Good day, everyone. Welcome to the Mercury Systems Second Quarter Fiscal 2022 Conference Call. Today's call is being recorded. At this time for opening remarks and introductions, I'd like to turn the call over to the company's Executive Vice President and Chief Financial Officer, Mike Ruppert. Please go ahead, sir..

Good afternoon. And thank you for joining us. With me today is our President and Chief Executive Officer of Mark Aslett. If you've not received a copy of the earnings press release we issued earlier this afternoon, you can find it at [ph] mrcy.com.

The slide presentation that Mark and I will be referring to is posted on the Investor Relations section of the website under Events and Presentations. Please turn to Slide 2 in the presentation.

Before we get started, I would like to remind you that today's presentation includes forward-looking statements, including information regarding Mercury's financial outlook, future plans, objectives, business prospects and anticipated financial performance.

These forward-looking statements are subject to future risks and uncertainties that could cause our actual results or performance to differ materially. All forward-looking statements should be considered in conjunction with the cautionary statements on Slide 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, specifically, adjusted income, adjusted earnings per share, adjusted EBITDA, free cash flow, organic revenue and acquired revenue.

A reconciliation of these non-GAAP metrics is included as an appendix to today's slide presentation and in the earnings press release. I'll now turn the call over to Mercury's President and CEO, Mark Aslett. Please turn to Slide 3..

first, organizational efficiency and scalability; second, procurement and supply chain; third, facilities optimization; and four, scalable common processes and systems. The fifth area is R&D investment efficiency and returns. Mercury's significant investment in research and development is a pillar of our growth strategy.

Tied to the current industry headwinds, this investment resulted in organic growth well above the industry average over a multiyear period. Our strong commitment to R&D is also in line with where the defense industry is headed. Mercury has proven that a high-tech investment model can operate successfully at scale and be part of all stakeholders.

As it relates to M&A, Impact is about leveraging our proven ability to integrate and grow acquired businesses, but it's at a greater scale going forward. Since fiscal '14, we've completed 15 acquisitions, deploying $1.4 billion of capital.

We dramatically scaled and transformed the business as a result growing total company revenue 4.4 times from FY '14 through FY '21. We fully integrated these acquired entities by moving them to common collaboration and engineering platforms as well as common ERP, HRIS and CRM systems while also consolidating facilities.

We've also unified these 15 businesses under the Mercury brand with sales force and single go-to-market strategy as well as the shared culture and values.

As a result of these actions, over the past 7 fiscal years, we've extracted substantial cost and revenue synergies, leading to adjusted EBITDA growing more than 9 times or twice the growth in revenues. This has resulted in substantial value creation for shareholders. We intend to apply the impact methodology to future M&A.

In addition to accelerating and increasing the value we create we believe that deploying 1MPACT could also allow us to increase our deal cadence and potentially the size of our transactions. Combined with the increased synergies generated, this could have a compounding effect on value creation.

For example, 6 of our 15 acquisitions now comprise our mission business. Here, we're combining our integration, growth and value capture efforts as part of 1MPACT. Turning to Slide 7. We continued our M&A momentum in the quarter, closing the Avalex Technologies and Atlanta Micro acquisitions in November.

As a result, we have now deployed $620 million in capital since December of 2020. This marks the largest 12-month M&A capital deployment in Mercury's history, and we're excited about the future. Avalex's touchpoints with all our prime mission acquisitions.

It positions us to compete more effectively for integrated displays, communications management and mission computing programs in the avionics domain. It also aligns well with the need for open mission systems driven by industry delayering. Atlanta Micro is an innovative, high margin semiconductor business.

It fits well with our RF mixed signal and trusted microelectronics businesses. Both integrations are progressing well as are the integrations of POC and Pentek, which we acquired last year. As it relates to future transactions, the M&A environment continues to be active and our pipeline is strong.

We will remain disciplined in terms of our deal pursuits, diligence, pricing and integration. Mercury has built an enviable in-house M&A capability and has a proven track record of acquiring and integrating significant acquisitions.

Through integration of our acquisitions, we've been able to average down the multiples we've paid through the recognition of both cost and revenue synergies, creating substantial value for our shareholders as a result.

Coupled with the strength of our balance sheet, we believe we can continue to execute on the M&A strategy that's been so successful for us over the past 7 years. Turning to Slide 8. We expect Mercury's total company revenue to continue growing faster than overall defense spending over time with organic growth being the core driver.

We focused the business on larger and faster growing parts of the defense market. And we now participate in more than 300 different programs. We're designed in on our top programs with the majority being sole-sourced positions. No single program was more than 5% of total company revenue in fiscal '21.

And looking ahead to the next 5 years, no single program is expected to be more than 6% of total revenue. We believe that our longer-term secular growth trends remain favorable. The significant actions we have taken over the last several years have aligned us well with the National Defense Strategy.

The government continues to push for modernization, speed and affordability in Central Mission Systems and C4I. Needs for secure processing, trusted microelectronics and open mission systems are growing.

We believe it will also continue to benefit from the ongoing effects of supply chain delayering and reshoring as well as increased outsourcing at the subsystem level by our customers.

The move to subsystems has been the driver of our low-risk content expansion growth strategy, which has allowed us to grow organically at a rate of far in excess of the industry. Back in 2016, with an eye towards expanding our margins, we acquired various assets from the Microsemi Corporation.

This was the genesis of our trusted microelectronics strategy. Mercury's focus here has been to create highly differentiated secure and trusted microelectronics capabilities as well as radiation tolerant devices for space applications, both developed and produced domestically.

These capabilities now represent the highest margin part of our business as planned. We expect our trusted microelectronics strategy to continue driving growth in expansion over time. Our vision has been the leading commercial provider of trust and secure devices to systems is what our customers are seeking.

They're looking to partner more with companies like Mercury and buy less on traditional suppliers. As a result, our engagements, which are not competitive with our customers' offerings, are becoming larger and more strategic for both parties.

We believe this vision, combined with our low-risk content expansion strategy will continue to drive organic growth in the business. During the second quarter, our largest bookings programs were a classified management program, Argon, 2 classified EW programs and CPS.

As I've said, we anticipate accelerated growth in bookings in the second half, leading to a positive book-to-bill and growth in backlog for fiscal '22 as a whole. Recent updates suggests that the development and the integration efforts related to the F-35 TR3 are doing better. We believe this improvement is mirrored in our bookings.

Year-to-date, we booked as much on the F-35 as we did for the whole of fiscal '21, and we're expecting a strong second half. In addition to the F-35, we continue to expect our bookings to be led by programs, including LTAMDS, [indiscernible] CWIP, F-18, F-16, P8 and T45.

We're also expecting a significant booking related to a classified trusted microelectronics program. In addition, we expect to receive a second substantially larger order for the FMS program that was delayed in Q1 of last fiscal year. The change since our last call relates to LTAMDS, which is now called Ghost Eye.

In response to our customer, we have previously moved the next booking related to Ghost Eye domestic and international production from our fiscal '22 to fiscal '23. Based on recent customer input, this may have moved to our fiscal '25 with the possible exception of unobligated funds for preproduction activities.

Like the F-35, Ghost Eye is an important program. It's the largest single design win in the company's history to date. We expect it to be a significant driver of growth beginning in fiscal '25. Looking specifically at fiscal '23, we expect bookings from our top 20 programs to ramp yet again.

We anticipate seeing fewer delays in key programs among them the F-35 as well as continued naval and airborne upgrades such as CWIP, a subsurface combat system upgrade, Filthy Buzzard, F-18, T-45 and other classified programs. With that, I'd like to turn the call over to Mike.

Mike?.

Thank you, Mark. And good afternoon, again, everyone. As usual, I'll start with our second quarter results and then move to our Q3 and fiscal '22 guidance. The team worked in Q2 to deliver solid financial results despite the external challenges that Mark discussed.

We saw a significant rebound in bookings from Q1 and finished the quarter with a book-to-bill above 1. The bookings momentum in Q2 is expected to accelerate, resulting in a strong second half of the fiscal year. For full fiscal '22, we're maintaining our prior guidance for revenue, adjusted EBITDA and adjusted EPS.

Our updated guidance incorporates the acquisitions of Avalex and Atlanta Micro as well as a more cautious organic revenue outlook, primarily due to elevated supply chain risk. We continue to expect fiscal '22 to be weighted towards H2 and especially Q4 as margins expand and free cash flow begins to normalize.

Given our backlog at the end of Q2 and forecasted Q3 bookings, we expect to exit Q3 with strong visibility into Q4. Looking ahead to fiscal '23, we continue to anticipate a return to above industry average organic revenue growth driven by the strong bookings and backlog growth in fiscal '22.

We expect this organic growth, coupled with improved operating leverage and our impact initiatives to result in margin expansion and increased adjusted EBITDA versus fiscal '22. Turning to our Q2 results on Slide 9. Bookings were up 13% compared to Q2 '21 and up 19% from last quarter.

During the quarter, we had over $25 million of bookings moved from Q2 into Q3 as a result of contracting delays. We've already received a majority of those orders in Q3. Despite these delays, our book-to-bill was still strong at 1.08. Our backlog at the end of the quarter was $954 million, up 8% compared to Q1.

Revenue in Q2 increased 5% from Q2 '21 to $220 million. Organic revenue was $183 million, down 13% year-over-year and slightly better than our expectations coming into the quarter. Acquired revenue, which included POC, Pentek, Avalex and Atlanta Micro was $37.5 million.

The Avalex and the Atlanta Micro acquisitions together contributed approximately $6 million of revenue in Q2. Acquired revenue was slightly below expectations, due to the contracting delays that I just mentioned. Gross margins for Q2 were 39.6% compared to 42.1% in Q2 fiscal '21, down 250 basis points.

This was impacted by the inclusion of POC, which had a 100 basis point impact. It also reflects program mix with a higher proportion of new program starts and development work compared to Q2 last year. In H2 and heading into fiscal '23 and beyond, we expect gross margins to expand as more of our programs transition into production.

Operating expenses in Q2 were up 24.2% compared to last year, primarily driven by the recent acquisitions as well as higher amortization expense and acquisition related expenses. We recorded $3.8 million of restructuring and other charges in Q2, primarily related to third-party consulting costs associated with our impact program.

Our growth focused R&D investments continue to exceed the industry average. R&D for Q2 was 12.9% of sales. Since fiscal '17, we've now invested over $450 million in secure processing, trusted microelectronics and open mission systems.

These investments, coupled with our strategic acquisitions have provided us differentiated technologies in fast growing segments of the market. We incurred a GAAP net loss of $2.6 million or negative $0.05 per share in Q2.

This was driven primarily by $6.5 million of acquisition related and restructuring and other charges as well as incremental amortization expense associated with Avalex and Atlanta Micro. Adjusted EBITDA for Q2 was $38.1 million. Our adjusted EBITDA margins were 17.3%, down 420 basis points from 21.5% in Q2 fiscal '21.

This was driven by lower gross margins compared to a year ago as well as negative operating leverage as organic revenue declined year-over-year while we continue to invest for growth. Free cash flow for Q2 was an outflow of $1.2 million, driven by restructuring and other charges as well as impacts from supply chain delays.

Slide 10 presents Mercury's balance sheet for the last 5 quarters. We ended Q2 with cash and cash equivalents of $105 million compared to $96 million in Q1 with the reduction from our free cash outflow being offset by cash associated with recent acquisitions.

Mercury ended the quarter with approximately $452 million of debt funded under our $750 million evolving credit facility, up approximately $252 million from Q1, driven by the acquisitions of Avalex and Atlanta Micro.

From a capital structure perspective, we remain well positioned to continue executing on disciplined M&A transactions that will create additional value for shareholders. From a working capital perspective, we continue to be focused on improving efficiencies in key accounts, including unbilled receivables and inventory.

Unbilled receivables, excluding our Q2 acquisitions and purchase accounting adjustments, decreased approximately $5 million from Q1 as we completed several significant program milestones. As Mark said, from fiscal 2014 through fiscal 2021, our total revenue increased 4.4 times.

However, due to the success of our low-risk content expansion strategy, our subsystems revenue increased 7.5 times. As a result of this strategic shift to larger integrated subsystems as well as the acquisition of POC a year ago, our proportion of overtime revenue to total revenue has increased to just below 50%.

Our unbilled receivables balance has naturally increased as well. We expect to continue to make progress in reducing our unbilled receivables as a percentage of overtime revenue in future quarters. Inventory excluding our Q2 acquisitions, increased approximately $7 million.

This was due to accelerated purchases to support customer demand and mitigate supply chain risk in the second half. We expect inventory turns to improve as we move into fiscal '23. However, going forward, we will always consider prebuys for key components where we believe our supply chain could be at risk.

We see this as a cost-effective short-term insurance policy. Turning to cash flow on Slide 11. Free cash flow for Q2 was an outflow of $1.2 million. This reflected restructuring and other charges associated with impact as well as acquisition related expenses primarily associated with Avalex and Atlanta Micro.

We also saw an impact on our cash flow as a result of supply chain delays that impacted our revenue and milestone linearity and therefore, billings. Supplier delays related to milestone payments had an approximate $20 million impact on free cash flow during the quarter. This was partially offset by other working capital accounts.

Let's now turn to our financial guidance, starting with the third quarter on Slide 12. I’ll begin by noting that our guidance for both Q3 and the full fiscal year assumes no incremental acquisition-related expense. The guidance includes both Avalex and Atlanta Micro.

As I've said, we're maintaining our full year fiscal '22 guidance for revenue, adjusted EBITDA and adjusted EPS, reflecting the incremental acquired revenue from Avalex and Atlanta Micro, offset by the elevated risk we expect to continue through the second half of the year.

While the team has worked diligently to manage headwinds observed across the industry, our Q2 results were impacted by supply chain constraints, the defense contracting environment, COVID and workforce retention.

As a result, while we are working to mitigate the impact from these risks, our Q3 and updated full year fiscal '22 guidance does reflect them going forward. I'll also note that our GAAP net income and GAAP EPS guidance for Q3 and fiscal '22 reflects restructuring and other charges related to Impact.

In addition, fiscal '22 includes acquisition related expenses incurred in H1. With that as background, looking at Q3 specifically, we expect continued growth in bookings and a book-to-bill materially above 1 for the quarter, driven by the programs Mark discussed.

We expect our backlog to increase exiting Q3, providing us with even greater visibility into the revenues expected for Q4, as I'll discuss in a moment. We currently expect revenue for Q3 in the range of $245 million to $255 million. This is an approximate 3% decline at the midpoint compared to the third quarter last year.

At the midpoint, we expect organic revenue to be approximately 9% from Q3 last year as a result of the lower bookings in fiscal '21. We expect a significant increase in our total and organic revenue growth in Q4. Q3 GAAP net income is expected to be $8.2 million to $10.4 million or $0.15 to $0.19 per share.

The year-over-year declines reflect the expected incremental impact related expenses and amortization expenses. Our guidance for Q3 includes restructuring and other charges of $3.7 million related to the Impact initiative. Q3 adjusted EPS is expected to be $0.55 to $0.59 per share.

We expect adjusted EBITDA for Q3 to be $50 million to $53 million, representing approximately 20.6% of revenue at the midpoint. This is over 300 basis points higher than Q2 driven primarily by higher gross margins as well as operating leverage on sales growth.

We expect free cash flow to adjusted EBITDA for Q3 to be approximately breakeven, driven by continued impact cash outflows, working capital investments associated with quarter-over-quarter revenue growth as well as additional interest expense. Turning to Slide 13.

For the full fiscal year '22, as I've said, we're expecting double-digit bookings growth and book-to-bill above 1. We expect total company revenue of $1 billion to $1.03 billion, representing 8% to 11% growth from fiscal '21. This is in line with our previous guidance and includes our recent acquisitions.

Organically, the midpoint is a 3% revenue decline year-over-year, reflecting the supply chain and other risks I previously mentioned. GAAP net income for fiscal '22 is expected to be $44.8 million to $50.1 million or $0.80 to $0.90 per share.

The declines year-over-year reflect expected restructuring and other charges as well as acquisition related and amortization expenses. They also reflect non-operating activity and discrete tax benefits in fiscal '21, which are not guided for fiscal '22.

Adjusted EPS for fiscal '22 is expected to be in the range of $2.51 to $2.60 per share, an increase of 4% to 7% compared to fiscal '21. Adjusted EBITDA for fiscal '22 is expected to be in the range of $220 million to $227 million, up 9% to 12% from fiscal '21. Adjusted EBITDA margins are expected to be approximately 22%.

Like revenue, we expect adjusted EBITDA and EBITDA margins to be heavily weighted toward Q4. From a free cash flow perspective, we expect free cash flow to adjusted EBITDA conversion to normalize in Q4. Based on our estimated cash flow through Q3, this would result in approximately 15% to 20% free cash flow to adjusted EBITDA in fiscal '22.

This conversion includes impact expenses through Q3 and assumes no additional impacts from supply chain delays in Q4. Turning to Slide 14. I want to touch on Q4, which we expect to be a record quarter for Mercury across all key metrics.

While we will not formally guide Q4 until next quarter, based on H1 actuals and our Q3 and updated fiscal '22 guidance, we can back into an implied forecast for the quarter. Looking at the midpoints of our fiscal '22 and Q3 guidance ranges, Q4 revenue at the midpoint would be approximately $320 million.

This is an increase of approximately 28% from Q4 '21 and organic growth of approximately 20%. GAAP net income and EPS would be approximately $48 million and $0.86, respectively. In addition, Q4 adjusted EBITDA would be approximately $96 million and adjusted EBITDA margins would be approximately 30%.

On Slide 15, I want to provide the key reasons why we're comfortable in guiding towards record results in Q4. In essence, it's about our strong visibility into the fourth quarter today, which we expect to be even clearer by the end of Q3. The implied Q4 guidance represents significant growth over Q4 '21 and Q3.

That said, between our strong current backlog and expected bookings in Q3, we expect to enter Q4 with forward backlog coverage in line with previous quarters. In addition to Q3 bookings, we have visibility into the major Q4 bookings that are expected to drive the remainder of the implied Q4 forecast.

Some of the key H2 programs include F-35 TR3, SEWIP, F-18, FMS programs and a variety of other programs that Mark discussed. We're designed into these programs. And we remain closely aligned with our customers.

As such, our Q4 guidance is based on existing backlog as well as the expected timing of H2 bookings informed by the best available information we have today. From a gross margin perspective, we also expect a strong Q4.

The mix of programs we expect to drive our growth is weighted towards production programs and licensing revenue, which tend to have higher margins. As a result, we're expecting significant gross margin expansion in Q4.

In addition, we expect R&D and SG&A on a dollar basis to be relatively flat compared to Q3 despite the significant growth in revenue in Q4, thereby driving adjusted EBITDA margins. So our comfort in the outlook is a result of the visibility into our Q4 programs and the associated profitability. With that, I'll turn the call back over to Mark..

Turning to Slide 16. Q2 was a strong quarter for Mercury. We're confident this will lead to a strong year in fiscal '23 as organic growth returns to normal levels and impact drives margin expansion. Looking ahead longer term, our model sitting at the intersection of the high-tech industry in defense is exceptionally well positioned.

We believe that our strategy and investments in secure processing, trusted microelectronics and open mission systems will continue to drive growth in the business.

While we're mindful of the potential risks associated with the defense budget and industry headwinds, we expect to continue to benefit from key secular trends such as outsourcing, delayering and reshoring. We're well aligned with our customers in the DoD. Our design win cadence is strong, and new business activity remains robust.

Our strategy is to deliver strong margins while growing the business organically and supplementing this organic growth with disciplined M&A and full integration. By executing on this strategy, we've created significant value for shareholders for nearly a decade, and we expect to continue doing so.

In closing, I'd like to extend my appreciation to the entire Mercury team for the outstanding work they've done during this challenging time, my sincere thanks to all of you. Before we move to questions, I'd like to address the recent public disclosures by two of our shareholders, Jana Partners and Starboard Value.

At Mercury, we frequently engage and maintain an ongoing dialogue with shareholders and have a history of seeking, considering and incorporating their feedback where appropriate. As we've communicated today, we're focused on executing our strategic plan, and we'll continue to evaluate opportunities to enhance value for all shareholders as we do so.

The purpose of today's call is to discuss our second quarter earnings results and outlook, and we ask that you please keep your questions focused on these topics. With that, operator, please proceed with the Q&A..

Thank you, sir. [Operator Instructions] Our first question is going to come from the line of Pete Skibitski with Alembic Global..

Hey. Good afternoon everyone. I just wanted to get a better sense with regard to this big ramp in the fourth quarter. It sounds -- I guess I'm trying to figure out to what degree you're predicating this fourth quarter revenue ramp on a kind of a timely end to the current CR.

In other words, if we get a full year CR, what kind of revenue chunk might we expect shift to fiscal '23?.

Sure. Let me take a crack at that, Pete. So we don't believe that there's a lot of risk associated with the CR itself. I think we've gone through the programs, and we feel pretty good. The ramp in Q4, I think although there's no forecast without risk, we've got a significant amount of Q4 revenue already in backlog.

And I think this backlog combined with the expected ramp in Q3 bookings is what really gives us the visibility and the comfort to the implied Q4 revenue and EBITDA that Mike discussed in the plan. So Quarter3 bookings is an important quarter for us, and we’re expecting continued momentum based on what we delivered in Quarter2..

Thank you. Our next question is going to come from the line of Seth Seifman with JPMorgan..

Thanks very much. Good evening. I wonder if you guys could talk a little bit more about the risk on the execution side, on the manufacturing side.

You talked about sort of, I guess, you think about headcount, you think about the supply chain challenges that you mentioned and those are still ongoing through much of the economy and will probably be ongoing in the June quarter as well.

And so to what degree does that level of kind of operational cadence or execution need to return to something like normal for you to deliver on the Q4 target and kind of what gives you confidence in that?.

Yeah. So few things there, Seth. So clearly, I think we've seen a pretty turbulent environment. And right now, we're not anticipating that things will be fully resolved likely until next calendar year. That said, I think we've been very, very proactive, working with our suppliers wherever we possibly can to minimize the risk going forward.

And we don't currently expect that the uncertainties around the supply chain will actually grow materially in the second half. We've been very, very focused on in doing whatever we can. We mentioned in the prepared remarks that we've purchased an additional $10 million of materials that is linked to second half revenue, those materials are flowing in.

We flowed down DPS ratings where appropriate. We're in daily contact with the suppliers. And obviously, we've taken into account what we believe to be the highest risks from both the supply chain as well as the labor perspective in the current guidance. So the team is doing a pretty good job overall, but it is quite challenging out there..

Thank you. Our next question is going to come from the line of Sheila Kahyaoglu with Jefferies..

Hi. Good afternoon, guys. Thanks for the time. Obviously, a lot going on this quarter. Hey, guys. And you talked about this in your prepared remarks a lot in terms of opportunities in your M&A pipeline, both historically and going forward.

What impact going on as well? Maybe can you give us a quantitative and qualitative outlook on your historical and going forward M&A on how Mercury's added value both from a revenue and EBITDA perspective because when we look at it, the growth is great. It's up 20%, both on the top line and the bottom line.

So I guess maybe can you talk about the potential opportunities you have going forward, whether it's through 1MPACT or on future opportunities?.

Yeah. Look, great question. I think as we said, we've built, I would say, an enviable M&A organization, our ability to source diligence, close and then integrate deals is very, very strong. To me, 1MPACT about leveraging proven ability that we have to integrate and grow future acquired businesses. We're doing a greater scale going forward.

I think as we said in the prepared remarks, since fiscal '14, we've now acquired 15 businesses, deploying $1.4 billion in capital. That's dramatically scaled Mercury as a business transformed the capability set that we have as well as the importance to our customers.

And as a result of the acquisitions, but more importantly through the synergies that we've generated through integration, we've been able to actually grow total company revenues by over 4.4x over the course of the last 7 or so years.

And because integration and full integration is such an important element of the strategy and 1MPACT about taking that to the next level, we've been able to actually grow adjusted EBITDA at 9x or twice the growth in revenues. And I think it's really this organic growth strategy that we have.

It's been driven by the shift to subsystems, coupled with M&A and full integration is what's delivered the value creation over the course of the period where we've been very, very active. 1MPACT to me is about taking it to the next level.

And so it’s about Mercury kind of achieving its full growth and adjusted EBITDA potential, doing what we’ve been doing, but doing it at a greater scale and potentially even better than what we’ve done in the past..

Thank you. Our next question is going to come from the line of Peter Arment with Baird..

Good evening, Mark and Mike. Mark, obviously, there's questions about kind of the timing and how this is all going to kick into the kind of the fourth quarter and you have a lot of confidence around that. You've in the past, I guess, talked about kind of returning to high single-digit or low double-digit growth.

And I wanted to see maybe just more qualitatively, do you think that's still possible in '23, just given the lingering effects of a CR, Pete's right about that full year CR or whether you get just lingering effects from the supply chain.

Just how you're thinking about kind of the return to the growth model?.

Yeah. Look, it's a great question. Thanks for that. So obviously, notwithstanding the elevated industry risks that we're facing for fiscal '22. I think we continue to expect very substantial growth in bookings year-over-year. Our bookings and backlog expectations for the year have actually improved since last quarter.

And we continue to remain pretty confident for the second half, just given the timing of the deals that we see. The expected growth in bookings, as we see it right now, should lead to a positive book-to-bill for the year as a whole as well as double-digit growth in total and 12-month backlog.

And it's really these bookings and the increase in backlog exiting this fiscal year that we believe positions us for a return to our more normal levels of growth organically in fiscal '23.

And this organic growth, coupled with the margin expansion that we expect associated with the impact of initiatives really do sell us well for pretty substantial value creation next year. So I think right now, we feel pretty confident in the second half. We're seeing the bookings momentum coming out of Q2.

As we said, we thought that Q1 was the low watermark. We're pleased with the progress, and we're expecting even faster growth in the second half..

And Peter, I would just add to that. We just went through our update to our 5-year forecast as of our midyear strategic plan exercise. And Mark just talked about fiscal '23, but when you look at the 5-year, it's very strong as well. And that growth is supported by the major programs we're on, the markets that we've been investing in.

So a clear path to return to the organic growth model. And then on top of that is impact ramping up not just in fiscal '23, but margin expansion over the 5-year period..

Thank you. Our next question is going to come from the line of Ken Herbert with RBC..

Hey. Good afternoon, Mark and Mike. 2-part question, if I could.

First, when you look market the new business opportunities today, your business development pipeline how has that changed relative to maybe a year or 2 ago? Is it possible to quantify that as we think about the impact maybe of the budget on some of the new program starts and your organic investment opportunities? And then second, I was just wondering if you could put a finer point on sort of how much of the fourth quarter revenues are currently in backlog with the $25 million? It sounds like you've largely booked it slipped out of second, third quarter and sort of what you expect to book in the third quarter? Thank you..

Sure. So Mike, I don't know if you want to take the Q4 backlog one. And then I can talk a little bit about the -- what we see over the 5 years and why we feel confident..

Yeah. So Ken, as we talked about in the prepared remarks, if you look at Q4, it's really driven by the key programs that were designed into. They're well supported. So this really is about timing. If you look historically, we've had about 50% to 60% of the next 12 months in 12-month backlog entering a year.

We haven't given out guidance on how much backlog covered we have entering a quarter because it can typically range anywhere from 70% to the mid-80% range. It depends on contract mix et cetera. As we look at our Q4 right now and why we're comfortable with the guidance we put out, we currently have about 70% of our Q4 in backlog today.

And if you look at the bookings that we see in Q3, we anticipate having over 80% of Q4 in backlog by the end of Q3. So even though we're forecasting a very big Q4, the coverage we expect going into Q4 is at the high end of the range that we normally see. So we've got a lot of insight into the programs.

And we feel like we've got a lot of insight into the timing, as I said in our prepared remarks that we're staying close with our customers on that..

Thanks, Mike. So let me kind of just talk a little bit about the longer term. So we've been investing heavily for growth and we've grown the business significantly organically over a multiyear period.

And so despite the headwinds that we're experiencing now in the latter half of '21 and '22 to date, we absolutely believe that our long-term business model is in fact, as Mike said we've just updated our 5-year plan at the midyear mark and continue to believe in our ability to grow the business at high single digit to low double-digit rates on average over time, as we have done for many, many years now.

And the reason that we believe though is that to begin with, I mean, we're positioned in large and well-funded high-priority programs of record that we believe are very much aligned with the National Defense Strategy as well as DoD priorities. We're designed in on many of these programs.

And by far, the majority are actually sole-source supply positions. None of our programs have been canceled. And I think, in fact, as we look forward, we think that the funding associated with the programs is -- remains strong.

We continue to out invest our competition from an internally funded R&D which we believe is in line with the direction that the industry is headed. And this is allowing us to deliver innovations far more quickly, far more affordably than what we're seeing other companies doing, which in turn means that we're taking share.

Our largest secular growth driver, which we've been focused on for quite some time now which is outsourcing at the subsystem level is occurring by our traditional customers as well as the they are seeking to delayer the supply chain to gain access to innovative tech oriented mid-tier such as Mercury.

And so although clearly, we may be a leading indicator one of the challenges that we’re seeing more broadly across the industry, we do believe that many of those are temporary in nature and that we can continue to grow the business, the way in which we have in the past. And again, probably the biggest driver of that is outsourcing..

Thank you. Our next question is going to come from the line of Michael Ciarmoli with Truist Securities..

Hey. Good evening, guys. Thanks for taking the questions. Just -- Mark or Mike, not sure which one you guys want to take this. But just to you talked about sort of the industry related risks. And I guess just at the programmatic level, we've seen some press about some SEWIP Block 2 shortfalls.

And then I guess even thinking about your comments on LTAMDS and kind of that first booking order sliding out. I mean just knowing how big that program was? Has that changed? Or has anything changed on the programmatic side? I mean 6-8 months ago as we were looking to '23 for a reacceleration of organic growth.

Presumably, LTAMDS was going to be a part of that.

Is it -- was that the case? Is it easy to backfill that? Or just if you can talk about some of these big programs? And how they're trending, given what we're seeing, I guess, a slide out and maybe some operational shortfalls there?.

Yeah. So the changes that we've talked about, right -- or the outlook, Mike actually is encompasses what we've seen programmatically based upon the best possible information today. SEWIP as we said, we started to see some impact last fiscal year here in the second half is based on the impact of COVID on the ship upgrade cycles.

And we're seeing that again this year in terms of lower numbers, which is encompassing our numbers. LTAMDS, we were originally expecting to get a large booking this year that now, again, has moved out. That is also encompassed in both our outlook for this year as well as over the 5 years.

And we do think that actually LTAMDS, even though it's nowhere near as large as what we thought it was going to be for fiscal -- for this fiscal year, the bookings are still going to be up 3x compared to what it was last year. So fundamentally, I don't believe anything has changed. I think we've got some great -- we're on some great programs.

We're seeing ramps in a number of those over the 5-year period, and it's really the growth in the top 20 programs as well as some of the new design wins transitioning into production over time that gives us the confidence in the outlook. So we feel pretty good that we've done the work and that we're well positioned, Mike..

And our next question is going to come from the line of Jonathan Ho with William Blair & Company..

Hi, good afternoon. I just wanted to, I guess, maybe get a sense for whether you've heard anything from your customers. I think you've referenced you're staying in close contact with them. But has anything changed? Or is there anything that's maybe giving you some additional confidence as we start to look at sort of this Q4 ramp and going into 2023.

I just want to get a sense from you Mark on how to think about what the customers are saying..

Yeah. So I mean, we spent a fair amount of time, obviously, with customers just looking at our major programs and just diligencing them as we continue to look at the ramp in H2. I think -- and yes, I think the major programs, right, the feedback that we've been -- that we've given support to the forecast and the guidance that we've just given overall.

So I think when we look at the forecast for H2 from a bookings perspective, Jonathan, I think it's really been driven by double-digit growth across our 2 major market segments, which as you know, C4I and Sensor and effect and Mission Systems. And the growth in both those markets are really again being driven by our top 20 programs.

In the top 20 programs, we're actually expecting the bookings from them are likely going to more than double versus H1 primarily because there's actually more of them producing and the ones that are producing at the higher rate. And so when I look at those programs, we've got the large FMS program that moved from Q1 of last year.

We've got a substantial ramp in the F-16, which -- that was one of the orders that moved from Q2 -- sorry, Q1 into Q2 and we've already received that order. We've got F-18, we've got a ramp on LTAMDS. SEWIP, although it's lower is in the second half as well. So I think our program -- we feel good about it.

I mean the stable well-funded programs that we don't expect them to be affected by the CR. And we have got the best possible information from the customers as we look at the second half..

Our next question comes from Austin Moeller with Canaccord Genuity..

Good evening, Mark and Mike. I just have a question here.

If Russia launches an invasion into Ukraine, do you anticipate that we could have an expansion of about 35 sales towards some of our NATO allies? And if we see an increase in F-35 sales and the number of customers that are already are assigned to the F-35 as well as a large amount of electronic warfare and radar equipment being sent to Eastern Europe for use by NATO allies and DoD, do you anticipate that could yield upside in your fiscal year '23?.

So it's hard to say exactly what obviously is going to happen in the Ukraine and specifically relating to the F-35. But if I just kind of talk a little bit about what we see happening with our program. Overall, we are expecting double-digit growth in bookings this fiscal year, greater than 40% as opposed to a 50% decline that we saw last year.

So we do think that as a result of the TR3 and kind of getting through the reprogramming, we're seeing a pretty substantial uptick. Year-to-date on the program, we've booked as much as what we did throughout the whole of last year. And we're expecting a strong second half as well as a substantial increase in bookings next fiscal year.

So that was one of the major programs that obviously there's now a lot of information out in the public domain around what happened with TR3 and Block IV and the production reprogramming. But from what we can see right now, things are -- appear to be back on track.

And we're seeing it in our bookings and our revenue, and we feel pretty good about the growth in the program longer term, just given some of the design wins that we've already won that TR3 and Block IV will enable.

So overall, I think it’s a really important program for us and for the industry, and we’re seeing a substantial pickup this year compared to last..

Thank you. Our next question comes from Christopher Rieger with Berenberg Capital Management..

Hi, guys. Thank you very much for taking the question. Just with regard to the elevated supply chain risk that you've been seeing in the lengthening lead times. Could you talk about sort of where you're seeing the pinch the most? Like which programs are more or less affected than others? Any color you could provide there would be appreciated. Thanks..

Yeah. So really not necessarily at a specific program level, but I think the biggest challenges that we faced was delays and in quarter decommits from suppliers and distributors. And a lot of that was around semiconductors and in particular FPGAs.

And so I think Mike said, we saw greater than a $5 million revenue impact in the second quarter associated with that. But we also saw revenue churn as suppliers were kind of decommitting and we're ending up -- to push some of the revenue towards the back end of the quarter which in turn impacted some of our cash collections.

So it's a very dynamic environment. It's the reason that we've -- this past quarter committed another $10 million in component buys to derisk the revenue in the second half and we're already getting those materials in. And that's on top of what we previously did. So most of what we're seeing the issues around are in semiconductors.

And again, most of that is FPGA-based..

And our next question will come from Ron Epstein with Bank of America..

Thanks. Good evening, guys.

Could you walk through why do you see yourself as a leading indicator? What about your business would make you a leading indicator?.

Yeah. To some extent, Ron, I think it's just the -- where we sit in the tier from an industry perspective and the fact that we've got a relatively short cycle business. And so when we started to see the impacts associated with F-35, right on TR3, that's a significant program for us.

And it wasn't until really 9 months after that we start to see the impact did a lot of the other companies start to describe what was happening and then demonstrate the impact that was having on them as well. So it's largely due to I think, where we sit in the supply chain, some of the program concentration that we have in short-cycle business..

Thank you. And our final question for the day will come from the line of Noah Poponak with Goldman Sachs..

Hey, everyone. .

Hi, Noah. Mark, I wanted to ask a similar question, and so I'll try it again, which is everybody in the industry is seeing a continuing resolution in supply chain and labor hurdles. And the order of magnitude of decline in your revenues organically is much larger than pretty much every other company in the industry.

And if you could spend a little bit more time on why that is.

I mean is being short cycle with a commercial model and a lack of multiyear contracts, does that mean when there's a delay on the program that the prime can just kind of almost turned you off completely and then pick it back up a year down the road? And if you could just get a little more specific on LTAMDS, too, the length of delay you're talking about there is quite long.

I'd love to be able to better understand what's going on in that program..

Yeah. So look, I think when we kind of assess kind of what happened in fiscal '21, the biggest challenge that we had last fiscal year from a bookings perspective.

And remember, the bookings slowdown that we saw in the second half of fiscal '21 and in the first half of this fiscal year, which we expect to ramp is largely what has driven the slowdown in organic revenue growth. So the largest bookings impact that we had last year was on the F-35.

And as I mentioned, our bookings on the F-35 were down 50% year-over-year compared with the prior year, which caused a 3 points decline in organic bookings overall. We have that large FMS contract that was delayed from Q1 which we now expect in the second half that had a roughly 3.5 point impact as well.

So literally, just there in 2 programs, we saw some pretty substantial impacts overall that has affected the growth in fiscal year '22, and I could go on with a few others. As it relates to LTAMDS, I think -- it's based upon the information that we got from our customer to date.

I think our understanding is that the next LTAMDS reduction award for will be in '24. That's based on what we're hearing from PEO space and missile and that is what's currently in the Army plan.

Because we didn't get a fit up last year, we don't know for sure how the budget has moved out of '22 based upon the army's portfolio and decisions around that. So we'll have more information hopefully, in the next few months as to what the actual plans for LTAMDS are. I would say, however, that I think the U.S.

Army continues to stress the importance of LTAMDS as a cornerstone of next-generation air and missile defense. And it's one of the army's 6 priority areas. So although we've kind of moved it out again in time, and we're expecting a substantial ramp in bookings in this fiscal year compared to last.

We're not going to see the big ramp in production orders, we believe until our fiscal '25. So the time that it takes Raytheon to get the order get it to us and the difference in the timing in fiscal years put it out into our fiscal ‘25 versus fiscal ‘24. So that’s what we know right now..

Thank you. I would now like to turn the call over to Mr. Mark Aslett for closing comments..

Okay. Well, it's been great to speak to everyone. Thank you very much for joining the call. We look forward to speaking to you again soon..