our next question will come from the line of Peter Arment with Baird equity research.
Yes, good evening, Mark and Mike.
Mark maybe if you could just circle back a little bit to Pete's question about the second half.
The EBITDA margins that you are having in the first half obviously below your historical you know what you've enjoyed in the second half obviously implies kind of a big step up so maybe if you could just highlight a couple of the key things that are going to drive that I know you talked about maybe less sea route or some of the development programs.
Yes, let me, let me kind of goes through.
Just a little bit H, two versus H, one kind.
Kind of overview from.
From a high level and then maybe kind of Mike can kind of dig in a little in.
Tease things apart so for the second half from a revenue perspective, as we said, we're expecting double digit growth in revenue.
This is the first half and year over year.
Pretty much like the growth that we're expecting for the full year, we're expecting that the growth will be driven sequentially by two major market segments in which we're participating.
Which is sensor and effector mission systems.
As well as C fly and the growth is going to come.
Similarly from a top 20 programs, which are largely expected to grow at a much higher rate.
And it's really this that I think is the primary driver.
The margin expansion, so taking it down a level if we look at in the second half from a programmatic perspective.
The growth.
The programs that are going to drive growth outcomes.
<unk> see with F 16, Saba F 35, and not large Fms program.
Moved from Q1 of last year.
Other programs are large programs in the second half of <unk> 56, a.
Classified CTC two program as well as $2 45, so it's kind of in line with Mike said right. It's really the program mix H one versus H two.
Yeah, Yeah, and Peter I think Mark just went through all of the programs I think as you look at the EBITDA for the year.
Midpoint of our guidance is still 22%.
22%.
Our Q1, and our Q2 kind of midpoint of our guidance for run at about 17, 5%. So.
We clearly expect to pickup in the second half and as I said in the prepared remarks.
In Q4, specifically as well.
And that's going to be driven by a couple of things number one is the gross margin expansion and Mark just talked about some of the specific programs, but at a high level. The program mix between the development programs that we had an H one.
Compared to production programs and H two is going to drive a lot of that.
Second thing is operating leverage and we're continuing to invest in R&D and H. One at levels that are consistent with what we've done in the past because of that we're seeing some negative operating leverage which is putting pressure on margins, we expect that to reverse in the in the <unk>.
Half and really drive margins as well. So those are the two big things as program mix and operating leverage driving the EBITDA margins in H two.
Thank you. Our next question will come from the line of Sheila <unk> with Jefferies.
Hey, good afternoon, guys and thanks for the time.
Just staying on the implied margin ramp when we think about the first half how much of the margin pressure is coming from new program next or is it like 500 bps does that 100.
Also talked about elevated supply chain and inflation as a watch item you know how are you kind of thinking about that into the second half.
So why don't I hit on the margin question first the preponderance of the lower gross margins Sheila <unk>.
Which one is related to.
Two the program mix and the new development programs and as we go through the second half of the year, we're going to see a ramp up in gross margins I think when we get to Q4, we're going to see gross margins that kind of look back at where we were in fiscal 'twenty for the year around 40, 45%.
I think that's where it will be around Q4, and again, we don't specifically guide gross margins, but the year level I think we're going to be.
Slightly above where we were in fiscal 'twenty, one, which implies that ramp up in gross margins and <unk>, two which is related to the programs that that mark.
Okay.
Yeah, and then on the.
The supply chain side of things Sheila Yeah, we clearly are seeing what many other companies have talked about right in this earning season with substantial increases in lead times and price inflation, yes.
Yeah.
I'd say that seem to date has done a very very good job.
Obligating around.
We Miss very little revenue in the first quarter associated with it.
But we do expect that the <unk>.
<unk> environment and the risk associated with revenue.
Yes, it will be around for quite some time.
It was one of the reasons that.
In the first quarter, we did make additional raw material purchase commitments that was tied to revenue in the second half that also it was able to take advantage of some better pricing. So yes the.
The team's doing a great job.
Challenging and we're managing through it.
Thank you.
Question will come from the line of Jonathan Ho with William Blair <unk> Company.
Yes.
Good afternoon, just wanted to maybe understand a little bit more about your comments around.
Sort of the the vaccine mandate and potentially how that could impact your business can you give us a sense of how much additional churn youre looking at and maybe your thoughts around sort of skill shortages difficultly hiring workers. How do you think about managing that process. Thank you.
Yes, so as you know Jonathan I think we did a very good job kind of monitoring through the initial stages of the pandemic. We're obviously now in a different phase.
With the the White house mandating the vaccines.
So we're working through that in a very large.
The majority of the population is vaccinated.
Currently, but there is still a portion that is not so we're working to educate those in.
Joel and coax them to actually get the boxing is unclear at this stage exactly how many of those.
Not to get vaccinated.
And it's still a little unclear just given some of the change in the.
The.
Coming out of the White house as to what companies are going to be able to do and what flexibility that they have with respect to the Monday to themselves. So.
We've notified employees that we intend to comply.
We're communicating with them in a two way dialogue, but at this point, it's unclear as to the exact impact it will hop yeah. We are.
Preparing.
Michigan's to actually offset any disruptions, but we may have.
Which includes overtime and temporary labor like other people.
Yes, we haven't had any issues with respect to hiring I think.
Going to hire.
It's still pretty strong and we have the labor that we need so right now.
We're doing okay.
But this is an important quarter with respect to those potential changes.
Thank you. Our next question will come from the line of Michael <unk> with <unk> Securities.
Hey, guys.
Good evening, Thanks for taking my question so.
Mark and Mike maybe what was the thought process I mean, we've obviously seen the larger defense peers here report call out these risks lower their guidance.
You guys are.
Still calling for substantial strength youre your fiscal year doesn't exactly align well with some of these risks I mean, it would seem like youre a bit more vulnerable, but you've obviously decided to keep the stake in the ground and not maybe account for some of these these risk factors and maybe reducing the guidance I mean.
Can you walk us through kind of the confidence level in calling out these risks, but not may be reflecting in the guidance.
Sure. Let me, let me kind of step back and just do a little bit of a recap in terms of kind of how we ended up here.
So yes, as we said on the call I think overall, we're pretty encouraged by the defense budget trends.
The longer term effects associated with the vaccine mandates.
Withstanding that as we said in the prepared remarks, I think in the short term.
Risk levels have increased due to the potential of the prolonged crs.
The impacts of the vaccine Mondays can hop on employee turnover and operations as well as the.
The supply chain constraints and inflation that we just discussed.
As we reflect it coming out of 'twenty, one and as we built our forecast what we did Mike as you know as we examined the areas that impacted organic growth. The most last year and believe that as we came into this year we plan.
Planned more conservatively.
It doesn't mean that plant is zero risk.
Clearly back end loaded in the environment is more challenging.
To recap what happened in 'twenty one.
We saw really a.
<unk> six point reduction in organic growth last year.
This was led by a three point reduction in organic revenue growth due to delight delays in naval modernization.
Particularly programs like C. With yes, we saw a two point reduction chewed at the now well publicized Lockheed supply delays on the F 35 T L. Three and block four as well as a greater than a one point reduction to various Fms programs.
So to risk adjust these as well as other areas coming into this year, we lowered organic revenue growth expectations by eight points and this decline.
Resulted in the guidance that we currently have which is flat organic revenue growth for the year.
But our belief that bookings will grow as the year progresses, leading to a positive book to bill for.
For the year as a whole and hence the return to more normal levels of organic growth.
In 2003, and Thats still very much up plan.
So let me let.
Let me talk a little bit about some of the programs that were impacted and just give you an update on some of those programs.
Programs that we further reduced in 'twenty two.
See with another enable upgrades.
35, just due to the impacts that we're seeing as well as various Fms programs.
No.
If you look at all times.
Still expecting substantial growth in bookings year over year.
Despite a slowing our rich our original bookings forecast.
Given that the <unk> was moved to fiscal 'twenty three.
On the naval fleet modernization schedule.
Yeah, the hottest and continues to be impacted.
Process affected several programs, including <unk> and yes.
As a result of that we lowered our revenue expectations and moved this Seawolf award to the fourth quarter.
Yes, which typically comes in Q3, which actually helped to Derisk the plan for them.
Probably the biggest shift was only F 35, and here again, we've kind of lowered revenues due to the ongoing engineering delays.
Associated with that ball, if 35 tier three and four the good news is that in Q1, we actually received a large order and expect additional awards in both Q3 and full now.
Now the bookings this year are far more weighted towards <unk> than what they were in.
Last year, which is a positive.
And overall, we expect double digit growth in F 35 bookings this year versus a 50% decline in 'twenty one.
In Q1 alone we booked nearly as much on the F 35, as we did for the whole of last year.
So that says, yes, there's still risk right because of low we booked a large order in Q1. The associated second half revenue is tied to long lead funding, which in itself is tied to tier III safety of flight test so as that revenue associated with F 35 currently.
Sits in Q4, and it's still in the plant, which is part of why the year is backend loaded.
On the Fms side, the biggest impact that we had last fiscal year was in Q1.
It's we're not very large Fms orders moved out of the year now the good news is that we received the initial award for that program.
In the fourth quarter earlier.
We had expected and we expect a substantial follow on order in Q2.
She will help for the year. So yeah. So overall, although this elevated risk in the second half.
True to our potential.
<unk>.
The Covid vaccine mandates in supply chain, we're actually pretty pleased with the progress that we made in the first quarter and our goal remains the same.
So long answer to a short question, but yes, we made some pretty good progress Mike.
Thank you. Our next question will come from the line of Austin Moeller with Canaccord Genuity.
Good evening, Mark and Mike.
Just on the the note about the impact of inflation I know, there's a lot of.
Expectation here that organic growth will manage to remain strong in fiscal year 'twenty three but are you concerned about the impact of inflation on even though the current defense budget or the future defense budget and that cost growth leading to a reduction in procurement quantities for key weapons systems or.
Alternatively, do you think that that will benefit mercury by driving D O D to further.
Engage and delayering of the supply chain and allow you to negotiate with them directly as opposed to through the prime.
Yeah. So I think it's probably going to be a little bit of both with clearly clearly seeing.
Delayering trends, particularly in the open mission systems Arena.
We're also seeing a flight to quality suppliers.
And in particular in RF as well as secure processing.
Customers are seeking to deal with those companies that.
<unk> automated or modernize their manufacturing capabilities as well as those that.
Willing and have the capacity to invest in.
The new technologies and capabilities, so it's a little bit of both.
Our next question will come from the line of Noah <unk> with Goldman Sachs.
Hi, good evening.
Hi, Noah.
Mark I just wanted to follow up on all of that detail. You just gave on some of your largest programs that had kind of had the delays yes.
I guess it seems concentrated into C weapon that F 35 tier three and then Altai herbs.
<unk>.
Notwithstanding the fact that you already gave a lot of detail there.
What's actually whats actually transpired with those programs like have there been meaningful.
<unk> stake in the ground hard milestones you can point us to have you had conversations with the prime about the order timing that you can point us to because otherwise it feels a little bit like we're still just kind of guessing on the timing and you don't know if it will slip out of your <unk> and your <unk>.
Are there are there concrete things that of.
Transpire that you can point us to that get us a little more comparable so.
Yes, I'd kind of just reiterate.
No what we basically said right I think there has been a tremendous amount.
Disclosure.
That was pre previously maybe not out in the public domain around the delays on.
T L. Three.
Unblocked full.
It resulted in.
Substantial cost increases delays to the program and potentially.
Changing the production levels.
Yes, maybe we will.
Leading indicator right to see the effects of hard to tell.
I think many of the updates that I think has been discussed publicly suggests.
The tier three development and integration efforts are actually doing better than what they were.
There's still some important milestones to go.
Yes, one of those is obviously the integration of the capabilities in the flight safety certification testing that is likely going to begin or.
Early in the.
The new calendar year.
Which would bode well for our revenues in the second half so that's kind of the new information.
Let's see with.
Yes, I think it's.
Again generally understood that is.
Being a pretty significant impact to the ship modernization upgrade cycle that affected.
Both <unk> as well as for US other enabled programs, yes, we have taken that into account.
Yes.
<unk> forecast.
The fact that we typically get the order in the third quarter, which our customer still intends to do.
We've been even more conservative pushing it into Q4 gain kind of Derisking the plan.
We'll now hear.
<unk>.
That shift.
Moved a.
The next production order into our next fiscal year. However, we're still expecting significant bookings associated with Tom's ramps.
<unk> and other development efforts that should lead to substantial.
Both in bookings year over year, so, yes, we've been having dialogues with customers, yes, it's a very dynamic environment and we've.
We've tried to reflect those changes and to communicate the latest information.
In the remarks that I've just said.
Once again to ask a question press star one.
Our next question comes from Pete Skibinski with Alembic Global.
Yes, thanks, guys.
Just wanted to go further on the F 35 outlook.
Just because lockheed put out the updated production profile and Mark you talked at length about tier three.
It sounds like as we head into maybe fiscal 'twenty three you'll have 35 revenue and it'll be a fairly easy comp for you given the delays in the tier three.
But how should we think about what the new production profile of how we should think.
Excuse me how should we think about the profile for you guys through the midterm in other words is F. 35 is going to be a growth program for you guys for for quite a long time or will you you know.
In the near term, let's say run into kind of this.
Production flattening profile that that some of the bigger guys are running into.
So we think that F 35 is going to be obviously continue to be a really important program for us.
Yes, Unlike say Lockheed right that.
Growth is obviously dependent upon the growth in the production rate.
A few things going on with Mercury.
So.
The first is obviously.
Getting beyond the issues that we've experienced around tier three tier three becomes an enabler of a block full.
Blocked full for us enables content expansion.
Different parts of the system as it should lead to growth in both processing as well as RF content.
The second thing is that it.
Likely that.
The existing <unk>.
Systems, both tier one and tier two yes, it will be retrofitted over time, which could be a pretty substantial opportunity for us as well and then obviously over time this likely going to be continued tech refreshes. So we're not a platform provider business is really tied to.
To both the electronics systems on new platforms as well as the ongoing modernization.
There are existing systems.
F 35 is a great example, its already on it.
The tech refresh of the underlying yes.
Processing and memory subsystem.
Yes.
Which will benefit from.
So hopefully that answered your question.
Thank you that's all the time, we have for question and answer session I'd like to turn the call back to Mark.
<unk> for closing comments.
Okay, well, thanks, very much everyone for joining us this evening and we look forward to speaking to you again next quarter take care.
Once again, we would like to thank you for participating on today's conference call. You may now disconnect.
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