Q2 2023 Mercury Systems Inc Earnings Call
Speaker 1: And that's a wrap.
Speaker 2: Good day everyone and welcome to the Mercury Systems second quarter fiscal 2023 conference call.
Speaker 3: Today's call is being recorded.
Speaker 4: 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.
Speaker 5: Please go ahead, sir. Good afternoon, and thank you for joining us. I hope you have the chance to reveal the press releases we issued earlier this afternoon. If not, you can find them on our website at mrcny.com.
Speaker 6: 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.
Speaker 7: With me today is our President and Chief Executive Officer, Mark Asselt.
Speaker 8: I'm also very pleased to welcome Michelle McCarthy to the call.
Speaker 9: Serving as Mercury's Senior Vice President and Chief Accounting Officer for the past five years, Michelle has been an active and valuable member of our leadership team. I'm looking forward to working closely with Michelle in her new position as Interim Chief Financial Officer to ensure a seamless transition prior to my departure in February .
Speaker 10: Turning to slide 2 in the presentation, I'd like to remind you that today's presentation includes forward-looking statements, including information regarding Mercury's financial outlook, future plans, objectives, business prospects, and anticipated financial performance. These forward-looking statements are subject to future risks and uncertainties that could cause our actual results or performance to differ materially. All forward-looking statements should be considered in conjunction with the cautionary statements on slide 2 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.
Speaker 11: Specifically, adjusted income, adjusted earnings per share, adjusted EBITDA, free cash flow, organic revenue, and acquired revenue. Our reconciliation of these non-GAAP metrics is included as an appendix to today's slide presentation and in the earnings press release.
Speaker 12: I'll now turn the call over to Mercury's President and CEO , Mark Aslin.
Speaker 13: Please turn the slide the ring. Thanks Mike, good afternoon everyone and thanks for joining us.
Speaker 14: Typically, I'd sign up for bad remarks with the review of our results for the course of, however, given the other news we've announced today, I'll begin with key takeaways from those announcements.
Speaker 15: I'll then review the business, Mike will cover our financial results and guidance, and then we'll open it up for your questions.
Speaker 16: We both decision to initiate a review of strategic alternatives underscores that commitment to exploring all available avenues to enhance That will deploy.
Speaker 17: We've engaged two leading investing banks to pursue a range of options, including a potential sale.
Speaker 18: During the fourth evaluation, we'll continue to execute our strategic plan for growth and value creation.
Speaker 19: As you know, we need to let this process play out, and as such, we won't have further comment on it today.
Speaker 20: I want to emphasize that there can be no assurance that a transaction will result from the review.
Speaker 21: We also don't intend to disclose developments relating to this process unless and until the board has approved a specific agreement or transaction or has terminated its review.
Speaker 22: Now let me say a few words about Mike. As you saw from our announcement, Mike has decided to step down from Mercury to accept an opportunity at a private retail company headquartered in Virginia where he and his family reside.
Speaker 23: Mike has been a great partner for the past eight years. He's made significant contributions to Mercury, including helping drive our M&A strategy and many acquisitions.
Speaker 24: Mike, on behalf of myself and the entire military team, we wish you all the best for your new role.
Speaker 25: We've initiated a search for a permanent successor with the assistance of a leading executive search firm.
Speaker 26: We're fortunate to have a deep bench of talent on our finance team during this transition period.
Speaker 27: In addition to Michelle McCarthy's appointment as interim CFO , Nelson Erickson, Senior Vice President of Strategy and Corporate Development, will formally assume responsibility for investor relations. U.S. compensated for the
Speaker 28: Last week, we also announced that Vivek Yupadhyaya, who joins Mercury as our Vice President of Financial Planning and Analysis, further bolstering our team.
Speaker 29: Over the coming weeks, Michael worked closely with Michelle Nelson, Biddick and I to ensure illustrate the panel's rushed to part 3.
Speaker 30: With that, let's discuss our second quarter results.
Speaker 31: Turn to slide 4.
Speaker 32: The first quarter revenue was E-Live with our guidance, green 4% year over year. More importantly, we returned to organic growth and generated positive cash flow in the quarter.
Got net loss and loss to share, as well as adjusted EBITDA and adjusted earnings to share, well short of guidance.
This is primarily due to an unforeseen delay in farming to our customer for a large FMS program.
Opsimist delay, which reduced Q2 revenue in margin by 10 million and 7 million respectively, our results would have been Ops or bulk the high end of Ops Q2 guidance.
The drain resulted in lower Q3 guidance also, as an additional $10 million of revenue and $7 million margin moved to fiscal 24.
Obviously, disappointed with the delay and the short-term impact anticipated for this fiscal year, this is a large program and the time is outside of our immediate control.
I'll say our customers confident that that funding issues will ultimately be resolved, allowing us to recognize the entire 20 million in revenue and 14 million of margin early in work these new fiscal year.
Working with the customer, we've located in other related opportunities that we expect will partially accept the impact of this delay in the second half of fiscal 23.
As we continue the back half in our full fiscal year guidance, we will continue to
We're shifting our outlook to incorporate this program timing and the prolonged supply chain impact resulting in program delays and inefficiencies, which are temporarily affecting margins.
On the plus side, we believe that Reddy is currently trending above the midpoint of our fiscal 23 guidance, while net income and adjusted EBITDA are now expected to be toward the low end.
We are now four fiscal years dealing with these impacts.
In addition to program delays and related inefficiencies, we continue to face long semiconductor lead times, tight labor markets, and inflation.
These challenges however are not related to end market demand which remains strong.
They're largely timing related, they're short term, and they're not unique to Mercury.
We continue to execute on our plan to control what we can in this environment, and we are optimistic about the future of good knocker positioning.
We'll be looking for the Q2 in pre-40% year of the year, the largest in F-35, F-18, L times in the classified C2 program.
In nearly $60 million, the S-35 order for advanced microactronics capabilities was the largest booking in the company's history.
Driven by the growth in bookings, our book to bill was 1.18 in the quarter and 1.16 over the last 12 months.
Backlog grew 17% year over year to a record $1.12 billion, which positions us well for future growth.
To find the SMS, custom-affonding delay, I'll cut you a revenue increased 4% year-over-year.
Organic revenue turned positive, growing 1%, versus a 13% decline in Q2 of fiscal 22.
We expect to return to organic growth for the year as a whole as expected.
Our largest revenue programs in the quarter were F-35, F-16, NDSA trans-trapping layer, F-28 and F-30.
Q2 of GAT and IN was negative and adjusted to our decline year over year.
Both with the low guidance primarily due to the FMS customer funding delay.
Although revenue is trending above our fiscal 23 guidance midpoint, other financial measures, including adjusted EBITDA, are trending toward the low end, as I said, largely due to program delays and related inefficiencies.
We believe these impacts are temporary in nature. We expect margins to increase the supply chain conditions begin to improve and as we realise further benefits from impact and the continued shift in our program next from development to production.
Operating in pre-carsola for Q2 look positive, the substantial improvements sequentially. We expect to deliver breakeven to slightly positive recarsola for FY23, including the impact of the R&D tax legislation.
Turn to slide 5.
The Defense Appropriations Bill was approved after the midterm elections as expected, resulting in substantial spending increases in response to national security threats.
That said, the House GOP rules package adopted this month and the reported deal between Stephen McCarpey and the Freedom Caucus create risk-to-government FY24 discretion spending, including defense.
An extended budget continuing resolution appears to be the base case scenario for GFY24, including the potential for a full year CR.
However, although this does exist, we don't expect Congress to approve a reduction in DOD appropriations.
Given the geopolitical challenges we face, there appears to be strong underlying bipartisan support to increase defence spending.
Looking ahead long-term, we believe the defence spending outlook remains positive both domestically and internationally and that worker is well positioned to benefit in this environment.
The growth in demand for the compute capability on board anilf who platforms shows no sign of swelling.
We also stand the benefit from the ongoing push for platform electrification.
We believe that we are well positioned to continue to benefit from long-term industry trends.
These include supply chain delaying and reshoring as well as increased outsourcing at the?.
Our adjustable market has increased substantially, largely driven by our strategic move into mission systems and the potential to deliver innovative processing solutions at chip scale.
Our model, simply at the intersection of high-tech and defense, positions us well.
Turn to slide six. The industry environment continues to be challenging in the short term. Despite incremental improvement in the second quarter, supply chain constraints continue to affect program timing and efficiency.
Note whose sophisticated aim-to-aim processing platform passed through the most critical AED missions.
High-end processing represents about 70% of the business.
This is where Mercury likely has the largest opportunity to grow over the next five years.
Prior to the pandemic, semiconductor cost us lead times were 10 to 12 weeks.
They increased rapidly in the second half of fiscal 2021 and now range from 36 to 72 weeks.
Although current lead times on average are slightly shorter than in Q1, we don't expect to see a significant improvement until the second half of fiscal 24.
Semiconductor inflationary pressures remain a challenge as well. Semiconductors equate to 38% of our direct supply spend, far more than our peers, we believe.
We're making good progress in mitigating the impact of highly semiconductor costs.
As part of our impact program, we established a centralized procurement organization that's enabled us to improve our purchasing efficiency while helping us deal with the effective supply chain disruption. Ourerma ministry of
We also established a pricing team, the Repriest Standard Products, and incorporated a type of just-of-mechanism in our rate-based businesses and multi-apt proposals.
In addition, we implemented an across-the-board price increase in our microelectronics business.
Through the pandemic, we've used the strength of our biology to invest in the working capital necessary to mitigate supply chain risk as best we can.
As a result, we position the recruits to deliver a game's custom of commitment and generate stronger results at the time.
Change to slide 7. We believe that we have entered a multi-year period of accelerating growth and profitability. Demand is improving as evidenced by our strong LTM bookings and record backlog.
The next several years could resemble the period post sequestration in 2013, after the significant budget events in GFI24.
Similar to the enhancements that we made in our business at that time, True Impact was strengthening our fundamentals once again.
The launch impact early in fiscal 22 and it's evolved substantially since then. We began by streamlining our organizational structure and strengthening the leadership team and continue to do so.
We also focus on margin expansion initiatives, and we're now pushing their execution deeper into the business.
With the recent addition of Alan Couture as Head of Execution Excellence and Mitch Stevenson taking over our permission business last quarter, we've doubled down on these efforts, keeping the drive continuous improvement around supply chain, operations and program execution.
These areas were all being affected by the fuel of the impact of operating during the pandemic, with the resulting program delays and related inefficiencies temporarily impacting margins.
We believe these headwinds will diminish the supply chain and labor market conditions continue to improve, leading to market expansion.
At the same time we continue the photosome supply chain, the mitigation, work and capital burn down and accelerated cash release.
We believe that substantial cash will move off the balance sheet as the supply chain-related impacts on the business begin to unwind.
Another admission of this R&D investment efficiency in returns.
In addition, our digital transformation efforts in engineering, operations and the back office will help improve our cost structure and give us better productivity, scalability and efficiency over time.
We're also moving on our manufacturing facility footprint strategy. We consolidate our Mesa Arizon facility into the Phoenix site in Q2 and release two additional facilities as planned. With that, I'd like to show you all over tonight.
We're also moving on our manufacturing facility footprint strategy. We consolidate our Mesa Arizona facility into the Phoenix site in Q2, and release two additional facilities as planned. With that, I'd like to send the call over to Mike. Mike? Thank you, Mark, and good afternoon again, everyone.
Before I discuss our results, I do want to say a few words about my decision in mercury.
Mercury has been a big part of my life for the better part of a decade.
Since I started at the company in 2014, we've grown the business organically, completed 15 acquisitions, and assembled a set of capabilities that uniquely position us in the defense industry.
It's been a tremendous opportunity to be mercury CFO working alongside Mark and the rest of our talented leadership teams during this time.
A few months ago I was approached by a company that had recently been taken private, based closer to my home in Virginia.
This is not something I saw down, but when the opportunity was prevented to me, I felt at this point in my career, it was something I had to explore.
There's never a great time for a move like this, but I'm firmly committed to making this transition a success.
Michelle and I have been in lockstep for years and I've developed our finances.
So I know how much talent there is in Mercury.
I wouldn't have made the decision to leave if I didn't have complete confidence in this decision, and in the company's ability to enhance value for all shareholders, including
To our investors and analysts, it's been a pleasure getting to know all of you over the years.
Now turning to Mercury's results, as always, I'll begin with our second quarter actual.
and then move to our Q3 and fiscal 23 guidance.
As Mark discussed, Mercury delivered revenue in line with guidance, returning to organic growth and generating positive cash flow in Q2.
Demand continues to be strong as we enter the second half.
Our 12-month backlog was up 34% compared to Q2 last year and up 10% compared to last quarter, adding a solid visibility into the remainder of the year.
For fiscal 23, we expected to deliver increased booking versus fiscal 22, a positive book of bill, a record one billion in revenues, and positive organic growth.
As Mark said, we expect our performance to be heavily weighted to the fourth quarter.
Rebooting that revenue is currently trending above the mid-point of our fiscal 23 guidance while adjusted either the DAW is trending toward the low end of all this GOS.
Demand remains strong, supported by our position on well-funded franchise programs.
However, supply chain constraints, labor availability and inflation continue to contribute to program delays and efficiencies.
With the post-pandemic impact persisting through fiscal 23, we're experiencing shifts in high-margin production programs.
including FMS sales, into Q4 and fiscal 24, impacting Q3 and fiscal 23 gross margin expansion as a result.
Slide 8 covers the bookings of the bill, backlog and revenue growth results that Mark discussed.
We're highlighting, again, the large FMS program customer funding delay.
that had an impact of approximately $10 million on our Q2 revenue.
Given the program's high margin profile, it also impacted profitability by approximately $7 million, resulting in the adjusted EBITDA guidance missed for the quarter.
This delay in customer funding reflects the nature of FMS contracting, which requires alignment between U.S. government and the foreign government as well as our direct customers. This being an approved FMS deal, the delay only relates to the award timing for both our customer and mercury.
We now expect this program in Office 124.
As Mark mentioned, we expect this to have an approximate $20 million and $14 million revenue and adjusted either by impact of fiscal 23 respectively.
First margins for the second quarter were down 430 patients.
As we expected coming into the quarter, growth margins reflected a higher proportion of lower margin development revenue.
as well as material and labor inflation year over year.
Gross margins were slightly lower than expectations, driven by the FMS delay, which had an approximate 140 basis point impact on gross margins.
Q2 gross margin was also impacted by incremental depreciation expense and lower absorption in the quarter primarily due to our site consolidation efforts.
We expect to see higher growth margins in the second half of the fiscal year and especially in Q4.
This is primarily a result of program mix shifts due to the high margin FMS sale as well as execution on some of our larger development programs taking a little longer than expected in the current environment.
Gavnet loss with 10.9 million for the quarter. Well, adjust the Vida always 35.7 million. Down 6% from 2 to 2 last year on lower growth margins.
Our adjusted EBITDA margins were 15.5% for the quarter, down 180 basis points from 17.3% and Q2 P
Again, the delay in the large FMS opportunities resulted in adjusted EBITDA and adjusted EBITDA margins being below our guidance range.
Had we received this contract, Adjustity of the Don and Adjustity of the Don margins would have exceeded our Q2 guidance.
Precash flow for the second quarter was an inflow of approximately 22 million, despite delays and payments from our customers at the end of their fiscal years.
Delayed payment behavior across our customer base was partially offset by receivables factoring, which we discussed last quarter.
Slide 9 presents Mercury's balance sheet for the last five quarters.
Our balance sheet remains strong with significant capacity under our 1.1 billion revolving credit facility.
Trident by the anticipated strong cash flow generation needs to, we expect to be well positioned to deliver the balance sheet while continuing to invest in business.
We ended Q2 with cash and cash equivalents of $77 million and approximately $512 million of cash funded under a revolver.
At current leverage levels, the interest rate under the revolver is approximately 5%, which positions mercury to continue to allocate capital at attractive rates.
From a working capital perspective,
We've invested approximately $240 million since fiscal 21, essentially the start of the pandemic, to support performance obligations to our customers and ensure delivery on critical program.
As these obligations are completed, we expect working capital, especially un-builder seasonals and inventory, to convert to cash and decrease substantially the percentage of annualized sales.
Current cash flow on slide 10. Last quarter we forecasted breakeven to slightly positive free cash flow in Q2.
Turn the cash flow on slide 10. Last quarter we forecasted breakeven to slightly positive free cash flow in Q2. Free cash flow for the quarter was $22 million.
In Q2, we did see delays of approximately $30 million in receipts from billed receivables from our customers at the end of their fiscal years. It was partially upset that we were factoring $20 million receivables.
At this point in Q3, we have received the $30 million of delayed payments from our customers.
Given our fiscal year timing, we did not see any impact related to the R&B tax legislation in H1, but we're now forecasting an impact in H2.
I'll now turn to our financial guidance starting with Q3 on slide 11.
Forecasting in the current environment remains challenging.
Our guidance incorporates to the extent we can.
potential impacts associated with the ongoing supply chain constraints, and material and labor inflation headbands.
As a result of the high margin FMS program moving into fiscal 24, coupled with the headwinds contributing to program delays and inefficiencies,
H2 is more related to Q4 than Q3.
For Q3, we currently expect revenue in the range of $245 to $260 million.
At the midpoint, this is approximately flat growth compared to the third quarter last year.
Although we remain cautious with regard to award timing, program execution and the current understood head benutzen.
We expect gross margins to increase gradually in Q3 and more dramatically in Q4 as we complete execution across several of our lower margin development contracts.
The revenue growth in H2, and especially Q4, is expected to be driven by higher margin production programs as well as licensed sales.
We expect Q3 GAAP results to range from a net loss of $5.8 million to net income of $1 million.
We expect Adjust Me to die to be 40 to 47 million, representing approximately 17% of revenue at the mid-term.
As I've said, our Q3 adjustability with down margins are being impacted by the delay in the SMS sale as well as a higher proportion of development contracts.
I'll now turn to our guidance for full year fiscal 23 on slide 12. The near term outlook across the industry remains far from certain.
But the demand environment continues to be strong as highlighted by our continued booking's momentum.
Balancing these two dynamics, we're maintaining our previous guidance for the year for revenue and adjusted even time.
From a total company revenue perspective, our guidance remains 1.01 to 1.05 billion in fiscal 23. This represents 2 to 6 percent growth year over year and approximately flat to 4 percent organic growth.
Based on our current demand environment, despite the approaching 20 million foot in FMF revenue, we still expect to see fiscal 23 revenue toward the high end of this range.
GAP net income for fiscal 23 is expected to be in the range of $13.9 to $24.8 million, with GAP EPS at 24 to 44 cents per share.
The reduction at the low end and midpoint is a function of the incremental depreciation expense in the second quarter, partially offset by lower expected stock-based compensation.
We're maintaining our fiscal 23 adjusted EDA-DOT guidance range of $202.5 to $215 million, up 1 to 7% from fiscal 22.
while we expect revenues at the high end of the range.
We expect adjusted either die or trend toward the lower end of the range.
This is driven primarily by program mix including the FMS SAM.
as well as supply chain related program delays and inefficiencies also impacting the justice related Outlarge.
Adjusted EPS is expected to be in the range of $1.90 to $2.08 per share.
The reduction from our prior guidance is also a function of the incremental depreciation expense in the second quarter.
From a free cash flow perspective, we're now targeting break even to slightly positive free cash flow for the year.
This includes approximately 36 million cash outflows related to R&D tax legislation in each two, which we've now incorporated into our guidance.
Turning to slide 13, I want to briefly touch on Q4, which we expect to be a record quarter for Mercury across all key metrics.
But we will not formally guide Q4 until next quarter. Based on H1 actuals and our Q3 and fiscal 23 guidance, we can arrive at an implied forecast for the fourth quarter.
Looking at the midpoints of our fiscal 23 and Q3 guidance range.
Q-4 revenue at the midpoint will be approximately 321.
This is an increase of approximately 11% from our records for its quarter last year.
Given our current backlog and anticipated bookings in Q3, we expect to enter Q4 in solid forward backlog coverage, which is the basis for our current guidance.
GABnet income and GAB ETS will be approximately $47,083 per share respectively at the mid-court.
Q4 adjusted to be the dot would be approximately 98 million and adjusted to be the dot margin would be approximately 31%.
These results are driven by growth margin expansion, reflecting the mix weighted toward higher margin production programs, and licensing revenue.
We also expect adjustity to be non-margin-proven as a result of the operating leverage we've created in business.
From a free cash flow perspective, we expect to see a strong rebound in Q4.
So while Q4 would represent a record quarter across all our Q metrics to mark your rate.
So while Q4 would represent a record quarter across all our key metrics for mercury, we believe we have a clear path to achieve our guidance.
With that, I'll now turn the call back over to Mark.
Thanks Mike. Turning now to slide 14. MOCREY has delivered strong bookings in the second quarter. We returned to organic growth and generated positive cash flow in a still challenging environment.
Demanded strong and getting stronger are a bot stage 1 booking, record backlog and substantial forward remedial coverage, providers with good usability into second half of fiscal 23. Turning however remains a risk in the short term as you win larger, more complex soft-system deals.
Given the impact of the delays associated with the FMS program, we have a larger fourth quarter than previously anticipated.
We have a high level of confidence in our ability to recognize the associated revenue and margin in the first half of fiscal 24. And as a result of the additional opportunities we've rotated into the plan, we're maintaining our fiscal 23 revenue and adjusted our guidance.
As I said earlier, while revenue is trending above the midpoint, adjusted EBITDA is likely to come in toward the low-end of guidance as a result of NICS and supply chain driven program delays and inefficiencies. For the year, we expect to see a lot of strong orbits way toward Q4.
We expect a positive book to build and a return to work on it growth, with revenue clicks in 1 billion for the first time.
We should position us well for fiscal 24 as the supply chain conditions begin to normalize.
We expect to deliver strong organic growth, margin expansion and improved cash flows as we release working capital.
all of which should position us for further growth and value creation in future years.
That said, the potential for disruption around the GFI 24 budget and the timing and level of a defense appropriation present additional risk.
Looking further ahead, our outlook to the next five years remains strong.
We expect increased defense spending, and domestic payments nationally.
We're well positioned strategically in the right part of the market with the right capabilities on the right programs.
We believe that monthly count and will grow organically is high single digit to low double digit rates. In addition to organic and M&A related growth, our five year planning includes margin expansion, driven by better execution as the industry headwinds subside, improved program and content mix as well as impact. We should lead to stronger profitability as well as improved working capital efficiency and cash conversion. For more than a decade, we successfully execute it on our own.
over to Q&A. I ask that you please keep your questions focused on our earnings results.
Without operator, please proceed with the Q&A.
Thank you.
If you would like to ask a question today, press star followed by the number 1 on your telephone keypad.
If you would like to remove your question, again press the star 1.
We ask today that you limit yourself to one question and one follow-up. Thank you.
Your first question comes from the line of Peter Arment with Baird. Your line is now open.
Yeah, good afternoon, Mark. Mike. And Mark, the impact program that you've talked about quite a bit about on this call and in previous calls, I think you targeted net savings to be 30 to 50 million when you look out to fiscal 25. Just wondering where that stands today. I know that
you achieved at least $22 million in your first fiscal year. Can that still grow just given all the efforts you've done? And then just as a follow-up, I'll ask it now, just your confidence around kind of, is there much FMS mix in the fourth quarter that could also slide out, just given the kind of the impacts that you've had from customer shifts? Thanks.
So thanks for the question, Peter. So I think we're absolutely on target for the impact savings. I think the program's going extremely well. If anything, we're probably slightly ahead of schedule compared to where we thought we were going to be at this point in time. Unfortunately, I think...
a lot of the efforts and the results that we've delivered aren't really showing up in our financials right now because they are simply offsetting some of the headwinds that we're facing. But for the programs on track, and we think there's substantial upside associated with it going forward.
As it relates to FMS, we do have some FMS in the fourth quarter. As we rotated out the $20 million of revenue and $14 million of margin from Q2 and Q3, we were working with the customer to rotate in additional revenue that partially offset.
Peter, that the magnitude of the revenue we have is much lower than the 20 million of gross margin that slipped out.
Appreciate the color.
Your next question comes from the line of Seth Seifman with JP Morgan. Your line is now open.
Thanks very much, and good evening, guys. I guess just on the topic of the availability of semiconductors and chips, I guess I'm wondering kind of what makes that take until the second half of your 24.
You know, we saw Intel's results last week. It seems like demand in the civil economy is really drying up. And you know, you would think that maybe that would free up capacity more quickly for the defense industry. What makes that take so long?
Yeah, so first of all, I think it's based upon the feedback that we're getting specifically from some of those semiconductor companies based upon what they think is going to happen in terms of the capacity and their ability to supply. We did see some incremental improvements set in the second quarter.
down, you know, 36 to 72 weeks. So, you know, it's still extremely long, you know, and far longer than what we saw pre-pandemic, which is in the 10 to 12-week range. So we're pleased to see the improvement and see the average coming down, but it's sort of a long way to go. Okay, okay, thanks. And then—
Just as a follow-up, when we look at the data that comes out in the filing about the sales breakdown between different types of products, different customers, is there anything there that offers a little bit more insight into the gross margin compression that we've seen? Whether it's, you know, I mean...
It's the last quarter, we only have it as a September quarter so far, but fewer sales into radar applications, fewer sales into components, more sales to lock-eat. As we look through these different categories, is there anything about the mix that's changing?
that we can be aware of in terms of thinking about the gross margin and the profitability of different types of sales. Not specifically the macro level, Seth. I think, if anything, what we are seeing is just the cumulative effects of operating under the pandemic that ends.
the delays that we've seen on programs and the resulting in efficiencies. So things are taking longer. We've seen cost growth and that's clearly what is impacting the margin. As we look forward, as we said, as more of these programs can get out of the development phase.
and into production, we'll start to see some mix shifts and some margin improvements there, coupled with some probably better efficiencies in supply chain, less of a headwind, and then continue better from impact is really what's going to drive the margins as we go forward.
So I don't know Mike if you'd like to add anything to them. No, I mean, you'll see the detail when the Q comes out in terms of subsystems, components, modules. I think what Mark said is correct. It's going to be not going to see anything there significant that's going to stand out as the driver of the margin.
degradation. It really is the new program starts that we've talked about as the development programs transition over time to production. They're just taking a little longer in this environment and then we expect that to transition in fiscal 24. So nothing specifically to to 1, 2 and the Q.
more just around the trends that we're expecting in Q4 and in fiscal 24. Obviously the FMS program that moved, that was pretty high margin based upon the capabilities that we're providing.
that includes IP licenses and royalties. And we do see a pickup of that as we're going into the second half as well. So the mix in terms of capabilities and the programs really do matter. And it's unfortunate that the customer has this funding delay that delay that...
Yeah, move the 20 million revenue and 14 million out of the year.
move the 20 million in revenue and 14 million out of the year. Thank you very much.
and 14 million out of the year. South Rickey County Fr Note Var Ped R
Your next question comes from the line of Ken Herbert with RBC. Your line is now open.
Hey, Mark and Mike.
I wanted to ask Mark, on the free cash flow guidance, sorry if I missed it, but as you think about sort of break even a slightly positive call it 60 million in the second half of the year, how does that split between the third and fourth quarter or what's the guidance implied for the cadence of cash in the second half of the year?
Yeah, Ken, I'll take that one. It's Mike. So when we look at the second half, it is going to be more weighted to Q4. We did Q3 prior to the R&D tax, and I'll give you a split between those between Q3 and Q4, but prior to the R&D tax payments.
We think Q3 is going to look a lot like Q2, which we expected coming in prior to factoring to be break even to slightly positive. And that's what we're seeing in Q3 right now. That's pretty the R&D tax payment, which we estimate is going to be $23 million.
In Q3, it's going to be 13 million in Q4 to get to the 36 million that we mentioned in the prepared remarks. So what we're looking at is a free cash outflow in Q3 and magnitude 20 million and Q4 is going to make up the difference as we see the higher net income, higher off income, and we actually are going to be a free cash outflow.
expect working capital and the C4 to release, especially an unbilled and inventory which is driving the cash flow for the year.
Thanks, Mike. It sounds like for cash earnings or cash and earnings, obviously, a pretty significant ramp in the fourth quarter. Is there any program you'd specifically call out maybe around progress payments or anything like that that we should keep in mind as significant or material swing factors?
the fourth quarter or you know the could either be potential risk or that are obviously embedded in in what's going to help sort of hit the full year number. Seems like a pretty aggressive ramp in the fourth quarter.
I was just going to say, it's definitely a large quarter, Ken, but we do feel good. The good news as we look at it is we have good backlog coverage right now going into H2. It's improved volume, and we have kids at that age group who are giving training with
and into Q4. We've got good visibility into the programs that aren't in backlog that make up the balance of our FY 23 and specifically the Q4. So we're entering with strong backlog coverage, a majority of the remaining are recurring programs, programs for which we're designed in on.
We also have, and I think Mark touched on a brief week, we have improved visibility and coordination into the supply chain than we had in H1. So still risk around it, but we feel better about it. And then we've got line of sight into some key execution milestones that drive revenue in Q4 and a couple of key programs. So.
There's still uncertainty in the environment, supply chain, contracting delays, things that we've talked about. We're working to control what we can, but overall we feel good about the demand environment and the programs. We're just cautious on items that are out of our control.
And just from a profitability perspective, we obviously expect margin expansion in Q4, and that's going to drive cash flow as well.
Yes, just following up, this kind of fight things, right? So the higher margin program mix in the second part, as we talked about, we do have a pickup in high margin IP licenses and royalties on various programs.
We are anticipating fewer execution delays and some inefficiencies. We saw supply chain, I would say, improve incrementally in the second quarter. And so as the conditions stabilize and as hiring continues to pick up,
Yeah, I think we've got fewer headwinds there. Impact I think continues. Yeah, we've got continued savings relating to pricing initiatives that we undertook early in the year. Yeah, we've got some procurement savings. And yeah, this quarter, yeah, we had some facility footprint consolidation, we got further
we've done the work and we know what's going to drive the increase. Great, thank you for all the color.
Your next question comes from the line of Jonathan Ho with William Blair. Your line is now open.
Hi, good afternoon. I just wanted to start out with some of the delayed payments that you were seeing from your customers. Are you seeing that behavior maybe persist or are you sort of building that into your guidance just given some of the challenges around cash flow management that everybody is sort of facing? Sure, Jonathan.
to us at the end of the quarter. And as we mentioned, it was about 30 million that we saw held that was due for us in the quarter. We've received all of that already in Q3. So it was just a couple of weeks or less than a week delay as they...
straddle their fiscal calendar years. Go away forward. I think we've got a really good group of customers that don't really pay on time. And so, we're managing that with them. We also put in the factoring facility that I mentioned.
And we used it exactly for this reason, Jonathan, which was a tool that we have that's a very low cost of financing to us in order to mitigate the impacts on our cash flow statement and our financials because of our customer behavior. So we feel good that we're in a position to manage it from an organic standpoint, but we also have a tool. 4
in the factoring facility should we need to use it? Should we see this behavior continued? Got it, got it, that's helpful. And then in terms of some of the pricing actions that you've taken, how should we be thinking about the timing and the magnitude of how that flows through? I know there's...
There's a variety of different actions across both the pricing of services as well as products, but any color would be helpful. Thank you. So pricing has obviously been one of the major elements of the IMPACT program. And so we stood up a pricing center of excellence.
to try and bribe strategic pricing and best practices in both pricing and cost estimation depending upon the part of the business. In the commercial portfolio, I think the team's done a really good job and we're actually offsetting a significant amount of the inflation repression that we're seeing on the Sunday that we conducted.
side of things. So, you know, focus on value-based pricing. You know, we're looking at the discounting and the quote validity. And I think as I mentioned on the last call, you know, we did do an across-the-board price increase on our commercial products.
at the start of the year, that is really the major driver of offsetting the inflation pressures that we see there. Now on the non-commercial portfolio, it's slightly different right here. That's largely some of the cost disclosure type of the business. Here we're really mainly focused on wherever we possibly can, passing through both material and the labor inflation costs that we see.
But I think overall the team's done a pretty good job. I think the inflationary headwinds with the work that we've done aren't as detrimental to what we thought they could be coming into the year. Mike, do you like to do anything?
No, you got it.
Thank you. Your next question comes from the line of Sheila Quagua with Jefferies. Your line is now open. Your next question comes from the line of Sheila Quagua with Jefferies.
Thanks. Good evening, Mark and Mike. Thank you for the time.
So it seems like there's a lot going on, Mark. Just both externally with the board and internally. Maybe can you just talk to us about how you're balancing all the internal factors and what you're most focused on now? You know, in terms of the business, is it just ensuring the sales come through? It's supply chain.
if you could talk to us a little bit about that. You mentioned R&D as well. Sure. So it's a good question. So I think the demand environment continues to be strong. So we're still very, very focused on the top line. So bookings as we said, we're up 14% year over year. We've had a 1.18 of the bill.
is the execution in the second part. It was unfortunate that we saw those aforemessed delays, which has made the year more bucket loaded. But we did talk about the coverage that we've got, which is far higher than what we had coming into the second part last fiscal year.
So, you know, we're continuing to focus on mitigating the supply chain and the summit conduct the lead times, you know, which continues to be a challenge or be it incrementally improved hiring. I think is that it's, you know, for the third quarter in a row, you know, we are actually hiring more people than you know.
very focused on just execution. You know, focused on growing the business and focusing on continuing to deal with the cumulative effects of the pandemic schiller.
Sure, no that's helpful. And if I could follow up, I don't know if you mentioned this in answer to a question, the FMS sale that slipped out you said was $20 million of sales and $14 million of earnings associated with it. Was that right? That's correct. Yes. $10 million and $3 million in Q2 and the same in Q3. Okay, so it's a pretty high margin contract in terms of thinking about that.
It is, so it's a mix of capabilities. So again, there's hardware associated with it. But based upon the capabilities that there's also revenues and royalties.
It is. So it's a mix of capabilities. So again, there's hardware associated with it. But based upon the capabilities that there's also revenues and royalties. Great. Okay. Thank you.
Your next question comes from the line of Michael Tremoli with Truist Security. Your line is not open.
Hey, good evening guys. Thanks for taking the questions here. Kind of staying on what Sheila was asking with kind of internal, external, a lot going on. I guess Mark, labor's been tight to begin with. How do you think about managing talent right now, talent loss and...
you know, doesn't this potential announcement of strategic alternatives, I mean, can't that add to disruption and kind of take employees off, you know, the ball, you know, focusing on execution, you know, so how do you kind of think about managing that risk right now? Yeah, so I mean, look, it's a possibility obviously with just what we know, but I do think that we've got a fair amount of hiring momentum.
inside of the company. I think there's obviously a lot of growth ahead of us. And I think we're a great company to work for. So I don't see necessarily a major challenge with respect to retention. On the attraction side of things, I think we're really focused on two areas. One is on the direct labor side of things.
I don't really believe that the announcements that we made this morning, so it's really stuck in the run around the potential process will have an impact there. Probably the more challenging areas on the engineering side, but again, I think we've got a great employee value proposition and I feel pretty confident just based on an momentum that we're going to be able to actually make the highs.
So I think we're expecting, again, strong bookings sequentially, H2 over H1, Mike, I think just with some of the recent shifts.
We've followed any more of the growth in the fourth quarter, just given some of the movements that we've seen. But, you know, we're expecting strong growth, you know, year over year with a positive book of bills. So, you know, I think, yeah, this is not a, you know, demand issue. Obviously, the demand environment is very strong. If anything, these are kind of short term timing issues.
and really a result of the effects of the pandemic. Got it. To be clear, you think you can do, you did $600 million, almost $30 million in booking second half last year. You think you guys can do better than that? Is that what you're saying? So, this year if you look at, you know, H1 was far stronger.
just given the weighting H1, H2, I think it's going to be more of a sequential story than it is here at the end.
Got it. Helpful. Thanks guys. Yeah. Thanks Mike.
Your next question comes from the line of Austin Moeller with Canaccord. Your line is now open.
Hi, good afternoon Mark and Mike.
Hi, good afternoon, Mark and Mike. Hey Austin, how are you?
Just so my first question here if we just stay on the topic of the supply chain. If we do continue to see lead times come down, I mean I know it was sort of an incremental improvement in the second quarter, but it's still notable. If we continue to see lead times come down, I mean we still have a lot of
Do you expect you're going to be reducing inventory stockpiling if lead times continue to fall? And do you expect as we go into a potential year recession here that materials costs might come down from our theory?
Why didn't you take the first and I'll take the second one?
Yeah, so with regards to the balance sheet, Austin, as the supply chain normalizes, as we've discussed, we do expect to see an unwind of inventory and an increase in inventory turns and also has been impacting our un-billed receivables where we've been...
unable to deliver in some circumstances because of long lead times or even a shortage of parts. And once that normalizes, we expect both those accounts, inventory and on-bill, to decrease, which is why we think there's stronger cash flow in Q4, but really adding into fiscal 24 as things begin to normalize.
we expect that there should be a significant reduction in working capital again once that supply chain normalizes.
And then on the semiconductor side of things, clearly I think part of the semiconductor marketplace is rolled over on the lower end largely as a result of what is going on on the consumer electronic side of things.
The high end, as I mentioned, is still, although it's softened somewhat in the lead time, it's come down a little bit on average, it's still far longer than what it was pre-pandemic. And so we haven't seen much movement there. And if anything, the prices are going the other way still.
The high end semiconductors and price increases from Intel, from Xylenx, from Alonc devices. And so the high end is still, pricing is still pretty challenging. On the lower-end side of things, we have been able to negotiate better price things in some parts of the market. But it's...
It's still pretty challenging out there, Austin. Okay, and then just to follow up on that, I think you said in the remarks you're sort of anticipating improvement in the lead times in the second half of fiscal year 24. What are you seeing on your end that gives you confidence?
companies whose chips are actually fogged in the TSMC facility, as well as other facilities offshore from various other companies. And so the 36 to 72 week lead times that I mentioned is what we are seeing right now with respect to the path that we've got on the high end of the market.
Okay, great. Thanks for diving into the details there.
Thanks for diving into the details there.
Your next question comes from the line of Noah Pappenok with Goldman Sachs. Your line is now open.
Hey, good evening everyone.
And Mike, thanks for spending time with us and working with us over the years and all the best going forward.
Thanks, Bill.
It's been a funky.
You know, it's been a funky year and a half or two years.
If I kind of zoom out and try to sort of recalibrate for it.
The top line actually never really got that bad. There's kind of three distinct quarters where the revenue decline is a little more severe and then a few where it's really actually not that severe and that's kind of it.
Relative to that, the margin change is more significant and pretty volatile in the year.
And then the cash flow change is very significant in working capital in particular.
I guess how do I square all of that when you kind of look back at this 18 to 24 month window? Why is the profitability in the cash flow so much more volatile than the top one? So I think it's a good question.
So it has been a few years and each year has been slightly different in terms of the impact. And so, you know, bookings bottom down and I think in the third quarter officially, 21 organic growth actually bottomed out this quarter. We have 1% organic growth.
in Q2 versus a 13% decline. So we've got various metrics beginning to head in the right direction. If you look at the margin profile.
It's really, I think, as a result of kind of what's happened a little bit with respect to linearity. So, you know, over the course of the pandemic, as lead times dramatically increased, and as we started to see, you know, just the the perturbations in the supply chain in terms of supply decommits, it obviously created a push more of the business into the industry.
to the pandemic and the effects of social aid with that. There's nothing underlying the business. And if anything, I think as we look forward, as a result of the shift from development into production.
to fulfill the next as well as the ongoing benefits with impact. We see substantial opportunities for margin growth.
And then the cash flow, I think as you know, is very much tied up with the balance sheet. Again, it's the supply chain conditions. It became far more challenging as the loop times actually increased. We ended up leveraging the balance sheet to make sure that wherever possible we could meet our customer commitment.
you know, it collects everything and that's where we saw the greatest fall. So, Mike, if you want to.
I think that's, I think, marketed. I mean, just giving some numbers. If you look back, you know, and just starting with the justice, the job, the measure of profitability. We look back, fiscal 19, 2021, we're all around 22%. We came into fiscal 22, we dropped down to 20%.
I think we talked about publicly that we had about 70 basis points or so as a result of supply chain inflation. You look at fiscal 23 and where our guide is, 20.3% of the midpoint probably have a similar 70 basis point inflation impact.
So those two would put you at 21%. And the reduction there from 22% from 19 to 21 down to 21 in 22 and 23 is really a result of the development programs that we've talked about. And so as Mark said, when we look at even down margins going forward, and we'll guide Crystal 24 when we get to our Q4.
But we do see the opportunity for EBITDA margin expansion. So I don't think anything's fundamentally changed in the business from a profitability perspective. When you look at gross margins, there's a lot more movement.
as you know, we had COVID expenses in fiscal 21, running through our gross margins. We've had some movements between development programs and production on a quarterly basis. We've had a physical opt-in acquisition which impacted.
gross margins, and then again on a quarterly basis things like this FMS sale, you know our program mix, you know makes Create some volatility, but again going to either looking over the long term You know a couple of key metrics and we think the profitability of the business structurally
is the same with opportunities for upside in fiscal 24 on the earth. Okay, I'll leave it there. I appreciate the color.
Mr. Aslet, it appears there are no further questions. Therefore, I would like to turn the call back over to you for any closing remarks.
Okay, well, thank you very much for taking the time to join us this evening. Lots of news from Mercury. We look forward to seeing you again next quarter. Thank you.
This concludes today's conference call. Thank you for attending. You may now disconnect.