Good day, everyone. And welcome to the Mercury Systems Second Quarter Fiscal 2020 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, Mark Aslett. If you have not received a copy of the earnings press release we issued earlier this afternoon, you can find it on our website at 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 & 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 would 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.

Thanks, Mike. Good afternoon, everyone. And thanks for joining us. I'll begin with a business update. Mike will review the financials and guidance, and then we'll open it up for your questions. Mercury delivered solid results in the second quarter of fiscal '20, building on the momentum from Q1. It was a record quarter for total revenue, adjusted EPS, and adjusted EBITDA. The industry environment is positive as we begin the second half. There's a Defense Appropriations Bill in place, and design win activity is very robust. Our business model is performing extremely well. We're investing to inflect growth in the business while at the same time delivering record results. We're again raising our fiscal '20 guidance for total revenue, adjusted EBITDA, and adjusted EPS, and we now expect to deliver 13% to 14% organic growth for the year. Turning to our Q2 financial highlights on Slide 4. Total revenue for the first quarter increased 22% from Q2 of fiscal '19. We delivered 12% organic growth, one point higher than a year ago. Our largest revenue programs in the quarter were P-8, F-35, Filthy Badger, F-16 SABR, and the next generation missile system. Q2 was another very strong quarter for new business. Total bookings were up 21% year-over-year, leading to a record backlog and a book-to-bill of 1.08. Our largest bookings programs in the quarter were ALR-56, LTAMDS, ProVision, Paragon MODS, and an international sale. Profitability for the quarter was strong. Adjusted EBITDA was up 16% from Q2 last year. Free cash flow was above our expectations at 48% of adjusted EBITDA. Working capital continues to improve, and we maintain a strong unlevered balance sheet. Turning to Slide 5, Mercury's ability to win new business has never been better. We've successfully pioneered the next generation defense electronics company. We're making commercially available, trusted, and secure technologies profoundly more accessible to the defense industry. We've created a proven transformational business model that sits at the intersection of the high-tech world and the defense industry. It's fueled by R&D levels that are four to five times the industry average, focused on developing highly innovative, trusted, and secure mission-critical technologies. In addition, we're funding growth capital investments at a rate that's two to three times what most consider a healthy level of CapEx in our industry. We're creating pre-integrated sensor processing and C4I subsystems. And the way in which we're doing that allows us to introduce new capabilities far more quickly with lower risk and far more affordably than ever before. We have industry-leading secure computing solutions that are developed by a highly cleared workforce. These solutions are both developed and produced in trusted domestic facilities. Sitting at the intersection of defense and high-tech, we believe Mercury's business model is perfectly aligned with recent defense procurement reform initiatives. While it's still focused on affordability, the major shift that we've seen is the DoD's focus on accelerating innovation and fielding new technologies and capabilities. This is to deal with rising obsolescence and maintenance costs, as well as emerging threats. The DoD is seeking to speed things up by leveraging more of the investments in innovation occurring in the high-tech world. This includes using different types of contracting methodologies and greater reliance on non-traditional defense contractors, of which Mercury is one. The nation faces a very challenging global security environment with Chinese militarization and power projection, a resurgent Russia, as well as general instability in the Middle East, and all this is leading to increased defense spending. Turning to Slide 6. Growth of our target markets, Sensor and Effector Mission Systems and C4I are well-funded and growing faster than the defense market overall. Over the past five years, we've delivered 18% compound annual growth in Sensor and Effector revenue and greater than 84% growth in C4I. The estimated lifetime value of our top 30 programs and pursuits has grown more than five times since fiscal '14. For the second quarter, Sensor and Effector Mission Systems' revenue was 57% of total revenue, increasing 24% from Q2 last year. C4I revenue increased 22% year-over-year to 30% of revenue. This growth was driven by our ability to add content on existing programs and expand into new programs like LTAMDS, which we announced last quarter. We're benefiting from a significant wave of modernization occurring in radar, EW, and C4I. We're also seeing new opportunities in weapon systems, space, avionics processing, mission computing, as well as secure rugged servers. Turning to new business. In Q2, we have the largest number of new design wins we've ever had in a single quarter. These wins encompass existing platforms as well as new platforms. We're winning new designs in existing and new markets. In particular, we're seeing significant activity around Mercury's industry-leading secure processing capabilities. At the customer level, Mercury's growth has been driven by three dominant trends we've discussed in the past. These trends include: first, supply chains delayering by the government and the primes; second, the flight to quality suppliers by the primes; and the most important, increased outsourcing by our customers at the subsystem level. We continue to see outsourcing as the largest secular growth opportunity in defense. These trends play to Mercury's strengths. Today, we're tracking well over 100 active programs, and our top programs are growing faster than total company revenue. Turning to Slide 7. What we've done strategically through M&A over the past seven years or so is to focus on low-risk content expansion in terms of our capability set and addressable markets. First, we acquired new capabilities that transformed Mercury from a tier three product company into a company that provides tier two solutions at the subsystem level. Second, we used the acquired capabilities to expand more broadly in our traditional Sensor and Effector Mission Systems' markets. Third, we're in the midst of a market expansion into other types of computers onboard military platforms. These encompass C3I processing as well as platform and mission management. And finally, we see an exciting opportunity to expand our existing microelectronics business by replicating our sensor processing subsystems integration strategy, but at chip scale. We believe that Mercury is uniquely positioned to provide the defense industry with trusted, secure chiplet-based silicon solutions to support next-generation defense applications. As we discussed last quarter, we're investing $15 million in our trusted microelectronics business in Phoenix to capitalize on this opportunity. The buildouts of both the clean room and the team in Phoenix are underway. We're engaged with several silicon OEMs and involved in discussions with key customers. The response to what we're doing has been overwhelmingly positive. Looking at our footprint more broadly. We're now on a multiyear journey to improve and scale our trusted domestic manufacturing capabilities. Our latest milestone in this effort was completing our west coast RF facility build-out and consolidation. As a result, we now have state-of-the-art RF manufacturing located in close proximity to our customers on both the east and west coasts. We're also continuing to make solid progress integrating Mercury's previous acquisitions, and the integration of APC, which closed in Q1, has begun. So now turning to Slide 8, and that's a strategy that's delivering the above-average levels of growth and profitability. To grow a business, we strongly believe that you need to invest in it organically. We invest in our people, processes, technologies, and trusted domestic manufacturing capabilities to support the continued organic growth in the business. At the same time, we've used M&A strategically in three ways: to expand our capability set, gain access to adjacent markets, and then penetrate those markets over time. As a full integrator, we've generated significant cost and revenue synergies. As a result, our adjusted EBITDA has grown faster at a rate faster than revenue. We've invested in trust and secure innovations that really matter for the aerospace and defense industries. Finally, we've never been in a better position to attract, retain and engage the best possible talent that we need to grow our business. Turning to Slide 9. We're positive about our business outlook. We're seeing very high levels of new design win activity and opportunities for continued growth. The defense appropriations bill has been approved, meaning that we are no longer operating under CR, momentum in the business remains strong. Over the longer term, our baseline forecast is for overall defense spending to increase at low single-digit rates. Our goal is to deliver organic revenue growth at a rate that far exceeds this industry average. We're also well-positioned to supplement our high levels of organic growth with M&A. We continue to be successful at acquiring and rapidly integrating businesses that fit well with Mercury. The M&A pipeline is robust, and we're seeing interesting opportunities of varying sizes that are consistent with our strategy. We intend to remain active and disciplined in our approach to M&A, focusing on the Sensor and Effector Mission Systems and C4I markets as we have in the past. We're looking for deals that are strategically aligned and that have the potential to be accretive in the short and long term. The combination of strong margins and organic revenue growth, supplemented with disciplined M&A and full integration forms the core of our strategy. We believe this strategy will continue to generate significant value for shareholders over the longer term as we execute our plans in five areas. First is to grow our revenues organically at high single to low double digits, averaging 10% over time, and to supplement this high level of organic growth with acquisitions. This is consistent with the 26% compound annual growth in total company revenue we've delivered over the last five fiscal years. The second is to invest in new technologies, our facilities, manufacturing assets, and business systems. We will also invest heavily in our people. Third is manufacturing insourcing, as well as driving strong operating performance across our manufacturing locations. The goal here is to enhance margins, quality, and on-time delivery while improving working capital efficiencies over time. Four, we're seeking to grow revenues faster than operating expenses. This will allow us to continue investing in organic growth while maintaining strong operating leverage in the business. And finally, we're fully integrating the businesses we acquire to generate cost and revenue synergies. These synergies, combined with other areas of the plan, should produce attractive returns for shareholders. So in summary, the strategy I've just outlined has worked very well over the past five years and we look forward to extending this record of success. We're anticipating another year of double-digit growth in revenue and adjusted EBITDA in fiscal '20 now including 13% to 14% organic revenue growth. Mike will take you through the guidance in detail. But before Mike begins, I'd like to note that earlier this month, Orlando Carvalho, former EVP of Lockheed Martin's Aeronautics Business, was elected to Mercury's Board of Directors. Orlando has deep experience from his many years in senior executive roles across major defense programs, including the F-35. We welcome Orlando to Mercury and look forward to benefiting from his knowledge and insight as we execute our strategy. With that, I’d like to turn the call over to Mike.

Thank you, Mark. And good afternoon again, everyone. Q2 was another quarter of strong financial results for Mercury, marking a solid first half of fiscal year '20. As Mark mentioned, revenue, adjusted EBITDA, and adjusted EPS were up significantly from Q2 last year and all at record levels. We delivered solid bookings growth and concluded the quarter with another record backlog. Mercury's first half performance gives us the flexibility to continue investing for growth during the second half while still delivering strong results. We're increasing our full-year fiscal '20 guidance for revenue, adjusted EBITDA, and adjusted EPS, and I'll go through those numbers shortly. Turning now to the metrics on Slide 10. Mercury's continued bookings and revenue growth translated into solid profitability in Q2. Following a strong bookings quarter in Q1, Q2 bookings were about $200 million for the third consecutive quarter. Total bookings increased 21% from Q2 last year to $210 million, driving a 1.08 book-to-bill ratio. For the first half, bookings were up 21% from H1 last year with a strong book-to-bill of 1.15. This increase was driven by large contract wins across the business. We ended the second quarter with a record backlog of $728 million, an increase of 39% compared to Q2 of fiscal '19. Backlog expected to ship within the next 12 months increased 34% from Q2 last year to $522 million. Twelve-month backlog is now 72% of total backlog, providing us with solid visibility into the second half. Total revenue increased 22% from Q2 last year to $194 million, near the high end of our guidance of $185 million to $195 million. Q2 results included an aggregate of approximately $16.3 million of revenue attributable to the Gecko Avionics, Athena Group, Syntonic Microwave, and APC acquired businesses. APC, which we closed at the end of Q1, performed well in Q2, and we're pleased with our progress on the integration so far. Organic revenue was up 12% year-over-year in Q2 and up 14% in H1 compared to the first half last year. As a reminder, organic revenue excludes acquired revenue, which represents revenue from acquired companies through the first four full quarters since the acquisition date. Based on our year-to-date performance, coupled with continued momentum in design wins and bookings, we now expect 13% to 14% organic growth for the fiscal year. Gross margin for Q2 was 45.6%, up from 44.6% in Q2 of fiscal '19. In addition to favorable program mix, Q2 gross margin benefited from operational efficiencies, including increased throughput at our manufacturing facilities, as well as continued purchasing power synergies from the Themis and Germane combination. In H2, we expect gross margin to be similar to what we saw in Q1, driven by the continued ramp-up in new program starts. Our strong gross margin is allowing us to continue to invest in organic growth opportunities while also delivering record results. Internal R&D spend for Q2 was $24.7 million, up 52% compared to $16.2 million a year ago, primarily driven by investments to support design wins across the key franchise programs, like LTAMDS. We also saw an increase in R&D related to our acquisitions over the last 12 months. As a percentage of sales, R&D was 12.7%, which is up approximately 2.5 points from 10.2% in Q2 fiscal '19. For the first half, R&D was 12.5% of sales compared to 10.3% in H1 last year, demonstrating the increased percentage of sales we're investing back into the business. SG&A for Q2 was $32.8 million, an increase of 17.9% from $27.8 million in Q2 last year, driven by our organic and acquired growth over the last 12 months. As a percentage of sales, SG&A declined to 16.9% from 17.5% in Q2 of fiscal '19, driven by strong operating leverage in the business. We expect this trend to continue in the second half. Q2 GAAP net income and EPS increased 27% and 12% year-over-year respectively. Adjusted income for the second quarter increased 31%. Adjusted EPS was $0.54, up 15% from $0.47 in Q2 last year and above our guidance of $0.46 to $0.48. Adjusted EBITDA for Q2 increased 16% year-over-year to a record $42.8 million. This exceeded our guidance of $38.5 million to $40.5 million, driven primarily by strong gross margin. Adjusted EBITDA margin in Q2 was 22.1% compared to 23.2% in Q2 last year. This reflects the increase in R&D as a percentage of sales as we invest in opportunities for growth in the business. Q2 adjusted EBITDA margins were above our guidance of approximately 21%, primarily driven by strong gross margin as a percentage of sales. Finally, free cash flow, which we define as cash flow from operations less capital expenditures, was $20.7 million, up 14% from $18.2 million in Q2 of fiscal '19. This increase was driven by record operating cash flow, which was partially offset by higher capital expenditures compared to a year ago. Slide 11 presents Mercury's balance sheet for the last five quarters. We ended Q2 fiscal '20 with cash and cash equivalents of $182 million, up from $161 million in Q1, driven by the free cash flow generation in the business. From a capital structure perspective, we remain well-positioned with continued flexibility and good access to capital. At the end of the quarter, we had zero debt and $182 million of cash on the balance sheet. In addition, we have $750 million unfunded revolver with attractive rates. This provides us with significant financial capacity for future R&D and capital investments to drive organic growth, as well as capacity to execute on our M&A pipeline. Turning to cash flow on Slide 12. Operating cash flow for Q2 was a record $32.1 million, up 27% from $25.3 million in Q2 of fiscal '19. This increase was driven by higher net income and noncash adjustments. The increase in cash flow from operations was partially offset by higher capital expenditures as we invest in new growth opportunities. CapEx in Q2 was $11.3 million or 5.8% of revenue compared with $7.1 million or 4.4% of sales in Q2 last year. While completing the majority of the capital outlays associated with the consolidation of our West Coast RF facilities, we continued investing in the trusted microelectronics build-out in Phoenix. Looking forward, we expect CapEx to be approximately 7% of revenue for the full fiscal year. CapEx for the first half of fiscal '20 was $20.9 million or 5.6% of revenue. We expect the majority of the remaining CapEx associated with the Phoenix build-out to occur in H2 of this fiscal year. Free cash flow for Q2 was $20.7 million or 48% of adjusted EBITDA. As a result of our growth investments, we continue to expect free cash flow to come in at approximately 40% of adjusted EBITDA for the year. For the first half, free cash flow is approximately 45% of adjusted EBITDA. Turning to Slide 13, Mercury's Q2 results position us well to continue to execute our long-term financial model. As Mark said and as we discussed during the Investor Day, we've created a differentiated and attractive financial profile for Mercury by executing strategically against three objectives. First, we're delivering industry-leading adjusted EBITDA margins, and our goal was to increase those margins over time. We expect to continue to benefit from the operating leverage that we've built into the business. We have a large number of new design wins and development programs. These are the precursors to higher margin hardware annuity revenues as these programs transition into production over time. We've made substantial investments to improve operating efficiencies across the business. And at the same time as full integrators, we've delivered significant margin expansion through cost synergies from our recent acquisitions. Our second objective is to grow our revenues organically at high single digits to low double digits averaging 10% over time, driven by above industry average levels of internal R&D as a percentage of sales. We're leveraging the trend towards outsourcing to expand our content on existing programs. At the same time, we're taking share in our core markets and expanding into adjacent markets. Our third objective is to supplement our margin expansion and organic growth with strategic M&A. Over the past four years, we've completed 11 acquisitions, deploying over $800 million of capital, and we continue to have a large pipeline of acquisition targets. We're fully integrating the companies we acquired to generate cost synergies and inflect their growth. And our strong unlevered balance sheet positions us for continued acquisition-driven growth. Overall, Mercury's strategy and business model continue to deliver financial performance in Q2 that was well above the industry averages and consistent with our unique financial profile. So with that, I'll now turn to our financial guidance. Starting with Q3 guidance on Slide 14; we're forecasting revenue to be $190 million to $200 million; Q3 GAAP net income is expected to be $15.9 million to $17.4 million, or $0.29 to $0.32 per share; adjusted EPS is expected to be $0.50 to $0.53; finally, adjusted EBITDA is expected to be 42 million to 44 million, representing approximately 22.1% of revenue. We expect to see continued expansion in CapEx in Q3 as we continue our investment in growing the business, including our investments in Phoenix.

Turning to Slide 15. Our fiscal '20 outlook reflects continued growth and profitability. For the full fiscal year, we now expect revenues of $780 million to $795 million. This represents 19% to 21% growth from fiscal '19 and is an increase from our previous guidance. In addition, we now expect organic growth of 13% to 14% for fiscal '20. Total GAAP net income for fiscal '20 is expected to be $71.7 million to $74.5 million or $1.30 to $1.35 per share. Adjusted EPS is expected to be in the range of $2.09 to $2.13, an increase of 14% to 16% compared to fiscal '19 results. Our guidance for adjusted EBITDA is $172.5 million to $176 million or approximately 22% of revenue. This increase reflects our higher revenue guidance, as well as additional planned R&D investments in the second half. And as I mentioned, we expect CapEx for fiscal '20 to be approximately 7% of revenue.

Turning to Slide 16 and summary. Mercury delivered a strong second quarter and first half of fiscal '20. As a result, we're well positioned to make substantial growth investments in the business while continuing to deliver strong results for the fiscal year. With that, we'll be happy to take your questions. Operator, you can proceed with the Q&A now.

Thank you. Our first question comes from Jon Raviv from Citi. Your line is now open.

So certainly appreciate that adjusted EBITDA margin, you are expanding the adjusted EBITDA margin as part of the business, the differentiated financial profile you've laid out. As we kind of move through the year, any additional visibility on potentially getting beyond the 22% as you digest the mix, the investments as some of those new development programs and new business plans ramp up. Thank you.

So as we look at the year, you can see that our EBITDA margins for Q2 were 22.1%. The midpoint of our guidance for Q3 is 22.1%, and the midpoint of our guidance for fiscal '20 is 22.1%. So we had 20.7% in Q1, which implies higher EBITDA margins in Q4 at the midpoint. So we do expect to see some more operating leverage in the second half, really driven by higher revenue in Q4. And as I mentioned in my prepared remarks, that's somewhat offset by some of the additional investment that we're making in the business.

And then just thinking about customer funded R&D versus internally funded R&D, I feel like at one point we'd had sort of the mix headwinds from the higher customer funded and then your IRAD went down and now we're having some gross margin opportunity here, but then your IRAD is going up, I mean that affect on adjusted EBITDA margin somewhat unchanged. Can you just talk about that journey and kind of what drives that pendulum between the two sides?

So from a numbers perspective, you're right. If you look at our gross margins, they vary quarter-by-quarter and a lot of it's based on program mix, of which is some customer-funded R&D. And if you look at this quarter, you'll see that customer-funded R&D was actually down a little bit year-over-year, it was down about 10%, but again, a lot of that's just timing. And in the second half, we expect customer-funded R&D to tick back up. And what you'll see is you also see that impact, as you mentioned, in our internally funded R&D numbers. So our internally funded R&D, as a percentage of sales, was higher this quarter. We expect it to be a little bit less in the second half as a percentage of sales, even though we're investing more in the business for the future. And it's really Jon why we started looking at EBITDA margins, because of that mix that we're seeing. We think that EBITDA margins are the right way to look at the business. And as we talked about, we see an expansion of those in Q2.

Your next question comes from Seth Seifman with JPMorgan.

I was just wondering, within the last maybe six weeks or so here, we've seen a couple of deals announced by others in the space with some pretty big multiples on them. Just kind of wondering what you're seeing out there and if how what seems to be expanding valuations for transactions in the space are affecting your M&A opportunities?

Yes. So clearly, I think the market is being pretty active and we've got a pretty robust pipeline of opportunities. I think you're right. When you look at a few transactions that were announced in the last quarter, the multiples on those deals were slightly higher than what we've seen in the past, we don't believe that it affects our ability to either complete the transactions or to get deals done. But we're going to remain disciplined in our approach as we have in the past, Seth.

And then just, I know some years the seasonality seems to vary a little bit. Are there one or two things you can kind of point to for the fourth quarter that give you the confidence in kind of nice revenue step-up that looks like that's better than the guidance?

Yes. So I think when we build guidance, we build it bottoms-up program by program, which gives us the confidence in our ability to execute against the plan. So it's really those two things, knowing which programs that we're on, and that they are coupled with a record backlog.

Your next question comes from Pete Skibitski with Alembic Global.

Mike, the prior full year R&D guidance, it was 11% for the full year. Has that changed now?

So Pete, we didn't specifically guide R&D in terms of a percentage of sales. And the reason is because of the shifts that we talked about between customer-funded R&D and internally funded R&D that are neutral at the EBITDA level. That having been said, we do see R&D in terms of the new opportunities that are in front of us, we do see R&D picking up significantly from last year. You can see it was up over 2 points from where we were in Q2 of last year. So we do see it picking up during the year, but we're not providing specific guidance because of that balance between customer-funded R&D and internally funded R&D.

And I'd just add to that, Pete, that I think we're in a very unique environment, with the amount of modernization activity and new design wins. I mentioned in my prepared remarks that this is probably, in fact, is a record in terms of the number of design wins that we've achieved in the quarter, and it doesn't look like it's slowing down. So there's a tremendous amount of opportunity for what we do. And given that defense is a long-term business, we want to capture those design wins to allow us to continue to grow organically at the rates that we have been.

Mark, if I could ask just one program question, this DARPA GAPS program. I don't usually at least publicly see the Mercury name associated with a DARPA program, but it seems like you have a big role on there. Can you talk about that program and kind of your role in it? And which site is working in it and maybe what kind of opportunity it could lead to in the future?

I'm not actually sure what the name of the program is, Pete.

The DARPA GAPS program seems somewhat small and is possibly located on the West Coast, specifically with Tortuga. Instead of that, I would like to ask about Lockheed Martin's increased discussions regarding their international radar initiatives. The SPY-7 has reportedly just been designated. Do you usually participate in their international radar programs, or do they tend to rely on local sourcing for roles like yours? I'm curious to know.

So, we typically do. Our business model is that when we win a position on a specific program, we get dragged along in those international sales. So yes, many of the major radar programs, we're providing them domestically and internationally.

Thank you. And our next question comes from Sheila Kahyaoglu from Jefferies. Your line is now open.

Mark, you mentioned a few bookings in the quarter that I don't think you've highlighted before as your top bookings. Could you go over them? Are any of these completely new business? You also mentioned the design wins.

Yeah. So, ALR-56 is a new program for us. This is a competitive win in the RF space, the radar early warning receiver, which we're pretty pleased about. The second win, which we announced last quarter, but we actually received the first booking this quarter, was the LTAMDS. We had a large international booking for a customer direct, and then Paragon MODS is a second program. So the range of new as well as existing spans the markets in which we normally operate, a lot of radar and EW.

And I know we've beat the R&D question to death. But should we think about it growing longer term organically in line with your sales growth? If your sales are growing high single digits, that's what R&D should grow or does it outpace that because of outsized investments?

Yes, it really depends, Sheila. I mean, we don't give guidance obviously beyond fiscal '20. But if you look back at our R&D as a percentage of sales, we were 13% in fiscal '17. We were 12% in fiscal '18. We had a lot of customer-funded R&D in fiscal '19. So we were lower. We were 10.5%. We were kind of 12.5% for H1 of this year, 12.7% in Q2. And so it really jumps around depending on the opportunities that we see in front of us where we're investing with our customers, as well as the amount of customer-funded R&D that we're getting from our customers. That having been said, we've talked a lot but R&D is an important part of our business model and we're going to continue to invest at high levels.

And then last question, once the Phoenix facility is 100% complete. Do you go back to a maintenance CapEx level or do you continue to grow the business?

So this is obviously high based upon really two activities. One is the consolidation of our RF locations on the West Coast, that activity is coming to an end. But right behind it is the decision that we made to invest to expand the capabilities of our trusted microelectronics business in Phoenix. So we're going to continue to invest in the business to be able to continue to grow our revenues organically at rates that are well above the industry average. But it really depends upon what's going on in terms of the opportunities to inflect growth, as well as to generate the right returns.

If you keep winning, you're going to invest, is the bottom line...

Yes, I mean, absolutely. We're in a very unique period of time in the industry with all the modernization, and we've got some critical technologies and capabilities that we think are important to the industry and to our ability to grow the business. And so we're going to continue to invest in those areas that we think will allow us to generate higher levels of growth and strong margins.

Our next question comes from Peter Arment with Baird.

Mark, just kind of staying on the outsourcing or the design win theme. Are you seeing the design wins? Is it because you're putting the secure process and capabilities together, or is it just this bow wave of modernization spending? Is there any way to parse the difference?

Yes, it's actually both. So I think we're seeing significant modernization activities in radar, EW, as well as C4I. And we've got great growth really across those market segments. And we think we're going to continue to see that going forward. As I said in my prepared remarks, we have seen a pretty substantial uptick in secure processing. I think one is kind of cross the CASM. And we've seen a move away from the use of waivers that have previously been in place. And we are now on our fourth generation of those sets of capabilities and we think we're very well positioned. So a number of different trends are underway, Peter.

And just when we think about the monetization efforts or your design efforts, I know it's unfair to compare it to LTAMDS since that was your largest win in history. But are there other large pursuits out there that you see that are other opportunities for the company?

They're all. I mean that one is the largest that we think we've won in the company's history. Last quarter, there was a classified program that we won while providing some very advanced processing that is $300 million in potential lifetime value. So we're winning some nice awards and pursuing some other ones. And I feel really good about positioning in terms of capabilities and the markets in which we're participating.

Lastly, you mentioned the M&A pipeline. In terms of deal size, given your capacity to generate a lot of cash, are you seeing larger deals now that you have the ability to pursue them?

As I said in my prepared remarks, we're seeing deals of varying sizes, some larger than what we've done, others more in line with the sorts of deals that we've done. Our goal is really, it's not to just focus on the size, it's to make sure that we're doing the right deals that fit strategically with us, where we can extract costs and revenue synergies over time and that continue to build the capability set that is in demand from our customers. So I think we're going to remain very active from an M&A perspective but disciplined at the same time.

No, we've looked at deals of all sizes. And as Mark said, our focus is making sure it's got the right strategic fit and the right financial profile.

Thank you. Our next question comes from Ken Herbert with Canaccord. Your line is now open.

I would like to ask about the transitions from the first to the second quarter. You've experienced several quarters of strong bookings. Is there anything notable in the third quarter bookings that stands out, perhaps related to the flight to quality, subsystem outsourcing, or de-marrying? Are you observing any changes in bookings sequentially? Could you provide more detail about the bookings, especially anything that stood out in the second quarter?

In the second quarter, we had our two largest bookings, ALR-56 and LTAMDS. ALR-56 represents competitive displacement and reflects increased outsourcing by our customers in the RF domain. Similarly, LTAMDS is an example of expanding outsourcing, where we've partnered effectively with Raytheon, allowing them to leverage the significant investments we've made in advanced capabilities through internally funded R&D. Additionally, there were notable design wins this quarter, particularly in mission computing, illustrating a shift toward outsourcing work that was once handled in-house. Our continued growth in platform and mission computing has enabled us to gain market share. Overall, we are observing significant trends of delayering and outsourcing across nearly all the markets where we operate.

Following the Investor Day, you spent a considerable amount of time focusing on electronic warfare with the new team and capabilities. Could you provide more details on how you see the opportunity set expanding, any early successes, or anything else noteworthy regarding electronic warfare?

Our EW business was up 41% in Q2. Year-over-year in the first half, it's up 52%. And we continue to win some nice business there, whether it would be on existing programs where we continue to take share or winning new programs, and I think there's more to come. So I feel pretty good about the positioning from a capability perspective, and we're seeing that wave of modernization occur.

Our next question comes from Michael Ciarmoli with SunTrust.

Mark, you've got the backlog growth, you've got the bookings, modernization tailwind, outsourcing tailwinds. You've kind of laid out that five-year hypothetical model. And you're saying, I guess you construct the outlook with a bottoms-up of all the programs. Can you give us any color, just directionally on the program portfolio? Maybe what percentage of the portfolios in early growth mode? What might be in sort of that mid-growth mode, if there are any programs in the portfolio that are declining, maybe some of your legacy programs or even a percent of the portfolio that might be sort of flat-lining at a steady state as sort of implementations continue?

It's not something that we've really talked about Mike and are ready to kind of disclose at this point. But again, I think we feel pretty comfortable about our ability to be able to grow the business organically at that high-single-digit to low-double-digit rates as we've talked about in the two major markets in which we're focused on, which are Sensor and Effector Mission Systems and C4I. I think as we laid out in detail at Investor Day, we believe that there's still a lot of opportunity for us to continue to grow in our more traditional sensor processing market and we're at the very early stages. It's beginning to penetrate both C3I as well as platform and mission management. So there's a lot of opportunity for us to continue to execute against the strategy that we've laid out and to deliver against the financial profile that Mike discussed in his prepared remarks.

And then just on gross margins, I know you're kind of deemphasizing those a little bit at the expense of EBITDA margins, but they were a multiyear high. You called out I think some of the purchasing power synergies on Themis and Germane. Just wondering if that's more tied to the consolidation and everything going on. Can those types of synergies accelerate even as you look at continued progression on maybe APC, and can we maybe see some more leverage there on just overall cost synergies?

Mike, I think that's a core part of the strategy in the acquisition philosophy. So Themis and Germane, the purchasing power synergies have been impressive. If you'll recall when we first did the Germane acquisition, we laid out some of their gross margins, and they were down at the 23% gross margin range. And we've really been able to put them together with Themis and get their gross margin profile into our range. We think we can continue to do that. And we've done it on previous acquisitions and as we look at acquisitions, whether it be in C4I or Sensor and Effector, as we integrate them together, we think we've got a good track record of recognizing synergies on the gross margin line, but also from an OpEx perspective. And then we've also been able to leverage R&D from an expense standpoint. And don't forget one of the most important things we've been able to do is inflect their growth from a revenue perspective. So yes, I do think it's something that we can continue to do going forward.

Thank you. Our next question comes from Jonathan Ho with William Blair. Your line is now open.

I just wanted to start out with a broader landscape question. You know, as you start to take share on the outsourcing and consolidation side. Are you seeing any changes in the competitive landscape, particularly with smaller players that maybe can't match your scale and breadth of capability?

Yes, I think the answer is yes to that, Jonathan. I think, you know, where we see those smaller companies challenge is really their ability to invest. In this environment with the shifting defense procurement form to more data for type contracting and the use of OTAs, our customers and our customers' customers are expecting industry to basically step up and invest more. A lot of the small companies don't have the wherewithal to invest in the new capabilities and technologies that the industry is looking for. In particular, as we've seen, in particular in the RF domain, there's very little capital expenditure, you know, around modernization or facility consolidation that's occurred and we've clearly benefited from that and it's a reason that we're taking share. So I think that we're extremely well-positioned with the business model that we've created. We're generating high levels of profitability, but we're investing back significantly in the business to capture new growth opportunities. And you can see that in our forecast for the year and now with organic growth with 13% to 14%, which is significantly up from where it was previously or what we did last year.

And then as we start to look at some of the commercial advances in merchant silicon around chiplets and some of the AMD custom development, can you talk a little bit about. Does that change the landscape? Do others have maybe the ability to take advantage of some of the cutting-edge commercial development? And is that starting to show up in some of the new design wins that you're talking about?

Our strategy is to utilize the best commercially available silicon and adapt it for specific defense applications. We believe we are in a very strong position to achieve this. We have a robust microelectronics business that has more than doubled since acquiring Microsemi in 2016. Our deep expertise lies in radar and electronic warfare, which we will focus on initially. We possess trusted domestic packaging capabilities, essential for transforming commercially available silicon into specialized devices for our targeted applications. Additionally, we have industry-leading embedded security intellectual property that will enhance our unique capabilities, along with a cleared workforce ready to pursue these opportunities. Furthermore, we have a strong distribution channel. Overall, we are in a unique position to connect the innovations occurring in the high-tech sector with the defense industry, which defines our company's positioning.

And we have a follow-up from Jon Raviv from Citi.

Regarding your comment, Mike, about the guidance suggesting that EBITDA margin will increase somewhat in the fourth quarter. Is the implication here that we will start to see some benefits from mix and biomarkers that will continue beyond this fiscal year? I understand this fiscal year is at 22%. However, looking ahead into the 22% to 26% range, can we consider the fourth quarter as a baseline?

I think I'd look at it on an annual basis, Jon. Because we always have a bigger second half than first half, so we tend to see, depending on program mix we can see more operating leverage. In this Q4, our revenue is going to be up significantly over our midpoint guidance for Q3. So we're going to see a little bit more operating leverage in Q4. So what I look at is EBITDA margins on an annual basis. And then as we talked about at Investor Day, us setting out on a clear path to expand those EBITDA margins over time.

We have next question from Ronald Epstein from Bank of America.

When you think about the opportunity that China presents? I mean, how do you think about that? Meaning every procurement executive officer whoever you talk to in DoD, there's been this flushing of China out of the procurement system kind of at all levels, right? I mean, everything from private equity funding down to Tier 4, Tier 3, Tier 2 suppliers, I mean the whole 9 yards. What kind of opportunity does that present for you? And then I guess my flip question is also, what risk does that present using commercial silicon?

So I think it's an enormous opportunity. I mean, if you go back to, Ron, how we have positioned the company, which is to be developing technologies and capabilities and funding it like a high-tech company, but recognizing that what we do is operating inside of the defense industry, which requires U.S. citizens' trusted domestic development and manufacturing. So we think that we've created a very unique business model to be able to give the Department of Defense or the defense industry as a whole access to commercially developed capabilities far more quickly and far more affordably than what's ever been done before and that's how we kind of position the company. And we can do that for the capabilities that we are working on, which now with this latest investment that we're making, takes it down to chip scale. So if you look at it from a silicon perspective, the risk actually in large part is not in the silicon itself, it's actually in the packaging of the silicon. And that's basically what we're building out in Phoenix is the ability to be able to package commercially developed silicon in very unique ways, combining the best of what's available into heterogeneous devices, adding a layer of security IP, which Mercury has invested in through certain acquisitions over time and then package it and be able to produce it here in the U.S. So I think there's an enormous opportunity for us to capitalize on what is really a set of capabilities that are really required to take these systems to the next level and to benefit from that given our business model over time.

Thank you. Our next question comes from Noah Poponak with Goldman Sachs. Your line is now open.

Is your M&A pipeline right now substantially more active than your average period in history, or is it more in line?

So we're seeing a lot of opportunities of different sizes. And I think as Mike laid at Investor Day, we have kind of alluded from our traditional market of Sensor and Effector Mission Systems processing into these two other markets, in particular C3I processing, as well as platform and mission management, which encompasses our avionic strategy. I think there's far more opportunity available to us than what we've seen in the past.

Mike, you have the chart that shows the pro forma multiple paid for acquisitions in the past. After achieving all of your synergies, it is about four or five turns lower than when it was announced. Are the businesses acquired less than a year ago on track to achieve that?

Yes. I mean, I think the way we were able to achieve those is by businesses at reasonable multiples, and multiples that were supported by the standalone value of the company and then integrating those into Mercury. And so if you look at that chart over the years, clearly with the Microsemi transaction, we were able to do that. Themis and Germane, we talked about on this call. We feel like that is going incredibly well, both from a revenue perspective and design win opportunity, as well as cost synergies. And as a result of that, we're averaging that multiple down. And then as you look at the newer acquisitions, we do feel that we can inflect their growth and average down the multiple, but to varying degrees. So APC is a new platform opportunity for us. It wasn't a pure synergy acquisition when we bought it. We've already seen some really good new design win opportunities associated with that along with the GECO Avionics acquisition. So we do think that as we our strategy of integrating the acquisitions and inflecting their growth is going to continue to work, and we're seeing it in the new design wins. As we get more platforms and like we did with Germane when we added that on to Themis, we do see additional opportunity for cost synergies as we integrate those future potential acquisitions into the new platforms.

Regarding the impact of new programs on margins, could you clarify what margins these new programs are achieving compared to the overall company average? I'm trying to understand the extent of the dilution you initially mentioned.

We've never broken that out in terms of the margins that we have, it can vary program by program but we haven't broken out the margins we normally get on customer-funded R&D versus new program wins versus internally funded R&D versus the rate production because it varies.

Last one just when do you expect the Phoenix build-out to be complete, just so we can think about when CapEx normalizes?

Yes. So right now our goal is to have it complete by the end of this fiscal year. A lot of the clean room build-out has been done. A lot of it is getting new equipment into the facility. So we're targeting the end of this fiscal year, although that could slip a little bit into Q1 of next year, so within the next six to nine months.

Thank you. And Aslett, it appears there are no further questions. Therefore, I'd like to turn the call back over to you for any closing remarks.

Okay, well, thanks everyone for listening. We look forward to speaking to you again next quarter. Thank you.

Ladies and gentlemen, thank you for your participation on today's conference. This does conclude your program, and you may now disconnect.