Q2 2022 Mercury Systems Inc Earnings Call
Good day, everyone welcome to the Mercury systems second 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 outlet.
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.
<unk> 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 our call. We will also discuss several non-GAAP financial measures specifically adjusted income adjusted earnings per share adjusted EBITDA and 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 Aslib, Please turn to slide three.
Thanks, Mike Good afternoon, everyone and thanks for joining us.
Again with the business update Mike will review the financials and guidance and then we'll open it up for your questions.
We delivered solid results for the second quarter of fiscal 'twenty, two bookings were up substantially from what we believe was the low watermark in Q1, resulting in a one dose zero eight book to Bill.
We remain confident in achieving even stronger bookings in the second half leading to substantial growth for the year. As a result, we expect to exit fiscal 'twenty, two well positioned for return to our normal levels of growth and margin expansion.
This should lead to a strong performance overall in fiscal 'twenty three as planned.
Looking further ahead at our five year plan the impact program, we launched in fiscal 'twenty. One is providing the foundation for our next phase of value creation at greater scale.
We expected to deliver high single digit to low double digit organic revenue growth over time, coupled with margin expansion and M&A.
Our long term model sitting at the intersection of the high Tech industry and defense his position Mercury exceptionally well.
Our strategy and investments and secure processing trusted microelectronics in open mission systems are serving as the engines of growth in the business.
Turning to the numbers on slide four total revenue for Q2 was up 5% year over year, reflecting the anticipated challenging industry conditions.
Our largest revenue programs in the quarter were classified C. Two program.
60 P. Eight C D S awesome in F 16.
We continue to see high levels of new business activity and our pipeline remains strong design wins in Q2 totaled more than $160 million in estimated lifetime value for us.
In the first half of fiscal 'twenty. Two we've won 30, new designs with an estimated lifetime values of more than $580 million.
Free cash flow for Q2 was improved from Q1, but slightly negative due to supply chain challenges adjusted EPS and adjusted EBITDA were in line with our guidance.
Turning to slide five for fiscal 'twenty. Two we continue to expect total company revenue to grow approximately 10% exceeding $1 billion for the first time.
Besides look reflects a slightly more conservative forecast for organic revenue growth, reflecting the industry headwinds offset by potential upside from the recent all blacks in the Atlanta micro acquisitions.
Bottom line, we're still expecting to deliver a record adjusted EBITDA.
The three we began to see the impact of Covid and program related to FX in the back half of fiscal 'twenty one.
It's clear from the most recent earnings season that these challenges as well as the now extended C. All have caught up to the industry overall.
Over the past two quarters, we've seen substantial changes in actual results versus forecast guidance and outlook by many of our peers and customers.
In essence Mercury experienced these challenges early on and we believe that we were a leading indicator for the industry.
It's taken a year for these challenges to filter through the defense industry as a whole.
Despite the impacts of the CR, we saw substantial progress in the second quarter as anticipated and expect even stronger bookings in Q3 and Q4.
We expect the issues around the C ought to be rectified in March if Congress passes the defense Appropriations Bill.
As we discussed last quarter. The team is working closely with our suppliers as well as our customers to mitigate supply chain risks.
These risks are related to longer lead times for semiconductor components and materials supplier decommit as well as price inflation.
We've been largely successful in those efforts to date.
To further mitigate risk we've placed orders for accelerated material procurement to meet our second half demand.
Since our last call in November risks have clearly become elevated with respect to the pandemic.
We work to educate assist and motivate unvaccinated employees to get the vaccine with good result, and minimal financial and operational disruption.
Currently 98% of all U S employees to read the fully box needed all have received an exemption.
While it's possible we could see an impact from Covid in Q3, we've kept all of our facilities open and operational throughout the pandemic and expect to continue doing so.
I'll look to all the emerging risks first possible Fms order delays and second ensuring we have the qualified people we need to support our growth objectives.
On the latter while Mercury continues to be seen as a destination employer of choice with currently contending with challenging labor markets, we continue to evaluate and influence initiatives aimed at attracting top talent.
Turning to slide six.
April 2021, we proactively launched our impact program to lay the foundation of our next phase of value creation at scale.
We began impart because we knew that we needed to do things differently to achieve mercury's full growth and adjusted EBITDA potential organically and through M&A over the course of the next four years.
To be clear our decision to launch and pop 10 months ago was not related to the industry challenges that began shortly thereafter.
Impact is about transforming the business to operate at the greatest scale and what we are today.
The program is led by Thomas Hooper, who says on our leadership team and reports directly to me.
We continue to expect impact to generate $30 million to $50 million of incremental adjusted EBITDA by fiscal 'twenty. Five. This includes the $27 million net benefit related to impact actions taken in fiscal 'twenty two.
We're on track to meet our targets with upside opportunities that would allow us to deliver value in excess of our targets and quicker than originally expected.
Impact is it aimed at improving our organic growth as well as the fundamentals of the business over and above what we've done in the past.
It's enabling us to better align our investments with our customers' priorities and to partner with them on larger opportunities.
As a result, we expect to continue to take share and grow faster than the industry over time.
In addition to optimizing our balance sheet by improving our capital and after deficiency, we see substantial potential through impart to expand our margins.
We're focusing on five major areas first organizational efficiency and scalability.
Procurement and supply chain.
The facilities optimization and for scalable common processes and systems.
The fifth area is R&D investment efficiency and returns.
Mercury significant investment in research and development is a pillar of our growth strategy.
Prior to the current industry headwinds this investment resulted in organic growth well above the industry average over a multiyear period.
Our strong commitment to R&D is also in line with where the defense industry is headed.
<unk> proven that a high tech investment model kind of operate successfully at scale on behalf of all stakeholders.
As it relates to M&A impact is about leveraging our proven ability to integrate and grow acquired businesses, but it has the greatest scale going forward.
Since fiscal 14, we completed 15 acquisitions deploying $1 $4 billion of capital.
We have dramatically scaled and transformed the business as a result growing total company revenue four four times from FY <unk> through FY 'twenty one.
We fully integrated these acquired entities by moving them to common collaboration and engineering platforms as well as common ERP HR, yes, and CRM systems, while also consolidating facilities.
We've also unifies these 15 businesses under the Mercury brand with the combined sales force and single go to market strategy as well as the shared culture and values.
As a result of these auctions over the past seven fiscal years, we've extracted substantial cost and revenue synergies leading to adjusted EBITDA growing more than nine times or twice the growth in revenues.
This has resulted in substantial value creation for shareholders.
We intend to apply the impact methodology to future M&A. In addition to accelerating and increasing the value. We create we believe that deploying impact could also allow us to increase our deal cadence and potentially the size of our transactions.
Combined with the increased synergies generated this could have a compounding effect on value creation.
For example, six of our 15 acquisitions now comprise a mission business here, we're combining our integration growth on value capture rapids as part of impact.
Turning to slide seven we continue the M&A momentum in the quarter closing the Avalanche technologies in Atlanta micro acquisitions in November .
As a result, we've now deployed $620 million in capital since December of 2020. This marks the largest 12 month M&A capital deployment in Mercury's history, and we're excited about the future.
I will ask this touch points with all our prime mission acquisitions it positions us to compete more effectively for integrated displays communications management and mission computing programs in the avionics domain.
It also aligns well with the need for open mission systems, driven by industry Delayering.
Lots of micro is an innovative high margin semi conductor business.
It fits well with our RF mixed signal and trusted microelectronics businesses.
Both integrations are progressing well as all the integrations of POC and Pentech, which we acquired last year.
As it relates to future transactions the M&A environment continues to be active and our pipeline is strong.
We will remain disciplined in terms of odd deal pursuits diligence pricing and integration.
Mercury has built an enviable in house M&A capability and has a proven track record of acquiring and integrating significant acquisitions.
Through integration of our acquisitions, we've been able to average down the multiples we've paid through the recognition of both cost and revenue synergies, creating substantial value for our shareholders as a result.
Coupled with the strength of our balance sheet. We believe we can continue to execute on the M&A strategy. That's been so successful for us over the past seven years.
Turning to slide eight we expect Mercury's total company revenue to continue growing faster than overall defense spending over time with organic growth being the core driver.
We focused the business on larger and faster growing parts of the defense market. We now participate in more than 300 different programs.
We are designed in 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.
We believe that our longer term secular growth trends remained favorable.
The significant actions we have taken over the last several years have aligned us well with the national defense strategy.
The government continues to push for modernization speed and affordability and sensor and effector mission systems on <unk>.
Needs with scale processing trusted microelectronics in open mission systems are growing.
We believe that will also continue to benefit from the ongoing effects of supply chain, delivering and re shoring as well as increased outsourcing at the subsystem level by our customers.
The move to sub systems has been the driver of a low risk content expansion growth strategy, which has allowed us to grow organically at a rate foreign excess of the industry.
Back in 2016 with an eye towards expanding our margins we acquired various assets from the micro semi corporation.
This was the Genesis of our trusted microelectronics strategy.
With <unk> focus has been to create highly differentiated secure and trusted microelectronics capabilities as well as radiation tolerant devices for space applications, both developed and produced domestically.
These capabilities now represent the highest margin part of our business as planned we expect our trusted microelectronics strategy to continue driving growth and margin expansion over time.
Our vision of being the leading commercial provider of trust and secure 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 a result, our engagements, which are noncompetitive with our customer's offerings are becoming larger and more strategic but both parties.
We believe this vision combined with a low risk content expansion strategy will continue to drive organic growth in the business.
During the second quarter, our largest bookings programs, where our classified platform mission management program organ to classify DW programs and C. P. S.
As I said, we anticipate accelerated growth in bookings in the second half leading to a positive book to bill and growth in backlog for fiscal 'twenty two as a whole.
Recent update suggests that the development and the integration efforts related to the F 35 T. All three are doing better.
We believe this improvement is mirrored in our bookings year to date, we booked as much on the F 35, as we did for the whole of fiscal 'twenty, one and we're expecting a strong second half.
In addition to the F 35, we continue to expect our bookings to be led by programs, including outcomes Filthy Buzzard C. With F 18 F 16, P eight and T 45.
We're also expecting a significant booking relate to a classified trusted microelectronics program. In addition, we expect to receive a second substantially larger order for the Fms program that was delayed in Q1 of last fiscal year.
The change since our last call relates to <unk>, which is now called Goldstein and.
In response to our customer we had previously moved the next booking related to go side domestic and international production from a fiscal 'twenty two to fiscal 'twenty three.
Based on recent customer input. This may have moved to our fiscal 25 with a possible exception of <unk> phones for preproduction activities.
Like the F. 35 go saw is an important program. It's the largest single design win in the company's history to date, we expect it to be a significant driver of growth beginning in fiscal 'twenty five.
Looking specifically at 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. The F 35, as well as continued naval and airborne upgrades such as C. With the subsurface comeback system upgrade filthy Buzzard F 18, T 45, and all of the classified programs 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 second quarter results and then move to our Q3 and fiscal 'twenty two guidance.
The team worked in Q2 to deliver solid financial results. Despite the external challenges that Mark discussed we saw a significant rebound in bookings from Q1 and finished the quarter with a book to bill above one.
The bookings momentum in Q2 is expected to accelerate resulting in a strong second half of the fiscal year.
For full fiscal 'twenty, two or maintaining our prior guidance for revenue adjusted EBITDA and adjusted EPS.
Our updated guidance incorporates the acquisitions of Abbott, Lex and Atlanta micro as well as a more cautious organic revenue outlook, primarily due to elevated supply chain risk.
We continue to expect fiscal 'twenty two to be weighted towards age two and especially Q4 as margins expand and free cash flow begins to normalize.
Given our backlog at the end of Q2 and forecasted Q3 bookings, we expect to exit Q3 with strong visibility into Q4.
Looking ahead to fiscal 'twenty three we continue to anticipate a return to above industry average organic revenue growth driven by the strong bookings and backlog growth in fiscal 'twenty two.
We expect this organic growth coupled with improved operating leverage in our impact initiatives to result in margin expansion and increased adjusted EBITDA versus fiscal 'twenty two.
Turning to our Q2 results on slide nine bookings were up 13% compared to Q2, 'twenty, one and up 19% from last quarter.
During the quarter, we had over $25 million of bookings move from Q2 into Q3 as a result of contracting delays. We've already received a majority of those orders in Q3.
Despite these delays our book to Bill was still strong at one point O eight.
Our backlog at the end of the quarter with $954 million up 8% compared to Q1.
Revenue in Q2 increased 5% from Q2, 'twenty $1 million to $220 million.
Organic revenue was $183 million down, 13% year over year, and slightly better than our expectations coming into the quarter.
Acquired revenue, which included POC, Pentech Avalanche and Atlanta, Mike Brown was $37 5 million.
The Appalachian Atlanta micro acquisitions, together contributed approximately $6 million of revenue in Q2.
Acquired revenue was slightly below expectations due to the contracting delays that I just mentioned.
Gross margins for Q2 were 39, 6% compared to 42, 1% in Q2 fiscal 'twenty, one down 250 basis points.
This was impacted by the inclusion of POC, which had 100 basis point impact.
It also reflected program mix with a higher proportion of new program starts and development work compared to Q2 last year.
In H, two and heading into fiscal 'twenty, three and beyond we expect gross margins to expand as more of our programs transition into production.
Operating expenses in Q2 were up 24, 2% compared to last year, primarily driven by the recent acquisitions as well as higher amortization expense and acquisition related expenses.
We recorded $3 8 million of restructuring and other charges in Q2.
Primarily related to third party consulting costs associated with our impact program.
Our growth focused R&D investments continue to exceed the industry average R&D.
R&D for Q2 was 12, 9% of sales.
Since fiscal 2017, we've now invested over $450 million in secure processing trusted microelectronics and open mission systems.
These investments coupled with our strategic acquisitions have provided us differentiated technologies in fast growing segments of the market.
We incurred a GAAP net loss of $2 6 million or negative <unk> <unk> per share in Q2.
This was driven primarily by $6 5 million of acquisition related and restructuring and other charges as well as the incremental amortization expense associated with Avalanche and Atlanta micro.
Adjusted EBITDA for Q2 was $38 1 million, our adjusted EBITDA margins were 17, 3% down 420 basis points from 21, 5% in Q2 fiscal 'twenty one.
This was driven by lower gross margins compared to a year ago as well as negative operating leverage as organic revenue declined year over year, while we continue to invest for growth.
Free cash flow for Q2 was an outflow of $1 2 million driven by restructuring and other charges as well as impacts from supply chain delays.
Slide 10 presents Mercury's balance sheet for the last five quarters.
We ended Q2 with cash and cash equivalents of $105 million compared to 96 million in Q1 with a reduction from our free cash outflow in offset by cash associated with recent acquisitions.
Mercury ended the quarter with approximately $452 million of debt funded under our $750 million revolving credit facility.
Approximately $252 million from Q1, driven by the acquisitions of Avalanche and Atlanta might grow.
From a capital structure perspective, we remain well positioned to continue executing our disciplined M&A transactions that will create additional value for shareholders.
From a working capital perspective, we continue to be focused on improving efficiencies and key accounts, including unbilled receivables and inventory.
Unfilled receivables, excluding our Q2 acquisitions and purchase accounting adjustments decreased approximately $5 million from Q1, as we completed several significant program milestones.
As Mark said from fiscal 2014 through fiscal 2021 our total revenue increased four four times.
However, due to the success of our low risk content expansion strategy, our subsystems revenue increased seven five times.
As a result of this strategic shift to larger integrated sub systems as well as the acquisition of POC a year ago.
Our proportion of overtime revenue to total revenue has increased to just below 50%.
Our unbilled receivables balance has naturally increased as well.
Expect to continue to make progress in reducing our unbilled receivables as a percentage of overtime revenue in future quarters.
Inventory, excluding our Q2 acquisitions increased approximately $7 million.
This was due to accelerated purchases to support customer demand.
And mitigate supply chain risks in the second half.
We expect inventory turns to improve as we move into fiscal 'twenty three.
However, going forward, we will always consider pre buys for key components, where we believe our supply chain could be at risk. We see this as a cost effective short term insurance policy.
Turning to cash flow on slide 11 free cash flow for Q2 was an outflow of $1 2 million.
This reflected restructuring and other charges associated with the impact as well as acquisition related expenses, primarily associated with Avalere and Atlanta Micra.
We also saw an impact on our cash flow as a result of supply chain delays that impacted our revenue and milestone linearity and therefore billings.
Supplier delays related to milestone payments had an approximate $20 million impact on free cash flow during the quarter.
This was partially offset by other working capital accounts.
Let's now turn to our financial guidance, starting with the third quarter on slide 12.
I'll begin by noting that our guidance for both Q3 and the full fiscal year assumes no incremental acquisition related expense.
The guidance includes both Avalanche and Atlanta Micra.
As I've said, we're maintaining our full year fiscal 'twenty two guidance for revenue adjusted EBITDA and adjusted EPS.
Selecting the incremental acquired revenue from Appalachia, and Atlanta, Mike Brown offset by the elevated risk we expect to continue through the second half of the year.
While the team has worked diligently to manage headwinds observed across the industry are.
Our Q2 results were impacted by supply chain constraints, the defense contracting environment, Covid and workforce retention.
As a result, while we are working to mitigate the impact from these risks are Q3 and updated full year fiscal 'twenty two guidance does reflect them going forward.
I'll also note that our GAAP net income and GAAP EPS guidance for Q3 and fiscal 'twenty, two reflects restructuring and other charges related to impact in.
In addition fiscal 'twenty two includes acquisition related expenses incurred in each one.
With that as background looking at Q3, specifically, we expect continued growth in bookings and a book to bill materially above one for the quarter driven by the programs Mark discussed.
We expect our backlog to increase exiting Q3.
Providing us with even greater visibility into the revenue as expected for Q4 as I'll discuss in a moment.
We currently expect revenue for Q3 in the range of $245 million to $255 million.
This is an approximate 3% decline at the midpoint compared to the third quarter last year.
At the midpoint, we expect organic revenue to be down approximately 9% from Q3 last year as a result of the lower bookings in fiscal 'twenty one.
We expect a significant increase in our total and organic revenue growth in Q4.
Q3, GAAP net income is expected to be eight to $10 4 million or 15 to 19 cents per share.
The year over year declines reflect the expected incremental impact related expenses and amortization expenses.
Our guidance for Q3 includes restructuring and other charges of $3 7 million related to the impact initiatives.
Q3, adjusted EPS is expected to be 55 to 59 per share.
We expect adjusted EBITDA for Q3 to be $50 million to $53 million, representing approximately 26% of revenue at the midpoint.
This is over 300 basis points higher than Q2, driven primarily by higher gross margins as well as operating leverage on sales growth.
We expect free cash flow to adjusted EBITDA for Q3 to be approximately breakeven driven by continued impact cash outflows working capital investments associated with quarter over quarter revenue growth as well as additional interest expense.
Turning to slide 13 for the full fiscal year 'twenty two as I've said, we're expecting double digit bookings growth and a book to bill above one we.
We expect total company revenue of one to 1.83 billion, representing 8% to 11% growth from fiscal 'twenty one.
This is in line with our previous guidance and includes our recent acquisitions.
Organically the midpoint is a 3% revenue decline year over year, reflecting the supply chain and other risks I previously mentioned.
GAAP net income for fiscal 'twenty, two is expected to be 44, eight to $50 1 million or 80 to 90 per share.
The declines year over year reflect expected restructuring and other charges as well as acquisition related amortization expenses.
They also reflect 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.
Adjusted EBITDA margins are expected to be approximately 22%.
Like revenue, we expect adjusted EBITDA and EBITDA margins to be heavily weighted towards Q4.
From a free cash flow perspective, we expect free cash flow to adjusted EBITDA conversion to normalize in Q4.
Our estimated cash flow through Q3. This would result in approximately 15% to 20% free cash flow to adjusted EBITDA in fiscal 'twenty two.
This conversion include impact expenses through Q3 and assumes no additional impacts from supply chain delays in Q4.
Turning to slide 14, I wanted to touch on Q4, which we expect to be a record quarter for mercury across all key metrics.
While we will not formally guide Q4 until next quarter.
Based on H, one actuals and our Q3 and updated fiscal 'twenty two guidance, we can back into an implied forecast for the quarter.
Looking at the mid points of our fiscal 'twenty, two and Q3 guidance ranges.
Q4 revenue at the midpoint would be approximately $320 million.
This is an increase of approximately 28% from Q4, 'twenty, one and organic growth of approximately 20%.
GAAP net income and GAAP EPS would be approximately $48 million.86, respectively.
In addition, Q4 adjusted EBITDA would be approximately $96 million and adjusted EBITDA margins would be approximately 30%.
On slide 15, I want to provide the key reasons why we're comfortable in guiding toward record results in Q4.
In essence, it's about our strong visibility into the fourth quarter today, which we expect to be even clearer by the end of Q3.
The implied Q4 guidance represents significant growth over Q4, 'twenty, one and Q3.
That said between our strong current backlog and expected bookings in Q3, we expect to enter Q4 with forward backlog coverage in line with previous quarters.
In addition to Q3 bookings we have visibility into the major Q4 bookings that are expected to drive the remainder of the implied Q4 forecast.
Some of the key H two programs include F 35 tier three C with F 18, Fms programs and a variety of other programs that Mark discussed.
We're designed into these programs and we remain closely aligned with our customers.
As such our Q4 guidance is based on existing backlog as well as the expected timing of H two bookings informed by the best available information we have today.
From a gross margin perspective, we also expect a strong Q4.
The mix of programs, we expect to drive our growth is weighted towards production programs and licensing revenue, which tend to have higher margins. As a result, we're expecting significant gross margin expansion in Q4.
In addition, we expect R&D and SG&A on a dollar basis to be relatively flat compared to Q3. Despite the significant growth in revenue in Q4, thereby driving adjusted EBITDA margins.
So our comfort in the outlook as a result of the visibility into our Q4 programs and the associated profitability.
With that I'll turn the call back over to Mark.
Turning to slide 16, Q2 was a strong quarter for Mercury. We're confident this will lead to a strong year in fiscal 'twenty three as organic growth returns to normal levels and impart drives margin expansion.
Looking ahead longer term our model sitting at the intersection of the high Tech industry and defense is exceptionally well positioned.
We believe that our strategy and investments and secure processing trusted microelectronics in open mission systems will continue to drive growth in the business.
While we're mindful of the potential risks associated with the defense budget and industry headwinds, we expect to continue to benefit from key secular trends such as outsourcing delivering and re shoring.
We're well aligned with our customers and the D O D. Our design win cadence as strong new business activity remains robust.
Our strategy is to deliver strong margins, while growing the business organically and supplementing this organic growth with disciplined M&A and full integration.
By executing on this strategy, we've created significant value for shareholders for nearly a decade and we expect to continue doing so.
In closing I'd like to extend my appreciation to the entire Mercury team for the outstanding work they've done during this challenging time my sincere thanks to all of you.
Before we move to questions I'd like to address the recent public disclosures by two of our shareholders John of partners install both volume and.
Mercury, we frequently engage and maintained an ongoing dialogue with shareholders and have a history of seeking considering and incorporating their feedback where appropriate.
As we've communicated today will focus on executing our strategic plan and we'll continue to evaluate opportunities to enhance value for all shareholders as we do so.
The purpose of todays call is to discuss our second quarter earnings results and outlook and we ask that you. Please keep your questions focused on these topics with that operator. Please proceed with the Q&A.
Thank you Sir at this time, we would like to inform everyone that people would like to ask a question. Please press Star then one on your telephone keypad and as a reminder, we will limit your questions to one question in order to allow as many callers as possible to ask a question again.
One.
Our first question is going to come from the line of Pete Kubicki with Alembic Global.
Hey, good afternoon, everyone.
<unk>.
Hey, guys just wanted to get a better sense with regard to this big ramp in the fourth quarter.
It sound I guess I'm trying to figure out to what degree you're predicating This fourth quarter revenue ramp on.
On a kind of a timely.
And to the current CR none of them were in other words, if we get a full year CR.
What kind of revenue chunk might we expect shifts to fiscal 'twenty three.
Sure Let me, let me take a crack at that Pete So yeah, we don't believe that.
There's a lower risk associated with the CR itself.
Yeah, I think we've gone through the programs and we feel pretty good.
You know the ramp in Q4, Yeah, I think although.
There is no forecast without risk yeah, we've got a significant amount of Q4 revenue already in backlog.
This backlog combined with the expected ramp in Q3 bookings is what really gives us the visibility and the comfort to the implied Q4 revenue and EBITDA that Mike discussed and aplomb and.
So Q3 bookings is an important quarter for us and we're expecting continued momentum based on what we delivered in Q2.
Thank you. Our next question is going to come from the line of Seth Schiffman with J P. Morgan.
Thanks, very much good evening.
I wonder.
I Wonder if you guys could.
Talk a little bit more about the.
The risk on the on the execution side on the manufacturing side, you know you talked about.
Sort of.
I guess you'd think about head count.
Think about the supply chain challenges that you mentioned and you know those are still ongoing through much of the economy and I will probably be ongoing in the in the June quarter.
As well.
And so to what degree does that level of kind of operational cadence or execution need to return to something like normal for you to do.
Over on the Q4 targets.
And and.
Kind of what gives you confidence in that.
Yeah, So a few things there so.
So clearly I think we've seen a pretty turbulent environment and right now we're not anticipating that things will be fully resolved now likely until next calendar year.
Said I think we are being very very proactive working with our supply is wherever we possibly can.
To minimize the risk going forward and we don't currently expect that the uncertainties around the supply chain will actually grow materially in the second half.
We've been very very focused on doing whatever we can we mentioned in the prepared remarks that.
Yeah, we've purchased an additional $10 million.
The materials. It is linked to second half revenue as materials are flowing in.
Flow down deep cost ratings, where appropriate we're in daily contact with the supply is.
And obviously, we've taken into account what we believe to be the highest risks from both the supply chain as well as the labor perspective in the current guidance.
The team's done a pretty pretty good job overall.
But it is quite challenging out there.
Thank you. Our next question is going to come from the line of Sheila <unk> with Jefferies.
Hi.
Good afternoon, guys. Thanks for the time, obviously a lot going on.
And you talked about this in your prepared remarks, a lot in terms of.
Opportunities in your M&A pipeline, both historically and going forward.
Yeah, one impact going on as well, maybe can you give us a quantitative and qualitative outlook on your historical win going forward.
Now.
You know Mercury has added value both from a revenue and EBITDA perspective, because when we look at it the growth is great.
It's up 20% both on the topline and the bottom line. So I guess, maybe can you talk about.
The potential opportunities you have going forward, whether it's tier one impact or on future opportunities.
Yes look great question.
Yeah, I think as we said we built.
I'd say, an enviable M&A organization our ability to.
<unk> diligence closed and then integrate deals is very very strong.
To me impart Tibet leveraging.
The proven ability that we have to integrate and grow.
Future acquired businesses, but doing it at a greater scale going forward.
I think as we said in the prepared remarks since fiscal <unk>.
We've now acquired 15 businesses deploying 1 billion full in capital.
That's dramatically scaled mercury as a business transformed the capability set that we have.
As well as the importance to our customers.
And as a result of the acquisitions, but more importantly through the synergies that we've generated through full integration, we've been able to actually grow total company revenues by over four four times over.
Over the course of the last.
Seven or so years and because the integration full integration is such an important element of the strategy and impact of that would take not to the next level. Yeah, we've been able to actually grow adjusted EBITDA at nine times or twice the growth in revenues.
And I think it's really this well.
Organic growth strategy that we have.
Driven by you know that.
The shift to sub systems.
Coupled with M&A on.
<unk> integration is what's delivered the value creation over the course of the year.
The period, while we've been very very opposite impact to me, it's about taking it to the next level.
So it's about mercury kind of achieving its full growth in adjusted EBITDA potential doing what we've been doing but doing it at a greater scale and potentially even better than what we've done in the past.
Thank you. Our next question is going to come from the line of Peter Arment with Baird.
Yeah, Good evening, Mark and Mike.
Mark.
Obviously, there's been some questions about you know kind of the timing and how this is all going to kick into the to kind of the fourth quarter you have a lot of confidence around that you have in the past I guess talked about kind of returning to high single digit or low double digit growth and I wanted to maybe just more qualitatively do you think that's still possible in 'twenty three just given the lingering.
<unk> have a CR pizza right about on a full year CR or whether you get.
No just lingering effects from the supply chain, just how youre thinking about kind of the return to the growth model.
Yeah look it's a great question. Thanks for that so yeah, obviously.
Obviously, notwithstanding the you know the elevated industry risks that we're facing.
Fiscal 'twenty two.
We continue to expect very substantial growth in bookings year over year.
Bookings and backlog expectation for the year have actually improved since last quarter and yeah. We continue to be remain.
Pretty confident for the for the second half just given the timing of the deals that we see.
The expected growth in bookings.
You know as we see it right now should lead to a positive book to Bill.
For the year as a whole as well as double digit growth in total and 12 month backlog and its really these bookings and the increase in backlog exiting this fiscal year that we believe positions us for a return to a more normal levels of growth.
Organically in fiscal 'twenty, three and this organic growth coupled with the margin expansion that.
We expect associated with the impact of initiatives really do set us well.
Pretty substantial value creation next year.
So I think right now we feel pretty confident in the second half we're seeing the bookings momentum coming out of Q2, Yes. We said we thought that Q1 was the low watermark. We were pleased with the progress and we're expecting even faster growth in.
In the second half.
And Peter I would just add to that.
We just went through our update to our five year forecast as part of our.
Mid year strategic planning exercise and March it talked about fiscal 'twenty three but when you look at the five year.
It is very strong as well and that growth is supported by.
By the major programs, we're on the markets that we have been investing in.
So a clear path to returning to the organic growth model and then on top of that is impact ramping up not just in fiscal 'twenty three.
But margin expansion over the five year period.
Thank you. Our next question is kind of come from the line of Ken Herbert with RBC.
Hey, good afternoon, Mark and Mike.
Two part question if I could first when you look market the new business opportunities today your business development pipeline.
Has that changed relative to maybe a year or two ago is it possible to quantify that as we think about the impact maybe of the budget on some of the new program starts and your organic investment opportunities and then second I was just wondering if you could put a finer point on sort of how much of the fourth quarter revenues are currently in backlog with.
The 25 million it sounds like you've largely books that slipped out of the second to the third quarter and sort of what you expect to book in the third quarter. Thank you.
Sure so.
Yeah, Mike I don't know if you want to take the Q4 backlog one.
Talk a little bit about the what.
What we see over the.
Five years and why we feel confident yes, so Ken as we talked about in the prepared remarks. If you look at Q4, it's really driven by the key programs that were designed into their.
They are well supported so this really is about timing.
If you look historically.
We've had about 50% to 60% of the next 12 months in 12 month backlog entering the year.
We haven't given out guidance on how much backlog coverage, we have entering a quarter because it can typically range anywhere from from 70% to the to the mid 80% range that depends on.
Contract mix et cetera.
As we look at our Q4 right now and why we're comfortable with the guidance. We put out we currently have about 70% of our Q4 in backlog today.
And if you look at the bookings that we see in Q3.
We anticipate having over 80%.
Q4 in backlog by the end of Q3, so even though we're forecasting a very big Q4.
Coverage, we expect going into Q4 is at the high end.
The range that we normally see so we've got a lot of insight into the programs and we feel like we've got a lot of insight into the timing as I said in our prepared remarks that we're staying close with our customers on that.
Thanks, Mike So let me kind of just talk a little bit about the.
The longer term.
So we you know we've been investing heavily for growth and we've grown the business significantly organically over a multiyear period.
And so despite the headwinds that we're experiencing now in the latter half of 'twenty, one and 'twenty two to date.
We absolutely believe that our long term business model is intact as Mike said, we've just updated.
Our five year plan at the midyear Mark and continue to believe in our ability to grow the business at high single digit to low double digit rates on average over time.
As we have done for many many years now so and the reason that we belief, though is that to begin with I mean with what position in large and well funded and high priority programs of record that.
That we believe are very much aligned with the national defense strategy as well as T O D priorities.
Designed in on many of these programs.
And by far the majority are actually sole source supplier positions.
None of our programs have been canceled.
Yeah.
I think in.
In fact, as we look forward, we think that the funding associated with our programs.
Is remained strong we continue to out invest our competition.
From an internally funded R&D, which we believe is in line with the direction that the industry is.
Is headed and this is allowing us to deliver innovations far more quickly far more affordably.
And what we're seeing other companies doing which in turn means that we're taking share.
Our largest secular growth driver, which we've been focused on for <unk>.
Quite some time now which is outsourcing at the subsystem level.
Is occurring by our traditional customers as well as the government as they are seeking to the lay of the supply chain to gain access to innovative.
Tech oriented mid tier companies such as Mercury.
Although clearly we were maybe a leading indicator.
What are the challenges that we're seeing more broadly across the industry. We do believe that many of those are temporary in nature and we can continue to grow the business the way in which we have in the past.
And again, probably the biggest driver of that is outsourcing.
Thank you. Our next question is going to come from the line of Michael <unk> with Truest Securities.
Hey, Yeah. Good evening guys. Thanks for thanks for taking my questions.
Just.
I guess, mark or Mike I'm, not sure, which one of you guys kind of take this but just you talked about sort of the industry related risks and I guess just at the programmatic level, we've seen some press about some seaward block two shortfalls.
I guess, you've been thinking about your comments on <unk>.
And kind of.
That that first booking order sliding out I mean, just knowing how big that program was.
Has that changed.
Or has anything changed on the programmatic side I mean.
Six months ago, as we were looking to 'twenty three for a reacceleration of organic growth, presumably <unk> who's going to be a part of that is it.
What is that the case is it easy to backfill that or just.
Talk about some of these these big programs and how.
Theyre trending given what were seeing I guess, a slide out and maybe some operational shortfalls there.
Yeah, so yeah the the.
<unk> that we've talked about right or the outlook.
Mike actually.
Encompasses what we have seen programmatically based upon the best possible information today.
<unk> as we said we start to see some impact.
Last fiscal year.
The second half just based on the <unk>.
Lots of Covid on the ship upgrade cycle.
Cycles and yeah, we are.
Seeing that again this year in terms of low numbers, which is encompassed in our numbers.
All times.
Yes.
We were originally expecting to get a large.
Bookings this year.
No again has moved out that is also encompass in both yeah outlook for this year as well as over the five years.
And we do think that actually L times, even though it's.
Nowhere near as large as what we thought it was going to be for fiscal for this fiscal year.
The bookings is still going to be up three X compared to what it was last year. So fundamentally I don't believe anything has changed I think we've got some great. We're on some great programs.
Yeah, we're seeing ramp.
<unk> seen in a number of those over the.
Five year period, and it's really the growth in the top 20 programs is.
As well as some of the new design wins.
Transitioning into production over time that gives us the confidence in the outlook. So we feel pretty good.
We've done the work and you know that.
We're well positioned Mike.
And our next question is going to come from the line of Jonathan Ho with William Blair <unk> Company.
Okay.
Hi, good afternoon.
I just wanted to I guess, maybe you get a sense for whether you've heard anything from your customers I think you've referenced.
Staying in close contact with them anything.
Anything changed or is there anything that's maybe giving you some additional confidence as we start to look at sort of this Q4 ramp and going into 2023.
Just wanted to get a sense from you know from.
From your Mark on how to think about what the customers are saying.
Yeah. So I mean, we spend a fair amount of time, obviously with.
With customers just looking at.
All major programs and just diligent saying them.
<unk>.
Continuing to look at the ramp in H two.
Yeah, I think and yes, I think the major programs right. The feedback that we've been that we've given support to the forecast.
That within the guidance that we've just given overall so I think when we look at the forecast for <unk> two from a bookings perspective.
Jonathan I think it's really being driven by double digit growth across two major market segments, which as you know <unk>.
C fly in sensor and effector mission systems.
And the growth in both of those markets are really again being driven by our top 20 programs.
In the top 20 programs, we're actually expecting the bookings from them.
Are likely going to more than double versus H one.
Primarily because there's actually more than producing.
And the ones that are producing and producing at a higher rate and so when I look at those programs.
We've got the large Fms program that moved from Q1 of last year.
Yeah, we've got a substantial ramp and the F 16.
Of which you know that was one of the orders that moved from Q2.
Through Q1 into Q Q2.
Uh huh.
And we've already received that order.
We're going to ramp on <unk>.
See with below its lower is in the is in the second half as well. So I think our program and we feel we feel good about it I mean, the stable well funded programs that yeah, we don't expect them to be affected by the CR and yeah. We have got the best possible information from the customers has.
We looked at the second half.
Our next question comes from Austin, Moeller with Canaccord Genuity.
Good evening, Mark and Mike.
I just have a question here.
Launches an invasion into Ukraine do you anticipate that we could have an expansion of about 35 sales towards some of our NATO allies and.
We see an increase in F 35 sales and the number of customers that are already are assigned to the F 35, as well as the large amount of electronic warfare and radar equipment being sent to eastern Europe .
Are you finding a wildlife.
Do you anticipate that could yield upside in your fiscal year 'twenty three.
So it's hard to say exactly what obviously is going to happen in the Ukraine and specifically.
Relating to the F 35, but if I just kind of talk a little bit about what we see happening with our program.
Overall, we are expecting.
Double digit growth in bookings this fiscal year.
Greater than 40% as opposed to.
50% decline that we saw last year. So we do think that as a result of the tier three and kind of getting through the reprogramming, yeah, we're seeing a pretty substantial uptick.
Year to date on the program, we've booked as much.
Here is what we did throughout the whole of last year.
We're expecting a strong second half as well as the substantial increase in bookings next fiscal year. So that was one of the major programs that obviously, yeah Theres now a lot of information out in the public domain around what happened with tier three and block four in the production.
Reprogramming, but yeah from from what we can see right now things.
<unk> appear to be back on track and we're seeing it in our bookings and our revenue and we feel pretty good about the growth in the program longer term.
Just given some of the design wins that we've already won.
T.
All three and block four will enable so overall, yeah I think it's a really important program for Ross on for the industry and we're seeing a substantial pickup this year compared to last.
Thank you. Our next question comes from Christopher Rieger, with Baron Burt Capital management.
Hi, guys. Thank you very much for taking the question.
Just with regard to.
The elevated supply chain risk that you've been seeing in the lengthening lead times could you talk about sort of where youre seeing the pinch the most like.
Which programs are more or less affected than others. Any color you could provide you could provide there would be appreciated. Thanks.
Yes so.
Really not necessarily at a specific program level, but I think the biggest challenges that we faced.
It was delays in in quarter Decommit from supply isn't distributors a lot of that was around semiconductors and in particular fpga's.
And so I think Mike said, we saw greater than $5 million revenue impact in the second quarter associated with that.
But we also saw revenue churn.
Yeah. It is.
Supply is what kind of decommissioning and yeah, we were ending up that pushed some of the revenue towards the back into the quarter, which in turn impacted some of our cash collections. So it's a very dynamic environment.
It's the reason that we have.
Yeah.
This quarter.
Quarter Covid.
And another $10 million.
Component buys to Derisk the.
Revenue in the second half and we're already getting those materials in and Thats on top of what we previously did so most of what we're seeing.
You know the issues around our in semiconductors in the game.
<unk> is FPGA based.
And our next question will come from Ron Epstein with Bank of America.
Hey, good evening guys.
Could you walk through why do you see yourself as a leading indicator and what about your business would make you a leading indicator.
Yes to some extent Rod I think it's just where we sit in the us.
<unk>.
The Tia from an industry perspective, and the fact that we've got a relatively short cycle business.
When we started to see.
The impacts associated with F 35, right.
L. Three.
That's a significant program for us.
And it wasn't until really.
Nine months after that we start to see the impact did a lot of the other companies start to describe what was happening.
Then.
Demonstrate the impact that was having on them as well so it's largely due to I think where we sit in the supply chain. Some of the program concentration that we have.
And short cycle business.
Thank you and our final question for the day will come from the line of Noah <unk> with Goldman Sachs.
Hey, everyone.
Sure.
Hi, Noah.
Mark I wanted to ask a similar question so I'll try it again, which is.
Everybody in the industry.
Seeing a continuing resolution in supply chain and labor hurdles and the order of magnitude of decline in your revenues organically is much larger than pretty much every other company in the industry.
If you could spend a little bit more time on on why that is I mean is being short cycle with the commercial model and a lack of multiyear contracts.
I mean, when there is a delay on the program that the prime can just kind of.
Almost turned you off completely and then pick it back up a year down the road and if you could just get a little more specific on <unk> two of a length of delay you're talking about there is quite long.
I'd love to be able to better understand what's going on in that program.
Yeah, So look I think.
When we kind of.
Yeah assess kind of what happened in fiscal 'twenty one.
The biggest challenge that we had last fiscal year from a bookings perspective.
Remember the bookings.
Slowdown that we saw in the second half of fiscal 'twenty one in the first half of this fiscal year, which we expect to ramp.
Is largely what is driven.
The slowdown in organic revenue growth. So the largest bookings impact that we had last year. It was on the F 35.
And as I mentioned, our bookings on the F 35.
We're down 50% year over year.
Debates.
Compared with the prior year, which caused a three point decline in.
In organic bookings overall.
That large Fms contract.
That was delayed from Q1.
Yes, which we now expect in the second half that has a roughly three and a half point.
Impart as well so literally just theyre in two programs.
We saw some pretty substantial.
Impasse overall that has affected the growth.
In fiscal year 'twenty two.
Go on with a few others as it relates to L. Tums.
Yes, I think yes.
<unk>.
Yeah, it's based upon the information that we got from our customers today I think.
Our understanding is that the.
The next <unk> reduction award for Raytheon will be in 'twenty, four and that's based on what we're hearing from PEO space and missile.
Yeah.
<unk> is.
What's currently in the Army plant, because we didn't get a fit it last year, we don't know for sure.
How the budget has moved.
Out of 22 based upon the army's portfolio and decisions around that so we'll have more information hopefully in the next few months as to what the actual plans for <unk>.
<unk>.
Paul.
I would say however that I think the U S Army continues to stress.
The importance of <unk> as a cornerstone of next generation Air and missile defense.
One of the Army's six priority areas. So, although we've kind of moved it out again in time and.
And we're expecting a substantial ramp in bookings in.
This fiscal year compared to last year.
We're not going to see the big.
The ramp in production orders, we believe until <unk>.
Fiscal 'twenty five so the time that it takes raytheon to get the order get it to us in the difference in the timing in fiscal years puts it out into our fiscal 'twenty five versus fiscal 'twenty full so that's what we know right now.
Thank you I would now like to turn the call over to Mr. Mark <unk>.
Closing comments.
Okay, well, it's been great to speak to everyone. Thank you very much who joined the call. We look forward to speaking to you again soon.
Yeah.
Yeah.
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