Q2 2025 Mercury Systems Inc Earnings Call
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Good day, everyone, and welcome to the Mercury Systems second quarter fiscal 2025 conference call. Today's call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to the company's Vice President of Investor Relations, Tyler Hojo. Please go ahead, Mr. Hojo.
Scenarios 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 a reconciliation of these non-GAAP metrics is included as an appendix to today's slide presentation and in the earnings press release.
Speaker Change: Now I'll turn the call over to Mercury's Chairman and CEO Bill Bahl House, Please turn to slide three.
Speaker Change: Thanks, Colin good afternoon.
Speaker Change: Thank you for joining our Q2 FY 'twenty five earnings call. We delivered solid results in Q2 that were once again in line with or ahead of our expectations and Im optimistic about our ongoing efforts to improve performance as we move through the fiscal year.
Speaker Change: Today I'd like to cover three topics.
Speaker Change: First some introductory comments on our business and results.
Speaker Change: Second an update on our core priorities delivering predictable performance building thriving growth engine, expanding margins and driving improved free cash flow and third performance expectations for FY, 'twenty fives and longer term.
Then I'll turn it over to Dave who will walk through our financial results in more detail.
Speaker Change: Before jumping in I'd like to thank our customers for their collaborative partnership and the trust they put in Mercury to support their most critical programs and our mercury team for their dedication and commitment to delivering mission critical processing at the edge.
Speaker Change: Please turn to slide four our Q2 results reinforce my confidence in our strategic positioning and our expectations and delivering predictable organic growth with expanding margins and robust free cash flow bookings.
Speaker Change: Bookings of $242 million and a trailing book to Bill of one one to <unk>.
Speaker Change: Revenue of $223 million up 13% year over year.
Speaker Change: Adjusted EBITDA of $22 million and adjusted EBITDA margin of nine 9%, both up substantially year over year.
Speaker Change: And record free cash flow of 82 million up $44 million year over year. We ended Q2 with $243 million of cash on hand. These results reflect continued progress in each of our four priority areas with highlights that include solid execution across our broad portfolio.
Speaker Change: Production and development programs, our record backlog of $1 4 billion reduced operating expense, enabling increased positive operating leverage and continued progress on free cash flow drivers with networking capital down $150 million year over year or $19 five.
Speaker Change: Person.
Speaker Change: Please turn to slide five starting now with our four priorities and priority one delivering predictable performance.
Speaker Change: In the second quarter, our focus on predictable performance positively impacted our results primarily in three areas.
Speaker Change: First we continue to make progress mitigating what we believe to be predominantly transitory impacts as discussed over the last several quarters.
Speaker Change: In Q2, we recognized approximately $4 4 million of Nike AAC change impacts across our portfolio, which is the lowest in the last few years and reflects the progress we are making and maturing our processes and program management engineering and operations.
Speaker Change: Second we continued to make progress in the quarter ramping production in our common processing architecture product area.
Speaker Change: We expect to have our full capacity become available as we move through the second half of the year. This progress is enabling follow on production awards as we discussed last quarter and led to a notable takeaway in Q2 from a processor board competitor there wasn't able to meet the security requirements provided by our common price.
Speaker Change: <unk> architecture. This reflects our ability to take share in this attractive market segment based on our technology leadership position and third our focus on accelerating customer deliveries generated a $29 million or 31% year over year increase in point in time revenue.
Speaker Change: The majority of which was driven by pull forward deliveries and revenue from Q3.
Speaker Change: Please turn to slide six.
Speaker Change: Moving on to priority to driving organic growth.
Speaker Change: Solid Q2 bookings of 242 million resulted in a record backlog of $1 4 billion in line with our expectations over 80% of trailing 12 months bookings were production in nature, which has driven a mix shift towards production in.
Speaker Change: In line with this shift we recently announced a workforce restructuring to align our team composition with this increased production mix.
Speaker Change: Wins in the quarter worth, noting a development contract from the U S defense Prime contractor, where we will replace and upgrade our competitors existing processing capabilities with our solution leveraging our common processing architecture.
Speaker Change: Our additional protection features enable this system to be eligible for export to Allied nations to support forward deployed operations.
Speaker Change: $24 $5 million contract to develop a data processing and storage subsystem for a U S Defense Department satellite program.
Speaker Change: Under this contract with an innovative space systems Prime contractor, we will deliver a number of sub systems that leverage our commercial products and deep expertise in data recording data processing and subsystem integration for defense applications.
Speaker Change: Awards with Naval Air Systems Command at $16 5 million delivery order for data transfer units and a $14 million contract option for high definition video are quarters that support U S and Allied military aircrafts and follow on production awards for too long running <unk>.
Speaker Change: The us Navy programs of record supported by multiple lines of business and two key U S. Air force programs of record, where mercurius the sole source provider of memory modules.
Speaker Change: These awards are important not only because of their value and the impact on our growth trajectory, but also because they reflect those customers trust and mercury to support their most critical franchise programs.
Speaker Change: We know from engagements with our customers that are unique capabilities, providing mission critical processing at the edge align well with their priorities and what we believe is strong demand in growth markets, including sensors and effectors electronic warfare avionics <unk> and space.
Speaker Change: All in all Q2 was a good bookings quarter with multiple competitive wins, where we believe we are growing share based on our technical differentiation.
Speaker Change: Please forward to slide seven now turning to priority three expanding margins.
As we've discussed in prior calls and our efforts to achieve our targeted adjusted EBITDA margins in the low to mid 20% range. We are focused on the following levers executing on our development programs and minimizing cost growth impacts.
Speaker Change: <unk> back toward a more historical 2080 next of development to production programs.
Speaker Change: Driving organic growth to generate positive operating leverage and achieving cost efficiencies Q2, adjusted EBITDA margin of nine 9% was in line with our expectations and indicative of progress on each of these levers in our effort to reach our targeted margins overtime.
Speaker Change: Gross margin of 27% was in line with our expectations and largely driven by the average margin in our backlog coming into FY 'twenty five.
Speaker Change: As we've discussed over the last two quarters, our backlog margin coming out of FY 'twenty four was lower than what we expect to see on a go forward basis, driven primarily by a small number of low margin development programs and programs that incurred adverse net EAC change impacts in FY 'twenty four we expect backup.
Speaker Change: <unk> margin to increase going forward as we continue to bring in new bookings as we did once again in Q2 that we believe will be in line with our targeted margin profile and accretive to the current average margin in our backlog.
Speaker Change: Operating expenses, specifically R&D and SG&A are down significantly year over year as a result of prior and ongoing actions to streamline and focus our operations as.
Speaker Change: As expected R&D levels increased sequentially in the quarter.
Speaker Change: These forward to slide eight.
Speaker Change: Finally, turning to priority for improved free cash flow, we continue to make significant progress on the drivers of free cash flow and in particular in reducing net working capital, which had $475 million is at the lowest level since Q3 of FY 'twenty two.
Speaker Change: Notably combined free cash flow over the last three quarters is approximately $122 million and net debt is down to $349 million the lowest level since Q2 of FY 'twenty two.
Speaker Change: We believe our continuous improvement related to program execution and hardware delivery.
Speaker Change: Just in time material and appropriately timed payment terms will lead to continued reduction in working capital and improve free cash flow performance going forward. Please turn to slide nine.
Looking ahead I am optimistic about our team our leadership position in delivering mission critical processing at the edge and our expected ability over time to deliver results in line with our targeted profile of above market topline growth adjusted EBITDA margins in the low to mid 20% range and free cash.
Speaker Change: Flow conversion at 50%.
Speaker Change: As we discussed last quarter, although it will not be providing specific guidance for FY 'twenty five I will update the color. We previously discussed.
Speaker Change: First half revenue up 13% year over year exceeded our expectation that the first half would be in line with last year. The over performance was largely driven by the acceleration of about $30 million in customer deliveries and revenue into Q2 from Q3 for.
Speaker Change: For full year FY 'twenty five we now expect revenue growth approaching mid single digits year over year versus our prior expectation that revenue growth would be relatively flat.
Speaker Change: As we discussed last quarter, our current backlog margin is lower than what we expect to see on a go forward basis, driven primarily by a small number of low margin development programs and programs that incurred adverse net EAC change impacts in FY 'twenty four.
Speaker Change: Although we are encouraged that our recent quarter bookings are accretive to our overall backlog margin. We continue to expect low double digit adjusted EBITDA margins overall for FY 'twenty five as we complete lower margin development efforts and continue to shift our mix toward production, we expect Q4 adjusted EBITDA.
Speaker Change: <unk> to be the highest level of the fiscal year.
Speaker Change: Finally, with respect to free cash flow, we continue to expect to be cash flow positive in FY 'twenty five giga.
Speaker Change: Given the large acceleration of cash from Q3 into the first half and first half free cash flow of $61 million, which is well ahead of our prior expectations, we expect free cash flow to be around breakeven in the second half.
Speaker Change: In summary, given the operational improvements over the last several quarters and our recent momentum I expect that our performance in FY 'twenty five in particular, our exit run rate will represent a positive step toward our target profile given our progress in the first half and our momentum heading into the second half.
Speaker Change: I look forward to providing additional insights relative to our expectations for full year performance as we progress through the back half of the year.
Speaker Change: With that I'll turn it over to Dave to walk through the financial results for the second quarter and I look forward to your questions Dave.
Dave: Thank you Bill our second quarter results reflects solid progress toward our goal of positioning the business to deliver predictable performance characterized by organic growth expanding margins and robust free cash flow.
Speaker Change: There is still work to be done, but we are encouraged by the progress we have made and expect the second half of fiscal 2025 revenue and adjusted EBITDA margins to improve over the first half.
Speaker Change: Our continued progress in our priority areas is highlighted by a few key milestones that we achieved during the second quarter.
Speaker Change: This includes delivering improved operating performance, making additional progress in ramping production in our common processing architecture product area and continuing to expand our record backlog.
Speaker Change: With that please turn to slide 10, which details our second quarter results.
Our bookings for the quarter were $242 million with a book to Bill of one <unk>, yielding a backlog of $1 4 billion up $77 million or 6% year over year.
Speaker Change: Revenues for the first quarter were $223 million up $26 million or 13% compared to the prior year.
Speaker Change: The increase is primarily driven by higher point in time revenue of $29 million largely accelerated from Q3 as we continue to focus on delivering for our customers.
Speaker Change: Gross margin for the second quarter increased to 27, 3% from 16% in the same quarter last year.
Speaker Change: The increase in gross margin during the current quarter was primarily driven by a reduction in the net EAC change impact on our programs recognized overtime to $4 million as compared to $31 million in the same quarter last year and lower inventory reserves of approximately $12 million.
Speaker Change: These improvements in gross margin were partially offset by higher manufacturing adjustments of approximately $4 million as Bill previously noted we expect to see an improvement in our gross margin performance over time as the average margin in our backlog improves resulting from newer awards at targeted margins.
Speaker Change: Operating expenses decreased approximately $12 million year over year, primarily due to lower R&D and SG&A expenses.
Speaker Change: These decreases were driven by the actions taken in fiscal 2024 to improve our performance by consolidating and simplifying our operations GAAP.
Speaker Change: GAAP net loss and loss per share in the second quarter were approximately $18 million 30, respectively.
Speaker Change: Compared to GAAP net loss and loss per share of <unk> $46 million and 79% respectively. In the same quarter last year.
Speaker Change: The improvement in year over year earnings is primarily a result of increased revenue and the associated gross margin coupled with reduced operating expenses adjusted.
Speaker Change: EBITDA for the second quarter was approximately $22 million compared to negative $21 million in the same quarter last year.
Speaker Change: Adjusted earnings per share were <unk> seven.
Speaker Change: As compared to adjusted loss per share of <unk> 42.
Speaker Change: In the prior year.
Speaker Change: Year over year increase was primarily related to lower net losses in the current period as compared to the prior year period.
Speaker Change: Free cash flow for the second quarter was a record of nearly $82 million.
Speaker Change: As compared to approximately $38 million in the prior year.
Speaker Change: The significant increase cash flow was primarily driven by the improvement in cash provided by operating activities of approximately $40 million in the current year as compared to the prior year.
Speaker Change: Slide 11 presents Mercury's balance sheet for the last five quarters.
Speaker Change: We ended the second quarter with cash and cash equivalents of approximately $243 million driven primarily by approximately $85 million in cash provided by operations and investments of approximately $4 million in capital expenditures.
Speaker Change: Bills receivables decreased approximately $20 million or 16% sequentially.
Speaker Change: Unbilled receivables decreased year over year and sequentially by approximately $72 million or 21%.
Speaker Change: And $20 million or 7% respectively.
Speaker Change: These decreases reflect the incremental progress we've made by delivering on programs to our customers, which significantly drove our cash flow performance during the current quarter.
Speaker Change: Inventory decreased slightly year over year and sequentially by approximately $10 million and $7 million respectively.
Speaker Change: The current quarter balance also included approximately $15 million of material receipts supporting milestone invoicing, which largely drove the increase in our deferred revenue of nearly $40 million.
Speaker Change: These material receipts, partially offset our decrease in inventory from accelerated point in time revenue.
Speaker Change: This increase in milestone invoicing activity reflects the progress we've made to better align the payment structure of our contracts to match the corresponding cash outflows of these arrangements accounts payable decreased approximately $10 million sequentially driven by the timing of payments to our suppliers.
Speaker Change: Accrued expenses decreased approximately $2 million sequentially, primarily due to payments under our restructuring taken in fiscal 2024.
Speaker Change: Deferred revenues increased year over year on sequentially by approximately $55 million and $40 million, respectively. As a result of additional milestone billing events achieved during the period.
Speaker Change: Working capital decreased in the second quarter, approximately $115 million year over year or 20% in.
Speaker Change: <unk> decreased by $89 million or 16% sequentially.
Speaker Change: This demonstrates the progress we've made in reversing the multiyear trend of growth in working capital highlighted by five quarters of sequential reductions in unbilled receivables, resulting in the lowest net working capital since Q3 fiscal 'twenty two.
Speaker Change: As a reference point, we have driven our net working capital in the last three quarters from our highest 72% of trailing 12 month revenue to under 54% net.
Speaker Change: Net working capital remains a primary focus area and we believe we can continue to deliver improvement.
Speaker Change: Turning to cash flow on slide 12.
Speaker Change: Free cash flow for the second quarter was approximately $82 million as compared to $38 million in the prior year.
Speaker Change: We believe our continuous improvement related to program execution and hardware delivery just in time material and.
Speaker Change: And appropriate lead time payment terms.
Speaker Change: It will lead to continued reduction in working capital improved free cash flow performance going forward.
Speaker Change: In closing we are pleased with our first half performance for the fiscal year and the higher level of predictability in the business we.
Speaker Change: We believe continuing to execute on our four priority of focus areas will not only drive revenue growth and profitability, but will also result in further margin expansion and cash conversion.
Speaker Change: Remonstrated, the long term value creation potential of our business.
Bill: With that I'll now turn the call back over to Bill.
Bill: Thanks, Dave with that operator. Please proceed with the Q&A.
Bill: Thank you if you would like to ask a question. Please press star one on your telephone keypad. If you would like to withdraw your question simply press Star one again.
Bill: We ask that you please limit yourself to one question and rejoin the queue if needed.
Bill: I remember a depressed we ask that you submit your questions via the web.
Bill: Please ensure you are not on speaker phone and that your phone is not on mute when called upon thank you.
Speaker Change: Your first question comes from the line of Pizza Kubicki with Alembic Global Your line is open.
Pizza Kubicki: Hey, good evening guys great quarter.
Bill: Yes.
Bill: It looks like even excluding the pull forward revenue was still a strong quarter, especially on the cash flow side.
Speaker Change: So bill I'll ask a question Ive asked before but maybe this is the last time I need to ask.
Speaker Change: Just can you talk about the progress in the second quarter on the CPA kind of processes and programs in terms of the maturity there.
Speaker Change: Are there any kind of technical risks to remain at this point or is it just a matter of slowly kind of ramping from L. Rip to full rate production on the programs.
Speaker Change: Yes, well first of all thanks for the comments upfront and.
Speaker Change: I would characterize our progress on Tpa as as plan and consistent with what we discussed previously we are.
Speaker Change: Our ramping to full rate production, we expect to get our capacity.
Speaker Change: To be fully available as we move through through the back half of the year and of course, how we use that capacity will benefit the business in a number of ways. We've already seen as we brought production online that we've received significant production awards, we talked about that in Q1, we had a re.
Speaker Change: Really nice takeaway from a competitor based on our technical differentiation. This quarter, that's been another benefit and as we progress through the second half, we'll be able to allocate that capacity.
Speaker Change: Drive revenue performance and deliver for our customers on New awards and continue to burn down Unbilled balances.
Speaker Change: Where we have receivables on older contracts. So continued progress all sort of normal course at this point and very much progressing to plan and consistent with what we've discussed previously.
Speaker Change: Okay. That's great just one more for me.
Speaker Change: As you guys build confidence in that system I'll call it.
Speaker Change: Could you talk about order flow back.
Backlog is kind of inched upward in the first half of the year.
Speaker Change: Can say I think.
Speaker Change: How are we expecting the order flow to trend in the second half of the year should that accelerate or.
Speaker Change: In conjunction how is the continuing resolution that impacting order flow.
Speaker Change: Yes.
Speaker Change: I don't get too granular and focusing in on orders by quarter, because like cash it can be a little bit lumpy I do think that our trailing 12 months book to Bill of 112 is.
Speaker Change: Reflective of solid performance and as we're looking forward, we still feel really confident about not only our strategic positioning which we've talked about consistently.
Speaker Change: But also the enduring demand drivers and the need for mission critical processing at the edge. So.
Speaker Change: In all I feel very optimistic about that outlook, our trailing 12 month book to Bill I think it is solid at one point once you and I think it positions us well for the second half of the year.
Speaker Change: Great. Thank you very much.
Speaker Change: Your next question comes from the line of Peter Arment with Baird. Your line is open yes.
Speaker Change: Yes, good afternoon, Bill, Dave Tyler welcome to the call.
Peter Arment: Congrats on the quarter, obviously, a lot of progress being made here I guess I just wanted to understand the back half of the year free cash flow kind of breakeven commentary because I think you've made a tremendous amount of progress of bringing the unbilled down and again you saw I haven't done that this quarter, but now you've also got this deferred revenue growth and then I just want to understand how.
Peter Arment: How it whether that's tied to the new contract structure and on receiving the milestones or could you maybe just walk us through a little bit of the dynamics of why there isn't positive still casting generally in the second half.
Peter Arment: Yes.
Peter Arment: As we said when we looked at the first half our cash was ahead of where we were expecting and some of that was driven by the milestones that we were able to achieve.
Peter Arment: Drove as you saw a significant increase in our deferred revenue.
Peter Arment: Based on the timing on those milestones so those milestones as we work through the second half will be will be performing effort against that cash that we've already received so we expect to see the deferred revenue come down.
Peter Arment: And as we as we get through the back half of the year. It does not mean unbilled.
Peter Arment: You too.
Be something that we're working aggressively on but we do expect to see.
Peter Arment: The material drawn down of debt.
Peter Arment: That deferred revenue that was bought in those milestones that were completed earlier.
Peter Arment: I appreciate that I'll jump back in the queue. Thanks.
Peter Arment: Jim comes from the line of Ken Herbert with RBC capital markets. Your line is open.
Ken Herbert: Hey, good afternoon, Dave.
Ken Herbert: You've consistently talked about sort of the longer term opportunity to get to get adjusted EBITDA margins back into the 20%.
Ken Herbert: The low Twenty's range.
Ken Herbert: Can you provide without getting maybe too specific on timing, but how does the business look when you get to that level. I mean is there a way we should think about that from a revenue standpoint from a from an efficiency standpoint can you provide any more.
Ken Herbert: Parameters around how you think about that maybe from a timing standpoint or just operationally.
Ken Herbert: Think about the business moving forward.
Ken Herbert: Yes.
Ken Herbert: Thanks for the question. Let me. This is bill I'll take we've talked pretty consistently for the last several quarters about the main levers that we're focused on and we've made progress on each of the levers and I think as we're sitting here looking forward and thinking about the path to our target margins.
Ken Herbert: I think there's really two primary things that we're focused on one is the conversion of our backlog margin that we've talked about.
Ken Herbert: The fact that coming out of <unk>.
Ken Herbert: Slide 24, our backlog margin was lower than what we expect to see on a go forward basis impacted by a small number of low margin development programs and a number of programs that were impacted by EAC adjustments.
Ken Herbert: Slide 24 and.
Ken Herbert: And as we're progressing each quarter and we're bringing in new bookings were really pleased to see that the margin on those bookings are coming in in line with our target margins associated with our targeted EBITDA margins that were working to get to.
Ken Herbert: So that's a dynamic that will play out over time, we haven't been specific around the timing, where we expect the backlog margin to be at a place where its consistent with targa.
Ken Herbert: Target margins, but we have a duration associated with our backlog. So you can do some thinking around how that might turn over over time, but that's the first.
Ken Herbert: The first driver and then the second is around our operating expense. So that we can get positive operating leverage as we continue to drive volume.
Ken Herbert: And I feel like at this place where we are with our operating expense. We've made significant progress over the last 18 months on that part of our cost structure and while we said before and it will continue to be a focus that will drive efficiencies into the business as we go forward on an ongoing basis, but I feel good about.
Ken Herbert: Our operating expenses relative to the positive operating leverage that we expect to see as part of our game plan to get to our targeted margins. So those are really the two pieces and I feel like we're in a pretty good place in terms of understanding where we are and being able to see.
Ken Herbert: Those two moving pieces work together to get us to our targeted margins.
Speaker Change: Thanks for all the detail Bill.
Speaker Change: The next question comes from Seth Statesman of J P. Morgan Your line is open.
Speaker Change: Okay, Thanks, very much and good afternoon and nice quarter.
Seth Statesman: I guess just thinking about the growth rate you could talk about.
Seth Statesman: Above market, maybe just to put some parameters around that when you. When you think about what market is do you think about it kind of as you know.
Seth Statesman: The defense budget, which I think a lot of people think about maybe.
Seth Statesman: Low to mid single digit growth over time do you think about it as a more as a certain subset of the defense market.
Seth Statesman: That might be growing faster.
Seth Statesman: And then the second part of that question is the common processing architecture and when you are fully ramped up there kind of what role that plays in the mix and how.
Seth Statesman: That plays into your thoughts about.
Seth Statesman: The overall growth rate of the business as we look out over.
Seth Statesman: Let's say one to three year period.
Seth Statesman: Yes.
Seth Statesman: As we discussed before we're focused on delivering top line growth spurt.
Speaker Change: Ah represents a growth rate above market growth rate and specifically the market that we're focused in on is the defense electronics tier III defense electronics market.
Speaker Change: With growth rates that are historically in the 5% to 6% range.
Speaker Change: We believe for a number of reasons with it in particular, when we focus in on the sub segments of that market, where we're well positioned and we focus and in particular thats around deliver.
Speaker Change: Delivering processing power and capability to the edge those sub segments tend to grow a little bit faster and we feel like we're very well positioned based on our technical differentiation.
Speaker Change: And to deliver growth that exceeds the market growth rate. So that's really what we mean by when we talk about our targeted growth rates.
Speaker Change: With respect to the common processing architecture.
Speaker Change: As we've worked through.
Speaker Change: The technical challenges in that area and gotten those behind US and then ramp to full rate production it impacts our business in a number of different ways positively.
Speaker Change: First it unlocks bookings because a number of customers were holding back follow on development and production awards and so we have demonstrated we got to root cause.
Speaker Change: Eliminated the technical risk.
Speaker Change: Then ramped up production. So it's opened up new production awards.
Speaker Change: It also now gives us the opportunity with a capacity becoming available to allocate that capacity in a way that makes the most sense and that could be either burning down backlog in delivering new units and revenue that goes with it or allocating our capacity to more legacy programs that rep.
Speaker Change: Present are unbilled balances that when we deliver those units there was less revenue associated with those units because the revenue has been recognized in prior periods, but it allows us to deliver the units invoice our customers and collect cash so having that capacity online gives us a number of different degrees.
Speaker Change: The freedom to drive performance and have it flow through our P&L.
Speaker Change: Our cash flow statement and into the balance sheet. So hopefully that's helpful.
Speaker Change: Okay.
Speaker Change: Yes, absolutely. Thank you.
Speaker Change: The next question comes from Jonathan Ho with William Blair. Your line is open.
Speaker Change: Hi, Let me Echo my congratulations as well.
Speaker Change: I just wanted to get some additional color on what drove the $30 million and pull forward contract activity was concentrated in a handful or single program and was there sort of a customer impetus or.
Speaker Change: Government directive to drive earlier deliveries. Thank you.
Speaker Change: Yes, thanks, Jonathan Thanks for the comment upfront.
Speaker Change: <unk>.
Speaker Change: Four.
Speaker Change: 18 months, we've been very consistent in that prioritize focus of the business with priority one being a focus on delivering predictable performance.
Speaker Change: Looking backward a lot of that effort was focusing on completing the large mix of development programs.
Speaker Change: Our portfolio.
Speaker Change: But it also includes a relentless focus on delivering for our customers. So a lot of.
Speaker Change: What we've seen in our results for both Q1 and in Q2 is a byproduct of our team in relentless on delivering for our customers and that shows up in two ways, it's delivering out of our backlog on new awards delivering hardware associated with that backlog.
Speaker Change: Getting it out the door.
Speaker Change: As well as working down our unbilled balances in this quarter really the over performance was tied to a point in time revenue and those were on programs and for products, where based on that focus on delivering for our customers, we're able to pull to the left from our initial expectations and thats, what really drove that.
Speaker Change: Into the quarter.
Speaker Change: And Jonathan I would add it was not a single contract to a single customer it was multiple different products and customer said and again as Bill said.
Speaker Change: As we're improving our capacity in our in our operational facilities, we were able to pull some things that we thought we would not get delivery on and is at the point in time revenue was on delivery.
Speaker Change: We would not get revenue on and deliver in Q2, we were able to pull them forward out of Q3 into Q2 deliver them early and get them to our costs earlier than expected and get them to our customers. So.
Speaker Change: Positive all of them and I think one of the things that was encouraging in the quarter is as we really focused our capacity we were able to demonstrate both the pull forward of deliveries to drive revenue and at the same time finish off programs and drive down our unbilled receivables and I think thats.
Speaker Change: Really a credit to our team the improvement in our management system and our focus on delivering for our customers.
Speaker Change: Excellent. Thank you.
Speaker Change: The next question comes from Michael <unk> with <unk> Securities. Your line is open.
Speaker Change: Hey, good evening guys. Thanks for taking my question nice results.
Speaker Change: Dave maybe just to stay on that topic and get some more clarity I mean, it sounds like the pull forward was just.
Speaker Change: Basic blocking and tackling and delivering I mean, because if I when I hear pull forward I'd, probably want to strip it out and your revenues would have been down year over year and down sequentially, but.
Speaker Change: That doesn't seem like the way we should interpret this and then I guess.
Speaker Change: Pull forward and thinking about the back half of the year. So you've got mid single digit revenue growth kind of implies flattish sequential trajectory.
Speaker Change: But what would drive in that flattish.
Speaker Change: Revenue environment for the rest of the year, what drives the margins higher, especially in the fourth quarter or is that kind of what you were referencing with the bookings coming in at.
Speaker Change: At that targeted margin rate.
Speaker Change: Yes, So let me start with the.
Speaker Change: Top line and the revenue revenue movement within the period and again I don't want to get.
Too granular on the revenue between quarters, but I do want to remind.
Speaker Change: Everyone that in Q1, we had some pull forward.
Speaker Change: From Q2 into Q1.
Speaker Change: And then again from Q3 into into Q2, now if you kind of normalize the.
Speaker Change: The volume and where it sits it does sort of spread out the growth throughout the year to get a more balanced and consistent growth between the first half and the second half and I think if you adjust that $30 million and Youre thinking youll see a more balanced.
Speaker Change: Growth rate across across the full year.
Speaker Change: As far as the margin uplift in the fourth quarter I think there's two things that are that are happening it's yes.
Speaker Change: Dynamics in the backlog. So we are seeing the roll forward of the lower margin backlog.
Speaker Change: Being replaced with the New awards that are coming in in line with our target margins.
Speaker Change: As we saw last year.
Speaker Change: In the fourth quarter, we would expect to see some positive operating leverage with the increased volume that would be additive to our margins and that's why we're expecting the fourth quarter to be the highest margins in the year hopefully that makes sense.
Speaker Change: And I think there are two things that impact that backlog margin as bill discussed one is of course, the new bookings coming in and the margin rate on those bookings and we said that.
Speaker Change: It's being accretive as we have been.
Speaker Change: We've been going forward and the other is done.
Speaker Change: A level of <unk>.
Speaker Change: Margin on the contracts that were actually performing executing on.
And we've talked about.
Speaker Change: Some of the contracts that we're completing and moving past some of the lower margin contract. So those two phenomenon acting in concert with each other.
Speaker Change: Naturally start to raise that backlog margin.
Speaker Change: Got it helpful. Thanks, Scott.
Speaker Change: Okay. Thank you.
Brian: The next question comes from Brian <unk> with Raymond James Your line is open.
Speaker Change: Hey, nice quarter.
Speaker Change: And thank you for taking my questions.
Speaker Change: I wanted to maybe just delve into this journey, we are taking to remix the business away from not away from but this natural shift from development to production work can you talk about where we're at in that journey, and then maybe give us a little bit of sensitivity.
Speaker Change: The margin shift higher as development moves every 500 or 1000 basis points.
Speaker Change: Yes, we have.
Speaker Change: We've talked about this in the past kind of the difference between margin rates typically on development versus production contracts and the way, we think about that model and what we've talked about in the past.
Speaker Change: For instance.
Speaker Change: <unk> thousand basis points kind of range the difference between those two.
Speaker Change: And so.
Speaker Change: We are and we've talked about the bookings we're seeing are in line with our targeted margins.
Speaker Change: As Bill talked about when we look at our bookings from the last.
Speaker Change: Trailing 12 months.
Speaker Change: The 80% range production, so we're seeing that happen.
Speaker Change: It's.
Speaker Change: Some of that is as a consequence of finishing these development programs we have.
Speaker Change: As a large number of development programs that we're we've been working through I wanted to make sure that people don't take the.
Speaker Change: The amount of production happening is a natural phenomenon of finishing those development programs and getting the follow on production awards, we still are focused on.
Speaker Change: On new development and the right kinds of new development and then we still.
Speaker Change: Our moving innovation along in the company, but this is a natural move how we see the business proceeding we expect.
Speaker Change: This level of kind of bookings.
Speaker Change: To be the case for some fees some period of time.
Speaker Change: Alright, and then maybe just a quick follow up so if you think about how that backlog naturally progresses towards your target margin.
Speaker Change: How do you how.
Speaker Change: How much of that margin bridge from 10% to 20% or 10% to 20%.
Speaker Change: Comes from this natural mix shift.
Speaker Change: As opposed to some of the other levers that bill.
Bill: Bill alluded to earlier.
Speaker Change: Yes.
Speaker Change: Think we broken out the individual components of that so.
Speaker Change: I wouldn't I wouldn't want to try and detailed work.
Speaker Change: Okay fair enough. Thank you.
Speaker Change: Once again, ladies and gentlemen, if you have a question. It is star one on your telephone keypad.
Speaker Change: Your next question comes from the line.
Speaker Change: As Sheila K like glue.
Speaker Change: Of Jefferies. Your line is open.
Speaker Change: And great quarter guys. Thanks for taking the time I wanted to maybe start on free cash flow and just ask for $82 million of free cash flow in the quarter. I think was your all time high free cash flow in a quarter.
Speaker Change: In a year, let alone a quarter or so.
Speaker Change: Can we talk about how we bridge that free cash flow.
Speaker Change: But true free cash flow is given you're implying breakeven in the second half there was a <unk>.
Speaker Change: Obviously, some factoring in there.
Speaker Change: And some benefit from other items. So maybe if you could just talk about how we should be thinking about second half being breakeven and as we head into fiscal 'twenty.
Speaker Change: Yes, I think Sheila this is Dave.
Speaker Change: I think that the way to think about it is.
Speaker Change: We were able to accelerate cash in essence into the second quarter largely when you look at our deferred revenue you see our deferred revenues up around $40 million.
Speaker Change: Yes milestones that we achieved that.
Speaker Change: Ed.
Speaker Change: All of the effort being completed.
Speaker Change: As we go through the second half we expect to be.
Seeing that deferred revenue come down.
Speaker Change: As we as we get the work done around those things our complete work around those things.
Speaker Change: And so we expect that we will have.
Speaker Change: It will lower the deferred revenue, resulting in an offset to the cash that we're bringing in on the other programs.
Speaker Change: That 40 ish million dollars, there's almost no pull forward the piece of that out in the second half of the year. So.
Speaker Change: We're not looking at it as a pure.
Speaker Change: As a breakeven back half of the year. We're looking at are you guys running running two offsets.
Speaker Change: That activity, we still are focused on our networking capital and bringing down our net working capital as well.
Speaker Change: Lowest it's been in several years I mean, we're headed in the right direction.
Speaker Change: Obviously, that's not at the exclusion of revenue our margin, but it's something we're working in concert.
Speaker Change: I think I think the way we're thinking about cash is consistent with what we've said.
Speaker Change: In the past.
Speaker Change: We expect to be a consistent positive cash flow generator.
Speaker Change: We expect to have positive cash as we exit the year obviously.
Speaker Change: With where we are today.
Speaker Change: A little bit ahead of where we thought we'd be through the first half.
Speaker Change: Got it and then maybe if we could just talk about.
Speaker Change: It's been asked a few different ways the profitability profile to any sort of.
Speaker Change: Color you could give on production versus development margins and then if you could just talk about the competitive win you mentioned in the slides what are those and how do we think about that.
Speaker Change: Yes.
Speaker Change: Yes, I'll start and then bill likes you talk about the.
Speaker Change: The wind.
Speaker Change: As we just said I think that.
Speaker Change: What we said historically is that production margins and development margins because of the different profile of those things are roughly.
Speaker Change: Sure.
Speaker Change: Targets, we see for those of roughly 1000 basis points different.
Speaker Change: We've seen that consistently in our bookings that that's about right.
Speaker Change: The bookings were bringing in are absolutely consistent as bill has said with the target model that we have and so we see the bookings that are coming in at the margins, we need to step towards our ultimate business model.
Speaker Change: And I'll just make a.
Speaker Change: Comment on the competitive on the.
Speaker Change: Competitive wins, we had a number of.
Speaker Change: Head to head competitive wins in the quarter I think a couple worth mentioning one is on U S Defense Department.
Speaker Change: Satellite is the program with an innovative space systems provider.
Speaker Change: What's interesting about this pursuit as it was led by our advanced concepts group, which as a group we launched last year to focus on our next generation technology and position US for next generation type pursuits came up with a very innovative solution that actually leveraged.
Speaker Change: Existing products and work that we had done for other customers and so we think it's right in line with an innovative development program with the right risk profile that will lead to production runs down the road. So it's exactly what we wanted to do with the advanced concepts group and a really good <unk>.
Speaker Change: <unk> story.
Speaker Change: And then the second is the takeaway associated with our common processor architecture.
Speaker Change: Product line and as we've said before this is an area, where we see emerging demand and we feel like we've got solid technical differentiation.
Speaker Change: And this takeaway it was a perfect example of that it was.
Speaker Change: Relatively entrenched competitor incumbent providing a processing capability.
Speaker Change: The end customer was looking to upgrade the capability to include the functionality consistent with our common processing architecture. The incumbent couldn't meet those requirements, we could and that was the basis of that takeaway in the development Award. So I think those are.
Speaker Change: Very notable they're worth mentioning and I think they are evidence of our.
Speaker Change: Our ability to compete head to head and win based on the technical differentiation associated with the Mercury processing platform.
Speaker Change: Got it thank you.
Speaker Change: Mr. Paul House. It appears there are no further questions. Therefore, I would like to turn the call back to you for closing remarks.
Paul House: Okay, well, thanks, everybody for your participation I would like to thank the mercury team because its people and teams that deliver the results that we talked through today and the team had an outstanding quarter. We appreciate your participation and we look forward to the update next quarter. Thank you. Thank you.
Paul House: This concludes today's conference call. We thank you for joining you may now disconnect.
Paul House: Please wait the conference will begin shortly.
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